Cogent Communications Holdings, Inc. — Q2 2014 Form 10-Q
Reporting period: Three and six months ended June 30, 2014; comparisons are with the corresponding 2013 periods. Financial figures below are in U.S. dollars and rounded to millions unless noted. The statements are unaudited. Cogent Communications Group reorganized under new parent Cogent Communications Holdings on May 15, 2014; the filing says operations and customers were unaffected and historical statements reflect the reorganization.
Financial performance
| Metric | Q2 2014 | Q2 2013 | H1 2014 | H1 2013 |
|---|---|---|---|---|
| Service revenue | $94.6M | $85.8M | $187.6M | $170.4M |
| Operating income | $14.3M | $11.6M | $27.2M | $21.5M |
| Net income | $1.2M | $1.6M | $1.3M | $2.0M |
| Operating margin | 15.1% | 13.5% | 14.5% | 12.6% |
| Net margin | 1.3% | 1.9% | 0.7% | 1.2% |
| Operating cash flow | Not presented by quarter | Not presented by quarter | $39.0M | $37.7M |
- Q2 revenue increased 10.3%; H1 revenue increased 10.1%. On-net revenue grew 12.3% in Q2 and 12.2% in H1, while off-net revenue grew 5.6% and 5.4%, respectively. Non-core revenue declined.
- Operating expenses rose more slowly than revenue overall, but SG&A increased 23.1% in Q2 and 22.8% in H1, and depreciation and amortization rose about 9%. Operating income improved, while higher interest costs contributed to lower net income.
- Q2 interest expense was $13.8M, up 35.0%; H1 interest expense was $25.1M, up 24.9%. Q2 included a $0.4M tax benefit; H1 tax expense was $1.2M.
- H1 investing cash outflow was $31.5M, principally $31.6M of property and equipment purchases, versus $28.8M of purchases in H1 2013. Approximate H1 operating cash flow less property and equipment purchases was $7.4M, before financing and other items.
- Cash and cash equivalents were $349.8M at June 30, up from $304.9M at year-end 2013. Current assets were $405.8M and current liabilities $60.1M.
Debt, capital allocation, and material changes
- Total indebtedness was reported as $604.2M, including $164.2M of capital lease obligations. Cash of $349.8M implies net indebtedness of approximately $254.4M. These are reported/derived figures; debt definitions and carrying amounts should be checked against the debt notes.
- Cogent issued $200M of 5.625% senior unsecured notes due 2021, receiving $195.8M net proceeds, and repaid the remaining $92.0M principal of its convertible notes in June. The existing senior secured notes carry an 8.375% coupon and mature in 2018. The unsecured notes are effectively subordinated to secured debt and subject to indenture covenants.
- H1 financing included $26.2M of dividends paid, $32.1M of share repurchases, $8.1M of capital lease principal payments, and the note refinancing. The board approved an additional $50M buyback authorization in August; $59.3M was then available under the program. A $0.30-per-share Q3 2014 regular dividend was declared after quarter-end.
- In Q2, equipment-exchange transactions generated a $2.7M gain; H1 gains were $5.0M. These gains reduced reported operating expenses and are an unusual item to distinguish from ongoing operating performance.
Management commentary, outlook, and risks
- Management emphasized network expansion, adding on-net buildings and customers, and growing sales capacity. At June 30, the company served 2,057 on-net buildings and had 37,411 on-net and 5,486 off-net customer connections. Sales-force headcount increased 28% year over year to 446.
- Connection growth exceeded revenue growth in part because average revenue per unit declined: Q2 on-net ARPU fell 4.3%, off-net ARPU fell 8.3%, and average price per megabit for the installed base fell 24.8%. Management cited volume and term discounts, lower pricing, and higher ARPU among customers that churned than among new customers.
- Management expects non-core service revenue to continue declining and stated that European operations continue to incur losses until scale is achieved. It believes cash on hand and operating cash generation will meet working-capital, capital expenditure, debt-service, and shareholder-return needs if the business plan is executed; this is not a quantified earnings or revenue forecast.
- Key disclosed risks include pricing pressure and competition, the need for traffic and customer growth to offset falling per-megabit prices, customer retention, peering arrangements, reliance on Cisco equipment and third-party fiber, network disruptions, foreign exchange, regulation, and execution of expansion plans. The filing provides no specific numeric operating guidance.
- Approximately 70 former sales employees filed individual suits after a collective action was decertified; the company denies the claims. Separately, leased-circuit and dark-fiber positions could produce up to $2.0M of loss above amounts accrued. Management said other routine claims are not expected to have a material impact.
- After quarter-end, the CEO’s employment agreement was extended through 2018; cash salary ends January 1, 2015, with potential annual bonuses up to $500,000 tied to stated revenue-growth and adjusted-EBITDA-growth targets. The CEO also received restricted-stock awards totaling 460,000 shares, subject to vesting.
Most important facts for investors to verify
- Whether customer and traffic growth can offset continuing price-per-megabit and ARPU declines, while preserving margins.
- The sustainability and cash cost of dividends and buybacks alongside network investment, capital leases, and debt service.
- The precise debt and covenant position, including the distinction between principal and carrying values and the treatment of capital lease obligations.
- The recurring earnings effect excluding equipment-exchange gains, and the drivers of higher SG&A and interest expense.
- Developments in the employee litigation and the potential leased-circuit/dark-fiber exposure.
- The impact of the new revenue-recognition standard; management was still evaluating the effect and had not selected a transition method.