Cogent Communications Holdings, Inc. — Q2 2019 Form 10-Q
Reporting period: Three and six months ended June 30, 2019. Unaudited interim results; dollar amounts below are in millions unless stated otherwise. Cogent provides Internet access, private network and data-center colocation services across North America and international markets.
Financial performance
| Metric | Q2 2019 | Q2 2018 | First half 2019 | First half 2018 |
|---|---|---|---|---|
| Service revenue | $134.8 | $129.3 | $268.9 | $258.0 |
| Operating income | $22.0 | $21.4 | $46.4 | $42.0 |
| Net income | $7.1 | $6.6 | $16.4 | $13.3 |
| Diluted EPS | $0.16 | $0.14 | $0.36 | $0.29 |
| Operating margin | 16.3% | 16.5% | 17.3% | 16.3% |
| Net margin | 5.3% | 5.1% | 6.1% | 5.2% |
Q2 revenue rose 4.2%; operating income rose 3.1% and net income rose 8.9%. For the first half, revenue increased 4.2%, operating income 10.6% and net income 22.6%. SG&A increased 14.4% in Q2 and 10.7% for the first half, while Q2 interest expense increased 9.9%.
Cash flow and liquidity: First-half operating cash flow was $69.3 million, compared with $61.5 million a year earlier; capital expenditures were $25.0 million versus $26.9 million. Operating cash flow less capital expenditures was therefore $44.3 million, up from $34.6 million. Cash and cash equivalents were $409.3 million at June 30, up from $276.1 million at year-end 2018. Current assets were $486.0 million and current liabilities $90.2 million.
Debt and equity: Reported total indebtedness was $967.9 million, including $168.2 million of finance lease obligations; cash was $409.3 million. In June, Cogent issued €135 million of 4.375% senior unsecured notes due 2024, receiving approximately $152.1 million net proceeds. Stockholders’ deficit was $176.6 million. First-half dividends paid were $54.3 million, and dividends declared were $1.18 per share.
Material changes and operating trends
- On-net revenue grew 4.8% in Q2 and 5.0% in the first half; off-net revenue grew 3.0% and 2.5%, respectively. On-net connections increased 10.7% year over year to 72,415, and off-net connections increased 8.0% to 11,321.
- Pricing and revenue mix are key pressures: average price per megabit fell 27.1% in Q2 and 26.1% in the first half. On-net ARPU decreased 6.0% in Q2; off-net ARPU decreased 5.0%. Corporate revenue grew, while net-centric revenue declined 7.7% in Q2 and 7.6% for the first half.
- Management attributed growth to sales-force expansion, network expansion, more connected buildings and customer penetration. Network operations expense was nearly flat in Q2 and down 0.6% for the first half, while SG&A rose with staffing and sales investment. Sales-force headcount was 656 versus 566 a year earlier; total headcount was 1,026 versus 917.
- Cogent adopted lease accounting on January 1, 2019, recording $97.3 million of right-of-use assets and operating lease liabilities. This changed balance-sheet presentation; the filing says operating lease liabilities are excluded from the indenture leverage calculations.
Outlook, risks and contingencies
- Management expects average price per megabit to continue declining at similar rates and expects corporate revenue to make up a greater share of total revenue. It anticipates adding a similar number of on-net buildings for the next several years.
- Management believes cash on hand and operating cash flow will cover working capital, capital expenditures, debt service and dividends for the next 12 months, provided the company executes its business plan. This is not a quantified earnings or revenue forecast.
- The consolidated leverage ratio was above 4.25 at June 30, 2019, a threshold relevant to indenture limits on dividends and other restricted payments. The company reported $166.9 million permitted for investment payments, including dividends and stock purchases, subject to indenture terms.
- Management identifies risks including competition and price declines, foreign-exchange movements, customer and traffic growth, peering arrangements, reliance on third-party fiber and Cisco equipment, network disruption, regulation, and debt service or refinancing. Foreign exchange reduced first-half revenue by approximately $3.6 million.
- Potential losses on leased-circuit positions could reach $3.0 million above amounts accrued. A Spanish arbitration involves a former fiber provider’s approximately $9 million termination claim, which the company says it accrued in 2015 and is contesting. Management does not expect ordinary-course legal matters to materially affect results, but outcomes are uncertain.
- After quarter-end, the board approved a $0.62-per-share dividend, estimated at $28.1 million, payable September 9, 2019. The buyback program had $34.9 million remaining through December 31, 2019; no shares were repurchased in the quarter.
Important facts for investors to verify
- Whether customer and connection growth can offset continuing per-megabit price declines, particularly in net-centric services.
- The drivers and sustainability of higher SG&A, interest expense and net-income growth, including the effect of the 2024 euro-denominated notes and foreign exchange.
- Debt and lease obligations, covenant restrictions, permitted distributions, and the company’s capacity to fund dividends, network investment and maturities.
- Actual capital spending, operating cash generation and customer/building additions against management’s stated plans.
- Developments in the Spanish arbitration, leased-circuit exposure and other legal contingencies.