Cogent Communications Holdings, Inc. — Q2 2020 Form 10-Q
Business context and period. Cogent provides high-speed internet access, private network services and data-center colocation across 46 countries. This unaudited report covers the quarter and six months ended June 30, 2020; comparisons are year over year unless noted.
Financial performance
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Service revenue | $141.0 million | $134.8 million | $281.9 million | $268.9 million |
| Operating income | $27.6 million | $22.0 million | $53.4 million | $46.4 million |
| Operating margin | 19.6% | 16.3% | 19.0% | 17.3% |
| Net income | $8.6 million | $7.1 million | $17.8 million | $16.4 million |
| Diluted EPS | $0.18 | $0.16 | $0.38 | $0.36 |
| Operating cash flow | — | $69.8 million | $69.3 million | |
| Capital expenditures | — | $26.8 million | $25.0 million |
Q2 revenue grew 4.6%, operating income 25.2%, and net income 20.0%. For the first half, revenue grew 4.8%, operating income 15.1%, and net income 8.8%. First-half operating cash flow less capital expenditures was approximately $43.0 million, versus $44.3 million in 2019.
Liquidity, debt and capital returns
- Cash and cash equivalents were $417.0 million at June 30, up from $399.4 million at year-end. Current assets were $497.1 million against current liabilities of $100.1 million.
- Total indebtedness was approximately $1.1 billion at par, including $203.8 million of finance lease obligations; cash less total indebtedness was approximately $683 million. Stockholders’ deficit was $235.6 million.
- In June, Cogent issued €215 million of 4.375% notes due 2024, receiving $240.3 million net proceeds, and redeemed the $189.2 million 5.625% notes due 2021. The redemption resulted in a $0.6 million loss. The remaining notes include $445 million of 5.375% secured notes due 2022 and €350 million of unsecured notes due 2024.
- First-half dividends paid were $62.3 million, or $1.34 per share declared. The board subsequently approved a $0.705-per-share quarterly dividend, estimated at $32.2 million, payable September 4, 2020. $34.9 million remained under the buyback authorization; no shares were repurchased in the first half.
- The company reported its consolidated leverage ratio was above 4.25, a threshold relevant to debt covenant restrictions on certain distributions. It stated $165.5 million remained permitted for investment payments, including dividends and stock purchases.
Material changes and operating trends
- On-net revenue increased 6.5% in both the quarter and first half; off-net revenue was nearly flat. At quarter-end, on-net connections rose 4.8% and off-net connections 4.6% year over year.
- Corporate revenue grew faster than net-centric revenue. Management cited continuing net-centric pricing pressure: average price per megabit fell 25.1% in Q2 and 23.4% for the first half. Off-net ARPU also declined.
- Q2 network operating expense declined 1.0%, while SG&A rose 3.3%; first-half expenses increased 1.2% and 6.8%, respectively. Management attributed SG&A growth largely to staffing and sales expansion.
- Interest expense rose 14.0% in Q2 and 13.6% in the first half, mainly reflecting new notes and higher finance lease obligations. Euro-note currency movements produced a $2.5 million realized gain on issuance and a $3.4 million Q2 unrealized loss; the company does not hedge these foreign-currency obligations.
- Property and equipment purchases were $26.8 million in the first half. A July 2020 vendor agreement requires $35 million of equipment purchases annually for three years; $20 million had been ordered and $6.8 million shipped.
Outlook, risks and contingencies
Management said COVID-19’s effect on the business remained limited in Q2, though corporate sales productivity decreased; network traffic continued to grow, at a slower rate than at the end of Q1. Building-access disruptions were described as effectively mitigated during Q2. The company waived late fees in April and May and had not seen a material change in payment patterns or customer turnover, but warned that economic deterioration could increase bad debt, churn and revenue pressure.
Management stated that cash on hand and operating cash flow should cover working capital, capital spending, debt service and dividends for the next 12 months if the business plan is achieved. It planned to continue the current dividend policy while monitoring capital spending and liquidity. No specific revenue or earnings guidance was provided. Management anticipated adding a similar number of buildings annually for the next several years.
- Key risks include pandemic-related customer demand, collections, building access and supply-chain disruption; competition and declining bandwidth prices; foreign-exchange exposure; dependence on third-party fiber, key equipment suppliers and peering arrangements; and refinancing and debt-service requirements.
- Potential additional loss of up to $3.2 million on certain leased-circuit matters was reasonably possible in excess of amounts accrued. A Spanish fiber-lease arbitration seeks approximately $9.0 million, accrued in 2015; Cogent disputes the claim and counterclaimed. Management did not expect ordinary-course legal matters to materially affect results.
- Credit-loss allowance was $2.1 million at June 30; first-half net bad-debt expense was $2.3 million. The company repaid a PPP loan received in April on April 30.
Investor verification points
- Confirm the debt and lease obligations included in the approximately $1.1 billion indebtedness figure, along with upcoming maturities and covenant capacity for dividends and repurchases.
- Assess whether on-net customer growth can offset continuing net-centric price-per-megabit declines and falling off-net ARPU.
- Monitor COVID-19 effects on sales productivity, customer collections, churn, installation access and equipment availability.
- Review the foreign-exchange sensitivity of unhedged Euro notes and the outcome of the Spanish arbitration and leased-circuit exposure.
- Track execution and funding of network investment, including the new equipment-purchase commitment and announced dividend.