Cogent Communications Holdings, Inc. — Q3 2018 Form 10-Q
Business and period: Facilities-based provider of Internet access, private network services and data-center colocation. This unaudited report covers the quarter and nine months ended September 30, 2018; comparisons are with the corresponding 2017 periods. Amounts below are in millions unless stated otherwise.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Service revenue | $130.1 | $123.0 | $388.1 | $359.9 |
| Operating income | $22.3 | $17.7 | $64.3 | $55.4 |
| Net income | $8.2 | $3.7 | $21.6 | $12.1 |
| Diluted EPS | $0.18 | $0.08 | $0.47 | $0.27 |
| Operating margin | 17.1% | 14.4% | 16.6% | 15.4% |
| Net margin | 6.3% | 3.0% | 5.6% | 3.4% |
Q3 revenue increased 5.8%; on-net revenue rose 6.7% and off-net revenue 3.8%. For the first nine months, revenue increased 7.8%; on-net rose 8.6% and off-net 6.1%. Operating expenses rose more slowly than revenue in both comparisons. Q3 interest expense was $12.8 million, up 4.1%; nine-month interest expense was $37.5 million, up 3.6%.
Cash flow and liquidity: For the first nine months, operating cash flow was $93.2 million, versus $80.3 million; capital spending was $39.0 million, versus $35.2 million. Dividends paid were $71.4 million, versus $59.8 million. Cash increased $37.5 million to $284.6 million. At September 30, current assets were $358.5 million and current liabilities $72.3 million.
Debt and capital: The company reported total indebtedness of $808.3 million, including $161.6 million of capital lease obligations, and cash of $284.6 million. It issued $70.0 million par value of 5.375% senior secured notes due 2022 in August, receiving $69.9 million net proceeds. Outstanding notes included $445.0 million secured notes due 2022 and $189.2 million unsecured notes due 2021. Stockholders’ deficit was $125.8 million.
Material changes and operating trends
- Customer connections at period-end increased 13.5% on-net and 10.0% off-net year over year; the network served 2,635 buildings, versus 2,472.
- Pricing pressure offset connection growth: Q3 on-net and off-net ARPU fell 6.2% and 6.6%, respectively. Average price per megabit declined 27.6% in Q3 and 25.8% for the nine-month period.
- Corporate-customer revenue grew 11.8% in Q3 and 11.9% year to date. Net-centric revenue declined 4.0% in Q3 and grew 1.2% year to date, as lower per-megabit prices offset customer growth.
- ASC 606 was adopted January 1, 2018 using the modified retrospective method. Adoption reduced accumulated deficit by $14.5 million at adoption and changed the timing of installation-fee revenue and commission expense recognition. The reported nine-month net income was $1.4 million higher than it would have been without adoption; cash flow was not affected.
- Tax provision declined to $3.2 million in Q3 and $9.0 million year to date, primarily reflecting the U.S. corporate tax rate reduction. The company said its Tax Act accounting remained provisional.
Outlook, risks and unusual items
- No formal earnings or revenue guidance is provided. Management anticipates adding a similar number of buildings annually for the next several years and expects average price per megabit to continue declining at similar rates.
- Management believes cash on hand and operating cash flow will cover working capital, capital spending, debt service and dividends for the next 12 months if it executes its business plan. Additional funding may be needed for acquisitions or significant unplanned costs; refinancing is not assured.
- The company’s indenture-defined leverage ratio exceeded 4.25 at September 30, 2018, a threshold relevant to restrictions on dividends and other restricted payments. The filing said $163.5 million was permitted for investment payments, including dividends to Holdings.
- Management estimated that adoption of the new lease standard in 2019 would add approximately $95 million of right-of-use assets and lease liabilities; the estimated lease liability is excluded from indenture leverage calculations.
- Contingencies include a Spanish arbitration over approximately $9 million of claimed early-termination charges, already accrued, which the company contests. It also disclosed reasonably possible losses of up to $2.8 million above accruals for certain leased-circuit obligations.
- Key risks identified include competition and price declines, foreign exchange, customer retention, peering arrangements, reliance on Cisco equipment and third-party fiber, network disruptions, regulation, and litigation. The company also reported a related-party headquarters lease with an entity owned by its CEO.
- On October 31, 2018, the board approved a Q4 dividend of $0.56 per share, estimated at $25.3 million. Future dividends and repurchases remain discretionary and subject to cash needs, legal and debt restrictions.
Important facts for investors to verify
- Whether customer and traffic growth can continue to offset falling ARPU and per-megabit pricing, particularly in the net-centric business.
- Debt maturities, interest costs, lease obligations and covenant capacity, including how leverage and dividend restrictions evolve.
- The sustainability of cash generation relative to capital spending and dividend payments, and the assumptions behind management’s 12-month liquidity assessment.
- The final tax effects of the Tax Act, the 2019 lease-accounting impact, and the financial-statement effects of ASC 606.
- Developments in the Spanish arbitration and leased-circuit exposure, along with progress and economics of network expansion.