Cogent Communications Holdings, Inc. — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018. Financial statements are unaudited. Cogent provides Internet access, private network and data-center colocation services, primarily in North America, Europe and Asia.
Financial performance
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Service revenue | $128.7 million | $117.2 million | +9.8% |
| Operating income | $20.6 million | $18.7 million | +10.6% |
| Net income | $6.8 million | $4.1 million | +64.0% |
| Diluted earnings per share | $0.15 | $0.09 | — |
| Cash provided by operating activities | $30.2 million | $23.5 million | — |
| Capital expenditures | $14.9 million | $12.2 million | — |
Operating margin was approximately 16.0%, versus 15.9% a year earlier; net margin was approximately 5.3%, versus 3.5%. Revenue increased across on-net and off-net services: on-net revenue rose 10.5% to $92.4 million and off-net revenue rose 8.3% to $36.1 million. On-net connections grew 15.6% and off-net connections 13.1%, while on-net and off-net average revenue per unit declined 4.6% and 5.4%, respectively. Average price per megabit for the installed base fell 24.5%.
Cash and cash equivalents were $236.0 million at March 31, down from $247.0 million at year-end. Current assets were $307.5 million and current liabilities $74.5 million. Cash flow after capital expenditures was $15.3 million; dividends paid were $22.8 million. Total indebtedness was reported as $733.5 million, including $157.9 million of capital lease obligations. The company had $189.2 million of 5.625% senior notes due 2021 and $375.0 million of 5.375% senior secured notes due 2022. Stockholders’ deficit was $97.1 million.
Changes versus the prior comparable period
- Revenue growth was accompanied by higher network operations expense (+8.3%), SG&A (+6.6%) and depreciation and amortization (+6.7%).
- Net income benefited from higher operating income and a lower income tax provision ($3.1 million versus $3.5 million), partly reflecting the U.S. corporate tax rate reduction. Interest expense increased 4.3% to $12.4 million.
- Equipment transaction gains declined to $0.1 million from $2.1 million, making the reported income improvement notable despite a smaller gain contribution.
- Operating cash flow increased to $30.2 million from $23.5 million; investing and financing cash outflows were $14.9 million and $26.8 million, respectively.
Outlook, accounting, risks and contingencies
- Management said cash on hand and operating cash generation should cover working capital, capital expenditures, debt service, dividends and other requirements for the next 12 months if the business plan is executed. No quantified revenue or earnings guidance was provided.
- Cogent planned to begin offering SDWAN service in Q2 2018. Its stated growth priorities include adding customers and buildings to its network, expanding sales efforts and investing in network capacity. Management noted that declining prices per megabit may constrain revenue and profitability growth.
- ASC 606 was adopted January 1, 2018 using the modified retrospective method. Adoption increased reported Q1 operating income by about $1.0 million and net income by about $1.0 million versus balances without adoption; it created customer contract cost assets, and had no net effect on operating cash flow. Prior-year results were not restated.
- Leverage under the debt indentures exceeded 4.25 at quarter-end, a threshold relevant to restrictions on dividends and stock repurchases. The filing said $41.5 million was permitted for investment payments, including dividends and repurchases; the separate buyback authorization also had approximately $41.5 million remaining. No shares were repurchased in Q1. A $0.52-per-share Q2 dividend was declared after quarter-end, estimated at $23.4 million.
- A Spanish arbitration concerns a former fiber provider’s approximately $9 million early-termination claim, accrued in 2015 and contested by Cogent. Other leased-circuit positions could result in up to $2.7 million of loss beyond amounts accrued. The company said ordinary-course claims were not expected to materially affect results, but outcomes are uncertain.
- Management expects adoption of the new lease standard in 2019 to result in a material right-of-use asset and lease liability; the impact had not yet been quantified. Tax Act accounting remained provisional and could be adjusted during 2018.
- Risks cited include competition and price declines, customer and traffic growth, peering terms, reliance on Cisco equipment and third-party fiber, network disruptions, regulation, foreign-exchange movements, expansion costs and litigation.
Important facts for investors to verify
- Whether connection growth and traffic gains can offset declining ARPU and per-megabit pricing.
- How much reported growth reflects foreign exchange (approximately $3.3 million of Q1 revenue uplift) and the ASC 606 accounting change.
- Cash generation relative to capital spending, dividends and debt obligations, and the practical effect of indenture restrictions on future shareholder returns.
- The eventual balance-sheet effect of lease-accounting adoption and any changes to provisional tax accounting.
- Developments in the Spanish arbitration and potential leased-circuit losses, as well as execution and commercial results for the planned SDWAN launch.