Cogent Communications Holdings, Inc. — Q3 2017 Form 10-Q
Business and period: Facilities-based provider of high-speed Internet access and IP communications services, primarily to businesses and bandwidth-intensive customers in North America, Europe and Asia. This unaudited filing covers the quarter and nine months ended September 30, 2017; comparisons are with the corresponding 2016 periods. Amounts below are in U.S. dollars.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Service revenue | $123.0 million | $113.1 million | $359.9 million | $331.3 million |
| Operating income | $17.7 million | $16.1 million | $55.4 million | $49.2 million |
| Net income | $3.7 million | $3.5 million | $12.1 million | $11.0 million |
| Diluted EPS | $0.08 | $0.08 | $0.27 | $0.25 |
| Operating margin | 14.4% | 14.2% | 15.4% | 14.9% |
Margins are calculated from reported figures. Service revenue grew 8.8% in Q3 and 8.6% for the nine-month period. Operating income rose 10.3% and 12.5%, respectively; net income increased 5.5% and 9.7%. Interest expense rose 24.0% in Q3 and 20.0% year to date, primarily reflecting $125 million of senior secured notes issued in December 2016. Nine-month gains on equipment transactions were $3.5 million, down from $7.1 million in 2016.
Revenue and operating trends: Q3 on-net revenue grew 7.4% and off-net revenue 12.6%; customer connections increased 16.2% on-net and 17.7% off-net year over year. Growth in connections outpaced revenue as ARPU declined 7.6% on-net and 4.1% off-net. Average price per megabit for the installed base fell 15.7%. Management attributed pricing pressure partly to volume and term discounts and lower pricing, particularly for net-centric services. Corporate customers supplied 62.2% of Q3 revenue; net-centric customers supplied 37.8%.
Q3 network operations expense increased 9.7% and SG&A increased 9.5%, reflecting network expansion, off-net service costs, and higher staffing and sales investment. Sales headcount rose 9.5% and total headcount 7.1% year over year. The filing does not present a gross-margin measure.
Cash flow, liquidity and debt
- Nine-month operating cash flow was $80.3 million, compared with $74.1 million; capital expenditures were $35.2 million, compared with $38.0 million.
- Financing cash outflow was $72.3 million, including $59.8 million of dividends, $9.4 million of capital-lease principal payments and $1.8 million of share repurchases. Cash declined $23.6 million to $250.8 million from year-end 2016.
- At September 30, cash was $250.8 million and current liabilities were $73.6 million. Reported total indebtedness was $728.5 million, including $154.3 million of capital-lease obligations; it comprised $375.0 million of secured notes, $189.2 million of unsecured notes, lease obligations and installment-payment obligations.
- The company reported a stockholders’ deficit of $80.1 million. Its indenture-defined consolidated leverage ratio exceeded 4.25; $86.1 million remained permitted for investment payments, including dividends and stock purchases. The indentures restrict certain distributions.
Outlook, risks and notable items
- Management said cash on hand and operating cash generation should be adequate for working capital, capital expenditures, debt service and dividends over the next 12 months, assuming execution of its business plan. Additional financing could be needed for acquisitions or significant unplanned requirements; availability and terms are not assured.
- The Board approved a $0.48-per-share fourth-quarter 2017 dividend, estimated at $21.5 million, payable December 4, 2017. Future dividends and repurchases are discretionary and subject to cash needs, legal and indenture limits. $41.5 million remained under the buyback authorization; no shares were repurchased in Q3 2017.
- A dispute over terminated Spanish IRU capital leases had an $8.9 million estimated liability accrued in current liabilities and was in arbitration. A separate leased-circuit position could result in up to $2.6 million of losses beyond the amount accrued. The $3.1 million settlement of a former-sales-employees case, accrued in 2016, was paid in October 2017.
- Key stated risks include competition and declining per-megabit prices, customer and traffic growth, foreign exchange, dependence on third-party fiber and Cisco equipment, network disruptions, regulation, and litigation. Management expects European operations to continue incurring losses until sufficient scale is achieved.
- ASU 2014-09 revenue guidance was expected to take effect January 1, 2018; the company anticipated no material impact to total revenue or operating income, but installation-fee recognition and capitalization of certain sales commissions would change. Lease accounting guidance effective in 2019 was expected to create material right-of-use assets and lease liabilities; impact had not been quantified.
Important facts for investors to verify
- Whether customer and revenue growth can offset falling ARPU and per-megabit pricing, while preserving margins.
- Debt service, capital-lease and dividend cash demands, and the effect of leverage-related indenture restrictions on future capital returns.
- Developments and ultimate costs in the Spanish arbitration and other disclosed contingencies.
- Actual cash requirements from network expansion and the implementation effects of new revenue and lease accounting standards.