Cogent Communications Holdings, Inc. — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018. Unaudited consolidated results. Cogent provides Internet access, private network services and data-center colocation to business and bandwidth-intensive customers.
Key financial metrics
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Service revenue | $129.3 million | $119.8 million | $258.0 million | $237.0 million |
| Operating income | $21.4 million | $19.0 million | $42.0 million | $37.7 million |
| Net income | $6.6 million | $4.3 million | $13.3 million | $8.5 million |
| Diluted EPS | $0.14 | $0.10 | $0.29 | $0.19 |
| Operating margin | 16.5% | 15.9% | 16.3% | 15.9% |
Margins are calculated from reported revenue and operating income. Q2 interest expense was $12.4 million, up 2.3%; the six-month amount was $24.8 million, up 3.3%. Income-tax provision fell to $2.6 million for Q2 and $5.8 million for the half, primarily reflecting the U.S. corporate tax-rate reduction.
Cash flow and liquidity: Six-month operating cash flow was $61.5 million, versus $51.6 million. Capital expenditures were $26.9 million, versus $24.3 million; operating cash flow less capital expenditures was therefore $34.6 million. Dividends paid were $46.6 million, versus $38.9 million. Cash declined $22.7 million to $224.3 million. Management said cash on hand and operating cash flow should cover expected needs for the next 12 months if the business plan is executed.
Debt and balance sheet: Management reported total indebtedness of $736.5 million, including $159.9 million of capital lease obligations for dark-fiber IRUs; cash was $224.3 million. The company had $375.0 million of 5.375% secured notes due 2022 and $189.2 million of 5.625% unsecured notes due 2021. A further $12.4 million was outstanding under an equipment installment agreement. Total liabilities were $814.9 million versus assets of $700.2 million, leaving a stockholders’ deficit of $114.6 million. The filing reports current assets of $296.7 million and current liabilities of $75.0 million.
Performance changes and operating trends
- Revenue grew 7.9% in Q2 and 8.9% for the first half. Foreign-exchange translation contributed approximately $1.9 million and $5.2 million, respectively.
- On-net revenue increased 8.7% in Q2 and 9.6% year to date; off-net revenue rose 6.3% and 7.3%. At quarter-end, on-net connections were up 14.1% and off-net connections 12.3% year over year; connected buildings increased to 2,599 from 2,438.
- Average revenue per unit declined: on-net ARPU fell 5.4% in Q2 and 4.7% year to date; off-net ARPU fell 5.7% and 5.9%. Average price per megabit declined 25.4% in Q2 and 25.0% for the half. Management attributed these trends to pricing pressure, discounts and lower net-centric customer pricing.
- Corporate-customer revenue grew faster than net-centric revenue: 11.9% versus 1.4% in Q2, and 12.0% versus 3.8% for the half. Management expects average price per megabit to continue declining at similar rates, with corporate customers representing a larger share of revenue.
- Operating expenses increased alongside network expansion and customer growth. Network operations expense rose 6.4% in Q2 and 7.3% for the half; SG&A increased 6.0% and 6.3%. Depreciation and amortization rose 7.0% and 6.9%. Gains on equipment transactions were lower than in 2017.
Outlook, accounting, risks and unusual items
- No specific revenue or earnings guidance is provided. Management anticipates adding a similar number of buildings to its network for the next several years and says future capital spending will primarily support network expansion and building additions.
- Management identified continued price-per-megabit declines, competition, foreign-exchange movements, customer retention, dependence on third-party fiber and Cisco equipment, network disruptions, regulation, and economic conditions as risks. European operations continue to incur losses until sufficient scale is achieved.
- ASC 606 was adopted January 1, 2018 using the modified retrospective method. Adoption reduced opening accumulated deficit by $14.5 million and introduced capitalization of certain contract acquisition costs. It had no net effect on operating cash flow. Prior-year results were not restated, so comparisons are not fully on the same accounting basis.
- The company expects adoption of the new lease standard on January 1, 2019 to result in a material right-of-use asset and lease liability; the impact had not been quantified. The Tax Act accounting remained provisional and was expected to be completed in 2018.
- In a Spanish arbitration, a former fiber provider seeks approximately $9 million for early lease termination; the company had accrued the claim in 2015 and is contesting liability. Separately, leased-circuit positions could result in losses up to $2.7 million above the amount accrued.
- The board approved a $0.54-per-share third-quarter dividend on August 1, estimated at $24.3 million, payable August 31. The buyback program had $41.5 million remaining through December 31, 2018; no shares were repurchased in the first half of 2018. Debt indentures limit distributions.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether connection growth and network expansion can offset falling ARPU and per-megabit pricing, particularly in the net-centric customer base.
- How much reported revenue growth reflects underlying customer demand versus foreign-exchange effects, and the comparability effects of adopting ASC 606.
- Cash generation relative to capital spending, dividends, lease and debt obligations, and the planned cash transfer from operating subsidiaries to Holdings.
- The eventual balance-sheet effect of lease-standard adoption and any final adjustments to provisional Tax Act accounting.
- Developments in the Spanish arbitration and leased-circuit contingencies, along with the continuing availability of cash for dividends and buybacks under indenture restrictions.