Cogent Communications Holdings, Inc. — 2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018; filed February 22, 2019. The company provides business Internet access, private-network and colocation services over its facilities-based network. This is an annual filing, with unaudited fourth-quarter results also presented.
Financial performance and liquidity
| Metric | 2018 | 2017 | Change |
|---|---|---|---|
| Service revenue | $520.2 million | $485.2 million | +7.2% |
| Operating income | $86.6 million | $75.9 million | +14.0% |
| Operating margin | 16.6% | 15.6% | +1.0 percentage point |
| Net income | $28.7 million | $5.9 million | Improved |
| Net margin | 5.5% | 1.2% | Improved |
| Operating cash flow | $133.9 million | $111.7 million | +19.9% |
| Capital expenditures | $49.9 million | $45.8 million | +9.0% |
Revenue growth was led by corporate customers: revenue increased 11.8% to $337.8 million, while net-centric revenue declined 0.4% to $182.3 million. On-net revenue rose 8.1% and off-net revenue 5.2%. End-of-year connections grew 12.1% on-net and 10.3% off-net, but average revenue per unit fell 5.1% and 6.8%, respectively. Average price per megabit declined 25.9% to $0.82.
Fourth-quarter 2018 revenue was $132.0 million, operating income $22.3 million and net income $7.1 million. Fourth-quarter 2017 included a $6.2 million net loss, which the filing attributes in part to higher tax expense.
Cash and cash equivalents were $276.1 million at year-end, versus $247.0 million in 2017. Current assets were $350.3 million and current liabilities $75.3 million. Total debt at par, including capital leases and an installment agreement, was $809.2 million; this included $445.0 million of 5.375% secured notes due 2022, $189.2 million of 5.625% unsecured notes due 2021, and $163.8 million of capital lease obligations. Interest expense was $51.1 million. Stockholders’ deficit was $149.0 million.
Operating cash flow less property and equipment purchases was approximately $84.0 million. Cash dividends paid were $97.9 million, and the company also repurchased $6.6 million of stock. Management said cash on hand and operating cash generation should cover expected requirements for the next 12 months if the business plan is executed.
Material changes and unusual items
- Operating income increased faster than revenue, while operating expenses rose 5.2% overall. Network operations costs increased 4.9%; SG&A increased 4.6% and included $16.8 million of equity compensation.
- Net income rose partly because income tax expense fell to $12.7 million from $25.2 million in 2017. The prior-year amount included approximately $11.3 million of additional noncash expense related to the Tax Cuts and Jobs Act.
- In August 2018, the company issued $70.0 million of additional secured notes due 2022, receiving net proceeds of $69.9 million. Interest expense increased 5.3% year over year.
- Adoption of ASC 606 increased opening retained earnings by $14.5 million and capitalized customer contract costs. For 2018, the company reported net income of $28.7 million versus $27.3 million without the new standard; adoption had no net impact on operating cash flow.
- Foreign currency translation reduced 2018 comprehensive income by $6.3 million. Foreign operations represented 23% of consolidated revenue; management estimated a 1% exchange-rate change would affect annual revenue by about $1.0 million.
Outlook, risks and contingencies
Management’s strategy is to add customers and buildings to its network, increase network utilization and grow on-net services, which it says generally carry higher gross margins. The filing provides no specific revenue, earnings or cash-flow guidance. Management expects continued declines in average price per megabit and cautions that revenue growth depends on traffic growth offsetting price reductions. The company began offering SD-WAN service in the second quarter of 2018.
- Leverage and distributions: Debt covenants restrict additional borrowing and dividends or stock repurchases. The company’s indenture-defined leverage ratio was above 4.25 at year-end; $131.3 million remained permitted for specified investment payments, including dividends and repurchases. The board approved a $0.58-per-share first-quarter 2019 dividend.
- Network dependencies: Much of the network uses third-party fiber under long-term IRUs, and Cisco supplies most network equipment. The company exercised a renewal right for a large portion of its U.S. intercity fiber lease due for renewal in 2020, but the fiber owner could abandon the fiber.
- Competition and interconnection: Price pressure is particularly acute in net-centric markets. The filing cites peering-capacity concerns, including Deutsche Telekom’s continued limits on interconnection capacity, and notes that changes to U.S. net-neutrality rules could affect carrier interconnection arrangements.
- Contingencies: The company disclosed possible losses of up to $2.9 million above accruals on disputed leased-circuit obligations. In a Spanish arbitration, a former fiber provider seeks approximately $9 million; the company accrued this amount in 2015 and is contesting the claim. Management does not expect ordinary-course legal matters to have a material effect.
- Accounting and tax: The company estimated that adopting the new lease standard in 2019 would add approximately $97 million of right-of-use assets and lease liabilities. Certain U.S. net operating losses are subject to Section 382 limits.
Ernst & Young issued unqualified opinions on the financial statements and internal control over financial reporting.
Key facts for investors to verify
- Whether growth in customer connections and traffic continues to offset falling per-megabit prices, especially given the decline in net-centric revenue.
- Cash generation relative to dividends, capital spending and debt service, and the practical effect of covenant limits on future capital returns.
- Refinancing plans and capacity for the 2021 and 2022 note maturities, alongside capital-lease and other contractual commitments.
- Progress on renewing the U.S. fiber lease due in 2020 and the status of peering capacity and the Spanish arbitration.
- The actual balance-sheet and disclosure effects of adopting lease accounting in 2019, and the realization and usability of deferred tax assets and net operating losses.