Item 2. Management’s Discussion and Analysis
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
You should read the following discussion and analysis together with our condensed 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. 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:
The impact of the COVID-19 pandemic and the related government policies worldwide; future economic instability in the global economy or a contraction of the capital markets, which could affect spending on Internet services and our ability to engage in financing activities; 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; cyber-attacks or security breaches of our network; 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 certain 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; our ability to make payments on our indebtedness as they become due; the management of network failures and/or disruptions; and outcomes in litigation as well as other risks discussed from time to time in our filings with the Securities and Exchange Commission, including, without limitation, our annual report on Form 10-K for the year ended December 31, 2020.
General Overview
We are a facilities-based provider of low-cost, high-speed Internet access, private network services, and data center colocation space. Our network is specifically designed and optimized to transmit packet switched data. We deliver our services primarily to small and medium-sized businesses, communications service providers and other bandwidth-intensive organizations in 48 countries across North America, Europe, Asia, South America, Australia and Africa. We are a Delaware corporation, and we are headquartered in Washington, DC.
We offer on-net Internet access services exclusively through our own facilities, which run from our network to our customers' premises. We offer our on-net services to customers located in buildings that are physically connected to our network. As a result, we are not dependent on local telephone companies or cable TV companies to serve our customers for our on-net Internet access and private network service. Our on-net service consists of high-speed Internet access and private network services offered at speeds ranging from 100 megabits per second ("Mbps") to 100 gigabits per second ("Gbps").
Our on-net revenues represented 74.9% of our revenues for the three months ended March 31, 2021 and 73.4% of our revenues for the three months ended March 31, 2020. We provide our on-net Internet access and private network services to our corporate and net-centric customers. Our corporate customers are located in multi-tenant office buildings 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. Our net-centric customers include bandwidth-intensive users that leverage our 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. Our net-centric customers include 7,471 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 our services in carrier neutral colocation facilities and in our data centers. We operate data centers throughout North America and Europe that allow our customers to collocate their equipment and access our network.
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In addition to providing our on-net services, we provide Internet access and private network services to customers that are not located in buildings directly connected to our network. We provide 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 our network. Our off-net revenues represented 25.0% of our revenues for the three months ended March 31, 2021 and 26.5% of our revenues for the three months ended March 31, 2020.
We also provide certain non-core services that resulted from acquisitions. We continue to support but do not actively sell these non-core services. We expect revenue from non-core services to continue to decline or to remain flat. Our non-core revenues represented 0.1% of our revenues for the three months ended March 31, 2021 and 0.1% of our revenues for the three months ended March 31, 2020.
Competitive Advantages
We believe we address many of the data communications needs of small and medium-sized businesses, communications service providers and other bandwidth-intensive organizations by offering them high-quality, high-speed Internet access and private network services at attractive prices. We believe that our organization has the following competitive advantages:
Low Cost of Operation: We believe that the wireline telecom industry is undergoing, and will continue to face, significant price deflation for its applications and services. This price deflation is a result of a variety of factors including increased competition, enhanced substitutability of certain products and services and the continued impact of Moore’s Law, which has driven down the cost of technology, particularly for customer premise, fiber optics and networking equipment. Faced with the backdrop of continued price deflation in our industry, we have made a series of discreet choices around our network design, operating strategy and product offering that are consistent with our objective of becoming the low cost operator in our industry. Since our initiation of operations, this strategy has resulted in a rapid decline in our cost to transmit bits, which has increased our margins and decreased our capital intensity as measured by our capital expenditures per total revenues. Over the last five fiscal years, our cost of goods sold per bit delivered for our customers has declined at a compounded annual rate of 22.5%. Important components of our low cost operating strategy includes:
● One Network Protocol . Upon our founding, we selected to operate our network solely using Ethernet protocol. We made this selection in order to take advantage of the significantly greater installed base and lower cost of Ethernet network equipment versus other protocols, the substantially lower costs associated with operating and maintaining one network protocol and the continued benefits of the rapid price performance ratio improvements of Ethernet-related equipment. Our single network design allows us to avoid many of the costs that our competitors who operate circuit-switched, TDM and hybrid fiber coaxial networks incur related to provisioning, monitoring and maintaining multiple transport protocols. Selecting one operating protocol has also had positive effects in terms of our operating overhead and the simplicity of our organization. We believe the vast majority of our competition currently operates their networks with multiple protocols and we believe that attempts to upgrade their networks to one protocol would be operationally challenging and costly.
● Broad Access to Fiber on a Cost Effective, Long Term Basis . We have acquired a large portfolio of dark fiber leases from around the world sourced from the excess inventory of existing networks. This choice to lease rather than build reduces our capital intensity and the operating costs of our intercity and metro networks. The nature of this portfolio and the individual leases provides us long-term access to dark fiber at attractive rates and the opportunity in many cases to extend these leases for multiple terms. On average, a modest number of our dark fiber leases come up for renewal each year. We have relationships with 280 dark fiber vendors across the globe enabling us to lease dark fiber on a long-term, cost-effective basis to virtually any geographic route or facility we require.
● Narrow and Focused Product Set . Since our founding, we have strategically focused on delivering a very narrow product set to our customers. The vast majority of our revenue is driven or related to our high-capacity, bi-directional, symmetric internet access services which can be accessed on-net in multi-tenant office buildings and carrier neutral data centers or off-net through other carriers’ “last mile” connections to customer facilities. There are significant cost advantages as a result of this narrow product set. We believe the relative size of our salesforce training, support and overhead is lower than comparable telecom providers which tend to offer a broader, one-stop shopping product set to their client base.
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● Scalable Network Equipment and Hub Configurations . Due to our single network protocol and narrow product set, our transmission and network operations rely mainly on two sets of equipment for operation. In order to further scale our operating leverage, we have systematically reused older equipment in less dense portions of our network. Due to interoperability between the generations of products, we are able to transfer older equipment from our core, high-traffic areas to newer, less congested routes. The result of this dynamic grooming process is that we are able to utilize our equipment for materially longer time frames than the expected life of this equipment thereby reducing our capital investment in our network. We design and build all of our network hubs to the same standards and configurations. This replication strategy provides us scale benefits in equipment purchases, training, and maintenance.
Greater Control and Superior Delivery. Our on-net service does not rely on circuits that must be provisioned by a third-party carrier. In on-net multi-tenant office buildings (“MTOBs”) we provide our customers the entire network, including the “last mile” and the in-building wiring connecting to our customer’s suite. In carrier neutral data centers (“CNDCs”) we are collocated with our customers. As a result, only a cross-connection within the data center is required to provide our services. The structure of our on-net service provides us more control over our service, quality and pricing. It also allows us to provision services more quickly and efficiently than provisioning services on a third-party carrier network.
High-Quality, Reliable Service. We are able to offer high-quality Internet service due to our network design and composition. We believe that we deliver a high level of technical performance because our network is optimized for packet switched traffic. Its design increases the speed and throughput of our network and reduces the number of data packets dropped during transmission compared to traditional circuit-switched networks. We believe that our network is more reliable and carries traffic at lower cost than networks built as overlays to traditional circuit-switched, or TDM networks.
Large Addressable Market. We have systematically evaluated and chosen our network extensions to buildings, data centers and markets based upon a rigorous set of criteria to evaluate the economic opportunity of network locations. Additional factors relevant to our pursuit of new buildings include the willingness of building owners to grant us access rights, the availability of optical fiber networks to serve those buildings, the costs to connect buildings to our network and equipment availability. Our network is connected to 2,939 total buildings located in 202 metropolitan markets. These buildings include 1,796 large MTOBs (totaling 978.1 million square feet of office space) in major North American cities where we offer our services to a diverse set of high-quality, low churn corporate customers within close physical proximity of each other. These buildings also include 1,274 CNDCs located in 1,089 buildings in North America, Europe, Asia, South America, Australia and Africa where our net-centric customers directly interconnect with our network. We also operate 54 of our own data centers across the United States and in Europe which comprise over 606,000 square feet of floor space and are directly connected to our network. We believe that these network points of presence strategically position our network to attract high levels of Internet traffic and maximize our revenue opportunities and profitability.
Balanced, High-Traffic Network. Since its inception, our network has grown significantly in terms of its geographic reach, customer connections, and traffic. We currently serve 7,471 access networks as well as numerous large and small content providers and 46,719 corporate customer connections. As a result of these growing bases of customers who distribute (content providers) and receive (access networks) content on our network, we believe that the majority of all the traffic on our network originates and terminates on our network. This control of traffic increases our reliability and speed of delivery and enhances our margins. The breadth of our network, extensive size of our customer base, and volume of our traffic enables us to be one of a handful of Tier One networks that are interconnected on a settlement free basis. This peering status broadens our geographic delivery capability and materially reduces our network costs.
Proven and Experienced Management Team. Our senior management team is composed of seasoned executives with extensive expertise in the telecommunications industry as well as knowledge of the markets in which we operate. The members of our senior management team have an average of over 20 years of experience in the telecommunications industry and many have been working together at the Company for several years. Several members of the senior management team have been working together at the Company since 2000. Our senior management team has designed and built our network and, during our formative years, led the integration of network assets we acquired through 13 significant acquisitions and managed the expansion and growth of our business.
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Our Strategy
We intend to become the leading provider of high-quality, high-speed Internet access and private network services and to continue to improve our profitability and cash flow. The principal elements of our strategy include:
Grow our Corporate Customer Base. Our on-net corporate customers are typically small- to medium-sized businesses connected to our network through our multi-tenant office buildings or connected to our network through one of our carrier neutral data centers. We generally sell two types of services to our corporate customers: dedicated internet access and private network services. We typically sell dedicated internet access at the same price per connection as our competitors, but our clients benefit from our significantly faster speeds and rapid installation times. These customers are increasingly integrating off-site data centers and cloud services into their IT infrastructure in order to take advantage of the safety, security and redundancy that is offered by locating company processing power, storage and software at a data center. An important part of this new infrastructure is a high-speed, dedicated internet connection from the corporate premises to the data center and the Internet and from one corporate premises to another corporate premises. We believe that the importance of data centers will increasingly lead tenants to reconfigure their communications infrastructure to include dedicated internet access across their locations.
Increase our Share of the Net-Centric Market. We are currently one of the leading providers of high-speed internet access to a variety of content providers and access networks across the world. We intend to further load our high-capacity network as a result of the growing demand for high-speed internet access generated by these types of bandwidth-intensive applications such as over-the-top (“OTT”) media services, online gaming, video, Internet of Things (“IoT”), voice over IP (“VOIP”), remote data storage, and other services. We expect that we will continue to grow our shares of these segments by offering our customers a series of attractive features including:
● Geographic breadth – We have the broadest carrier neutral data center footprint in the industry and currently offer network services in 48 countries;
● High capacity and reliability – We offer 1 Gbps to 100 Gbps ports in all of the carrier neutral data centers on our network, which differentiates the capacity choices we provide our net-centric clients;
● Balanced customer base – Our leading share of content providers and access networks increases the amount of traffic that originates and terminates on our network thereby reducing latency and enhancing reliability;
● Large and dedicated salesforce – Our team of 239 net-centric sales professionals is one of the largest salesforces in this industry segment and enables us to better serve this customer segment while also identifying new sales opportunities and gaining new business and customers; and
● Competitive pricing – We aggressively discount our services to customers in order to attract new customers and drive volume.
Develop a Worldwide Peering Platform. In late 2020 we introduced a new product, Global Peer Connect (“GPC”), targeted at the growing demand for certain net-centric customers to dynamically peer traffic anywhere on our global platform. Our GPC product provides access to our Global Peer Exchange (“GPE”) which is a worldwide connectivity platform for the exchange of peering traffic destined for the Internet. Similar product offerings in the marketplace offer a materially smaller geographic footprint configuration and require a higher fixed cost for customers. We believe our product offering provides the following unique advantages over other private peer exchanges or public Internet exchange points:
● Ubiquity through Leading CNDC Connectivity: We are collocated in 1,274 CNDCs in 48 countries. We believe this portfolio provides us a significant advantage over regional peer exchanges that typically have substantially fewer CNDC collocations and countries served. In order to take advantage of this footprint, we enable GPC customers to peer with any other member of our GPE regardless of location thereby significantly broadening the reach for potential customers.
● Attractive Economics and Terms: Our GPC product offers economics and terms which should make it attractive for potential users to switch to us. Customers only pay for direct usage and there are no fixed port charges or distance based fees. Our contracts have no minimum terms. These terms reduce the hurdle for new customers to join the GPE and should drive participation.
● Greater Customer Control and Selectivity: As our GPC offering provides direct connectivity to anywhere in our network, customers will be able to have greater control and reliability over their traffic as this eliminates intermediate networks and enables customers to selectively bypass certain regions due to regulatory or censorship concerns.
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Pursue On-Net Customer Growth. Our high-capacity network provides us with the ability to add a significant number of customers to our network with minimal direct incremental costs. We intend to increase usage of our network and operational infrastructure by adding customers in our existing on-net buildings, as well as developing additional markets and connecting more multi-tenant office buildings and carrier neutral data centers to our network. We emphasize our on-net services because they generate greater profit margins and we have more control over service levels, quality, pricing and our on-net services are provisioned in considerably less time than our off-net services. Our fiber network connects directly to our on-net customers’ premises and we pay no local access (“last mile”) charges to other carriers to provide our on-net services.
Grow and Improve our Sales Efforts. A critical factor in our success has been our growing investment and focus on our sales and marketing efforts. Over the past five years, we have increased the size of our quota bearing salesforce by 27% from 398 to 547 employees. We seek to pair this growth in the size of our salesforce with a consistent level of productivity as measured by the number of connections sold per salesperson per month, taking into account adjustments to the changing mix of products sold and installed. In order to gain market share in our targeted businesses, we expect to continue to increase our sales efforts, including increasing the number of sales representatives and introducing strategies and tools to optimize sales productivity.
Expand our Off-Net Corporate Business. We have agreements with national carriers providing us last mile network access to over 4.0 million commercial buildings across North America that are lit by fiber optic cable and that are not currently served by our network. We have developed an automated process to enable our salesforce to identify opportunities in the off-net market and to quickly offer pricing proposals to potential customers. We believe these agreements broaden our addressable market for corporate dedicated internet access and enable us to better leverage the skills and capacity of our direct salesforce. The carrier agreements also provide for discounts related to volume purchases thereby enabling us to reduce our cost of service if we are able to increase our pool of off-net customers.
Three Months Ended March 31, 2021 Compared to the Three Months Ended March 31, 2020
The following summary table presents a comparison of our results of operations with respect to certain key financial measures. The comparisons illustrated in the table are discussed in greater detail below.
Three months ended
March 31,
Percent
2021
2020
Change
(in thousands)
Service revenue
$
146,777
$
140,915
4.2
%
On-net revenue
109,947
103,457
6.3
%
Off-net revenue
36,723
37,321
(1.6)
%
Network operations expenses (1)
57,092
55,921
2.1
%
Selling, general, and administrative expenses (2)
41,442
39,675
4.5
%
Depreciation and amortization expenses
21,970
19,508
12.6
%
Unrealized foreign exchange gain on 2024 Notes
18,870
2,904
NM
Loss on debt extinguishment and repurchase – 2022 Notes
3,868
—
NM
Interest expense
15,836
15,220
4.0
%
Income tax provision
7,350
3,608
103.7
%
(1) Includes equity-based compensation expenses of $2,076 and $252 in the three months ended March 31, 2021 and 2020, respectively.
(2) Includes equity-based compensation expenses of $5,231 and $4,823 in the three months ended March 31, 2021 and 2020, respectively.
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NM – not meaningful
Three Months Ended
March 31,
Percent
2021
2020
Change
Other Operating Data
Average Revenue Per Unit (ARPU)
ARPU—on-net
$
471
$
461
2.2
%
ARPU—off-net
$
1,012
$
1,064
(4.9)
%
Average Price per Megabit — installed base
$
0.38
$
0.53
(28.1)
%
Customer Connections—end of period
On-net
78,389
75,163
4.3
%
Off-net
12,216
11,721
4.2
%
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 and by increasing the number of buildings that we are connected to, including carrier neutral data centers and multi-tenant office 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. Over the last five years we have grown our quota bearing salesforce by 27% to 547 full time equivalent salespeople. 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.
Our service revenue increased by 4.2% from the three months ended March 31, 2020 to the three months ended March 31, 2021. Exchange rates positively impacted our increase in service revenue by $2.6 million. All foreign currency comparisons herein reflect results for the three months ended March 31, 2021 translated at the average foreign currency exchange rates for the three months ended March 31, 2020. We increased our total service revenue by increasing the number of sales representatives selling our services, 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 operations. The impact of these taxes including the Universal Service Fund resulted in an increase to our revenues from the three months ended March 31, 2020 to the three months ended March 31, 2021 of $0.8 million.
Our corporate customers 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 62.7% and 37.3% of total service revenue, respectively, for the three months ended March 31, 2021 and represented 68.8% and 31.2% of total service revenue, respectively, for the three months ended March 31, 2020. Revenues from corporate customers decreased by 5.1% to $92.0 million for the three months ended March 31, 2021 from $97.0 million for the three months ended March 31, 2020. Revenues from our net-centric customers increased by 24.6% to $54.8 million for the three months ended March 31, 2021 from $44.0 million for the three months ended March 31, 2020.
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 and in order to supplement their VPN capabilities has also led to our growing corporate revenues. However, beginning in March 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.
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Our revenue from our net-centric customers increased primarily due to an increase in our number of net-centric 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 transmitting bits, and the commodity nature of the service where price is typically the only differentiating factor for these customers. Our average price per megabit declined by 28.1% from the three months ended March 31, 2020 to the three months ended March 31, 2021. 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 6.3% from the three months ended March 31, 2020 to the three months ended March 31, 2021. Our on-net revenues increased as we increased the number of our on-net customer connections by 4.3% at March 31, 2021 from March 31, 2020. On-net revenues increased at a greater rate than on-net customer connections primarily due to an increase in our usage based revenues, an increase in our on-net ARPU from the three months ended March 31, 2020 to the three months ended March 31, 2021 and the positive 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 1.6% from the three months ended March 31, 2020 to the three months ended March 31, 2021. Our off-net revenues decreased as the 4.9% decrease in our off-net ARPU more than offset the 4.2% increase in the number of our off-net customer connections from March 31, 2020 to March 31, 2021.
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 and was $2.1 million for the three months ended March 31, 2021 and $0.3 million for the three months ended March 31, 2020. Our network operations expenses, including non-cash equity-based compensation expense, increased by 2.1% for the three months ended March 31, 2021 from the three months ended March 31, 2020. The increase in network operations expense is primarily attributable to an increase in costs related to our network and facilities expansion activities and an increase in equity-based compensation expense from the vesting of restricted employee shares, partly offset by price reductions obtained in certain of our leased circuit costs, fewer operating leases for dark fiber and the impact of a renewal of an IRU fiber lease agreement in the second quarter of 2020. We adopted Leases (“ASU 2016-02”) on January 1, 2019. When we adopted ASU 2016-02 we elected to apply certain practical expedients under ASU 2016-02 including not separating the lease and nonlease components of our finance and operating leases. As a result of accounting for this IRU renewal under ASU 2016-02, the present value of $1.8 million of quarterly maintenance and co-location fees (non-lease components) that were previously accounted for as network operations expenses prior to the second quarter of 2020, were capitalized as a finance lease liability and right-of-use leased asset totaling $34.0 million. Amortization of the right-of-use asset is recorded as depreciation and amortization expense and the payments that are made toward the finance lease liability are recorded as a reduction of the finance lease liability and interest expense.
Selling, General, and Administrative (“SG&A”) Expenses. Our SG&A expenses, including non-cash equity-based compensation expense, increased by 4.5% for the three months ended March 31, 2021 from the three months ended March 31, 2020. Non-cash equity-based compensation expense is included in SG&A expenses consistent with the classification of the employee’s salary and other compensation and was $5.2 million for the three months ended March 31, 2021 and $4.8 million for the three months ended March 31, 2020. 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 sales meeting and travel costs related to the COVID-19 pandemic and a reduction in bad debt expense. Our sales force headcount increased from 684 at March 31, 2020 to 693 at March 31, 2021 and our total headcount increased from 1,052 at March 31, 2020 to 1,066 at March 31, 2021.
Depreciation and Amortization Expenses. Our depreciation and amortization expense increased by 12.6% for the three months ended March 31, 2021 from the three months ended March 31, 2020. The increase is primarily due to the depreciation expense associated with the increase in deployed fixed assets and the impact of a renewal of an IRU fiber lease agreement in the second quarter of 2020. We adopted Leases (“ASU 2016-02”) on January 1, 2019. When we adopted ASU 2016-02 we elected to apply certain practical expedients under ASU 2016-02 including not separating the lease and nonlease components of our finance and operating leases. As a result of accounting for this IRU renewal under ASU 2016-02, the present value of $1.8 million of quarterly maintenance and co-location fees (non-lease components) that were previously accounted for as network operations expenses prior to the second quarter of 2020, were capitalized as a finance lease liability and right-of-use leased asset totaling $34.0 million. Amortization of the right-of-use asset is recorded as depreciation and amortization expense and the payments that are made toward the finance lease liability are recorded as a reduction of the finance lease liability and interest expense.
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Interest Expense and Loss on Debt Extinguishment and Repurchase. Our interest expense resulted from interest incurred on our $329.1 million of senior secured notes due 2022 (“2022 Notes”), interest incurred on our $189.2 million of senior unsecured notes due 2021 (“2021 Notes") until these notes were repurchased in June 2020, interest incurred on our installment payment agreement, interest incurred on our finance lease obligations and interest incurred on our €350.0 million aggregate principal amount of senior unsecured notes due 2024 (“2024 Notes”). We issued €215.0 million of our 2024 Notes in June 2020 and €135.0 million of our 2024 Notes were issued in June 2019. In June 2020, we redeemed and extinguished our 2021 Notes at par value. In March 2021, we repurchased and extinguished $115.9 million of our 2022 Notes at 103.24% of par value resulting in a loss on debt extinguishment and repurchase of $3.9 million and reduced the par value from $445.0 million to $329.1 million. Our interest expense increased by 4.0% for the three months ended March 31, 2021 from the three months ended March 31, 2020 primarily due to an increase in our finance lease obligations and the issuances of our 2024 Notes, partly offset by the June 2020 repurchase of our 2021 Notes and the March 2021 partial extinguishment of our 2022 Notes.
Unrealized Gain on Foreign Exchange on 2024 Notes. Our 2024 Notes were issued in Euros and are reported in our reporting currency – US Dollars. As of March 31, 2021, the carrying value of our €350.0 million 2024 Notes was $410.5 million. Our unrealized gain on foreign exchange on our 2024 Notes from converting our 2024 Notes into US Dollars was an unrealized gain of $18.9 million for the three months ended March 31, 2021 and an unrealized gain of $2.9 million for the three months ended March 31, 2020. We have not entered into hedges for our foreign currency obligations.
Income Tax Provision. Our income tax provision was $7.4 million for the three months ended March 31, 2021 and $3.6 million for the three months ended March 31, 2020. The increase in our income tax expense is primarily related to an increase in our income before income taxes.
Buildings On-net. As of March 31, 2021 and 2020, we had a total of 2,939 and 2,823 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.
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.
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 $320 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. On April 6, 2021 we issued a notice of conditional partial redemption for $45.0 million of our 2022 Notes. The remaining $284.1 million of our original $445.0 million 2022 Notes mature in March 2022 and include annual interest payments of $15.3 million if held until maturity.
Our €350 million of 2024 Notes mature in June 2024 and include annual interest payments €15.3 million until maturity. Our 2024 Notes are denominated in Euros and expose us to potentially unfavorable adverse movements in foreign currency rate changes. Our overseas operations provides us access to Euros, however these amounts may be insufficient to fund our obligations under our 2024 Notes. Additionally, we have not entered into forward exchange contracts related to our foreign currency exposure.
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.
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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 of Directors 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.
Cash Flows
The following table sets forth our consolidated cash flows.
Three Months Ended March 31,
(in thousands)
2021
2020
Net cash provided by operating activities
$
47,106
$
28,458
Net cash used in investing activities
(15,444)
(12,866)
Net cash used in financing activities
(163,667)
(38,572)
Effect of exchange rates changes on cash
(1,316)
(1,326)
Net decrease in cash and cash equivalents
$
(133,321)
$
(24,306)
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, 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 the three months ended March 31, 2021 and 2020 includes interest payments on our note obligations of $12.4 million and $12.0 million, respectively.
Net Cash Used In Investing Activities. Our primary use of cash for investing activities is for purchases of property and equipment. Purchases of property and equipment were $15.4 million and $12.9 million for the three months ended March 31, 2021 and 2020, respectively. The 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.
Net Cash Used In Financing Activities. Our primary uses of cash for financing activities are payments to redeem and extinguish our debt, dividend payments, principal payments under our finance lease obligations and our installment payment agreement, and for purchases of our common stock. During the three months ended March 31, 2021 and 2020 we paid $36.1 million and $30.6 million, respectively, for our quarterly dividend payments. Our quarterly dividend payments have increased due to increases in our quarterly dividend per share amounts. 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. Principal payments under our finance lease obligations were $5.7 million and $6.2 million for the three months ended March 31, 2021 and 2020, respectively. The changes in our principal payments under our finance lease obligations are primarily due to the timing and scope of our network expansion activities including geographic expansion and adding buildings to our network. Principal payments under our installment payment agreement were $2.4 million and $2.6 million for the three months ended March 31, 2021 and 2020, respectively. There were no purchases of our common stock in the three months ended March 31, 2021 and 2020.
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Cash Position and Indebtedness
Our total indebtedness, at par, at March 31, 2021 was $963.4 million and our total cash and cash equivalents were $238.0 million. Our total indebtedness at March 31, 2021 includes $218.5 million of finance lease obligations for dark fiber under long-term IRU agreements.
Summarized Financial Information of Holdings
Holdings is not a restricted subsidiary as defined under the indentures governing our 2022 Notes and our 2024 Notes. Holdings is a guarantor under these 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 three months ended March 31, 2021 is detailed below (in thousands).
March 31, 2021
(Unaudited)
Cash and cash equivalents
$
59,228
Accrued interest receivable
1
Total assets
$
59,229
Investment from subsidiaries
$
211,721
Common stock
48
Accumulated deficit
(152,540)
Total equity
$
59,229
Three Months
Ended
March 31, 2021
(Unaudited)
Equity‑based compensation expense
(7,832)
Interest income
27
Net loss
$
(7,805)
Common Stock Buyback Program
Our Board of Directors has approved purchases of our common stock under a buyback program (the “Buyback Program”). There were no purchases of our common stock in the three months ended March 31, 2021 and 2020. As of March 31, 2021, there was a total of $30.4 million available under the Buyback Program which is authorized to continue through December 31, 2021.
Dividends on Common Stock and Return of Capital Program
On April 28, 2021, our Board of Directors approved the payment of our quarterly dividend of $0.78 per common share. This estimated $35.9 million dividend payment is expected to be made on May 28, 2021.
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 3 of our interim condensed consolidated financial statements for additional discussion of limitations on distributions.
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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 and refinancing strategy related to our 2022 Notes discussed below.
Our remaining $329.1 million of 2022 Notes mature in March 2022. On April 6, 2021 we issued a notice of conditional partial redemption for $45.0 million of our 2022 Notes. Subject to the satisfaction of conditions precedent stated therein, we will redeem the $45.0 million of 2022 Notes on May 6, 2021. The notes will be redeemed at par plus the "make-whole amount" as defined in the 2022 Notes indenture of $41.41533 per $1,000 aggregate principal amount plus accrued interest up to the redemption date of $9.70486 per aggregate principal amount. Following this $45.0 million redemption there will be $284.1 million of our 2022 Notes remaining. In May 2021, we anticipate refinancing the remaining $284.1 million of our 2022 Notes and raising additional debt at an interest rate below the 5.375% rate on our 2022 Notes.
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 risks that could arise if we had engaged in these relationships.
Impact of COVID-19 on Our Liquidity and Operating Performance
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. We believe we have been able to continue to operate effectively with the use of laptops, remote connectivity and the continued support of our critical support employees. Further, we severely curtailed all business travel and adopted new safety procedures for our on-site technical personnel and customers accessing our data centers. While we instituted a voluntary return to in-office presence for a small number of our offices, we expect to continue to have the vast majority of our workforce to work remotely for the foreseeable future. We believe the policies followed by our workforce and the support provided by our IT and other groups has enabled our employees to continue to perform tasks and activities that are essential for the operation of our network, our sales and marketing efforts and other support functions.
We experienced some delays with respect to the installation of new services in March and April of 2020 when certain multi-tenant office buildings were closed to our personnel. We worked with local authorities and building owners to categorize our employees as essential workers who need priority access to buildings. We believe that our disruption in access to buildings was effectively mitigated throughout our second and third quarters of 2020.
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In April and May 2020, we waived late fees for customers who were unable to pay their bills due to the pandemic. We have not encountered any material change in the payment profile of our customers or seen any significant increase in customer turnover since the beginning of the pandemic. There can be no assurance that we will continue to experience normal operations as economic dislocations may adversely affect our customers and may lead to higher customer turnover, bad debt expense and lower revenue and profitability.
We continue to operate with a high level of liquidity and as of March 31, 2021 we had cash and cash equivalents of approximately $238.0 million. 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. As a result, we experienced a slowdown in new sales to our corporate customers which negatively impacted our corporate revenue growth. 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 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.
Shortly after COVID-19 began its rapid spread around the world, domestic and worldwide capital markets ceased operating 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.
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.
Critical Accounting Policies and Significant Estimates
Management believes that as of March 31, 2021, there have been no material changes to our critical accounting policies and significant estimates from those listed in Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our annual report on Form 10-K for the year ended December 31, 2020.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Management believes that as of March 31, 2021, there have been no material changes to our exposures to market risk from those disclosed in Item 7A “Quantitative and Qualitative Disclosures About Market Risk,” of our annual report on Form 10-K for the year ended December 31, 2020.
Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.