ITEM 1A. RISK FACTORS
Market Risks
The COVID-19 pandemic has had, and may continue to have, an adverse impact on our business, financial condition and results of operations.
We offer our services in 51 countries, most of which were significantly impacted by the COVID-19 pandemic. The extent of the impact of the COVID-19 pandemic on our business and financial results will continue to depend on numerous evolving factors that we are not able to accurately predict and which will vary by market. Such future uncertain and unpredictable developments include the ultimate duration and scope of the pandemic, the rise and spread of new COVID-19 variants, the availability and efficacy of vaccines and therapeutic treatments and the willingness of the public to accept such vaccines and treatments, governmental actions that have been taken, or may be taken in the future, in response to the pandemic, and global economic conditions during and after the pandemic.
Approximately 57.1% of our revenue for the year ended December 31, 2022 was from our corporate customers. Corporate customers are located in MTOBs, almost exclusively in the United States and Canada. Authorities in many of these markets implemented numerous measures in response to the pandemic, such as travel bans and restrictions, quarantines, curfews, shelter-in-place and stay-at-home orders and business shutdowns and closures, and also implemented multi-step polices with the goal of re-opening these markets. While many of these measures have been lifted, the business shutdowns and closures due to the COVID-19 pandemic and the accompanying shift to remote or hybrid work schedules continues to have an impact on business activity in the central business districts in which many of our MTOBs are located. This lingering impact and the impact of any new mandates, restrictions, laws or regulations could have a material adverse impact on our operations and the operations of our customers or others with whom we do business.
In addition, a significant number of our corporate customers have continued remote work policies instituted at the beginning of the COVID-19 pandemic, slowed the pace of opening new offices and closed offices due to global economic conditions. We believe the rapid spread of the Delta and Omicron variants during 2021 influenced corporate customers to delay or rescind their plans to end their remote work policies. In addition, the prevalence of hybrid or fully remote work environments during the pandemic has caused some companies to transition to such environments on a permanent basis, and we do not know what impact this may have on demand for commercial office space and for our services. As a result, through much of 2022, we saw corporate customers continue to take a cautious approach to adding new services and upgrading existing services as well as reduced demand for connecting smaller satellite offices. Since the beginning of the pandemic, we have experienced a deteriorating real estate market in the buildings we serve. Vacancy rates for many of our MTOBs have risen as a result of many tenants terminating leases and exiting buildings and as a result
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of lower new leasing activity. The impact of this greater level of vacancy rates was more pronounced in Northern cities and in the California market and less impactful in our Southern markets.
In addition, the shift of our office workers working remotely at certain times during the past few years has amplified certain risks to our business, including increased demand on our information technology resources and systems, increased phishing and other cybersecurity attacks as cybercriminals try to exploit the uncertainty surrounding the COVID-19 pandemic, and an increase in the number of points of potential attack, such as laptops and mobile devices (both of which are now being used in increased numbers), to be secured. Any failure to effectively manage these risks, including to timely identify and appropriately respond to any cyberattacks, may adversely affect our business.
We may find it difficult to retain existing employees or to hire new employees because we have required all employees to return to the office on a full-time basis and in the United States to receive the COVID-19 vaccine and boosters.
In the second half of 2021, we notified our employees worldwide that they would be required to return to the office on a full-time basis when permitted by local regulations. For employees in the United States, our return to office began in September 2021. As other countries relaxed their COVID regulations, our employees in those countries returned to the office as well. . Except for a brief period at the beginning of 2022 when we temporarily shifted a portion of our workforce to remote work, by the end of the spring of 2022, the overwhelming majority of all employees were working full-time in our offices.
In August 2021, we also notified employees in the United States that they would be required to attest that they were fully vaccinated against the COVID-19 virus unless they received a medical or religious exemption. We subsequently mandated that all U.S. employees receive a COVID-19 booster vaccine no later than six weeks after first becoming eligible for such vaccine. Our employees have largely complied with our vaccine mandate in the United States.
However, we experienced an increase in employee departures, particularly within our sales department, beginning in the second half of 2021 and continuing into 2022. We believe that this rise in departures was attributable, in part, to the unwillingness of some employees to work in a full-time, in-office environment. In the United States, we believe the rise in departures was also attributable to the unwillingness of some employees to be vaccinated. If we continue to require employees to work in the office on a full-time basis and/or to mandate COVID-19 vaccinations in the United States, we may find it difficult to retain existing employees or hire new employees. Further, a resurgence of COVID-19 due to immunity-resistant variants may cause employees to be more reluctant to continue in, or make new employees more reluctant to accept, a full-time, in-office position due to concerns about COVID-19. If this occurs, this may impact our revenue growth and profitability.
We will require also that the employees of the Wireline Business also attest that they are fully vaccinated against the COVID-19 virus unless they received a medical or religious exemption. Certain of these employees are not vaccinated against the COVID-19 virus and as a result, may elect not to join our organization.
We are experiencing delays in the delivery of networking equipment and other services from certain of our vendors.
During the pandemic we experienced a slowdown in the delivery of network equipment and delays in the projected delivery time of network equipment orders, and those delays have continued to the present. In addition, we have experienced delays in the delivery of services from vendors who supply us with dark fiber or lit circuits. We believe these delays are caused by supply chain issues due to component shortages and scarcity of raw materials as well as labor shortages, and that these supply chain issues have their origin in the responses to the COVID-19 pandemic. While we believe that we can adequately manage the operation, maintenance, upgrading and growth of our network, a worsening or prolonged slowdown of the delivery of network equipment, dark fiber and lit circuits may impact our ability to expand and augment our network and service offerings. If this occurs, this may impact our revenue growth and profitability.
Our growth and financial health are subject to a number of economic risks.
A downturn in the world economy, especially the economies of North America and Europe, would negatively impact our growth. Our net-centric business would be particularly impacted by a decline in the development of new applications and businesses that make use of the Internet. Our corporate business would be particularly impacted by an increase in vacancy rates in the MTOBs that we serve. Our total revenue growth is predicated on growth in the use of the Internet that makes up for the declining prices of Internet service. An economic downturn could impact the Internet business more significantly than other businesses that are less dependent on new applications and growth in the use of those applications and less susceptible to increases in office vacancy rates resulting from the retrenchment by consumers and businesses that typically occurs in an economic downturn.
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Our historical reductions in our prices are expected to continue in an inflationary economy even as our costs may increase.
Many of the regions in which we operate are experiencing an increase in inflation rates. Due to the nature of our product offerings and the industry in which we operate, which is deflationary, we may be unable to raise our prices. We expect that our historical pricing patterns will continue for the foreseeable future.
These historical pricing patterns are occurring against the backdrop of a general increase in prices due to inflation. In particular, the cost of electricity has increased greatly in all countries where we purchase power. While we have negotiated contracts that cap price increases due to inflation or that have fixed the price of electricity, we may experience increases in the costs of electricity and other services that we cannot pass on to our customers or may only be able to pass on partially to our customers. If these price increases continue, this may impact our profitability.
Events beyond our control may impact our ability to provide our services to our customers or increase the costs or reduce the profitability of providing our services.
Catastrophic events, such as major natural disasters, extreme weather, fire, flooding or similar events as well as the continued threat of terrorist activity and other acts of war or hostility have had, and may continue to have, an adverse effect on our headquarters, other offices, our network, infrastructure or equipment or our customers and prospective customers, which could adversely affect our business. These events may also have an adverse impact on business, financial and general economic conditions around the world. We have certain locations through which a large amount of our Internet traffic passes. Examples are facilities in which we exchange traffic with other carriers, the facilities through which our transoceanic traffic passes, and certain of our network hub sites. We are particularly vulnerable to acts of terrorism because our largest customer concentration is located in New York, our headquarters is located in Washington, D.C., and we have significant operations in Paris, Madrid and London, cities that have historically been targets for terrorist attacks and vulnerable to pandemics.
If these or any other of our key facilities were destroyed or seriously damaged, a significant amount of our network traffic could be disrupted. Because of the large volume of traffic passing through these facilities our ability (and the ability of carriers with whom we exchange traffic) to quickly restore service would be challenged. There could be parts of our network or the networks of other carriers that could not be quickly restored or that would experience substantially reduced service for a significant time. If such a disruption occurs, our reputation could be negatively impacted which may cause us to lose customers and adversely affect our ability to attract new customers, resulting in an adverse effect on our business and operating results.
Risks Relating to Our Proposed Acquisition of the Wireline Business of Sprint Communications
Regulatory approvals necessary for our acquisition of the Wireline Business of Sprint Communications may not be received, may take longer than expected or may impose conditions that are not presently anticipated or that could have an adverse effect on the combined company following closing of the Transaction.
In September 2022, we announced our acquisition of the Wireline Business of Sprint Communications. Subject to the satisfaction of the required closing conditions, we expect the Transaction to close in 2023. Any failure to close or an extended delay in closing the Transaction may have an adverse effect on us.
Our acquisition of the Wireline Business of Sprint Communications requires us to obtain certain regulatory approvals, waivers or consents. Regulators may impose conditions on these approvals. Such conditions could have the effect of delaying or preventing the completion of the Transaction, causing us to incur additional costs or limiting the competitive position of the combined company following the Transaction. Any of these conditions may have an adverse effect on the combined company following the Transaction. Additionally, any delay in closing the Transaction may adversely affect our business, the business of Sprint Communications or the business of the combined company, including an adverse effect on Sprint Communications’ ability to retain key employees during the transition period or on Sprint Communications’ relationship with its customers or vendors if such parties attempt to terminate, or negotiate changes in, their existing business relationships, consider entering into business relationships with competitors of Sprint Communications or otherwise delay or defer decisions concerning their business with Sprint Communications.
We may not realize the anticipated benefits of the acquisition of the Wireline Business of Sprint Communications, and the integration of the Wireline Business of Sprint Communications may disrupt our business and management.
The success of our acquisition of the Wireline Business of Sprint Communications, including the realization of anticipated benefits and cost savings, will depend, in part, on our ability to successfully combine our business and the Wireline Business. The
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integration may be more difficult, costly or time consuming than expected. The integration process involves numerous risks. These risks include:
● inability to retain personnel of the Wireline Business;
● any non-occurrence of anticipated tax benefits;
● incompatibility of business cultures.
If we experience difficulties during the integration process and are unable to integrate the Wireline Business successfully or in a timely manner, we may not realize the benefits of the Transaction to the extent anticipated. These integration matters could have an adverse effect on us during the transition period and on the combined company for an undetermined period after completion of the Transaction.
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Business Risks
We need to retain existing customers and continue to add new customers in order to become consistently profitable and cash flow positive.
In order to be consistently profitable and consistently cash flow positive, we need to both retain existing customers and continue to add a large number of new customers. The precise number of additional customers required is dependent on a number of factors, including the turnover of existing customers, the pricing of our product offerings and the revenue mix among our customers. We may not succeed in adding customers if our sales and marketing efforts are unsuccessful. In addition, many of our targeted customers are businesses that are already purchasing Internet access services from one or more providers, often under a contractual commitment. It has been our experience that such targeted customers are often reluctant to switch providers due to costs and effort associated with switching providers. Further, as some of our customers grow larger they may decide to build their own Internet backbone networks or enter into direct connection agreements with telephone and cable companies that provide Internet service to consumers. A migration of a few very large Internet users to their own networks, or to special networks that may be offered by major telephone and cable providers of last mile broadband connections to consumers, or the loss or reduced purchases from several significant customers could impair our growth, cash flow and profitability.
The customers of the Wireline Business include a number of large enterprise customers, a type of customer that we have not traditionally served. We may encounter difficulties retaining such customers or in converting such customers from their legacy services to newer technologies. Our inability to retain such customers or are unable to convert them to our services, could impair our growth, cash flow and profitability.
We have customers who depend on the U.S. government’s E-rate program for funding. There can be no assurance that the E-rate program will continue or that other governmental programs that fund governments and organizations that are or might become customers will continue. A failure of such programs to continue could result in a loss of customers and impair our growth, cash flow and profitability.
A substantial and long-term shift to remote work may impact our ability to add new customers and to retain existing customers.
Through much of 2021 and 2022, we saw corporate customers continue their remote work policies and take a cautious approach to new services and upgrades, as well as a reduced demand for connecting smaller satellite offices. We also witnessed a deteriorating real estate market in and around the buildings we service, with rising vacancy levels and falling lease initiations or renewals resulting in fewer sales opportunities for our salesforce. As a result, we experienced a slowdown in new sales to our corporate customers which negatively impacted our corporate revenue growth. If, after the end of the COVID-19 pandemic, a significant number of our corporate customers or potential customers decide to retain remote work policies, we may experience increased customer turnover, fewer upgrades of existing customer configurations and fewer new tenant opportunities. These trends may negatively impact our revenue growth, cash flows and profitability.
Lower vacancy rates as a result of diminished lease terminations and increased leasing and subleasing activity will be a key factor in driving renewed growth in our corporate business.
During the pandemic, we saw increasing vacancy rates in many of our buildings due to higher lease terminations and lower leasing activity. This reduction in tenancy levels was particularly challenging in our Northern and Californian markets. As a result, our level of activity in our corporate business has been adversely affected. In order to see a growing level of corporate activity, we believe there will need to be an improvement in the tenancy levels of our buildings through a reduction in tenant exits and increased leasing activity.
Our business and operations are growing rapidly, and we may not be able to efficiently manage our growth.
We have grown our Company rapidly through network expansion and by obtaining new customers through our sales efforts. Our expansion places significant strains on our management, operational and financial infrastructure. Our ability to manage our growth will be particularly dependent upon our ability to:
● expand, develop and retain an effective sales force and qualified personnel;
● maintain the quality of our operations and our service offerings;
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If we fail to implement these measures successfully, our ability to manage our growth will be impaired.
Demand from certain employees to work remotely may reduce the attractiveness of our business as an employer versus some competitors who are allowing employees to work remotely.
In the fall of 2021, we began to implement an in-office work policy designed to return the vast majority of our employees to an in-office work environment. Except for a brief return to remote work at the beginning of 2022 for a portion of our workforce, we have maintained our requirement that all employees work in our offices wherever possible. A small minority of our workforce declined to return to full-time in-office employment and left our employment. We are experiencing modest competitive challenges versus some competitors who are offering some employees a hybrid work option. Increasing demands to work in a hybrid work style may reduce our ability to attract and retain employees, in particular attracting and retaining salespeople.
We may not successfully make or integrate acquisitions or enter into strategic alliances.
As part of our growth strategy, we may pursue selected acquisitions and strategic alliances. To date, we have completed 13 significant acquisitions, not including our pending acquisition of the Wireline Business. However, we are very selective with respect to such acquisitions and alliances and, prior to the acquisition of the Wireline Business, we had not undertaken either for more than 17 years. We compete with other companies for acquisition opportunities and we cannot assure you that we will be able to execute future acquisitions or strategic alliances on commercially reasonable terms, or at all. Even if we enter into these transactions, we may experience:
● delays in realizing or a failure to realize the benefits we anticipate;
● attrition of key personnel from acquired businesses;
● unexpected costs or charges; and
In the past, our acquisitions have often included assets, service offerings and financial obligations that are not compatible with our core business strategy. We have expended management attention and other resources to the divestiture of assets, modification of products and systems as well as restructuring financial obligations of acquired operations. In most acquisitions, we have been successful in renegotiating the agreements that we have acquired. If we are unable to satisfactorily renegotiate such agreements in the future or with respect to future acquisitions, we may be exposed to large claims for payment for services and facilities we do not need.
Consummating these transactions could also result in the incurrence of additional debt and related interest expense, as well as unforeseen contingent liabilities, all of which could have a material adverse effect on our business, financial condition and results of operations. Because we have typically purchased financially distressed companies or their assets, and may continue to do so in the future, we have not had, and may not have, the opportunity to perform extensive due diligence or obtain contractual protections and indemnifications that are customarily provided in acquisitions. As a result, we may face unexpected contingent liabilities arising from these acquisitions. We may also issue additional equity in connection with these transactions, which would dilute our existing shareholders.
Following an acquisition, we have experienced a decline in revenue attributable to acquired customers as these customers’ contracts have expired and they have entered into our standard customer contracts at generally lower rates or have chosen not to renew service with us. We anticipate that we would experience similar revenue declines with respect to customers we may acquire in the future.
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Competitive Risks
Our connections to the Internet require us to establish and maintain relationships with other providers, which we may not be able to maintain.
The Internet is composed of various network providers who operate their own networks that interconnect at public and private interconnection points. Our network is one such network. In order to obtain Internet connectivity for our network, we must establish and maintain relationships with other ISPs and certain of our larger customers. These providers may be customers (who connect their network to ours by buying Internet access from us) or may be other large ISPs to whom we connect on a settlement-free peering basis as described below. Both customers and settlement-free peers may be competitors of ours.
By entering into what are known as settlement-free peering arrangements, providers agree to exchange traffic between their respective networks without charging each other. Our ability to avoid the higher costs of acquiring paid dedicated network capacity (transit or paid peering) and to maintain high network performance is dependent upon our ability to establish and maintain settlement-free peering relationships and to increase the capacity or to add additional locations of the interconnections provided by these relationships. The terms and conditions of our settlement-free peering relationships may also be subject to adverse changes, which we may not be able to control. If we are not able to maintain or increase our settlement-free peering relationships in all of our markets on favorable terms or to upgrade the capacity of our existing settlement-free peering relationships, we may not be able to provide our customers with high performance, affordable or reliable services, which could cause us to lose existing and potential customers, damage our reputation and have a material adverse effect on our business. Additionally, certain of our current customers may seek to become settlement-free peers with us.
We cannot assure you that we will be able to continue to establish and maintain relationships with other ISPs, favorably resolve disputes with such providers, or increase the capacity of our interconnections with such providers.
The sector in which we operate is highly competitive, and we may not be able to compete effectively.
We face significant competition from incumbent carriers, Internet service providers and facilities-based network operators. Relative to us, many of these providers have significantly greater financial resources, more well established brand names, larger customer bases, and more diverse strategic plans and service offerings. A number of these providers also have large bases of consumers, which makes their networks particularly attractive to content providers as they can provide a direct connection to their customers.
Intense competition from these traditional and new communications companies has led to declining prices and margins for many communications services, and we expect this trend to continue as competition intensifies in the future. Decreasing prices for high-speed Internet services have somewhat diminished the competitive advantage that we have enjoyed as a result of our service pricing.
Our business is premised on the idea that customers want simple Internet access and private networks rather than a combination of such services with other services such as voice services and complex managed services. Our competitors offer such services. Should the market come to favor such services our ability to acquire and keep customers would be impaired. Our competitors may also upgrade their existing services or introduce new technologies or services, such as satellite-based Internet or 5G services that could make our services less attractive to potential customers.
Our business could suffer because telephone companies and cable companies may provide better delivery of certain Internet content, including content originating on their own networks, than content on the public Internet.
Broadband connections provided by cable TV, telephone, and fixed and mobile companies have become the predominant means by which consumers connect to the Internet. The providers of these broadband connections may treat Internet content or other broadband content delivered from different sources differently. The possibility of this has been characterized as an issue of “net neutrality.” As many of our customers operate websites and services that deliver content to consumers our ability to sell our services would be negatively impacted if Internet content delivered by us was less easily received by consumers than Internet content delivered by others. The FCC had promulgated rules that would have banned practices such as blocking and throttling of Internet traffic, but those rules were rescinded by the FCC in December 2017. Some US states have either issued or are considering their own net neutrality rules. Also, the European Union and other countries in which we operate have issued similar net neutrality rules. We also do not know the extent to which the providers of broadband Internet access to consumers may favor certain content or providers in ways that may disadvantage us.
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Operational Risks
Our network may be the target of potential cyber-attacks and other security breaches that could have significant negative consequences.
Our business depends on our ability to limit and mitigate interruptions to or degradation of the security of our network. We are considered a critical infrastructure provider and therefore may be more likely to be the target of cyber-attacks. Our network, systems, applications, and routers may be vulnerable to unauthorized access, computer viruses, cyber-attacks, distributed denial of service (“DDOS”), and other security breaches. We experience such cyber-attacks and other security incidents of varying degrees from time to time, though none which individually or in the aggregate has led to costs or consequences which have materially impacted our operations or business. An attack on or security breach of our network could result in theft of trade secrets, intellectual property, or other company confidential information, the interruption, degradation, or cessation of services, an inability to meet our service level commitments or our financial reporting obligations, and potentially compromise customer data stored on or transmitted over our network. We have experienced cyber-attacks of increasing sophistication which suggest an increase in cyber-attacks that may be state-sponsored or conducted by other well-financed organizations. Moreover, as cyber warfare becomes a tool in asymmetric conflicts between the United States and other nations, we, as a US provider, may be targeted with increasing frequency. We cannot guarantee that our security measures will not be circumvented, thereby resulting in security events, network failures or interruptions that could impact our network security or availability and have a material adverse effect on our business, our ability to meet our financial reporting obligations, financial condition and operational results. We may be required to expend significant resources to protect against such threats, and may experience a reduction in revenues, litigation, and a diminution in goodwill, caused by a compromise of our cybersecurity. Although our customer contracts limit our liability, affected customers and third parties may seek to recover damages from us under various legal theories. In response to past attacks, we have implemented further controls and taken and planned for other preventative actions to further strengthen our systems against future attacks. However, we cannot assure you that such measures will provide absolute security, that we will be able to react in a timely manner, or that our remediation efforts following any past or future attacks will be successful.
If the information systems that we depend on to support our customers, network operations, sales, billing and financial reporting do not perform as expected, our operations and our financial results may be adversely affected.
We rely on complex information systems to operate our network and support our other business functions. Our ability to track sales leads, close sales opportunities, provision services, bill our customers for our services and prepare our financial statements depends upon the effective integration of our various information systems. In 2020, we developed and deployed our own customer relationship management software for our sales force. We may have difficulty maintaining this software and adding features that our sales representatives require. If our information systems, individually or collectively, fail or do not perform as expected, our ability to make sales, to process and provision orders, to make timely payments to vendors, to ensure that we collect amounts owed to us and prepare and file our financial statements would be adversely affected. Such failures or delays could result in increased capital expenditures, customer and vendor dissatisfaction, loss of business or the inability to add new customers or additional services, and the inability to prepare accurate and timely financial statements all of which would adversely affect our business and results of operations.
Network Augmentation and Maintenance Risks
Our network is comprised of a number of separate components, and we may be unable to obtain or maintain the agreements necessary to augment or maintain our network.
Our network is primarily composed of (i) leased capacity on transoceanic optical fiber; (ii) terrestrial inter-city dark optical fiber; (iii) intra-city dark optical fiber; and (iv) the buildings that we serve and the associated optical fiber connecting those buildings. We lease our optical fiber and obtain access to the buildings on our network, both CNDCs and MTOBs, from a number of vendors. A number of our leases, both for fiber and building access, are up for renewal in any given year. A deterioration in our existing relationship with these operators could impact our network, harm our sales and marketing efforts and could substantially reduce our potential customer base. In addition, portions of our long-haul optical fiber and metro optical fiber are nearing the end of their original projected useful life. While we believe that this fiber will remain usable beyond the projected end date, we face the risk that portions of our network may need to be replaced in the future.
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We expect to enter additional agreements with carriers and operators to obtain additional facilities, whether optical fiber or buildings, for our network in order to add capacity to our network and to expand our addressable market. However, we cannot assure you that we will be able to enter into such agreements in the future, be able to do so on economically attractive terms or find an adequate substitute if we are unable to reach an agreement. Failure to acquire new facilities to augment our network could keep us from adding new markets, capacity or buildings to our network and negatively impact our growth opportunities.
Our off-net business could suffer delays and problems due to the actions of “last mile” providers on whom we are partially dependent.
Our off-net customers are connected to our network by means of fiber optic capacity that are provided as services by local telephone and cable companies and others. We may experience problems with the installation, maintenance and pricing of these lines which could adversely affect our results of operations and our plans to add additional off-net customers to our network using such services. We have historically experienced installation and maintenance delays when the network provider is devoting resources to other services, such as traditional telephony, cable TV services and private network services. We have also experienced pricing problems when a lack of alternatives allows a provider to charge high prices for capacity in a particular area or to a particular building. We attempt to reduce this problem by using many different providers so that we have alternatives for linking an off-net customer to our network. Competition among the providers tends to improve installation intervals, maintenance and pricing. Additionally, these providers are often competing with us for the same customers, and have marketed their own service to our off-net customers when our initial contract with our customer nears the end of its term.
Our business could suffer from an interruption of service from our fiber providers.
The optical fiber cable owners from whom we have obtained our inter-city and intra-city dark fiber maintain that dark fiber. We are contractually obligated under the agreements with these carriers to pay maintenance fees, and if we are unable to continue to pay such fees we would be in default under these agreements. If these carriers fail to maintain the fiber or disrupt our fiber connections due to our default or for other reasons, such as business disputes with us, bankruptcy, and governmental takings, our ability to provide service in the affected markets or parts of markets would be impaired unless we have or can obtain alternative fiber routes. Some of the companies that maintain our inter-city dark fiber and some of the companies that maintain our intra-city dark fiber are also competitors of ours in portions of our business. Consequently, they may have incentives to act in ways unfavorable to us. While we have successfully mitigated the effects of prior service interruptions and business disputes in the past, we may incur significant delays and costs in restoring service to our customers in connection with future service interruptions, and as a result we may lose customers.
Substantially all of our network infrastructure equipment is manufactured or provided by a single network infrastructure vendor.
We purchase from Cisco Systems, Inc. (“Cisco”) the routers and transmission equipment used in our network. We have recently experienced delays in obtaining certain network equipment from Cisco due to supply chain issues. If Cisco fails to provide equipment on a timely basis or fails to meet our performance expectations, including in the event that Cisco fails to enhance, maintain, upgrade or improve its products, hardware or software we purchase from them when and how we need them, we may be delayed or unable to provide services as and when requested by our customers. We also may be unable to upgrade our network and face greater difficulty maintaining and expanding our network.
Transitioning from Cisco to another vendor would be disruptive because of the time and expense required to learn to install, maintain and operate the new vendor’s equipment and to operate a multi-vendor network. Any such disruption could increase our costs, decrease our operating efficiencies and have an adverse effect on our business, results of operations and financial condition.
Cisco may also be subject to litigation with respect to the technology on which we depend, including litigation involving claims of patent infringement. Such claims have been growing rapidly in the communications industry. Regardless of the merit of these claims, they can result in the diversion of technical and management personnel, or require us to obtain non-infringing technology or enter into license agreements for the technology on which we depend. There can be no assurance that such non-infringing technology or licenses will be available on acceptable terms and conditions, if at all.
In 2023, we entered into an agreement to purchase routers and transmission equipment used in our network from Ciena Corporation that will begin to diversify the suppliers of our network equipment. The Wireline Business also includes additional equipment vendors.
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International Operations Risks
Our international operations expose us to numerous risks.
We have expanded our network into 51 countries worldwide on every continent other than Antarctica. We continue to explore expansion opportunities. We have experienced difficulties, ranging from lack of dark fiber, to regulatory issues, to slower revenue growth rates from our operations in these markets. If we are not successful in developing our market presence in these regions, our operating results and revenue growth could be adversely impacted.
Our international operations involve a number of risks, including:
● difficulties in staffing and managing our foreign operations;
● changes in political and economic conditions; and
● exposure to additional and potentially adverse tax regimes.
As we continue to expand into other countries, our success will depend, in part, on our ability to anticipate and effectively manage these and other risks. Our failure to manage these risks and grow our operations outside the United States may have a material adverse effect on our business and results of operations.
Litigation Risks
As an Internet service provider, we may incur liabilities for the content disseminated through our network or for network failures, delays or errors in transmissions.
The law relating to the liabilities of ISPs for information carried on or disseminated through their networks is unsettled. As the law in this area develops and as we expand our international operations, the potential imposition of liabilities upon us for the behavior of our customers or the information carried on and disseminated through our network could require us to implement measures to reduce our exposure to such liabilities, which may require the expenditure of substantial resources or the discontinuation of certain products or service offerings. Any costs that are incurred as a result of such measures or the imposition of liabilities could have a material adverse effect on our business.
Regulatory Risks
Existing and proposed privacy regulations may impact our business.
Many countries, including the United States, are considering adopting, or have already adopted, privacy regulations or laws that would govern the way an Internet user’s data is used. The primary impact of these rules are on businesses that collect personal information about consumer users of their services. We do not provide services to individual consumers and do not collect such personal information. However, we transmit data across the Internet, which data may include personal information collected by our customers. As the applicability of privacy regulations to the types of services we provide remains unsettled, we may be required to adopt additional measures in the future.
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Privacy regulations, such as the General Data Protection Regulation (“GDPR”) in the European Union and the California Consumer Privacy Act (“CCPA”) in California vary in scope and in the obligations they impose on us. As new laws are implemented or existing structures are declared insufficient, such as the Privacy Shield program in place between the US and EU, we may find it difficult to comply with such regulations or find it costly to do so. Moreover, for our customers who collect personal information, increased regulation of the collection, processing and use of personal data may impact their business and their use of services in unknown ways.
Changes in laws, rules, and enforcement could adversely affect us.
We are not subject to substantial regulation by the FCC or the state public utilities commissions in the United States. Internet service is also subject to minimal regulation in Western Europe and in Canada. Elsewhere the regulation is greater, though not as extensive as the regulation for providers of voice services. However, governmental authorities may decide to impose additional regulation and taxes upon providers of Internet access and private network services. All of these matters could inhibit our ability to remain a low-cost carrier and could have a material adverse effect on our business, financial condition and our results of operations.
As with the privacy laws described earlier, much of the laws related to the liability of Internet service providers for content on the network and the behavior of our customers and their end users remains unsettled. Some jurisdictions have laws, regulations, or court decisions that impose obligations upon ISPs to restrict access to certain content. Other legal issues, such as the sharing of copyrighted information, data protection, trans-border data flow, unsolicited commercial email (“spam”), universal service, and liability for software viruses could become subjects of additional legislation and legal development and changes in enforcement policies. We cannot predict the impact of these changes on us. They could have a material adverse effect on our business, financial condition and our results of operations.
Changes in laws, rules and enforcement may also adversely affect our customers. For example, a possible repeal or curtailing of Section 230 of the Communications Decency Act in the United States could have an adverse impact on our customers and, consequently, on us. While our top 25 customers represented approximately 6.0% of our revenue for the year ended December 31, 2022, several large net-centric customers are or may be the subject of increased regulatory scrutiny, which may impact their businesses and, consequently, their use of our services in unknown ways.
We may be required to censor content on the Internet, which we may find difficult to do and which may impact our ability to provide our services in some countries as well as impact the growth of Internet usage, upon which we depend.
Some governments attempt to limit access to certain content on the Internet. It is impossible for us to filter all content that flows across the Internet connections we provide. For example, some content is encrypted when a secure website is accessed. It is difficult to limit access to websites by blocking a fixed set of Internet addresses when the website operators engage in practices that make it difficult to block them. Should any government require us to perform these types of blocking procedures we could experience difficulties ranging from incurring additional expenses to ceasing to provide service in that country. We could also be subject to penalties if we fail to implement the censorship.
Tax Risks
Governments may assert that we are liable for taxes which we have not collected from our customers or paid to our vendors and we may have to begin collecting a multitude of taxes if Internet services become subject to taxation similar to the taxation of telephone service.
In the United States, Internet services are generally not subject to taxes. Consequently, in the United States we collect few taxes from our customers even though most telecommunications services are subject to numerous taxes. Various local jurisdictions have asserted or may assert that some of our operations or services should be subject to local taxes. If such jurisdictions assess taxes on prior years we may be subject to a liability for unpaid taxes that we may be unable to collect from our customers or former customers. If the taxation of Internet service is expanded we will need to collect those taxes from our customers. The process of implementing a system to properly bill and collect such taxes may require significant resources. In addition, the FCC is considering changes to its Universal Services Fund that could result in its application to Internet services. This too would require that we expend resources to collect this tax. Finally, the cumulative effect of these taxes levied on Internet services could discourage potential customers from using Internet services to replace traditional telecommunication services and negatively impact our ability to grow our business.
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Our private network services, such as our VPN services, are subject to taxes and fees in various jurisdictions including the Universal Service Contribution tax in the US. We believe we collect all required taxes, however, a jurisdiction may assert we have failed to collect certain taxes. The expense of paying any unpaid taxes could be substantial and we might not be able to collect such back taxes from our customers.
We are subject to value-added taxes and other taxes in many jurisdictions outside of the United States. We are also subject to audit of our tax compliance in numerous jurisdictions. These may result in the assessment of amounts due that are material and therefore would have an adverse effect on us.
The utilization of certain of our net operating loss carryforwards is limited and depending upon the amount of our taxable income we may be subject to paying income taxes earlier than planned.
Section 382 of the Internal Revenue Code in the United States limits the utilization of net operating losses when ownership changes, as defined by that section, occur. We have performed an analysis of our Section 382 ownership changes and have determined that the utilization of certain of our net operating loss carryforwards in the United States is limited. Further, recent changes to the tax law in the United States and changes to tax laws in other jurisdictions in which we operate may impact our utilization of our net operating losses.
Risk Factors Related to Our Indebtedness
We have substantial debt which we may not be able to repay when due.
Our total indebtedness, at par, at December 31, 2022 was $1.3 billion and includes $500.0 million of our 3.50% senior secured notes due in May 2026 (“2026 Notes”) and $450.0 million of our 7.00% senior unsecured notes due in June 2027 (“2027 Notes”). Our 2026 Notes require annual interest payments of $17.5 million per year and our 2027 Notes require interest payments of $31.5 million per year, each paid semi-annually. All of our noteholders have the right to be paid the principal upon default and upon certain designated events, such as certain changes of control. Our total indebtedness at December 31, 2022 included $304.2 million of finance lease obligations for dark fiber primarily under 15 to 44 year IRUs. Our total indebtedness at December 31, 2022 excludes $106.6 million of operating lease liabilities which were required to be recorded as right-to-use assets and operating lease liabilities in connection with the adoption of ASU No. 2016-02 Leases on January 1, 2019. The amount of our IRU finance lease obligations may be impacted due to our expansion activities, the timing of payments and fluctuations in foreign currency rates. We may not have sufficient funds to pay the interest and principal related to these obligations at the time we are obligated to do so, which could result in bankruptcy, or we may only be able to raise the necessary funds on unfavorable terms.
We have assumed the risk associated with variable interest rates under our interest rate swap agreement.
We are party to an interest rate swap agreement (the “Swap Agreement”) that has the economic effect of modifying the fixed interest rate obligation associated with our 2026 Notes to a variable interest rate obligation based on the Secured Overnight Financing Rate (“SOFR”) so that the interest payable on the 2026 Notes effectively became variable based on overnight SOFR. The critical terms of the Swap Agreement match the terms of the 2026 Notes, including the notional amount and the optional redemption date on February 1, 2026. Under the Swap Agreement, we pay the counterparty a semi-annual payment based upon overnight SOFR plus a contractual interest rate spread, and the counterparty pays us a semi-annual fixed 3.50% interest payment. The settlement payment is made each November and May until the Swap Agreement expires in February 2026. By entering into the Swap Agreement, we have assumed the risk associated with variable interest rates. Changes in interest rates affect the valuation of the Swap Agreement that we recognize in our consolidated statements of comprehensive income.
Our substantial level of indebtedness could adversely affect our financial condition and prevent us from fulfilling our obligations under our notes and our other indebtedness.
We have substantial indebtedness. Our substantial debt may have important consequences. For instance, it could:
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Our ability to satisfy our obligations including our debt depends on our future operating performance and on economic, financial, competitive and other factors, many of which are beyond our control. Our business may not generate sufficient cash flow, and future financings may not be available to provide sufficient net proceeds, to meet these obligations or to successfully execute our business strategy.
Despite our leverage we may still be able to incur more debt. This could further exacerbate the risks that we and our subsidiaries face.
We and our subsidiaries may incur additional indebtedness, including additional secured indebtedness, in the future. The terms of our debt indentures restrict, but do not completely prohibit, us from doing so. In addition, the indentures allow us to issue additional notes and other indebtedness secured by the collateral under certain circumstances. Moreover, we are not prevented from incurring other liabilities that do not constitute indebtedness as defined in the indentures, including additional operating leases obligations and finance lease obligations in the form of IRUs. These liabilities may represent claims that are effectively prior to the claims of our note holders. If new debt or other liabilities are added to our debt levels the related risks that we and our subsidiaries now face could intensify.
The agreements governing our various debt obligations impose restrictions on our business and could adversely affect our ability to undertake certain corporate actions.
The agreements governing our various debt obligations include covenants imposing significant restrictions on our business. These restrictions may affect our ability to operate our business and may limit our ability to take advantage of potential business opportunities as they arise. These covenants place restrictions on our ability to, among other things:
● incur additional debt;
● create liens;
● make certain investments;
● enter into certain transactions with affiliates;
● consolidate, merge or transfer or sell all or substantially all of our assets.
Our ability to comply with these agreements may be affected by events beyond our control, including prevailing economic, financial and industry conditions. These covenants could have an adverse effect on our business by limiting our ability to take advantage of financing, merger and acquisition or other corporate opportunities. The breach of any of these covenants or restrictions could result in a default under the agreements governing our debt obligations.
To service our indebtedness, we will require a significant amount of cash. However, our ability to generate cash depends on many factors, many of which are beyond our control.
Our ability to make payments on and to refinance our indebtedness and to fund planned capital expenditures will depend on our ability to generate cash in the future, which, in turn, is subject to general economic, financial, competitive, regulatory and other factors, many of which are beyond our control.
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Our business may not generate sufficient cash flow from operations and we may not have available to us future borrowings in an amount sufficient to enable us to pay our indebtedness or to fund our other liquidity needs. In these circumstances, we may need to refinance all or a portion of our indebtedness on or before maturity. We may not be able to refinance any of our indebtedness on commercially reasonable terms or at all. Without this financing, we could be forced to sell assets or secure additional financing to make up for any shortfall in our payment obligations under unfavorable circumstances. However, we may not be able to secure additional financing on terms favorable to us or at all and, in addition, the terms of the indentures governing our notes limit our ability to sell assets and also restrict the use of proceeds from such a sale. We may not be able to sell assets quickly enough or for sufficient amounts to enable us to meet our obligations, including our obligations under our notes.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2. PROPERTIES
We lease space for offices, data centers, colocation facilities, and points-of-presence.
Our headquarters facility consists of 43,117 square feet located in Washington, D.C. The lease for our headquarters is with an entity controlled by our Chief Executive Officer and expires in May 2025. The lease may be cancelled by us upon 60 days’ notice.
On January 6, 2023, we entered into two lease agreements (the “New Leases”), one with Thorium LLC and one with Germanium LLC, entities owned by our Chief Executive Officer. The first of the New Leases is with Thorium LLC for approximately 54,803 square feet of office space, which will serve as office space replacing a portion of our current office space in the Northern Virginia area. The second of the New Leases is with Germanium LLC for approximately 1,587 square feet of technical space, in the building which will serve as network operations space. The term for each of the New Leases is five years beginning March 1, 2023 (or an actual later date of occupancy). Both of the New Leases are cancellable by us without penalty upon 60 days written notice.
We lease a total of approximately 755,000 square feet of space for our data centers, offices and operations centers. Certain of these leases are with entities controlled by our Chief Executive Officer. We believe that these facilities are generally in good condition and suitable for our operations.
ITEM 3. LEGAL PROCEEDINGS
We are involved in legal proceedings in the ordinary course of our business that we do not expect to have a material adverse effect on our business, financial condition or results of operations. For a discussion of the significant proceedings in which we are involved, see Note 6 to our consolidated financial statements.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
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PART II
Our sole class of common equity is our common stock, par value $0.001, which is currently traded on the NASDAQ Global Select Market under the symbol “CCOI.” Prior to March 6, 2006, our common stock traded on the American Stock Exchange under the symbol “COI.” Prior to February 5, 2002, no established public trading market for our common stock existed.
As of February 1, 2023, there were 127 holders of record of shares of our common stock holding 47,028,650 shares of our common stock.
Performance Graph
Our common stock currently trades on the NASDAQ Global Select Market. The chart below compares the relative changes in the cumulative total return of our common stock for the period from December 31, 2017 to December 31, 2022, against the cumulative total return for the same period of the (1) The Standard & Poor’s 500 (S&P 500) Index and (2) the NASDAQ Telecommunications Index. The comparison below assumes $100 was invested on December 31, 2017 in our common stock, the S&P 500 Index and the NASDAQ Telecommunications Index, with dividends, if any, reinvested.
The stock price performance included in this graph is not necessarily indicative of future stock price performance.
Issuer Purchases of Equity Securities
Our Board of Directors authorized a plan to permit the repurchase of up to $50.0 million of our common stock in negotiated and open market transactions through December 31, 2023. As of December 31, 2022, $30.4 million remained available for such negotiated and open market transactions concerning our common stock. We may purchase shares from time to time depending on market, economic, and other factors. We did not purchase shares of our common stock during 2022.
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You should read the following discussion and analysis together with our consolidated financial statements and related notes included in this report. The discussion in this report contains forward-looking statements that involve risks and uncertainties, such as statements of our plans, objectives, expectations and intentions. The cautionary statements made in this report should be read as applying to all related forward-looking statements wherever they appear in this report. Factors that could cause or contribute to these differences include those discussed in “Item 1A. Risk Factors,” as well as those discussed elsewhere. You should read “Item 1A. Risk Factors” and “Special Note Regarding Forward-Looking Statements.” Our actual results could differ materially from those discussed here. Factors that could cause or contribute to these differences include, but are not limited to:
Our pending acquisition of the Wireline Business of Sprint Communications, including delays in or conditions on obtaining necessary regulatory approvals, our failure to close the Transaction or difficulties integrating our business with the acquired Sprint Communications business; the COVID-19 pandemic and accompanying government policies worldwide; vaccination and in-office requirements, delays in the delivery of network equipment and optical fiber; future economic instability in the global economy, including the risk of economic recession, which could affect spending on Internet services; the impact of changing foreign exchange rates (in particular the Euro to US dollar and Canadian dollar to US dollar exchange rates) on the translation of our non-US dollar denominated revenues, expenses, assets and liabilities into US dollars; legal and operational difficulties in new markets; the imposition of a requirement that we contribute to the US Universal Service Fund on the basis of our Internet revenue; changes in government policy and/or regulation, including rules regarding data protection, cyber security and net neutrality; increasing competition leading to lower prices for our services; our ability to attract new customers and to increase and maintain the volume of traffic on our network; the ability to maintain our Internet peering arrangements on favorable terms; our ability to renew our long-term leases of optical fiber that comprise our network; our reliance on an equipment vendor, Cisco Systems Inc., and the potential for hardware or software problems associated with such equipment; the dependence of our network on the quality and dependability of third-party fiber providers; our ability to retain certain customers that comprise a significant portion of our revenue base; the management of network failures and/or disruptions; our ability to make payments on our indebtedness as they become due and outcomes in litigation, risks associated with variable interest rates under our Swap Agreement, as well as other risks discussed from time to time in our filings with the Securities and Exchange Commission, including, without limitation, this Annual Report on Form 10-K and our Quarterly Reports on Form 10-Q.
Ukraine & Russia
Following the Russian invasion of Ukraine in February 2022, we terminated services to customers based in Russia and customer linked to the Russian government. These customers represented less than 0.3% of our consolidated revenues for the three months ended March 31, 2022. We do not provide services within Russia but we do provide services in Ukraine via our Ukrainian subsidiary, TOV Cogent Communications Ukraine (“Cogent Ukraine”). As a result of the damage to facilities caused by the war, our services in Ukraine have experienced periodic outages which our third-party fiber provider repairs for us. We have taken steps to enhance our network security, provide financial flexibility to our Ukrainian customers and assist our Ukrainian employees. We do not believe that the termination of services to certain Russian customers or the impact of the war on our ability to provide services in Ukraine will have, taken together, a material impact on our network, financial statements or operating results. Cogent Ukraine represented less than 0.3% of our consolidated revenues for the year ended December 31, 2022 and less than 0.6% of our consolidated assets as of December 31, 2022.
Sprint Acquisition
On September 6, 2022, Cogent Infrastructure, Inc., a Delaware corporation (the “Buyer”) and a wholly owned subsidiary of the Company, entered into a Membership Interest Purchase Agreement (the “Purchase Agreement”) with Sprint Communications LLC, a Kansas limited liability company (“Sprint Communications”) and an indirect wholly owned subsidiary of T-Mobile US, Inc., a Delaware corporation (“T-Mobile”), and Sprint LLC, a Delaware limited liability company and a direct wholly owned subsidiary of T-Mobile (the “Seller”), pursuant to which the Company will acquire the U.S. long-haul fiber network (including the non-U.S. extensions thereof) of Sprint Communications and its subsidiaries (the “Wireline Business”). The Purchase Agreement provides that, upon the terms and conditions set forth therein, the Company will purchase from the Seller all of the issued and outstanding membership interests of a Delaware limited liability company that holds Sprint Communications’ assets and liabilities relating to the Wireline Business (such transactions contemplated by the Purchase Agreement, collectively, the “Transaction”).
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Results of Operations
Year Ended December 31, 2022 Compared to the Year Ended December 31, 2021
In this section, we discuss the results of our operations for the year ended December 31, 2022 compared to the year ended December 31, 2021. For a discussion of the year ended December 31, 2021 compared to the year ended December 31, 2020, please refer to Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended December 31, 2021.
Our management reviews and analyzes several key financial measures in order to manage our business and assess the quality and variability of our service revenue, operating results and cash flows. The following summary tables present a comparison of our results of operations with respect to certain key financial measures. The comparisons illustrated in the tables are discussed in greater detail below.
Year Ended
December 31, Percent
(in thousands)
Acquisition costs - Sprint (T-Mobile Wireline) 2,248 — NM
Depreciation and amortization expenses 92,222 89,240 3.3 %
NM - not meaningful
Year Ended
December 31, Percent
Other Operating Data
Average Revenue Per Unit (ARPU)
Average price per megabit $ 0.28 $ 0.35 (19.4) %
Customer Connections—end of period
Service Revenue. We continually work to grow our total service revenue by increasing the number of potential customers that we can reach on our network. We do this by investing capital to expand the geographic footprint of our network, increasing the number of buildings that we are connected to, including CNDCs and MTOBs, and increasing our penetration rate into our existing buildings. These efforts broaden the global reach of our network and increase the size of our potential addressable market. We also seek to grow our service revenue by investing in our sales and marketing team. We typically sell corporate connections at similar pricing to our competitors, but our clients benefit from our significantly faster speeds, enhanced service level agreements and rapid installation times. In the net-centric market, we offer comparable services in terms of capacity but typically at significantly lower prices.
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Our service revenue increased by 1.7% from 2021 to 2022. Exchange rates negatively impacted our increase in service revenue by $13.1 million. All foreign currency comparisons herein reflect results for 2022 translated at the average foreign currency exchange rates for 2021. We increased our total service revenue by expanding our network, by adding additional buildings to our network, by increasing our penetration into the buildings connected to our network and by gaining market share by offering our services at lower prices than our competitors.
Revenue recognition standards include guidance relating to any tax assessed by a governmental authority that is directly imposed on a revenue-producing transaction between a seller and a customer and may include, but is not limited to, gross receipts taxes, Universal Service Fund fees and certain state regulatory fees. We record these taxes billed to our customers on a gross basis (as service revenue and network operations expense) in our consolidated statements of comprehensive income. The impact of these taxes including the Universal Service Fund resulted in a decrease to our revenues from 2021 to 2022 of $3.1 million.
Our corporate customers generally purchase their services on a price per connection basis. Our net-centric customers generally purchase their services on a price per megabit basis. Revenues from our corporate and net-centric customers represented 57.1% and 42.9% of total service revenue, respectively, for 2022 and represented 60.8% and 39.2% of total service revenue, respectively, for 2021. Revenues from corporate customers decreased by 4.4% to $342.6 million for 2022 from 2021. Revenues from our net-centric customers increased by 11.1% to $257.0 million for 2022 from 2021. Exchange rates negatively impacted our increase in our net-centric service revenue by approximately $13.1 million.
Our corporate customers take advantage of our superior speeds, service levels and installation times versus our competitors. The growing trend of customers installing second lines for redundancy in order to construct virtual private networks (“VPNs”) has also led to our ability to increase our corporate revenues. However, beginning in the second quarter of 2020, we saw corporate customers take a more cautious approach to new configurations and upgrades as well as a reduction in demand for connecting smaller satellite offices as a result of the challenges and uncertainties of the COVID-19 pandemic. We also witnessed a deteriorating real estate market in and around the buildings we service, with rising vacancy levels and falling lease initiations or renewals resulting in fewer sales opportunities for our salesforce. As a result, we have experienced a slowdown in new sales to our corporate customers which negatively impacted our corporate revenue results. While we believe that demand for office space in the buildings in which we operate will remain among the strongest in our markets, we may experience increased corporate customer turnover, fewer upgrades of existing corporate customer configurations and fewer new tenant opportunities which would negatively impact our corporate revenue growth.
Our revenue from our net-centric customers increased primarily due to an increase in our number of net-centric customers and growth in network traffic from these customers partly offset by a decline in our average price per megabit. Our net-centric customers purchase our services on a price per megabit basis. The net-centric market exhibits significant pricing pressure due to the continued introduction of new technology which lowers the marginal cost of transmission and routing, and the commodity nature of the service where price is typically the only differentiating factor for these customers. Our average price per megabit of our installed base of customers declined by 19.4% from 2021 to 2022. We expect that our average price per megabit will continue to decline at similar rates. The impact of foreign exchange rates has a more significant impact on our net-centric revenues.
Our on-net revenues increased by 2.2% from 2021 to 2022. Our on-net revenues increased as we increased the number of our on-net customer connections. On-net customers increased at a greater rate than on-net revenues primarily due to a decrease in our on-net ARPU from 2021 to 2022 and the negative impact of foreign exchange. ARPU is determined by dividing revenue for the period by the average customer connections for that period.
Our off-net revenues decreased by 0.2% from 2021 to 2022. Our off-net revenues decreased primarily from the decrease in our off-net ARPU from 2021 to 2022, partly offset by the increase in the number of our off-net customer connections.
Network Operations Expenses. Network operations expenses include the costs of personnel associated with service delivery, network management and customer support, network facilities costs, fiber and equipment maintenance fees, leased circuit costs, access and facilities fees paid to building owners and excise taxes billed to our customers and recorded on a gross basis. Non-cash equity-based compensation expense is included in network operations expenses consistent with the classification of the employee’s salary and other compensation. Our network operations expenses, including non-cash equity-based compensation expense, increased by 0.8% from 2021 to 2022. The increase in network operations expense is primarily attributable to an increase in costs related to our network and facilities international expansion activities, partly offset by a reduction in taxes billed to our customers recorded on a gross basis (as service revenue and network operations expense) and price reductions obtained in certain of our domestic leased circuit costs.
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Selling, General, and Administrative (“SG&A”) Expenses. Our SG&A expenses, including non-cash equity-based compensation expense, increased by 0.4% for 2022 from 2021. Non-cash equity-based compensation expense is included in SG&A expenses consistent with the classification of the employee’s salary and other compensation. SG&A expenses increased primarily from an increase in salaries and related costs required to support our expansion and increases in our sales efforts, partly offset by a reduction in bad debt expense. Our sales force headcount was 633 at December 31, 2021 and 698 at December 31, 2022, and our total headcount was 1,001 at December 31, 2021 and 1,076 at December 31, 2022.
Acquisition Costs – Sprint (T-Mobile Wireline). In connection with the Transaction and the negotiation of the Purchase Agreement, we incurred $2.2 million of professional fees in 2022. Subject to the satisfaction or waiver of certain conditions and the other terms and conditions of the Purchase Agreement, the Transaction is expected to close in 2023.
Depreciation and Amortization Expenses. Our depreciation and amortization expense increased by 3.3% for 2022 from 2021. The increase is primarily due to the depreciation expense associated with the increase in deployed fixed assets.
Interest Expense and Losses on Debt Extinguishment and Redemption. Our interest expense resulted from interest incurred on our $445.0 million of 5.375% 2022 Notes until these notes were fully extinguished in May 2021, interest incurred on our €350.0 million of 4.375% 2024 Notes until these notes were fully extinguished in June 2022, interest incurred on our $500.0 million of 3.50% 2026 Notes that we issued in May 2021, interest incurred on our $450.0 million of 7.00% 2027 Notes that we issued in June 2022, interest incurred on our finance lease obligations and net interest paid on our Swap Agreement. Our interest expense increased by 16.4% from 2021 to 2022. The increase was primarily due to the increase in interest rates on our 7.00% 2027 Notes as compared to our 4.375% 2024 Notes, net interest paid in 2022 under our Swap Agreement, partially offset by the reduction in interest expense from the lower interest rate on our 3.50% 2026 Notes as compared to our 5.375% 2022 Notes.
In March 2021, we redeemed and extinguished $115.9 million of our 5.375% 2022 Notes at 103.24% of par value resulting in a loss on debt extinguishment and redemption of $3.9 million and reduced the par value from $445.0 million to $329.1 million. In May 2021, we extinguished the remaining $329.1 million of our 2022 Notes at par value resulting in a loss on debt extinguishment and redemption of $10.8 million. In June 2022, we extinguished our 4.375% 2024 Notes at 101.094% of par value resulting in a loss on debt extinguishment and redemption of $11.9 million.
Change in Valuation – Interest Rate Swap Agreement. As of December 31, 2022, the fair value of our Swap Agreement was a net liability of $52.1 million, and we recorded an unrealized loss for the non-cash change in the valuation of the Swap Agreement of $43.1 million in 2022 and $9.0 million in 2021.
Under the Swap Agreement settlement payment made in November 2021, we received $0.6 million from the counterparty for a net cash savings of $0.6 million for the period from August 9, 2021 (the Swap Agreement inception date) to October 31, 2021, in May 2022, we received $1.2 million from the counterparty for a net cash savings of $1.2 million for the period from November 1, 2021 to April 30, 2022. Under the Swap Agreement settlement payment made in November 2022, we paid $3.4 million to the counterparty for a net cash interest cost of $3.4 million for the period from May 1, 2022 to October 31, 2022.
Gains on Foreign Exchange – 2024 Notes. Our 2024 Notes were issued in Euros and were reported in our reporting currency, US dollars, until they were extinguished and redeemed in June 2022. Our 2024 Notes were issued in June 2019 and June 2020 when the Euro to USD exchange rate was approximately $1.13 and they were extinguished in June 2022 at a Euro to USD exchange rate of $1.06. Our gains on foreign exchange on our 2024 Notes from converting Euros into US dollars was $31.6 million for 2022 and was $32.5 million for 2021. We have not entered into hedging arrangements for our foreign currency obligations.
Income Tax Expense. Our income tax expense was $23.2 million for 2021 and $21.2 million for 2022 that includes deferred income taxes of $18.2 million for 2021 and $16.5 million for 2022. The decrease in our income tax expense is primarily related to the decrease in our income before income taxes.
Buildings On-net. As of December 31, 2022 and 2021, we had a total of 3,155 and 3,035 on-net buildings connected to our network, respectively. The increase in our on-net buildings was a result of our disciplined network expansion program. We anticipate adding a similar number of buildings to our network for the next several years.
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Liquidity and Capital Resources
In assessing our liquidity, management reviews and analyzes our current cash balances, accounts receivable, accounts payable, accrued liabilities, capital expenditure commitments, and required finance lease and debt payments and other obligations. As our business has grown as a result of an increasing customer base, broader geographic coverage and increased traffic on our network, we have produced a growing level of cash provided by operating activities. As a result of the operating leverage of our network, our annual capital expenditures as measured as a percentage of revenues has fallen over the last decade. Increasing our cash provided by operating activities is, in part, dependent upon expanding our geographic footprint and increasing our network capacity. Recent supply chain issues may adversely impact our ability to grow our network and revenue.
We have also had increasing success in raising capital by issuing notes and arranging financing and leases that have had a lower cost and more flexible terms. The combination of this improved operating performance and access to capital has enhanced our financial flexibility and increased our ability to make distributions to stockholders in the form of cash dividends or through share repurchases. Since our initial public offering, we have returned over $1.2 billion to our stockholders through share repurchases and dividends. We will continue to assess our capital and liquidity needs and, where appropriate, return capital to stockholders.
Over the next several years, we have significant contractual and anticipated cash outlays including our indicative dividend payments on our common stock, our maturing debt obligations, interest payments on our debt obligations and our projected capital expenditure requirements in order to help execute our business plan. Based upon our historical growth rate of our dividend, we expect that we would have to provide approximately $363 million in order to meet our expected quarterly dividend payments over the next two years. In March 2021, we redeemed and extinguished $115.9 million of our 2022 Notes. In April 2021, we redeemed $45.0 million of our 2022 Notes, and in May 2021, we redeemed the remaining $284.1 million of our 2022 Notes with the proceeds from our issuance of $500.0 million of our 2026 Notes. Our 2022 Notes accrued interest at 5.375% and our 2026 Notes accrue interest at 3.50%. Our $500.0 million of 2026 Notes mature in May 2026 and include annual interest payments of $17.5 million until maturity. In June 2022, we redeemed our 2024 Notes with the proceeds from our issuance of $450.0 million of our 2027 Notes. Our 2024 Notes accrued interest at 4.375% and our 2027 Notes accrue interest at 7.00%. Our $450.0 million of 2027 Notes mature in June 2027 and include annual interest payments of $31.5 million until maturity.
Under our Swap Agreement, we pay the counterparty a semi-annual payment based upon overnight SOFR plus a contractual interest rate spread, and the counterparty pays us a semi-annual fixed 3.50% interest payment. These settlement payments are made in November and May of each year until the Swap Agreement expires in February 2026. Under the first Swap Agreement settlement payment made in November 2021, we received $0.6 million from the counterparty for a net cash savings of $0.6 million for the period from August 9, 2021 (the Swap Agreement inception date) to October 31, 2021. Under the Swap Agreement settlement payment made in May 2022, we received $1.2 million from the counterparty for a net cash savings of $1.2 million for the period from November 1, 2021 to April 30, 2022. Under the Swap Agreement the settlement payment made in November 2022, the Company paid $3.4 million to the counterparty for a net cash interest cost of $3.4 million for the period from May 1, 2022 to October 31, 2022. As of December 31, 2022, the fair value of the Swap Agreement was a liability of $52.1 million. We have made a $61.7 million deposit with the counterparty to our Swap Agreement. If the fair value of our Swap Agreement exceeds a liability of $61.7 million we will be required to deposit additional funds with the counterparty equal to the liability fair value. As of December 31, 2022, $52.1 million of our deposit was restricted and $9.6 million was unrestricted.
Any future acquisitions or other significant unplanned costs or cash requirements in excess of amounts we currently hold may require that we raise additional funds through the issuance of debt or equity. We cannot assure you that such financing will be available on terms acceptable to us or our stockholders, or at all. Insufficient funds may require us to delay or scale back the number of buildings and markets that we add to our network, reduce our planned increase in our sales and marketing efforts, or require us to otherwise alter our business plan or take other actions that could have a material adverse effect on our business, results of operations and financial condition. If issuing equity securities raises additional funds, substantial dilution to existing stockholders may result.
We may need to, or elect to, refinance all or a portion of our indebtedness at or before maturity and we cannot provide assurances that we will be able to refinance any such indebtedness on commercially reasonable terms or at all. In addition, we may elect to secure additional capital in the future, at acceptable terms, to improve our liquidity or fund acquisitions or for general corporate purposes. In addition, in an effort to reduce future cash interest payments as well as future amounts due at maturity or to extend debt maturities, we may, from time to time, issue new debt, enter into interest rate swap agreements, enter into debt for debt, or cash transactions to purchase our outstanding debt securities in the open market or through privately negotiated transactions. We will evaluate any such transactions in light of the existing market conditions. The amounts involved in any such transaction, individually or in the aggregate, may be material.
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We or our affiliates may, at any time and from time to time, seek to retire or purchase our outstanding debt through cash purchases and/or exchanges for equity or debt, in open-market purchases, privately negotiated transactions or otherwise. Such repurchases or exchanges, if any, will be upon such terms and at such prices as we may determine, and will depend on prevailing market conditions, our liquidity requirements, contractual restrictions and other factors. The amounts involved may be material.
Any future acquisitions or other significant unplanned costs or cash requirements in excess of amounts we currently hold may require that we raise additional funds through the issuance of debt or equity. We cannot assure you that such financing will be available on terms acceptable to us or our stockholders, or at all. Insufficient funds may require us to delay or scale back the number of buildings and markets that we add to our network, reduce our planned increase in our sales and marketing efforts, or require us to otherwise alter our business plan or take other actions that could have a material adverse effect on our business, results of operations and financial condition. If issuing equity securities raises additional funds, substantial dilution to existing stockholders may result.
In light of the economic uncertainties associated with the COVID-19 pandemic, our executive officers and Board have continued to carefully monitor our liquidity and cash requirements. Based on current circumstances, we plan to continue our current dividend policy. Given uncertainties regarding the duration of the pandemic and timing for economic recovery, we will continue to monitor our capital spending. As we do each year, we will continue to monitor our future sources and uses of cash, and anticipate that we will make adjustments to our capital allocation strategies when, as and if determined by our Board of Directors.
Impact of COVID-19 on Our Liquidity and Operating Performance
We continue to operate with a high level of liquidity, and as of December 31, 2022, we had cash, cash equivalents and restricted cash of $275.9 million. The COVID-19 pandemic has not impacted our credit rating to date, nor do we believe that it has materially changed our cost of capital. We believe we are able to timely service our debt obligations and will not require any concessions to do so. We believe we will have access to additional capital from a variety of sources and the public capital markets for debt and equity.
In late March 2020, we adopted a mandatory policy through which we required all employees to work from home and follow shelter in place guidelines issued by state and local authorities. In July 2021, we allowed all employees to return voluntarily to all offices in the United States. In August 2021, we notified our employees that they would be required to return to the office on a full-time basis in the United States beginning in September 2021 and that they would be required to attest that they were fully vaccinated against the COVID-19 virus to do so. Employees had until October 11, 2021 to provide their vaccine self-attestation. Fully vaccinated employees in the United States returned to our offices on a full-time basis in early September 2021. In October 2021, we opened most of our non-US offices for employees to return on a voluntary basis and, where permitted, on a mandatory basis in November 2021.
The spread of the Omicron variant around the world in December 2021 caused us to modify further our office environment. First, we mandated that all U.S. employees receive a COVID-19 booster vaccine no later than six weeks after first becoming eligible for such vaccine. Second, we mandated that all U.S. employees provide proof of vaccination to us. Third, for offices around the world that had not been closed by government order, we shifted much of our workforce to fully remote status on a temporary basis at the end of 2021 in order to reduce the density of our offices. Sales representatives with less than 12 months tenure, sales representatives on performance improvement plans and their managers remained working in our offices on a full-time basis, as we believe that the training and coaching required by new and underperforming sales representatives is significantly more effective when provided in an in-office environment. In March 2022, all of our US employees returned to our offices on a full-time basis, and our employees around the world have returned to the office as and when permitted by local regulations.
Our employees have largely complied with our vaccine mandate in the United States. However, we experienced an increase in both voluntary and involuntary employee departures, particularly within our sales department, beginning in the second half of 2021 and continuing into 2022. We believe this rise in departures is attributable both to an increased focus on managing underperforming sales representatives and to the unwillingness of some employees to be vaccinated and/or to return to a full-time, in-office environment. As a result of our decisions to mandate COVID vaccination and to require employees to return to our offices on a full-time basis, we may find it difficult to retain existing employees or hire new employees. Further, a resurgence of COVID-19 due to immunity-resistant variants may cause employees to be more reluctant to continue in, or make new employees more reluctant to accept, a full-time, in-office position due to concerns about COVID-19. If this occurs, we may experience lower sales, revenue and profitability.
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We have experienced certain corporate customers taking a more cautious approach to new configurations and upgrades as well as a reduction in demand for connecting smaller satellite offices as a result of the challenges and uncertainties of the COVID-19 pandemic. We also have witnessed a deteriorating real estate market in and around the buildings we service with rising vacancy levels and falling lease initiations or renewals which resulted in fewer sales opportunities for our salesforce and a reduction in VPN opportunities. As a result, we experienced a slowdown in new sales to our corporate customers which negatively impacted our corporate revenue growth. Moreover, with the spread of the Delta variant of COVID-19 in the summer of 2021 and then the Omicron variant in December of 2021, we believe many companies delayed the return of their employees to in-office work. As the pandemic has continued, and the return of employees to their offices has been delayed, a greater number of corporate customers with contracts that reached their termination date have elected not to renew their service with us. As such, we began to see increased corporate customer turnover. We also experienced a reduction in new sales to corporate customers. While we believe that demand for office space in the buildings in which we operate will remain among the strongest in our markets, and that most employers will eventually require their employees to return to their offices, the timing and scope of a return to office, particularly in a number of key markets we serve, remains uncertain. As a result, we may experience increased customer turnover, fewer upgrades of existing customer configurations and fewer new tenant opportunities. A potential resurgence of COVID-19 due to new immunity-resistant variants could cause companies to continue to delay the return of their employees to the office, to cause companies to shift workers in the office back to remote work and to delay further opening new offices. These trends may negatively impact our revenue growth, cash flows and profitability. We continue to experience a slowdown in the availability and delivery of networking equipment and optical fiber. While we believe we can adequately manage the operation, maintenance, upgrading and growth of our network, a worsening or prolonged slowdown may impact our ability to expand and augment our network.
Shortly after COVID-19 began its rapid spread around the world, domestic and worldwide capital markets ceased normal operations for a short period. While worldwide capital markets have remained unstable or unpredictable since then, particularly for non-investment grade issuers, legislative bodies and reserve banks have taken various actions in response to the pandemic that have impacted the capital markets, and we expect that these efforts may continue. We cannot predict whether new COVID-19 variants will arise and spread widely, the impact of the spread of new COVID-19 variants on the global economy, how national and local governments may react to the spread of new variants nor predict the impact the variants and any measures taken in response may have on our operations, employee retention, revenue growth, cash flows and our profitability.
Cash Flows
The following table sets forth our consolidated cash flows.
Year Ended December 31,
(in thousands)
Effect of exchange rates on cash (2,599) (2,193) 3,513
Net Cash Provided By Operating Activities. Our primary source of operating cash is receipts from our customers who are billed on a monthly basis for our services. Our primary uses of operating cash are payments made to our vendors and employees and interest payments made to our finance lease vendors and our note holders. Our changes in cash provided by operating activities are primarily due to changes in our operating profit and changes in our interest payments. Cash provided by operating activities for 2022, 2021 and 2020 included interest payments on our note obligations of $40.6 million, $50.1 million and $48.8 million, respectively.
Net Cash Used In Investing Activities. Our primary use of investing cash is for purchases of property and equipment. These amounts were $79.0 million, $69.9 million and $56.0 million for 2022, 2021 and 2020, respectively. The annual changes in purchases of property and equipment are primarily due to the timing and scope of our network expansion activities, including geographic expansion and adding buildings to our network.
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Net Cash Used In Financing Activities. Our primary uses of cash for financing activities are for payments to redeem and extinguish our debt, dividend payments, stock purchases and principal payments under our debt and finance lease obligations. During 2022, 2021 and 2020, we paid $169.9 million, $150.3 million and $129.4 million, respectively, for our quarterly dividend payments. Our quarterly dividend payments have increased due to regular increases in our quarterly dividend per share amounts. Amounts paid under our stock buyback program were $4.5 million for 2020. There were no stock purchases during 2022 or 2021. Principal payments under our finance lease obligations were $45.5 million, $23.1 million and $24.0 million for 2022, 2021 and 2020, respectively, and are impacted by the timing and extent of our network expansion activities, including geographic expansion and adding buildings to our network. Total installment payment agreement principal payments were $0.8 million, $6.9 million and $10.5 million for 2022, 2021 and 2020, respectively.
We completed a series of debt redemptions and issuances in 2022, 2021 and 2020. In June 2022, we paid $375.4 million to redeem and extinguish our 2024 Notes at 101.094% of par value, and we issued $450.0 million of our 2027 Notes for net proceeds of $446.0 million. In March 2021, we paid $119.7 million to redeem and extinguish $115.9 million of our 2022 Notes at 103.24% of par value. In May 2021, we redeemed and extinguished the remaining $329.1 million of our 2022 Notes at par value and deposited funds with the trustee to pay $11.5 million of interest through December 1, 2021. The total payments to redeem our 2022 Notes were $459.3 million. In May 2021, we issued $500.0 million of our 2026 Notes for net proceeds of $496.9 million. In June 2020, we redeemed our $189.2 million of our 2021 Notes at par value and completed an offering of €215.0 million of our 2024 Notes for net proceeds of $240.3 million.
Indebtedness
Our total cash, cash equivalents and restricted cash at December 31, 2022 were $275.9 million. We believe this level of liquidity reduces our exposure to refinancing risk, potential underperformance of the business or other unforeseen challenges and enhances our ability to pursue acquisitions or operating opportunities. We intend to hold levels of cash and cash equivalents sufficient to maintain our ability to fund operations, refinance indebtedness and make dividend payments to our stockholders.
Our total indebtedness at December 31, 2022, at par value, was $1.3 billion. Our total indebtedness at December 31, 2022 includes $304.2 million of finance lease obligations for dark fiber under long-term IRU agreements.
On May 15, 2014, pursuant to the Agreement and Plan of Reorganization (the “Merger Agreement”) by and among Cogent Communications Group, Inc. (“Group”), a Delaware corporation, Cogent Communications Holdings, Inc., a Delaware corporation (“Holdings”) and Cogent Communications Merger Sub, Inc., a Delaware corporation (“Merger Sub”), Group adopted a new holding company organizational structure whereby Group is now a wholly owned subsidiary of Holdings. Holdings is a “successor issuer” to Group pursuant to Rule 12g-3(a) under the Exchange Act.
Senior unsecured 2027 notes—$450.0 million
In June 2022, Group issued $500.0 million of 2027 Notes. The 2027 Notes were sold in private offerings for resale to qualified institutional buyers pursuant to SEC Rule 144A and mature on June 15, 2027. Interest accrues at 7.00% and is paid semi-annually in arrears on June 15 and December 15 of each year. Holdings provided a guarantee of the 2027 Notes, but Holdings is not subject to the covenants under the indenture.
Senior secured 2026 notes—$500.0 million
In May 2021, Group issued $500.0 million of 2026 Notes. The 2026 Notes were sold in private offerings for resale to qualified institutional buyers pursuant to SEC Rule 144A and mature on May 1, 2026. Interest accrues at 3.50% and is paid semi-annually in arrears on May 1 and November 1 of each year. Holdings provided a guarantee of the 2026 Notes, but Holdings is not subject to the covenants under the indenture.
Senior unsecured 2024 notes—€350.0 million
In June 2019, Group completed an offering of €135.0 million of 2024 Notes. In June 2020, Group completed an offering of €215.0 million of 2024 Notes. The 2024 Notes were sold in private offerings for resale to qualified institutional buyers pursuant to SEC Rule 144A and were scheduled to mature on June 30, 2024. Interest accrued at 4.375% and was paid semi-annually in arrears on June 30 and December 30 of each year. In June 2022, the 2024 Notes were redeemed with the proceeds from our 2027 Notes.
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Limitations under the Indentures
The 2027 Notes Indenture and the 2026 Notes Indenture (the “Indentures”), among other things, limit the Company’s ability to incur indebtedness; to pay dividends or make other distributions; to make certain investments and other restricted payments; to create liens; to consolidate, merge, sell or otherwise dispose of all or substantially all of its assets; to incur restrictions on the ability of a subsidiary to pay dividends or make other payments; and to enter into certain transactions with its affiliates. There are certain exceptions to the limitations on the Company’s ability to incur indebtedness under the Indentures, including IRU agreements incurred in the normal course of business and any additional indebtedness if the Company’s consolidated leverage ratio, as defined in the Indentures, is less than 6.0 to 1.0 or the Company’s fixed charge coverage ratio, as defined in the Indentures, is 2.0 to 1.0 or greater. The Company can also incur unlimited liens (which can be used, together with capacity under the debt covenant, to incur additional secured indebtedness) if the Company’s consolidated secured leverage ratio, as defined in the Indentures, is less than 4.0 to 1.0. Under the Indentures, the Company can pay dividends, make other distributions, make certain investments and make other restricted payments under certain circumstances, including if, after giving pro forma effect to such restricted payment, the Company could still incur $1 of indebtedness, as defined (i.e., either its consolidated leverage ratio is less than 6.0 to 1.0 or its fixed charge coverage ratio is 2.0 to 1.0 or greater). As of December 31, 2022, the Company’s consolidated leverage ratio was below 6.0, the Company’s consolidated secured leverage ratio was below 4.0, and the Company’s fixed charge coverage ratio was above 2.0. As of December 31, 2022, a total of $442.2 million (inclusive of a $250.0 general basket) was unrestricted and permitted for restricted payments, including dividends and stock purchases.
Summarized Financial Information of Holdings
Holdings is a guarantor under the 2027 and 2026 Notes. Under the Indentures, we are required to disclose financial information of Holdings including its assets, liabilities and its operating results (“Holdings Financial Information”). The Holdings Financial Information as of and for the year ended December 31, 2022 is detailed below (in thousands).
(Unaudited)
Cash and cash equivalents $ 42,298
Accrued interest receivable 40
Investment from subsidiaries $ 469,551
Common stock 48
Accumulated deficit (427,261)
Year Ended
(Unaudited)
Equity‐based compensation expense $ 26,716
Interest income 1,040
Common Stock Buyback Program
Our Board of Directors has approved through December 31, 2023, purchases of our common stock under a buyback program (the “Buyback Program”). We purchased 79,056 shares of our common stock for $4.5 million during the year ended December 31, 2020 at an average price per share of $56.85. There were no purchases of common stock during the years ended December 31, 2022 and December 31, 2021. As of December 31, 2022, there was a total of $30.4 million available under the Buyback Program.
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Dividends on Common Stock
Dividends are recorded as a reduction to retained earnings. Dividends on unvested restricted shares of common stock are paid as the awards vest. Our initial quarterly dividend payment was made in the third quarter of 2012. On February 22, 2023, our Board of Directors approved the payment of our quarterly dividend of $0.925 per common share. The dividend for the first quarter of 2023 will be paid to holders of record on March 10, 2023. This estimated $43.3 million dividend payment is expected to be made on March 24, 2023. The payment of any future dividends and any other returns of capital, including stock buybacks, will be at the discretion of our Board of Directors and may be reduced, eliminated or increased and will be dependent upon our financial position, results of operations, available cash, cash flow, capital requirements, limitations under our debt indentures and other factors deemed relevant by the our Board of Directors. We are a Delaware Corporation and under the General Corporate Law of the State of Delaware distributions may be restricted including a restriction that distributions, including stock purchases and dividends, do not result in an impairment of a corporation’s capital, as defined under Delaware Law. The indentures governing our notes limit our ability to return cash to our stockholders. See Note 4 to our consolidated financial statements for additional discussion of limitations on distributions.
Future Capital Requirements
We believe that our cash on hand and cash generated from our operating activities will be adequate to meet our working capital, capital expenditure, debt service, dividend payments and other cash requirements for the next twelve months if we execute our business plan.
Any future acquisitions or other significant unplanned costs or cash requirements in excess of amounts we currently hold may require that we raise additional funds through the issuance of debt or equity. We cannot assure you that such financing will be available on terms acceptable to us or our stockholders, or at all. Insufficient funds may require us to delay or scale back the number of buildings and markets that we add to our network, reduce our planned increase in our sales and marketing efforts, or require us to otherwise alter our business plan or take other actions that could have a material adverse effect on our business, results of operations and financial condition. If issuing equity securities raises additional funds, substantial dilution to existing stockholders may result.
We may need to, or elect to, refinance all or a portion of our indebtedness at or before maturity and we cannot provide assurances that we will be able to refinance any such indebtedness on commercially reasonable terms or at all. In addition, we may elect to secure additional capital in the future, at acceptable terms, to improve our liquidity or fund acquisitions or for general corporate purposes. In addition, in an effort to reduce future cash interest payments as well as future amounts due at maturity or to extend debt maturities, we may, from time to time, issue new debt, enter into debt for debt, or cash transactions to purchase our outstanding debt securities in the open market or through privately negotiated transactions. We will evaluate any such transactions in light of the existing market conditions. The amounts involved in any such transaction, individually or in the aggregate, may be material.
Off-Balance Sheet Arrangements
We do not have relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. In addition, we do not engage in trading activities involving non-exchange traded contracts. As such, we are not materially exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in these relationships.
Income Taxes
Section 382 of the Internal Revenue Code in the United States limits the utilization of net operating losses when ownership changes, as defined by that section, occur. We have performed an analysis of our Section 382 ownership changes and have determined that the utilization of certain of our net operating loss carryforwards in the United States is limited.
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Critical Accounting Policies and Significant Estimates
Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and the related disclosure of contingent assets and liabilities. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
The accounting policies we believe to be most critical to understanding our financial results and condition or that require complex, significant and subjective management judgments are discussed below.
Finance Lease Obligations
We record assets and liabilities under finance leases at the lesser of the present value of the aggregate future minimum lease payments or the fair value of the assets under lease. We establish the number of renewal option periods used in determining the lease term, if any, based upon our assessment at the inception of the lease of the number of option periods for which failure to renew the lease imposes a penalty on us in such amount that renewal appears to be reasonably certain. Useful lives are determined based on historical usage with consideration given to technological changes and trends in the industry that could impact the asset utilization. We estimate the fair value of leased assets primarily using estimated replacement cost data for similar assets. We determine the incremental borrowing rate for each lease using our current borrowing rate adjusted for various factors including the level of collateralization and term to align with the term of the lease.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to certain market risks. These risks, which include interest rate risk and foreign currency exchange risk, arise in the normal course of business rather than from trading activities.
Interest Rate Risk
Interest Expense and Restricted Cash
Our cash flow exposure due to changes in interest rates related to our 2027 Notes is limited as our 2027 Notes have a fixed interest rate. Beginning in August 2021, we used a derivative financial instrument to manage our interest rate risk on our 2026 Notes. As of December 31, 2022, we were counterparty to our Swap Agreement that has the economic effect of modifying our fixed-interest rate obligation associated with our 2026 Notes to a variable interest rate obligation based on SOFR. The Swap Agreement is recorded at its fair value at each reporting period and we incur gains and losses due to changes in market interest rates. The values that we report for the Swap Agreement as of each reporting date are recognized as additional non-cash interest expense or a reduction to interest expense with the corresponding amount included in liabilities or assets, respectively, in our consolidated balance sheets. By entering into this Swap Agreement, we have assumed the risk associated with variable interest rates based upon SOFR related to our 2026 Notes. We have not entered into hedge agreements related to our 2027 Notes, and we do not use derivative financial instruments for trading purposes. We have a $61.7 million interest-bearing deposit with the counterparty to the Swap Agreement. If the fair value of the Swap Agreement exceeds a net liability of $61.7 million, we will be required to deposit additional funds with the counterparty equal to the net liability that is in excess of $61.7 million. As of December 31, 2022, the fair value of the Swap Agreement was a liability of $52.1 million, as a result, $52.1 million of the $61.7 million deposit was restricted and $9.6 million was unrestricted. A 1.0% change in interest rates as of December 31, 2022 would impact the change in our valuation of our Swap Agreement by approximately $15.3 million.
Interest Income
Our interest income is sensitive to changes in the general level of interest rates. However, based upon the nature and current level of our investments, which consist of cash, cash equivalents and restricted cash, we believe that there is no material interest rate exposure related to our investments.
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Foreign Currency Exchange Risk
Our operations outside of the United States expose us to potentially unfavorable adverse movements in foreign currency rate changes. We have not entered into forward exchange contracts related to our foreign currency exposure. While we record financial results and assets and liabilities from our international operations in the functional currency, which is generally the local currency, these results are reflected in our consolidated financial statements in US dollars. Therefore, our reported results are exposed to fluctuations in the exchange rates between the US dollar and the local currencies, in particular the Euro and the Canadian dollar. In addition, we may fund certain cash flow requirements of our international operations in US dollars. Accordingly, in the event that the local currencies strengthen versus the US dollar to a greater extent than planned, the revenues, expenses and cash flow requirements associated with our international operations may be significantly higher in US-dollar terms than planned. During the year ended December 31, 2022, our foreign activities accounted for 24.7% of our consolidated revenue. A 1.0% change in foreign exchange rates would impact our consolidated annual revenue by approximately $1.2 million. Changes in foreign currency rates could adversely and materially affect our operating results and cash flow.
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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Page
Report of Independent Registered Public Accounting Firm (PCAOB ID: 42) 41
Consolidated Balance Sheets as of December 31, 2022 and 2021 43
Notes to Consolidated Financial Statements 47
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Report of Ernst & Young LLP, Independent Registered Public Accounting Firm
To the Shareholders and the Board of Directors of Cogent Communications Holdings, Inc.
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Cogent Communications Holdings, Inc. and subsidiaries (the Company) as of December 31, 2022 and 2021, the related consolidated statements of comprehensive (loss) income, shareholders’ deficit and cash flows for each of the three years in the period ended December 31, 2022, and the related notes and financial statement schedule listed in the Index at Item 15(a)2 (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2022 and 2021, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2022, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2022, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 24, 2023 expressed an unqualified opinion thereon.
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion
Critical Audit Matter
The critical audit matter communicated below is a matter arising from the current period audit of the financial statements that was communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of the critical audit matter does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
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/s/ Ernst & Young LLP
We have served as the Company’s auditor since 2002
Tysons, VA
February 24, 2023
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COGENT COMMUNICATIONS HOLDINGS, INC., AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 2022 AND 2021
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
Assets
Current assets:
Prepaid expenses and other current assets 45,878 39,015
Property and equipment:
Accumulated depreciation and amortization (1,170,476) (1,161,635)
Liabilities and stockholders’ equity
Current liabilities:
Accrued and other current liabilities 63,889 39,057
Current maturities, operating lease liabilities 12,005 12,197
Finance lease obligations, current maturities 17,182 17,048
Operating lease liabilities, net of current maturities 94,587 111,794
Finance lease obligations, net of current maturities 287,044 228,822
Commitments and contingencies
Stockholders’ deficit:
Accumulated other comprehensive loss (19,156) (11,003)
Total liabilities and stockholders’ deficit $ 1,010,182 $ 984,557
The accompanying notes are an integral part of these consolidated balance sheets.
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COGENT COMMUNICATIONS HOLDINGS, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME
FOR EACH OF THE THREE YEARS ENDED DECEMBER 31, 2022
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
Operating expenses:
Acquisition costs – Sprint (T-Mobile Wireline) (Note 1) 2,248 — —
Gains on equipment transactions — 18 352
Gains (losses) on lease terminations — 7,375 (423)
Change in valuation – interest rate swap (43,113) (9,015) —
Realized foreign exchange gain on 2024 Notes — — 2,533
Loss on debt extinguishment and redemption – 2021 Notes — — (638)
Loss on debt extinguishment and redemption – 2022 Notes — (14,698) —
Loss on debt extinguishment and redemption – 2024 Notes (11,885) — —
Comprehensive (loss) income:
Foreign currency translation adjustment (8,153) (9,697) 11,020
Basic net income per common share $ 0.11 $ 1.04 $ 0.14
Diluted net income per common share $ 0.11 $ 1.03 $ 0.13
Dividends declared per common share $ 3.555 $ 3.170 $ 2.780
The accompanying notes are an integral part of these consolidated statements.
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COGENT COMMUNICATIONS HOLDINGS, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ DEFICIT
FOR EACH OF THE THREE YEARS ENDED DECEMBER 31, 2022
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
Accumulated
Additional Other Total
Common Stock Paid-in Comprehensive Accumulated Stockholder’s
Shares Amount Capital Income (Loss) Deficit Deficit
Forfeitures of shares granted to employees (53,428) — — — — —
Equity-based compensation — — 25,802 — — 25,802
Foreign currency translation — — — 11,020 — 11,020
Issuances of common stock 476,030 — — — — —
Equity-based compensation — — 30,044 — — 30,044
Foreign currency translation — — — (9,697) — (9,697)
Issuances of common stock 471,080 1 — — — 1
Dividends paid — — — — (150,288) (150,288)
Net income — — — — 48,185 48,185
Equity-based compensation — — 26,716 — — 26,716
Foreign currency translation — — — (8,153) — (8,153)
Issuances of common stock 401,036 — — — — —
Exercises of options 15,184 — 614 — — 614
Dividends paid — — — — (169,857) (169,857)
Net income — — — — 5,146 5,146
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COGENT COMMUNICATIONS HOLDINGS, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR EACH OF THE THREE YEARS ENDED DECEMBER 31, 2022
(IN THOUSANDS)
Cash flows from operating activities:
Amortization of debt discount and premium 1,464 1,759 1,894
Realized foreign currency exchange gain on 2024 Notes — — (2,533)
Loss on extinguishment & redemption of 2024 notes 11,885 — —
Loss on extinguishment & redemption of 2022 notes — 14,698 —
Loss on extinguishment & redemption of 2021 notes — — 638
Gain – lease termination — (7,375) —
Gains—equipment transactions and other, net 372 69 (546)
Changes in operating assets and liabilities:
Prepaid expenses and other current assets (7,427) (17) (2,771)
Change in valuation – interest rate swap agreement 43,113 9,015 —
Deposits and other assets (282) (12) (873)
Cash flows from investing activities:
Cash flows from financing activities:
Redemption and extinguishment of 2024 Notes (375,354) — —
Redemption and extinguishment of 2022 Notes — (459,317) —
Redemption and extinguishment of 2021 Notes — — (189,225)
Purchases of common stock — — (4,495)
Proceeds from exercises of common stock options 614 1,823 1,382
Effect of exchange rate changes on cash (2,599) (2,193) 3,513
Supplemental disclosures of cash flow information:
Non-cash investing and financing activities:
PP&E obtained for installment payment agreement — — 5,771
Fair value of equipment acquired in leases 1,969 — 536
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COGENT COMMUNICATIONS HOLDINGS, INC., AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Description of the business and summary of significant accounting policies:
Reorganization and merger
On May 15, 2014, pursuant to the Agreement and Plan of Reorganization (the “Merger Agreement”) by and among Cogent Communications Group, Inc. (“Group”), a Delaware corporation, Cogent Communications Holdings, Inc., a Delaware corporation (“Holdings” or the “Company”) and Cogent Communications Merger Sub, Inc., a Delaware corporation, Group adopted a new holding company organizational structure whereby Group is now a wholly owned subsidiary of Holdings. Holdings is a “successor issuer” to Group pursuant to Rule 12g-3(a) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Cogent Communications, Inc. is wholly owned by Group and the vast majority of Group’s assets, contractual arrangements, and operations are executed by Cogent Communications, Inc. and its subsidiaries.
Description of business
The Company is a facilities-based provider of low-cost, high-speed Internet access, private network services, and data center colocation space and power. The Company’s network is specifically designed and optimized to transmit packet switched data. The Company delivers its services primarily to small and medium-sized businesses, communications service providers and other bandwidth-intensive organizations in 51 countries across North America, Europe, Asia, South America, Oceania and Africa. The Company is a Delaware corporation and is headquartered in Washington, DC.
The Company offers on-net Internet access services exclusively through its own facilities, which run from its network to its customers’ premises. The Company offers its on-net services to customers located in buildings that are physically connected to its network. As a result, the Company is not dependent on local telephone companies or cable TV companies to serve its customers for its on-net Internet access and private network services. The Company’s on- net service consists of high-speed Internet access and private network services offered at speeds ranging from 100 megabits per second to 400 gigabits per second.
The Company provides its on-net Internet access and private network services to its corporate and net-centric customers. The Company’s corporate customers are located in multi-tenant office buildings (“MTOBs”) and typically include law firms, financial services firms, advertising and marketing firms, as well as health care providers, educational institutions and other professional services businesses. The Company’s net-centric customers include bandwidth-intensive users that leverage its network to either deliver content to end users or to provide access to residential or commercial internet users. Content delivery customers include over the top (“OTT”) media service providers, content delivery networks, web hosting companies, and commercial content and application software providers. Access customers include access networks comprised of other Internet Service Providers (“ISPs”), telephone companies, mobile phone operators and cable television companies that collectively provide internet access to a substantial number of broadband subscribers and mobile phone subscribers across the world. These net-centric customers generally receive the Company’s services in carrier neutral colocation facilities and in the Company’s own data centers. The Company operates data centers throughout North America and Europe that allow its customers to collocate their equipment and access the Company’s network.
In addition to providing on-net services, the Company provides Internet access and private network services to customers that are not located in buildings directly connected to its network. The Company provides these off-net services primarily to corporate customers using other carriers’ circuits to provide the “last mile” portion of the link from the customers’ premises to the Company’s network. The Company also provides certain non-core services that resulted from acquisitions. The Company continues to support but does not actively sell these non-core services.
In connection with the Company’s Sprint acquisition (discussed below), the Company will begin to provide optical wavelength services over the Company’s fiber network. The Company will sell these wavelength services to its existing customers, Sprint customers and to new customers who require dedicated optical transport connectivity without the capital and ongoing expenses associated with owning and operating network infrastructure.
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Acquisition of Sprint Communications
On September 6, 2022, Cogent Infrastructure, Inc., a Delaware corporation (the “Buyer”) and a wholly owned subsidiary of the Company, entered into a Membership Interest Purchase Agreement (the “Purchase Agreement”) with Sprint Communications LLC, a Kansas limited liability company (“Sprint Communications”) and an indirect wholly owned subsidiary of T-Mobile US, Inc., a Delaware corporation (“T-Mobile”), and Sprint LLC, a Delaware limited liability company and a direct wholly owned subsidiary of T-Mobile (the “Seller”), pursuant to which the Company will acquire the U.S. long-haul fiber network (including the non-U.S. extensions thereof) of Sprint Communications and its subsidiaries (the “Wireline Business”). The Purchase Agreement provides that, upon the terms and conditions set forth therein, the Company will purchase from the Seller all of the issued and outstanding membership interests (the “Purchased Interests”) of a Delaware limited liability company that holds Sprint Communications’ assets and liabilities relating to the Wireline Business (such transactions contemplated by the Purchase Agreement, collectively, the “Transaction”).
The parties have agreed to a $1 purchase price in consideration for the Purchased Interests, subject to customary adjustments set forth in the Purchase Agreement. In addition, at the consummation of the Transaction (the “Closing”), a T-Mobile affiliate will enter into an agreement for IP transit services, pursuant to which T-Mobile will pay the Company an aggregate of $700 million, consisting of (i) $350 million in equal monthly installments during the first year after the Closing and (ii) $350 million in equal monthly installments over the subsequent 42 months.
The Purchase Agreement includes customary representations, warranties, indemnities and covenants, including regarding the conduct of the Wireline Business prior to the Closing. In addition, the Closing is subject to customary closing conditions, including as to the receipt of certain required regulatory approvals and consents. Subject to the satisfaction or waiver of certain conditions and the other terms and conditions of the Purchase Agreement, the Transaction is expected to close in 2023.
The Purchase Agreement contains certain termination rights for the Buyer and Seller, including that, subject to certain limitations, either the Buyer or the Seller may terminate the Purchase Agreement if the Transaction is not consummated by September 6, 2023, subject to two automatic six-month extensions if certain regulatory approvals have not been obtained. The Purchase Agreement also provides that each party may specifically enforce the other party’s obligations under the Purchase Agreement.
The Company has agreed to guarantee the obligations of the Buyer under the Purchase Agreement pursuant to the terms of a Guaranty, dated as of September 6, 2022, by and between the Company and the Seller (the “Parent Guaranty”). The Parent Guaranty contains customary representations, warranties and covenants of the Company and the Seller.
Acquisition Related Costs
In connection with the Transaction and negotiation of the Purchase Agreement, the Company incurred $2.2 million of professional fees in the year ended December 31, 2022.
Principles of consolidation
The consolidated financial statements have been prepared in accordance with United States generally accepted accounting principles and include the accounts of the Company and all of its wholly-owned and majority-owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.
Use of estimates
The preparation of consolidated financial statements in conformity with United States generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results may differ from these estimates.
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Allowance for credit losses
The Company establishes an allowance for credit losses and other sales credit adjustments related to its trade receivables. Trade receivables are recorded at the invoiced amount and can bear interest. Allowances for sales credits are established through a reduction of revenue, while allowances for credit losses are established through a charge to selling, general, and administrative expenses as bad debt expense. The Company assesses the adequacy of these reserves by evaluating factors, such as the length of time individual receivables are past due, historical collection experience, and changes in the credit worthiness of its customers. The Company also assesses the ability of specific customers to meet their financial obligations and establishes specific allowances related to these customers. If circumstances relating to specific customers change or economic conditions change such that the Company’s past collection experience and assessment of the economic environment are no longer appropriate, the Company’s estimate of the recoverability of its trade receivables could be impacted. Accounts receivable balances are written off against the allowance for credit losses after all means of internal collection activities have been exhausted and the potential for recovery is considered remote. The Company uses third-party collection services to continue to seek collection for it’s written off accounts receivable.
Effective January 1, 2020, the Company adopted Accounting Standards Update (“ASU”) No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”) later codified as Accounting Standards Codification (“ASC”) 326 (“ASC 326”), using the modified retrospective transition approach. This guidance introduces a revised approach to the recognition and measurement of credit losses, emphasizing an updated model based on expected losses rather than incurred losses. As of January 1, 2020, the Company maintained an allowance for credit losses to cover its current expected credit losses on its trade receivables arising from the failure of customers to make contractual payments. The Company estimates credit losses expected over the life of its trade receivables based on historical information combined with current conditions that may affect a customer’s ability to pay and reasonable and supportable forecasts. While the Company uses various credit quality metrics, it primarily monitors collectability by reviewing the duration of collection pursuits on its delinquent trade receivables. Based on the Company’s experience, the customer’s delinquency status is the strongest indicator of the credit quality of the underlying trade receivables, which is analyzed monthly. Adoption of ASU 2016-13 did not have a material impact on the Company’s consolidated financial statements and related disclosures, and no cumulative adjustment was recorded.
Current-period
Balance at Provision for Write offs Balance at
Beginning Expected Credit Charged Against End of
Description of Period Losses Allowance Period
Allowance for credit losses (deducted from accounts receivable)
The current-period provision for expected credit losses is net of bad debt recoveries of $1.9 million, $2.2 million and $1.2 million for the years ended December 31, 2022, 2021 and 2020, respectively.
Leases
In February 2016, the FASB issued ASU No. 2016-02, Leases (“ASU 2016-02”). ASU 2016-02 replaced most existing lease accounting guidance. In July 2018, the FASB approved an Accounting Standards Update which, among other changes, allowed a company to elect to adopt ASU 2016-02 using the modified retrospective method applying the transition provisions at the beginning of the period of adoption, rather than at the beginning of the earliest comparative period presented in these financial statements. ASU 2016-02 was effective for the Company beginning on January 1, 2019 and required the Company to record a right-of-use asset and a lease liability for most of its facilities leases. These leases were previously treated as operating leases. The Company adopted ASU 2016-02 using the optional transition method whereby the new lease requirements under ASU 2016-02 were recorded through a cumulative-effect adjustment, which after completing the implementation analysis, did not result in an adjustment to the Company’s January 1, 2019 beginning retained earnings balance. The effect of ASU 2016-02 was to record a cumulative-effect adjustment on January 1, 2019 as a right-of-use asset and an operating lease liability totaling $97.3 million. The operating lease liability is not considered a liability under the consolidated leverage ratio calculations in the indentures governing the Company’s senior unsecured and senior secured note obligations. The Company has made an accounting policy election to not apply the recognition requirements of ASU 2016-02 to its short-term leases — leases with a term of one year or less. The Company has also elected to apply certain practical expedients under ASU 2016-02 including not separating lease and non-lease components on its finance and operating leases,
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not reassessing whether any existing contracts contained leases, not reconsidering lease classification, not reassessing initial direct costs and using hindsight in determining the lease reasonably certain term of its leases.
Year Year
Ended Ended
Finance lease cost amortization of right-of-use assets $ 28,915 $ 26,424
Interest expense on finance lease liabilities 23,317 19,419
Other lease information
Operating cash flows from finance leases (23,317) (17,366)
Operating cash flows from operating leases (18,836) (20,194)
Financing cash flows from finance leases (45,472) (23,054)
Weighted average discount rate — finance leases 8.6 % 9.0 %
Weighted average discount rate — operating leases 5.4 % 5.4 %
Finance leases—fiber lease agreements
The Company has entered into lease agreements with numerous providers of dark fiber under indefeasible-right-of-use agreements (“IRUs”). These IRUs typically have initial terms of 15-20 years and include renewal options after the initial lease term. The Company establishes the number of renewal option periods used in determining the lease term based upon its assessment at the inception of the lease of the number of option periods for which failure to renew the lease imposes a penalty in such amount that renewal appears to be reasonably certain. The option to renew may be automatic, at the option of the Company or mutually agreed to between the dark fiber provider and the Company. Once the Company has accepted the related fiber route, leases that meet the criteria for treatment as finance leases are recorded as a finance lease obligation and an IRU asset. The interest rate used in determining the present value of the aggregate future minimum lease payments is the Company’s incremental borrowing rate for the reasonably certain lease term. The determination of the Company’s incremental borrowing rate requires some judgment. Finance lease assets are included in property and equipment in the Company’s consolidated balance sheets. As of December 31, 2022, the Company had committed to additional dark fiber IRU lease agreements totaling $70.3 million in future payments to be paid over periods of up to 20 years. These obligations begin when the related fiber is accepted, which is generally expected to occur in the next 12 months.
Operating leases
The Company leases office space and certain data center facilities under operating leases. In certain cases the Company also enters into short-term operating leases for dark fiber. Right-of-use assets represent the Company’s right to use an underlying asset for the lease term and lease liabilities represent its obligation to make lease payments under the lease. Operating lease right-of-use assets and liabilities are recognized at the lease commencement date based on the present value of lease payments over the reasonably certain lease term. The implicit rates within the Company’s operating leases are generally not determinable and the Company uses its incremental borrowing rate at the lease commencement date to determine the present value of its lease payments. The determination of the Company’s incremental borrowing rate requires some judgment. The Company determines its incremental borrowing rate for each lease using its current borrowing rate, adjusted for various factors including level of collateralization and term to align with the term of the lease. Certain of the Company’s leases include options to extend or terminate the lease. The Company establishes the number of renewal option periods used in determining the operating lease term based upon its assessment at the inception of the operating lease of the number of option periods for which failure to renew the lease imposes a penalty in such amount that renewal appears to be reasonably certain. The option to renew may be automatic, at the option of the Company or mutually agreed to between the landlord or dark fiber provider and the Company. Once the Company has accepted the related fiber route or the facility lease term has begun, the present value of the aggregate future minimum operating lease payments is recorded as an operating lease liability and a right-of-use leased asset. Lease incentives and deferred rent liabilities for facilities operating leases are presented with, and netted against, the right-of-use leased asset. Lease expense for lease payments is recognized on a straight-line basis over the term of the lease.
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The future minimum payments under these operating lease and finance lease agreements are as follows (in thousands):
Operating Finance
For the twelve months ending December 31, Leases Leases
Less—amounts representing interest (52,389) (220,385)
Present value of minimum lease obligations 106,592 304,226
Lease obligations, net of current maturities $ 94,587 $ 287,044
Revenue recognition
The Company recognizes revenue under ASU No. 2014-09, Revenue from Contracts with Customers (“ASC 606”), which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. Under ASC 606 installation fees for contracts with terms longer than month-to-month are recognized over the contract term. The Company believes that the installation fee does not give rise to a material right as defined by ASC 606 for contracts with terms longer than month-to-month. The Company recognizes revenue over the estimated average customer life for installation fees associated with month-to-month contracts, because the installation fee represents a material right as defined by ASC 606. The Company capitalizes certain contract acquisition costs that relate directly to a customer contract, including commissions paid to its sales team and sales agents and amortizes these costs on straight-line basis over the period the services are transferred to the customer for commissions paid to its sales team (estimated customer life) and over the remaining original contract term for agent commissions. Management assesses these costs for impairment at least quarterly and as “triggering” events occur that indicate it is more likely than not that an impairment exists. These contract costs were $23.7 million as of December 31, 2022 and were $21.4 million as of December 31, 2021.
The Company’s service offerings consist of on-net and off-net telecommunications services. Fixed fees are billed monthly in advance and usage fees are billed monthly in arrears. Amounts billed are due upon receipt and contract lengths range from month to month to 60 months. The Company satisfies its performance obligations to provide services to customers over time as the services are rendered. In accordance with ASC 606, revenue is recognized when a customer obtains the promised service. The amount of revenue recognized reflects the consideration to which the Company expects to be entitled to receive in exchange for these services. The Company has adopted the practical expedient related to certain performance obligation disclosures since it has a right to consideration from its customer in an amount that corresponds directly with the value to the customer of the Company’s performance completed to date.
To achieve this core principle, the Company follows the following five steps:
1) Identification of the contract, or contracts with a customer;
2) Identification of the performance obligations in the contract;
3) Determination of the transaction price;
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Fees billed in connection with customer installations are deferred (as deferred revenue) and recognized as noted above. To the extent a customer contract is terminated prior to its contractual end the customer is subject to termination fees. The Company vigorously seeks payment of termination fees. The Company recognizes revenue for termination fees as they are collected. Service revenue recognized from amounts in deferred revenue (contract liabilities) at the beginning of the period during the years ended December 31, 2022, 2021 and 2020 was $5.0 million, $4.6 million and $4.4 million, respectively. Amortization expense for contract costs for the years ended December 31, 2022, 2021 and 2020 was $19.4 million, $18.4 million and $17.1 million, respectively.
Gross receipts taxes, universal service fund and other surcharges
Revenue recognition standards include guidance relating to taxes or surcharges assessed by a governmental authority that are directly imposed on a revenue-producing transaction between a seller and a customer and may include, but are not limited to, gross receipts taxes, excise taxes, Universal Service Fund fees and certain state regulatory fees. Such charges may be presented gross or net based upon the Company’s accounting policy election. The Company records certain excise taxes and surcharges on a gross basis and includes them in its revenues and costs of network operations. Excise taxes and surcharges billed to customers and recorded on a gross basis (as service revenue and network operations expense) were $15.4 million, $18.5 million, and $15.1 million for the years ended December 31, 2022, 2021 and 2020, respectively.
Network operations
Network operations expenses include the costs of personnel and related operating expenses associated with service delivery, network management, and customer support, network facilities costs, fiber and equipment maintenance fees, leased circuit costs, access fees paid to building owners and certain excise taxes and surcharges recorded on a gross basis. The Company estimates its accruals for any disputed leased circuit obligations based upon the nature and age of the dispute. Network operations costs are impacted by the timing and amounts of disputed circuit costs. The Company generally records these disputed amounts when billed by the vendor and reverses these amounts when the vendor credit has been received or the dispute has otherwise been resolved. The Company does not allocate depreciation and amortization expense to its network operations expense.
Foreign currency translation adjustment and comprehensive income
The consolidated financial statements of the Company’s non-US operations are translated into US dollars using the period-end foreign currency exchange rates for assets and liabilities and the average foreign currency exchange rates for revenues and expenses. Gains and losses on translation of the accounts are accumulated and reported as a component of other comprehensive income in stockholders’ equity. The Company’s only components of “other comprehensive income” are currency translation adjustments for all periods presented. The Company considers the majority of its investments in its foreign subsidiaries to be long-term in nature. The Company’s foreign exchange transaction gains (losses) are included within interest income and other on the consolidated statements of comprehensive income.
Financial instruments
The Company considers all highly liquid investments with an original maturity of three months or less at purchase to be cash equivalents. The Company determines the appropriate classification of its investments at the time of purchase and evaluates such designation at each balance sheet date.
At December 31, 2022 and December 31, 2021, the carrying amount of cash and cash equivalents, restricted cash, accounts receivable, prepaid and other current assets, accounts payable, and accrued expenses approximated fair value because of the short-term nature of these instruments. The Company measures its cash equivalents and restricted cash at amortized cost, which approximates fair value based upon quoted market prices (Level 1). Based upon recent trading prices (Level 2—market approach), at December 31, 2022, the fair value of the Company’s $500.0 million senior secured notes due 2026 was $452.5 million, the fair value of the Company’s $450.0 million senior unsecured notes due 2027 was $441.0 million and the estimated fair value of the Company’s Swap Agreement was $52.1 million.
Restricted cash and interest rate swap agreement
Restricted cash represents amounts held in segregated bank accounts by our clearing broker as margin in support of our Swap Agreement, as discussed in Note 4, and was $52.1 million as of December 31, 2022. Additional cash may be further restricted to maintain our interest rate swap instrument as interest rates fluctuate and margin requirements change. The Company does not use derivative financial instruments for trading purposes.
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Concentrations of credit risk