Cogent Communications Holdings, Inc. — Q2 2017 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2017; comparisons are with the corresponding 2016 periods. The unaudited statements cover Cogent’s facilities-based Internet access and IP communications business in North America, Europe and Asia. Dollar amounts below are in millions unless stated otherwise.
Financial performance and liquidity
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Service revenue | $119.8 | $110.0 | $237.0 | $218.2 |
| Operating income | $19.0 | $17.5 | $37.7 | $33.2 |
| Net income | $4.3 | $4.2 | $8.5 | $7.6 |
| Diluted EPS | $0.10 | $0.09 | $0.19 | $0.17 |
| Operating margin | 15.9% | 15.9% | 15.9% | 15.2% |
| Net margin | 3.6% | 3.8% | 3.6% | 3.5% |
Margins are calculated from reported revenue and income. Operating income includes equipment-transaction gains of $1.0 million in Q2 2017 versus $4.4 million in Q2 2016, and $3.1 million for the first half of 2017 versus $6.4 million in 2016.
- Revenue and operating trends: Q2 revenue grew 8.9%; first-half revenue grew 8.6%. Q2 on-net revenue rose 7.6% and off-net revenue 12.7%. Customer connections increased 16.4% on-net and 17.1% off-net year over year, while on-net ARPU fell 7.4% in Q2 and off-net ARPU fell 4.2%. Installed-base average price per megabit declined 14.3% in Q2. Management attributed the price and ARPU pressure to pricing discounts, lower prices, customer mix and foreign exchange.
- Costs and interest: Q2 network operations expense rose 6.8% and SG&A rose 6.6%; first-half increases were 7.0% and 6.6%, respectively. Interest expense increased 18.0% in Q2 and 18.1% for the first half, primarily reflecting the $125 million secured-note issuance in December 2016.
- Cash flow and investment: First-half operating cash flow was $51.6 million versus $51.3 million. Property and equipment purchases were $24.3 million versus $29.3 million; operating cash flow less these purchases was $27.3 million versus $22.0 million. Financing used $47.3 million, including $38.9 million of dividends, $1.8 million of share repurchases and $6.0 million of capital-lease principal payments. Cash declined $17.8 million to $256.5 million.
- Balance sheet and debt: At June 30, cash was $256.5 million, current assets $313.2 million and current liabilities $72.3 million. Reported total indebtedness was $723.5 million, including $149.8 million of capital-lease obligations; cash less reported indebtedness implies approximately $467.0 million of net indebtedness. Debt includes $375.0 million of 5.375% senior secured notes due 2022 and $189.2 million of 5.625% senior unsecured notes due 2021. Stockholders’ deficit was $71.2 million.
Material changes, outlook and risks
- Corporate-customer revenue grew 11.9% in both the quarter and first half; net-centric revenue grew 4.4% in Q2 and 3.5% for the first half. Foreign exchange reduced revenue by approximately $0.7 million in Q2 and $1.2 million for the first half.
- Network expansion continued: Cogent reported 2,438 on-net buildings at June 30, 2017, compared with 2,297 a year earlier. Management cited network expansion and increased sales efforts as drivers of higher operating costs and headcount.
- No specific earnings or revenue guidance is provided. Management believes cash on hand and operating cash flow should cover working capital, capital expenditures, debt service and dividends for the next 12 months if the business plan is executed. Acquisitions or other significant unplanned requirements could require new financing; availability and terms are not assured.
- Management said the debt-indentures’ consolidated leverage ratio was above 4.25 at quarter-end, a threshold restricting certain dividends and share repurchases. The filing stated $107.0 million remained permitted for investment payments, including dividends and stock purchases. The board approved a $0.46-per-share Q3 dividend, estimated at $20.6 million, payable September 1, 2017; future capital returns remain discretionary and subject to debt and legal restrictions.
- Risks cited include competition and declining per-megabit pricing, customer and traffic growth, peering arrangements, dependence on third-party fiber and Cisco equipment, network disruptions, foreign exchange, regulation and litigation. Management noted European operations continue to incur losses pending sufficient scale.
- Legal matters include a proposed approximately $3.1 million settlement of the remaining California former-sales-employee case, recorded and accrued but subject to court approval and possible opt-outs. Certain leased-circuit positions could result in losses up to $2.5 million above the amount accrued.
- Upcoming accounting changes: the company expects lease standard adoption in 2019 to create material right-of-use assets and lease liabilities; it had not quantified the balance-sheet effect. It expects revenue-standard adoption in 2018 to change installation-fee timing and require capitalization of certain commissions, while stating the effect on total revenue and operating income is not expected to be material.
Important facts for investors to verify
- Whether connection growth can offset falling ARPU and per-megabit pricing, particularly in net-centric services.
- How much operating performance depends on equipment-exchange gains and whether these gains recur at comparable levels.
- Debt-service, capital-lease and dividend demands relative to cash generation, including the leverage-related limits on capital returns.
- The outcome and final cost of the California settlement and leased-circuit contingencies.
- The eventual balance-sheet impact of lease accounting adoption and the detailed implementation effects of the revenue standard.