Business context and reporting period
Cogent Communications Holdings, Inc. filed this Form 10-K for the fiscal year ended December 31, 2015. The company provides IP-based Internet access and communications services to business, carrier and bandwidth-intensive customers, primarily in North America and Europe. Its network includes on-net facilities and off-net connections using other carriers’ “last mile” infrastructure.
Financial performance and position
Amounts below are in millions of dollars except per-share data, percentages and where otherwise noted.
| Metric | 2015 | 2014 |
|---|---|---|
| Service revenue | $404.2 | $380.0 |
| Operating income | $53.0 | $53.9 |
| Net income | $4.9 | $0.8 |
| Operating cash flow | $83.8 | $73.0 |
| Capital expenditures | $35.6 | $60.0 |
| Cash and cash equivalents at year-end | $203.6 | $287.8 |
| Total assets | $662.8 | $754.9 |
| Total indebtedness reported by management | $607.2 | Not clearly stated on the same basis |
| Stockholders’ equity (deficit) | $(12.3) | $83.8 |
Revenue grew 6.4%. Operating margin was approximately 13.1%, down from 14.2%; net margin was approximately 1.2%, up from 0.2%. Operating cash flow less property and equipment purchases was approximately $48.2 million. Cash declined $84.2 million during 2015. Year-end current assets were $251.3 million and current liabilities $68.9 million, implying a current ratio of approximately 3.6.
On-net revenue increased 4.6% to $294.8 million; off-net revenue rose 11.9% to $108.4 million; non-core revenue fell 20.7% to $1.0 million. Year-end customer connections increased 14.3% on-net and 19.8% off-net. Average revenue per unit fell 8.7% on-net and 6.5% off-net; average price per megabit fell 19.1%.
Material changes versus comparable periods
- Revenue growth was slower than in 2014, when it increased 9.2%. Management attributed 2015 growth in part to more corporate customers; foreign exchange reduced the reported revenue increase by approximately $16.6 million.
- Operating income edged down despite higher revenue, as network operations costs rose 9.1% and SG&A rose 5.0%. Lower equipment-exchange gains also affected the comparison.
- Interest expense fell 17.3% to $41.3 million after refinancing higher-rate notes and repaying convertible notes. The company issued $250 million of 5.375% secured notes due 2022 and redeemed $240 million of 8.375% notes due 2018, recording a $10.1 million extinguishment loss.
- Net income increased to $4.9 million, but included unusual gains of $11.6 million on capital-lease terminations and $5.4 million on equipment transactions. Income tax expense was $7.8 million.
- Operating cash flow rose to $83.8 million while capital expenditures declined to $35.6 million. Financing cash use was $128.8 million, including $66.3 million in dividends, $39.4 million in share repurchases, capital-lease principal payments and the note redemption.
- The company reported a $12.3 million stockholders’ deficit at year-end, compared with positive equity of $83.8 million a year earlier.
Outlook, commentary, risks and unusual items
- No specific revenue or earnings guidance is provided. Management said cash on hand and operating cash generation should cover working capital, capital expenditures, debt service and other needs for the next 12 months, conditional on execution of its business plan.
- Management’s strategy is to grow on-net customers and connected buildings, increase network utilization and pursue selective acquisitions. It noted that falling prices per megabit may pressure revenue growth and profitability, and that foreign operations in Europe continue to incur losses while seeking scale.
- Key operating risks include maintaining settlement-free peering and adequate interconnection capacity, competition and pricing pressure, dependence on third-party dark-fiber providers and Cisco equipment, network outages or cyberattacks, and access agreements for buildings and data centers. The filing describes congestion affecting traffic in Europe; U.S. congestion had been alleviated through agreements with most major carriers, but commitments may not keep pace with traffic.
- Debt totaled $607.2 million, including $136.0 million of dark-fiber capital-lease obligations. Debt covenants restrict dividends, repurchases, additional debt and other actions. The company’s leverage ratio was above 4.25, limiting additional permitted distributions; the board suspended the $12 million quarterly minimum under its capital-return program in November 2015. Regular dividends remain discretionary.
- Tax attributes include $446.1 million of U.S. net operating losses, of which $286.1 million were unavailable and $80.6 million limited under Section 382, plus $735.7 million outside the U.S. The company reported $45.1 million of net deferred tax assets after valuation allowance.
- Management disclosed a California wage-and-hour class and collective action, provisionally certified in January 2016, which the company is appealing and disputes. Certain leased-circuit and dark-fiber positions could result in up to $2.4 million of losses beyond amounts accrued. Management did not expect ordinary-course claims to materially affect results.
- Other items to note: related-party headquarters leases with an entity owned by the CEO and his wife; $21.2 million outstanding under a vendor equipment installment agreement at year-end; and a planned $15.9 million first-quarter 2016 dividend at $0.36 per share. The auditor issued unqualified opinions on the financial statements and internal controls.
Important facts for investors to verify
- Whether customer and traffic growth can offset declining ARPU and price per megabit, particularly in net-centric services.
- Whether cash generation can sustain network investment and debt service while supporting regular dividends; verify covenant headroom and the status of the suspended capital-return program.
- The sustainability of reported earnings after excluding lease-termination and equipment-exchange gains and the debt-redemption loss.
- Progress in Europe, including revenue trends, foreign-exchange exposure and resolution of interconnection congestion.
- Developments in the California wage-and-hour litigation, other contingencies and Section 382 limitations on tax-loss utilization.
- Terms and governance oversight of the CEO-related headquarters lease, and the company’s ongoing dependence on Cisco and third-party fiber providers.