Cogent Communications Holdings, Inc. — Q3 2014 Form 10-Q
Business context and reporting period. The unaudited report covers the quarter and nine months ended September 30, 2014, compared with the same 2013 periods. Cogent provides IP connectivity and related services across North America, Europe and Japan. The May 2014 holding-company reorganization did not affect operations; historical statements reflect the structure.
Financial performance
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Service revenue | $95.7 million | $87.8 million | $283.3 million | $258.1 million |
| Operating income | $13.6 million | $12.6 million | $40.8 million | $34.1 million |
| Net income (loss) | $(0.2) million | $2.1 million | $1.1 million | $4.1 million |
| Operating cash flow | Not provided quarterly | Not provided quarterly | $55.1 million | $52.6 million |
| Property and equipment purchases | Not provided quarterly | Not provided quarterly | $47.0 million | $38.9 million |
- Q3 revenue rose 9.0%; nine-month revenue rose 9.7%. Operating margins were approximately 14.2% and 14.4%, respectively, versus 14.3% and 13.2% in the comparable periods. Q3 net margin was approximately -0.2% versus 2.4%; nine-month net margin was approximately 0.4% versus 1.6%.
- Q3 operating expenses included a $3.1 million equipment-transaction gain; the nine-month period included $8.1 million of such gains. These gains supported reported operating income.
- Nine-month cash flow from operations less equipment purchases was approximately $8.1 million, compared with $13.6 million in 2013. Cash increased $6.9 million to $311.8 million.
- At September 30, cash was $311.8 million and total indebtedness was $607.0 million, including $162.5 million of capital lease obligations. Debt comprised $240 million principal of secured notes and $200 million of unsecured notes; the $92 million convertible notes were repaid in June. Current liabilities were $56.5 million, versus $143.7 million at year-end 2013, principally after the convertible notes ceased to be current debt.
Material changes and management commentary
- Customer connections grew: on-net +15.8% and off-net +16.5% year over year; on-net buildings increased to 2,090 from 1,955. Revenue growth lagged connection growth as pricing declined: Q3 on-net ARPU fell 5.5%, off-net ARPU fell 8.1%, and installed-base price per megabit fell 23.4%.
- SG&A increased 25.9% in Q3 and 23.9% year to date, reflecting expansion and sales-force costs and higher legal fees, primarily regulatory-related. Sales headcount was 452, up 16.8% year over year. Network operations costs increased 7.9% in Q3 and 6.3% year to date.
- Interest expense increased 19.8% in Q3 and 23.2% year to date, mainly due to new secured and unsecured notes, partly offset by repayment of convertible notes. The new $200 million unsecured notes carry a 5.625% coupon and mature in 2021; the $240 million secured notes carry an 8.375% coupon and mature in 2018.
- During the first nine months, Cogent paid $40.0 million in dividends, repurchased $48.0 million of shares and made $15.4 million of capital-lease principal payments. Approximately $47.7 million remained under the buyback authorization at quarter-end. After quarter-end, the board approved a $0.31-per-share Q4 dividend and raised the minimum quarterly capital-return amount to $12 million.
Outlook, risks and contingencies
- Management said cash on hand and operating cash generation should meet working-capital, capital-expenditure, debt-service and shareholder-return needs if the business plan is executed. Additional acquisitions or unplanned requirements could require financing; availability and terms are not assured.
- Management expects continued network expansion and customer growth, while noting that declining per-megabit prices may constrain revenue and profitability. European operations continue to incur losses pending sufficient scale. No numerical earnings or revenue guidance was provided.
- Risks include competition and pricing pressure, foreign-exchange movements, customer retention and traffic growth, peering arrangements, reliance on Cisco equipment and third-party fiber, network disruptions, regulation and litigation.
- Approximately 70 former sales employees filed individual actions after a collective wage-and-hour case was decertified; the company disputes the claims. Lease and dark-fiber positions could result in up to $2.0 million of losses above amounts accrued. Management did not expect other ordinary-course claims to materially affect results.
- The company was evaluating the new revenue-recognition standard (ASU 2014-09); its financial-statement effect and transition method had not been determined. Disclosure controls were assessed as effective, with no material change in internal control over financial reporting reported.
Key facts for investors to verify
- Whether customer and building growth can offset declining ARPU and per-megabit pricing.
- The sustainability of operating cash generation after elevated network investment, lease payments and dividends/buybacks.
- Debt service and covenant flexibility following the refinancing, including the secured and unsecured note terms.
- The nature and repeatability of equipment-exchange gains and the effect of higher SG&A, regulatory legal fees and taxes on earnings.
- Developments in wage-and-hour litigation, potential lease/dark-fiber losses, and the eventual impact of ASU 2014-09.