Cogent Communications Holdings, Inc. — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017; balance-sheet comparisons are to December 31, 2016. Cogent provides IP connectivity and Internet services, primarily to businesses, communications providers, and bandwidth-intensive organizations in North America and Europe.
Financial results and position
| Metric | Q1 2017 | Q1 2016 / prior period |
|---|---|---|
| Service revenue | $117.2 million | $108.3 million; up 8.2% |
| Operating income | $18.7 million | $15.7 million |
| Operating margin | 15.9% | 14.5% |
| Net income | $4.1 million | $3.4 million |
| Diluted EPS | $0.09 | $0.08 |
| Operating cash flow | $23.5 million | $27.6 million |
| Capital expenditures | $12.2 million | $15.0 million |
| Cash and cash equivalents | $263.2 million | $274.3 million at Dec. 31, 2016 |
| Total indebtedness | $718.0 million, including $145.1 million of capital lease obligations | Not provided as a comparable figure |
Revenue growth reflected increases in both on-net revenue (6.2%) and off-net revenue (13.7%). Corporate-customer revenue rose 12.0%; net-centric-customer revenue rose 2.6%. The company declared dividends of $0.42 per share during the quarter and paid $19.0 million in dividends. Total liabilities were $796.3 million and stockholders’ deficit was $63.6 million at quarter-end.
Changes and operating trends
- On-net connections increased 16.0% year over year to 54,805; off-net connections increased 18.3% to 9,055. The network reached 2,406 buildings, versus 2,271 a year earlier.
- Growth in connections outpaced revenue growth as on-net ARPU fell 8.5% and off-net ARPU fell 3.8%. Average price per megabit for the installed base declined 18.7%, reflecting pricing discounts and lower prices, particularly for on-net net-centric customers.
- Operating expenses increased: network operations by 7.2% and SG&A by 6.5%. Interest expense rose 18.1%, primarily following the December 2016 issuance of $125 million of additional secured notes. Income-tax provision increased to $3.5 million from $2.4 million.
- Net cash decreased during the quarter. The cash-flow statement reports a decrease of $11.1 million; the MD&A cash-flow table instead states $11.2 million, an apparent inconsistency.
Outlook, risks, and notable items
- Management says cash on hand and operating cash flow are expected to cover working capital, capital expenditures, debt service, dividends, and other requirements for the next 12 months, assuming execution of the business plan. Additional financing may be needed for acquisitions or significant unplanned needs; availability and terms are not assured.
- Management identifies continued Internet traffic growth and network utilization as opportunities, while warning that declining prices per megabit may constrain revenue growth and profitability. Other cited risks include competition, foreign-exchange movements, customer retention, peering arrangements, third-party fiber dependence, network disruptions, regulation, and equipment-vendor issues.
- The company’s consolidated leverage ratio was above 4.25 at March 31, 2017. The indentures restrict certain dividends and stock purchases above that threshold, subject to permitted amounts; $128.8 million was available for specified investment payments, including dividends and stock purchases.
- A proposed approximately $3.1 million settlement of one remaining former-employee wage case was accrued at quarter-end and remains subject to court approval and individual opt-outs. The company also disclosed a reasonably possible loss of up to $2.4 million above the amount accrued for leased-circuit matters.
- The board approved a $0.44-per-share second-quarter dividend, estimated at $19.7 million, payable June 2, 2017. The company expects the new lease-accounting standard to result in material right-of-use assets and lease liabilities; it had not quantified the impact. Adoption of the new revenue standard was expected to have no material effect on total service revenue or operating income, although installation-fee recognition and commission-cost accounting will change.
Important facts for investors to verify
- Reconcile the $11.1 million cash decrease in the cash-flow statement with the $11.2 million figure in MD&A.
- Monitor whether connection growth and network expansion can offset declining ARPU and per-megabit pricing while preserving margins and cash generation.
- Review debt service, lease obligations, leverage-related distribution limits, and the sustainability of dividends against cash flow and capital needs.
- Track court approval and potential opt-outs from the $3.1 million settlement, and developments in leased-circuit and other legal matters.
- Assess the eventual balance-sheet impact of lease-standard adoption and the effects of revenue-standard changes to installation fees and commission costs.