Cogent Communications Holdings Earnings 2019-06-30

CCOI 10Q Quarterly Report

Balance Sheet	Income Statement	Cash Flow

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

☒

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended June 30, 2019

☐

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File No. 000-51829

COGENT COMMUNICATIONS HOLDINGS, INC.

(Exact Name of Registrant as Specified in Its Charter)

Delaware		46-5706863
(State of Incorporation)		(I.R.S. Employer
		Identification Number)

2450 N Street N.W.

Washington, D.C. 20037

(Address of Principal Executive Offices and Zip Code)

(202) 295-4200

(Registrant’s Telephone Number, Including Area Code)

Securities registered pursuant to Section 12(b) of the Act:


Title of Each Class	Trading Symbol	Name of Each Exchange on which Registered
Common Stock, par value $0.001 per share	CCOI	NASDAQ Global Select Market

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes ⌧ No ◻

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ⌧ No ◻

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer	☒	Accelerated filer	☐
Non-accelerated filer	☐	Smaller reporting company	☐
		Emerging growth company	☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ◻

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Common Stock, $.001 par value 46,815,903 Shares Outstanding as of July 31, 2019

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INDEX


PART I
FINANCIAL INFORMATION

Item 1.	Financial Statements	1
	Condensed Consolidated Financial Statements (Unaudited)
	Condensed Consolidated Balance Sheets of Cogent Communications Holdings, Inc., and Subsidiaries as of June 30, 2019 (Unaudited) and December 31, 2018	1
	Condensed Consolidated Statements of Comprehensive Income of Cogent Communications Holdings, Inc., and Subsidiaries for the Three Months Ended June 30, 2019 and June 30, 2018 (Unaudited)	2
	Condensed Consolidated Statements of Comprehensive Income of Cogent Communications Holdings, Inc., and Subsidiaries for the Six Months Ended June 30, 2019 and June 30, 2018 (Unaudited)	3
	Condensed Consolidated Statements of Cash Flows of Cogent Communications Holdings, Inc., and Subsidiaries for the Six Months Ended June 30, 2019 and June 30, 2018 (Unaudited)	4
	Notes to Interim Condensed Consolidated Financial Statements (Unaudited)	5
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	17
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	27
Item 4.	Controls and Procedures	27

PART II
OTHER INFORMATION

Item 1.	Legal Proceedings	28
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	28
Item 6.	Exhibits	28
SIGNATURES		29
CERTIFICATIONS

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PART I FINANCIAL INFORMATION

ITEM 1.FINANCIAL STATEMENTS

COGENT COMMUNICATIONS HOLDINGS, INC., AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

AS OF JUNE 30, 2019 AND DECEMBER 31, 2018

(IN THOUSANDS, EXCEPT SHARE DATA)


	June 30,		December 31,
	2019		2018
	(Unaudited)
Assets
Current assets:
Cash and cash equivalents	$	409,279	$	276,093
Accounts receivable, net of allowance for doubtful accounts of $1,782 and $1,263, respectively		40,684		41,709
Prepaid expenses and other current assets		36,030		32,535
Total current assets		485,993		350,337
Property and equipment, net		375,936		375,325
Right-of-use leased assets		72,255		—
Deferred tax assets		—		2,733
Deposits and other assets		14,881		11,455
Total assets	$	949,065	$	739,850

Liabilities and stockholders’ equity
Current liabilities:
Accounts payable	$	11,570	$	8,519
Accrued and other current liabilities		51,615		51,431
Installment payment agreement, current portion, net of discount of $396 and $395, respectively		8,693		8,283
Current maturities, operating lease liabilities		10,639		—
Current maturities, finance lease obligations		7,700		7,074
Total current liabilities		90,217		75,307
Senior secured 2022 notes, net of unamortized debt costs of $2,301 and $2,695, respectively and including premium of $1,197 and $1,405, respectively		443,896		443,710
Senior unsecured 2024 Euro notes, net of unamortized debt costs of $1,550		151,957		—
Senior unsecured 2021 notes, net of unamortized debt costs of $1,171 and $1,476, respectively		188,054		187,749
Operating lease liabilities, net of current maturities		83,456		—
Finance lease obligations, net of current maturities		160,487		156,706
Other long term liabilities		7,588		25,380
Total liabilities		1,125,655		888,852
Commitments and contingencies:
Stockholders’ equity:
Common stock, $0.001 par value; 75,000,000 shares authorized; 46,806,370 and 46,336,499 shares issued and outstanding, respectively		47		46
Additional paid-in capital		481,734		471,331
Accumulated other comprehensive income — foreign currency translation		(10,967)		(10,928)
Accumulated deficit		(647,404)		(609,451)
Total stockholders’ deficit		(176,590)		(149,002)
Total liabilities and stockholders’ deficit	$	949,065	$	739,850

The accompanying notes are an integral part of these condensed consolidated balance sheets.

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COGENT COMMUNICATIONS HOLDINGS, INC., AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

FOR THE THREE MONTHS ENDED JUNE 30, 2019 AND JUNE 30, 2018

(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)


	Three Months		Three Months
	Ended		Ended
	June 30, 2019		June 30, 2018
	(Unaudited)		(Unaudited)
Service revenue	$	134,789	$	129,296
Operating expenses:
Network operations (including $226 and $232 of equity-based compensation expense, respectively, exclusive of depreciation and amortization shown separately below)		54,407		54,379
Selling, general, and administrative (including $5,063 and $4,463 of equity-based compensation expense, respectively)		38,566		33,704
Depreciation and amortization		19,979		20,216
Total operating expenses		112,952		108,299
Gains on equipment transactions		185		357
Operating income		22,022		21,354
Interest income and other, net		1,753		189
Interest expense		(13,595)		(12,373)
Income before income taxes		10,180		9,170
Income tax provision		(3,044)		(2,618)
Net income	$	7,136	$	6,552

Comprehensive income:
Net income	$	7,136	$	6,552
Foreign currency translation adjustment		1,786		(6,198)
Comprehensive income	$	8,922	$	354

Net income per common share:
Basic net income per common share	$	0.16	$	0.15
Diluted net income per common share	$	0.16	$	0.14
Dividends declared per common share	$	0.60	$	0.52

Weighted-average common shares - basic		45,354,327		45,016,767

Weighted-average common shares - diluted		45,912,291		45,536,473

The accompanying notes are an integral part of these condensed consolidated statements.

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COGENT COMMUNICATIONS HOLDINGS, INC., AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

FOR THE SIX MONTHS ENDED JUNE 30, 2019 AND JUNE 30, 2018

(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)


	Six Months		Six Months
	Ended		Ended
	June 30, 2019		June 30, 2018
	(Unaudited)		(Unaudited)
Service revenue	$	268,930	$	258,002
Operating expenses:
Network operations (including $406 and $421 of equity-based compensation expense, respectively, exclusive of depreciation and amortization shown separately below)		108,557		109,252
Selling, general, and administrative (including $8,318 and $8,058 of equity-based compensation expense, respectively)		74,427		67,227
Depreciation and amortization		40,240		40,004
Total operating expenses		223,224		216,483
Gains on equipment transactions		721		475
Operating income		46,427		41,994
Interest income and other, net		3,572		1,879
Interest expense		(27,051)		(24,780)
Income before income taxes		22,948		19,093
Income tax provision		(6,595)		(5,757)
Net income	$	16,353	$	13,336

Comprehensive income:
Net income	$	16,353	$	13,336
Foreign currency translation adjustment		(39)		(3,587)
Comprehensive income	$	16,314	$	9,749

Net income per common share:
Basic net income per common share	$	0.36	$	0.30
Diluted net income per common share	$	0.36	$	0.29

Dividends declared per common share	$	1.18	$	1.02

Weighted-average common shares - basic		45,349,397		45,011,616

Weighted-average common shares - diluted		45,838,918		45,456,831

The accompanying notes are an integral part of these condensed consolidated statements.

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COGENT COMMUNICATIONS HOLDINGS, INC., AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE SIX MONTHS ENDED JUNE 30, 2019 AND JUNE 30, 2018

(IN THOUSANDS)


	Six months		Six months
	Ended		Ended
	June 30, 2019		June 30, 2018
	(Unaudited)		(Unaudited)
Cash flows from operating activities:
Net income	$	16,353	$	13,336
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		40,240		40,004
Amortization of debt costs and premium		842		751
Equity-based compensation expense (net of amounts capitalized)		8,724		8,479
Gains - equipment transactions and other, net		(484)		(439)
Deferred income taxes		4,831		4,815
Changes in operating assets and liabilities:
Accounts receivable		1,005		(741)
Prepaid expenses and other current assets		(3,547)		(631)
Accounts payable, accrued liabilities and other long-term liabilities		5,088		(2,418)
Deposits and other assets		(3,783)		(1,706)
Net cash provided by operating activities		69,269		61,450
Cash flows from investing activities:
Purchases of property and equipment		(25,008)		(26,893)
Net cash used in investing activities		(25,008)		(26,893)
Cash flows from financing activities:
Dividends paid		(54,306)		(46,607)
Net proceeds from issuance of senior unsecured 2024 Euro Notes - net of debt costs of $1,556		152,128		—
Proceeds from exercises of stock options		919		1,002
Principal payments on installment payment agreement		(4,774)		(4,254)
Principal payments of finance lease obligations		(5,006)		(6,059)
Net cash provided by (used in) financing activities		88,961		(55,918)
Effect of exchange rates changes on cash		(36)		(1,368)
Net increase (decrease) in cash and cash equivalents		133,186		(22,729)
Cash and cash equivalents, beginning of period		276,093		247,011
Cash and cash equivalents, end of period	$	409,279	$	224,282
Supplemental disclosure of non-cash investing and financing activities:
Non-cash component of network equipment obtained in exchange transactions	$	684	$	460
PP&E obtained for installment payment agreement	$	5,483	$	5,943
Finance lease obligations incurred	$	8,562	$	10,735

The accompanying notes are an integral part of these condensed consolidated statements.

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COGENT COMMUNICATIONS HOLDINGS, INC., AND SUBSIDIARIES

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. Description of the business and recent developments:

Reorganization and merger

On May 15, 2014, pursuant to the Agreement and Plan of Reorganization by and among Cogent Communications Group, Inc. (“Group”), a Delaware corporation, Cogent Communications Holdings, Inc., a Delaware corporation (“Holdings”) and Cogent Communications Merger Sub, Inc., a Delaware corporation, Group adopted a new holding company organizational structure whereby Group is now a wholly owned subsidiary of Holdings. Holdings is a “successor issuer” to Group pursuant to Rule 12g-3(a) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”).

References to the “Company” for events that occurred prior to May 15, 2014 refer to Cogent Communications Group, Inc. and its subsidiaries and on and after May 15, 2014 the “Company” refers to Cogent Communications Holdings, Inc. and its subsidiaries.

Description of business

The Company is a Delaware corporation and is headquartered in Washington, DC. The Company is a facilities-based provider of low-cost, high-speed Internet access services, private network services and data center colocation space. The Company’s network is specifically designed and optimized to transmit packet routed data. The Company delivers its services primarily to small and medium-sized businesses, communications service providers and other bandwidth-intensive organizations in North America, Europe, and Asia and recently in Australia and Brazil.

The Company offers on-net Internet access and private network services exclusively through its own facilities, which run from its network to its customers’ premises. The Company is not dependent on local telephone companies or cable TV companies to serve its customers for its on-net Internet access and private network services because of its integrated network architecture. The Company offers its on-net services to customers located in buildings that are physically connected to its network. The Company’s on-net service consists of high-speed Internet access and private network services offered at speeds ranging from 100 Megabits per second to 100 Gigabits per second of bandwidth. The Company provides its on-net Internet access services and private network services to its corporate and net-centric customers. The Company’s corporate customers are located in multi-tenant office buildings and typically include law firms, financial services firms, advertising and marketing firms and other professional services businesses. The Company’s net-centric customers include bandwidth-intensive users such as other Internet access providers, telephone companies, cable television companies, web hosting companies, content delivery network companies and commercial content and application service providers. These net-centric customers obtain the Company’s services in carrier neutral data centers and in the Company’s data centers. The Company operates data centers throughout North America and Europe that allow its customers to collocate their equipment and access the Company’s network.

In addition to providing its on-net services, the Company provides Internet connectivity and private network services to customers that are not located in buildings directly connected to its network. The Company provides this off-net service primarily to corporate customers using other carriers’ circuits to provide the “last mile” portion of the link from the customers’ premises to the Company’s network. The Company also provides certain non-core services that resulted from acquisitions. The Company continues to support but does not actively sell these non-core services.

Basis of presentation

The accompanying unaudited condensed consolidated financial statements have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission. In the opinion of management, the unaudited condensed consolidated financial statements reflect all normal recurring adjustments that the Company considers necessary for the fair presentation of its results of operations and cash flows for the interim periods covered, and of the financial position of the Company at the date of the interim condensed consolidated balance sheet. Certain

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information and footnote disclosures normally included in the annual consolidated financial statements prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. The operating results for interim periods are not necessarily indicative of the operating results for the entire year. While the Company believes that the disclosures are adequate to not make the information misleading, these interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes included in its annual report on Form 10-K for the year ended December 31, 2018.

The accompanying unaudited condensed consolidated financial statements include all wholly-owned subsidiaries. All inter-company accounts and activity have been eliminated.

Use of estimates

The preparation of consolidated financial statements in conformity with United States generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results may differ from these estimates.

Financial instruments

At June 30, 2019, the carrying amount of cash and cash equivalents, accounts receivable, prepaid and other current assets, accounts payable and accrued expenses approximated fair value because of the short-term nature of these instruments. The Company measures its cash equivalents at amortized cost, which approximates fair value based upon quoted market prices (Level 1). Based upon recent trading prices (Level 2 — market approach) at June 30, 2019 the fair value of the Company’s $189.2 million senior unsecured notes was $191.8 million, the fair value of the Company’s $445.0 million senior secured notes was $461.7 million and the fair value of the Company’s 135.0 million Euro ($153.5 million USD) senior unsecured notes was $153.7 million.

Gross receipts taxes, universal service fund and other surcharges

Revenue recognition standards include guidance relating to taxes or surcharges assessed by a governmental authority that are directly imposed on a revenue-producing transaction between a seller and a customer and may include, but are not limited to, gross receipts taxes, excise taxes, Universal Service Fund fees and certain state regulatory fees. Such charges may be presented gross or net based upon the Company’s accounting policy election. The Company records certain excise taxes and surcharges on a gross basis and includes them in its revenues and costs of network operations. Excise taxes and surcharges billed to customers and recorded on a gross basis (as service revenue and network operations expense) were $3.2 million and $3.1 million for the three months ended June 30, 2019 and June 30, 2018, respectively, and $6.6 million and $6.3 million for the six months ended June 30, 2019 and June 30, 2018, respectively.

Basic and diluted net income per common share

Basic earnings per share (“EPS”) excludes dilution for common stock equivalents and is computed by dividing net income or (loss) available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted EPS is based on the weighted-average number of shares of common stock outstanding during each period, adjusted for the effect of dilutive common stock equivalents. Shares of restricted stock are included in the computation of basic EPS as they vest and are included in diluted EPS, to the extent they are dilutive, determined using the treasury stock method.

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The following details the determination of diluted weighted average shares:


	Three Months Ended	Three Months Ended	Six Months Ended	Six Months Ended
	June 30, 2019	June 30, 2018	June 30, 2019	June 30, 2018
Weighted average common shares - basic	45,354,327	45,016,767	45,349,397	45,011,616
Dilutive effect of stock options	35,895	36,320	30,972	32,222
Dilutive effect of restricted stock	522,069	483,386	458,549	412,993
Weighted average common shares - diluted	45,912,291	45,536,473	45,838,918	45,456,831

The following details unvested shares of restricted common stock as well as the anti-dilutive effects of stock options and restricted stock awards outstanding:


	Three Months	Three Months	Six Months	Six Months
	Ended	Ended	Ended	Ended
	June 30, 2019	June 30, 2018	June 30, 2019	June 30, 2018
Unvested shares of restricted common stock	1,442,520	1,417,669	1,442,520	1,417,669
Anti-dilutive options for common stock	36,381	43,308	52,338	50,353
Anti-dilutive shares of restricted common stock	37,494	—	87,686	44,672

Stockholder’s Deficit

The following details the changes in stockholder’s deficit for the three and six months ended June 30, 2019 and June 30, 2018 (in thousands except share amounts):


						Accumulated
				Additional		Other				Total
	Common Stock			Paid-in		Comprehensive		Accumulated		Stockholder’s
	Shares	Amount		Capital		Income (Loss)		Deficit		Equity (Deficit)
Balance at March 31, 2019	46,350,434	$	46	$	475,275	$	(12,753)	$	(626,799)	$	(164,231)
Forfeitures of shares granted to employees	(1,702)		—		—		—		—		—
Equity-based compensation	—		—		5,714		—		—		5,714
Foreign currency translation	—		—		—		1,786		—		1,786
Issuances of common stock	438,478		1		—		—		—		1
Exercises of options	19,160		—		745		—		—		745
Dividends paid	—		—		—		—		(27,741)		(27,741)
Net income	—		—		—		—		7,136		7,136
Balance at June 30, 2019	46,806,370	$	47	$	481,734	$	(10,967)	$	(647,404)	$	(176,590)


						Accumulated
				Additional		Other				Total
	Common Stock			Paid-in		Comprehensive		Accumulated		Stockholder’s
	Shares	Amount		Capital		Income (Loss)		Deficit		Equity (Deficit)
Balance at March 31, 2018	46,283,140	$	46	$	461,154	$	(1,989)	$	(556,266)	$	(97,055)
Forfeitures of shares granted to employees	(4,749)		—		—		—		—		—
Equity-based compensation	—		—		5,149		—		—		5,149
Foreign currency translation	—		—		—		(6,198)		—		(6,198)
Issuances of common stock	145,978		—		—		—		—		—
Exercises of options	19,576		—		704		—		—		704
Dividends paid	—		—		—		—		(23,788)		(23,788)
Net income	—		—		—		—		6,552		6,552
Balance at June 30, 2018	46,443,945	$	46	$	467,007	$	(8,187)	$	(573,502)	$	(114,636)

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						Accumulated
				Additional		Other				Total
	Common Stock			Paid-in		Comprehensive		Accumulated		Stockholder's
	Shares	Amount		Capital		Income (Loss)		Deficit		Equity (Deficit)
Balance at December 31, 2018	46,336,499	$	46	$	471,331	$	(10,928)	$	(609,451)	$	(149,002)
Forfeitures of shares granted to employees	(3,886)		—		—		—		—		—
Equity-based compensation	—		—		9,484		—		—		9,484
Foreign currency translation	—		—		—		(39)		—		(39)
Issuances of common stock	448,978		1		—		—		—		1
Exercises of options	24,779		—		919		—		—		919
Dividends paid	—		—		—		—		(54,306)		(54,306)
Net income	—		—		—		—		16,353		16,353
Balance at June 30, 2019	46,806,370	$	47	$	481,734	$	(10,967)	$	(647,404)	$	(176,590)


						Accumulated
				Additional		Other				Total
	Common Stock			Paid-in		Comprehensive		Accumulated		Stockholder's
	Shares	Amount		Capital		Income (Loss)		Deficit		Equity (Deficit)
Balance at December 31, 2017	45,960,799	$	46	$	456,696	$	(4,600)	$	(554,686)	$	(102,544)
Cumulative effect adjustment from adoption of ASC 606	—		—		—		—		14,455		14,455
Forfeitures of shares granted to employees	(11,528)		—		—		—		—		—
Equity-based compensation	—		—		9,310		—		—		9,310
Foreign currency translation	—		—		—		(3,587)		—		(3,587)
Issuances of common stock	463,978		—		—		—		—		—
Exercises of options	30,696		—		1,001		—		—		1,001
Dividends paid	—		—		—		—		(46,607)		(46,607)
Net income	—		—		—		—		13,336		13,336
Balance at June 30, 2018	46,443,945	$	46	$	467,007	$	(8,187)	$	(573,502)	$	(114,636)

Revenue recognition

The Company recognizes revenue under ASU No. 2014-09, Revenue from Contracts with Customers (“ASC 606”), which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. Under ASC 606 installation fees for contracts with terms longer than month-to-month are recognized over the contract term. The Company believes that the installation fee does not give rise to a material right as defined by ASC 606 for contracts with terms longer than month-to-month. The Company recognizes revenue over the estimated average customer life for installation fees associated with month-to-month contracts, because the fee represents a material right as defined by ASC 606. The Company capitalizes certain contract acquisition costs that relate directly to a customer contract, including commissions paid to its sales team and sales agents and amortizes these costs on straight-line basis over the period the services are transferred to the customer for commissions paid to its sales team (estimated customer life) and over the remaining original contract term for agent commissions. Management assesses these costs for impairment at least quarterly and as "triggering" events occur that indicate it is more likely than not that an impairment exists.

The Company’s service offerings consist of on-net and off-net telecommunications services. Fixed fees are billed monthly in advance and usage fees are billed monthly in arrears. Amounts billed are due upon receipt and contract lengths range from month to month to 60 months. The Company satisfies its performance obligations to provide services to customers over time as the services are rendered. In accordance with ASC 606, revenue is recognized when a customer obtains the promised service. The amount of revenue recognized reflects the consideration to which the Company expects to be entitled to receive in exchange for these services. The Company has adopted the practical

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expedient related to certain performance obligation disclosures since it has a right to consideration from its customer in an amount that corresponds directly with the value to the customer of the Company’s performance completed to date.

To achieve this core principle, the Company follows the following five steps:

Identification of the contract, or contracts with a customer

Identification of the performance obligations in the contract

Determination of the transaction price

Allocation of the transaction price to the performance obligations in the contract

Recognition of revenue when, or as, we satisfy a performance obligation

Fees billed in connection with customer installations are deferred (as deferred revenue) and recognized as noted above. To the extent a customer contract is terminated prior to its contractual end the customer is subject to termination fees. The Company vigorously seeks payment of these amounts. The Company recognizes revenue for these amounts as they are collected.

Service revenue recognized from amounts in deferred revenue (contract liabilities) at the beginning of the period during the three months ended June 30, 2019 was $1.7 million and during the three months ended June 30, 2018 was $1.9 million. Service revenue recognized from amounts in deferred revenue (contract liabilities) at the beginning of the period during the six months ended June 30, 2019 was $3.4 million and during the six months ended June 30, 2018 was $3.9 million. Amortization expense for contract costs was $4.3 million for the three months ended June 30, 2019 and $4.2 million for the three months ended June 30, 2018. Amortization expense for contract costs was $8.7 million for the six months ended June 30, 2019 and $8.3 million for the three months ended June 30, 2018.

Recent Accounting Pronouncements— Adopted

In February 2016, the FASB issued ASU No. 2016-02, Leases (“ASU 2016-02”). ASU 2016-02 replaced most existing lease accounting guidance. In July 2018 the FASB approved an Accounting Standards Update which, among other changes, allowed a company to elect to adopt ASU 2016-02 using the modified retrospective method applying the transition provisions at the beginning of the period of adoption, rather than at the beginning of the earliest comparative period presented in these financial statements. ASU 2016-02 was effective for the Company beginning on January 1, 2019 and required the Company to record a right-of-use asset and a lease liability for most of its facilities leases. Leases that were previously treated as operating leases. The effect of ASU 2016-02 was to record a cumulative-effect adjustment on January 1, 2019 as a right-of-use asset and an operating lease liability totaling $97.3 million. The operating lease liability is not considered a liability under the consolidated leverage ratio calculations in the indentures governing the Company’s senior unsecured and senior secured note obligations. The Company has made an accounting policy election to not apply the recognition requirements of ASU 2016-02 to its short-term leases - leases with a term of one year or less. The Company has also elected to apply certain practical expedients under ASU2016-02 including not separating lease and nonlease components on its finance and operating leases, not reassessing whether any existing contracts contained leases, not reconsidering lease classification, not reassessing initial direct costs and using hindsight in determining the lease reasonably certain term of its leases.


	Three Months
	Ended
	June 30, 2019

Finance lease cost
Amortization of right-of-use assets	$	4,917
Interest expense on finance lease liabilities		4,415
Operating lease cost		3,486
Total lease costs		12,818

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	Six Months
	Ended
	June 30, 2019

Finance lease cost Amortization of right-of-use assets	$	9,888
Interest expense on finance lease liabilities		8,816
Operating lease cost		6,780
Total lease costs		25,484
Other lease information
Cash paid for amounts included in the measurement of lease liabilities
Operating cash flows from finance leases		(8,827)
Operating cash flows from operating leases		(6,780)
Financing cash flows from finance leases		(5,006)
Right-of-use assets obtained in exchange for new finance lease liabilities		8,562
Right-of-use assets obtained in exchange for new operating lease liabilities		1,457
Weighted-average remaining lease term — finance leases (in years)		14.6
Weighted-average remaining lease term — operating leases (in years)		22.3
Weighted average discount rate — finance leases		10.6	%
Weighted average discount rate — operating leases		5.7	%

Finance leases—fiber lease agreements

The Company has entered into lease agreements with numerous providers of dark fiber under indefeasible-right-of use agreements (“IRU’s). These IRU’s typically have initial terms of 15-20 years and include renewal options after the initial lease term. The Company establishes the number of renewal option periods used in determining the lease term based upon its assessment at the inception of the lease of the number of option periods for which failure to renew the lease imposes a penalty in such amount that renewal appears to be reasonably certain. The option to renew may be automatic, at the option of the Company or mutually agreed to between the dark fiber provider and the Company. Once the Company has accepted the related fiber route, leases that meet the criteria for treatment as finance leases are recorded as a finance lease obligation and an IRU asset. The interest rate used in determining the present value of the aggregate future minimum lease payments is the Company’s incremental borrowing rate for the reasonably certain lease term. Finance lease assets are included in property and equipment in the Company’s consolidated balance sheets. As of June 30, 2019, the Company had committed to additional dark fiber IRU lease agreements totaling $12.3 million in future payments to be paid over periods of up to 20 years. These obligations begin when the related fiber is accepted, which is generally expected to occur in the next 12 months.

The future minimum payments (principal and interest) under these finance leases are as follows (in thousands):


For the twelve months ending June 30,
2020	$	24,926
2021		24,753
2022		23,742
2023		22,567
2024		21,704
Thereafter		225,184

Total minimum finance lease obligations		342,876
Less—amounts representing interest		(174,689)

Present value of minimum finance lease obligations		168,187
Current maturities		(7,700)

Finance lease obligations, net of current maturities	$	160,487

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Operating leases

The Company leases office space and certain data center facilities under operating leases. In certain cases the Company also enters into short term operating leases for dark fiber. Right-of-use assets represent the Company’s right to use an underlying asset for the lease term and lease liabilities represent its obligation to make lease payments under the lease. Operating lease right-of-use assets and liabilities are recognized at the lease commencement date based on the present value of lease payments over the reasonably certain lease term. The implicit rates within the Company’s operating leases are generally not determinable and the Company uses its incremental borrowing rate at the lease commencement date to determine the present value of its lease payments. The determination of the Company’s incremental borrowing rate requires judgment. The Company determines its incremental borrowing rate for each lease using its current borrowing rate, adjusted for various factors including level of collateralization and term to align with the term of the lease. Certain of the Company’s leases include options to extend or terminate the lease. The Company establishes the number of renewal option periods used in determining the operating lease term based upon its assessment at the inception of the operating lease of the number of option periods for which failure to renew the lease imposes a penalty in such amount that renewal appears to be reasonably certain. The option to renew may be automatic, at the option of the Company or mutually agreed to between the landlord or dark fiber provider and the Company. Once the Company has accepted the related fiber route or the facility lease term has begun, the present value of the aggregate future minimum operating lease payments are recorded as an operating lease liability and a right-of-use leased asset. Lease incentives and deferred rent liabilities for facilities operating leases are presented with the right-of-use leased asset. Lease expense for lease payments is recognized on a straight-line basis over the term of the lease.

The future minimum payments under these operating lease agreements are as follows (in thousands):


For the twelve months ending June 30,
2020	$	15,592
2021		13,504
2022		12,248
2023		10,985
2024		9,871
Thereafter		96,148

Total minimum operating lease obligations		158,348
Less—amounts representing interest		(64,253)

Present value of minimum operating lease obligations		94,095
Current maturities		(10,639)

Lease obligations, net of current maturities	$	83,456

Recent Accounting Pronouncements— to be Adopted

In June 2016, the FASB issued ASU No. 2016-13, “Financial Instruments—Credit Losses: Measurement of Credit Losses on Financial Instruments.” This guidance is intended to introduce a revised approach to the recognition and measurement of credit losses, emphasizing an updated model based on expected losses rather than incurred losses. This new standard is effective for annual and interim reporting periods beginning after December 15, 2019 and early adoption is permitted. The Company is currently evaluating the impact that this guidance may have on its financial statements and related disclosures.

2. Property and equipment:

Depreciation and amortization expense related to property and equipment and finance leases was $20.0 million and $20.2 million for the three months ended June 30, 2019, and 2018 respectively, and $40.2 million and $40.0 million for the six months ended June 30, 2019 and 2018, respectively. The Company capitalized salaries and related benefits of employees working directly on the construction and build-out of its network of $2.7 million and $2.7 million for the

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three months ended June 30, 2019 and 2018, respectively, and $5.3 million and $5.3 million for the six months ended June 30, 2019 and 2018, respectively.

Exchange agreement

In the three and six months ended June 30, 2019 and 2018, the Company exchanged certain used network equipment and cash consideration for new network equipment. The fair value of the equipment received was estimated to be $0.5 million and $1.1 million for the three months ended June 30, 2019 and 2018, respectively, and $2.2 million and $1.5 million for the six months ended June 30, 2019 and 2018, respectively and after considering the cash component the transactions resulted in gains of $0.1 million and $0.3 million for the three months ended June 30, 2019 and 2018, respectively, and $0.7 million and $0.5 million for the six months ended June 30, 2019 and 2018, respectively. The estimated fair value of the equipment received was based upon the cash consideration price the Company pays for the new network equipment on a standalone basis (Level 3).

Installment payment agreement

In March 2015, the Company entered into an installment payment agreement (“IPA”) with a vendor. Under the IPA the Company may purchase network equipment in exchange for interest free note obligations each with a twenty-four month term. There are no payments under each note obligation for the first six months followed by eighteen equal installment payments for the remaining eighteen month term. As of June 30, 2019, and December 31, 2018 there was $11.9 million and $11.2 million, respectively, of note obligations outstanding under the IPA, secured by the related equipment. The Company recorded the assets purchased and the net present value of the note obligation utilizing an imputed interest rate. The resulting discount was $0.4 million and $0.4 million as of June 30, 2019 and December 31, 2018, respectively, and is being amortized over the note term using the effective interest rate method.

3. Long-term debt:

Limitations under the indentures

The Company has $189.2 million of senior unsecured notes, $445.0 million of senior secured notes and 135.0 million Euros ($153.5 million USD) of senior unsecured notes outstanding. The $189.2 million of senior unsecured notes are due on April 15, 2021 (the “2021 Notes”) and bear interest at a rate of 5.625% per year. Interest is paid semi-annually on April 15 and October 15. The $445.0 million of senior secured notes are due on March 1, 2022 (the “2022 Notes”) and bear interest at a rate of 5.375% per year. Interest is paid semi-annually on March 1 and September 1. The 135.0 million Euro ($153.5 million USD) of senior unsecured notes are due on June 30, 2024 (the “2024 Notes”) and bear interest at a rate of 4.375% per year. Interest is paid semi-annually on June 30 and December 30.

The indentures governing the 2024 Notes, 2022 Notes and 2021 Notes, among other things, limit the Company’s ability to incur indebtedness; to pay dividends or make other distributions; to make certain investments and other restricted payments; to create liens; consolidate, merge, sell or otherwise dispose of all or substantially all of its assets; to incur restrictions on the ability of a subsidiary to pay dividends or make other payments; and to enter into certain transactions with its affiliates. Limitations on the ability to incur additional indebtedness (excluding IRU agreements incurred in the normal course of business) include a restriction on incurring additional indebtedness if the Company’s consolidated leverage ratio, as defined in the indentures, is greater than 6.0 for the 2024 Notes and greater than 5.0 for the 2022 Notes and 2021 Notes. Limitations on the ability to incur additional secured indebtedness include a restriction on incurring additional secured indebtedness if the Company’s consolidated secured leverage ratio, as defined in the indentures, is greater than 4.0 for the 2024 Notes and greater than 3.5 for the 2022 Notes and 2021 Notes. The indentures prohibit certain payments, such as dividends and stock purchases, when the Company’s consolidated leverage ratio, as defined by the indentures, is greater than 4.25. A certain amount of such unrestricted payments is permitted notwithstanding this prohibition. The unrestricted payment amount may be increased by the Company’s consolidated cash flow, as defined in the indentures, as long as the Company’s consolidated leverage ratio is less than 4.25. The Company’s consolidated leverage ratio was above 4.25 as of June 30, 2019. As of June 30, 2019, a total of $166.9 million (held by Holdings in cash and cash equivalents) was permitted for investment payments including dividends and stock purchases.

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Issuance of 2024 Notes

On June 25, 2019, Group completed an offering of €135.0 million ($153.7 million) aggregate principal amount of 4.375% senior unsecured notes due 2024. The net proceeds from the offering, after deducting offering expenses, were approximately $152.1 million. The Company expects to use the proceeds for general corporate purposes and/or to repurchase the Company’s common stock or for special or recurring dividends to the Company’s stockholders. The 2024 Notes are guaranteed (the “Guarantees”) on a senior unsecured basis, jointly and severally, by the Company’s material domestic subsidiaries, subject to certain exceptions, and by the Company (collectively, the “Guarantors”). Under certain circumstances, the Guarantors may be released from these Guarantees without the consent of the holders of the 2024 Notes.

The 2024 Notes and the Guarantees are Group’s and the Guarantors’ senior unsecured obligations. The 2024 Notes and the Guarantees are effectively subordinated to all of Groups’s and the Guarantors’ existing and future secured indebtedness to the extent of the value of the collateral securing such indebtedness, and are structurally subordinated to all indebtedness and other liabilities of subsidiaries that are not Guarantors. Without giving effect to collateral arrangements, the 2024 Notes and the Guarantees rank pari passu in right of payment with Group’s and the Guarantors’ existing and future senior indebtedness. The 2024 Notes and the Guarantees rank contractually senior in right of payment to all of Group’s and the Guarantors’ existing and future subordinated indebtedness.

The 2024 Notes were offered and sold only to persons reasonably believed to be qualified institutional buyers in an unregistered offering pursuant to Rule 144A under the Securities Act of 1933, as amended (the “Act”), and to certain non-U.S. persons in transactions outside the United States in compliance with Regulation S under the Act. The 2024 Notes have not been registered under the Act, and may not be offered or sold in the United States absent registration or an applicable exemption from registration requirements. Application will be made for the 2024 Notes to be listed on the Official List of The International Stock Exchange; however, there can be no assurance that the application will be successful or that any such listing will be granted or maintained.

The 2024 Notes bear interest at a rate of 4.375% per annum. Interest began to accrue on the 2024 Notes on June 25, 2019 and will be paid semi-annually in arrears on June 30 and December 30 of each year, commencing on December 30, 2019. Unless earlier redeemed, the 2024 Notes will mature on June 30, 2024. The 2024 Notes were issued at par for 135.0 million Euros ($153.7 million USD) on June 25, 2019. The 2024 Notes were issued in Euros and are reported in the Company’s reporting currency – US Dollars. As of June 30, 2019 the 2024 Notes were valued at $153.5 million resulting in an unrealized gain of $0.2 million recorded during the three and six months ended June 30, 2019.

Group may redeem some or all of the 2024 Notes at any time prior to June 30, 2021 at a price equal to 100% of the principal amount of the 2024 Notes, plus a “make-whole” premium as set forth in the indenture, plus accrued and unpaid interest, if any, to, but not including, the date of redemption. Thereafter, Group may redeem the 2024 Notes, in whole or in part, at a redemption price ranging from 102.188% to par (depending on the year), as set forth in the indenture. Group may also redeem up to 35% of the principal amount of the 2024 Notes using proceeds of certain equity offerings completed prior to June 30, 2021 at a redemption price equal to 104.375%, plus accrued and unpaid interest, if any, to, but not including, the date of redemption, subject to certain exceptions. Group may also redeem the 2024 Notes, in whole but not in part, in the event of certain changes in the tax laws of the United States (or any taxing authority in the United States). This redemption would be at 100% of the principal amount of the 2024 Notes to be redeemed (plus any accrued interest and additional amounts then payable with respect to the 2024 Notes to, but not including, the redemption date).

If Group undergoes specific kinds of change in control accompanied by certain ratings events, it will be required to offer to repurchase the 2024 Notes from holders at a price equal to 101% of the principal amount thereof, plus accrued and unpaid interest, if any, to, but not including, the date of repurchase. Additionally, if Group or any of its restricted subsidiaries sells assets and does not apply the proceeds from such sale in a certain manner or certain other events have not occurred, under certain circumstances, Group will be required to use the excess net proceeds to make an offer to purchase the 2024 Notes at an offer price in cash equal to 100% of the principal amount of the 2024 Notes, plus accrued and unpaid interest, if any, to, but not including, the repurchase date.

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In connection with any offer to purchase all or any of the 2024 Notes (including a change of control offer, asset sale offer or any tender offer), if holders of no less than 90% of the aggregate principal amount of the 2024 Notes validly tender their 2024 Notes, Group or a third party is entitled to redeem any remaining 2024 Notes at the price offered to each holder.

The 2024 notes indenture includes covenants that restrict Group and its restricted subsidiaries’ ability to, among other things: incur indebtedness; issue certain preferred stock or similar equity securities; pay dividends or make other distributions in respect of, or repurchase or redeem, capital stock; make certain investments and other restricted payments, such as prepayment, redemption or repurchase of certain indebtedness; create liens; consolidate, merge, sell or otherwise dispose of all or substantially all of the assets of Group and its restricted subsidiaries taken as a whole; incur restrictions on the ability of a subsidiary to pay dividends or make other payments; and enter into transactions with affiliates. However, the covenants provide for certain exceptions to these restrictions and the Company is not subject to the covenants under the 2024 Notes indenture. Certain covenants will cease to apply to the 2024 Notes if, and for so long as, the 2024 Notes have investment grade ratings from any two of Moody’s Investors Service, Inc., Fitch Ratings, Inc. and S&P Global Ratings and so long as no default or event of default under the Indenture has occurred and is continuing.

The principal amount of the 2024 Notes would become immediately due and payable upon the occurrence of certain bankruptcy or insolvency events involving Group or certain of its subsidiaries, and may be declared immediately due and payable by the trustee or the holders of at least 25% of the aggregate principal amount of the then-outstanding 2024 Notes upon the occurrence of certain events of default under the indenture.

4. Commitments and contingencies:

Current and potential litigation

In accordance with the accounting guidance for contingencies, the Company accrues its estimate of a contingent liability when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. Where it is probable that a liability has been incurred and there is a range of expected loss for which no amount in the range is more likely than any other amount, the Company accrues at the low end of the range. The Company reviews its accruals at least quarterly and adjusts them to reflect the impact of negotiations, settlements, rulings, advice of legal counsel, and other information and events pertaining to a particular matter. The Company has taken certain positions related to its obligations for leased circuits for which it is reasonably possible could result in a loss of up to $3.0 million in excess of the amount accrued at June 30, 2019.

The Company is engaged in an arbitration proceeding in Spain in which a former provider of optical fiber to the Company is seeking approximately $9 million for the Company’s early termination of the optical fiber leases, which amount the Company has accrued in 2015. The Company has counterclaimed for damages and is contesting its obligation to pay the termination liability in an arbitration proceeding in Spain. The arbitration is being conducted by the Civil and Commercial Arbitration Court (CIMA) in Madrid, Spain.

In the ordinary course of business the Company is involved in other legal activities and claims. Because such matters are subject to many uncertainties and the outcomes are not predictable with assurance, the liability related to these legal actions and claims cannot be determined with certainty. Management does not believe that such claims and actions will have a material impact on the Company’s financial condition or results of operations. Judgment is required in estimating the ultimate outcome of any dispute resolution process, as well as any other amounts that may be incurred to conclude the negotiations or settle any litigation. Actual results may differ from these estimates under different assumptions or conditions and such differences could be material.

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5. Income taxes:

The components of income before income taxes consist of the following (in thousands):


	Three Months Ended		Three Months Ended			Six Months Ended	Six Months Ended
	June 30, 2019		June 30, 2018			June 30, 2019	June 30, 2018

Domestic	$	16,332	$	15,446	$	35,084	$	29,582
Foreign		(6,152)		(6,276)		(12,136)		(10,489)
Total	$	10,180	$	9,170	$	22,948	$	19,093

6. Common stock buyback program stock option and award plan:

The Company’s Board of Directors has approved purchases of the Company’s common stock under a buyback program (the “Buyback Program”) through December 31, 2019. At June 30, 2019, there was approximately $34.9 million remaining for purchases under the Buyback Program. There were no purchases of common stock during the three and six months ended June 30, 2019 and June 30, 2018.

In the second quarter of 2019 the Company granted 0.4 million shares of common stock to its employees valued at $23.5 million. The vesting of 24,050 of these shares granted to the Company's executives are subject to certain performance conditions and the vesting of 105,000 shares granted to the Company's CEO are subject to the total shareholder return of the Company's common stock compared to the total shareholder return of the Nasdaq Telecommunications Index. The remaining shares vest over periods ending in December 2022.

7. Dividends on common stock:

On August 7, 2019, the Company’s Board of Directors approved the payment of a quarterly dividend of $0.62 per common share. This estimated $28.1 million dividend payment is expected to be made on September 9, 2019.

The payment of any future dividends and any other returns of capital, including stock buybacks will be at the discretion of the Company’s Board of Directors and may be reduced, eliminated or increased and will be dependent upon the Company’s financial position, results of operations, available cash, cash flow, capital requirements, limitations under the Company’s debt indentures and other factors deemed relevant by the Company’s Board of Directors. The Company is a Delaware Corporation and under the General Corporate Law of the State of Delaware distributions may be restricted including a restriction that distributions, including stock purchases and dividends, do not result in an impairment of a corporation’s capital, as defined under Delaware Law. The indentures governing the Company’s notes limit the Company’s ability to return cash to its stockholders.

8. Related party transactions:

Office leases

The Company’s headquarters is located in an office building owned by Sodium LLC whose owner is the Company’s Chief Executive Officer. The fixed annual rent for the headquarters building is $1.0 million per year plus an allocation of taxes and utilities. The lease began in May 2015 and the lease term is for five years which is cancellable by the Company upon 60 days’ notice. The Company’s audit committee reviews and approves all transactions with related parties. The Company paid $0.5 million and $0.5 million in the three months ended June 30, 2019 and 2018, respectively, and $0.9 million and $0.8 million in the six months ended June 30, 2019 and 2018, respectively, for rent and related costs (including taxes and utilities) to Sodium LLC for this lease.

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9. Segment information:

The Company operates as one operating segment. The Company’s service revenue by geographic region and product class and long lived assets by geographic region are as follows (in thousands):

Three months Ended June 30, 2019

Revenues

On net

Off-net

Non-core

Total

North America

78,484

32,864

Closing Price ($)	Shares Out (MM)	Market Cap ($MM)
$58.02	46	$2,690

10-Q	2019-06-30	Quarter: 2019-06-30
10-Q	2019-03-31	Quarter: 2019-03-31
10-K	2018-12-31	Annual: 2018-12-31
10-Q	2018-09-30	Quarter: 2018-09-30
10-Q	2018-06-30	Quarter: 2018-06-30
10-Q	2018-03-31	Quarter: 2018-03-31
10-K	2017-12-31	Annual: 2017-12-31
10-Q	2017-09-30	Quarter: 2017-09-30
10-Q	2017-06-30	Quarter: 2017-06-30
10-Q	2017-03-31	Quarter: 2017-03-31
10-K	2016-12-31	Annual: 2016-12-31
10-Q	2016-09-30	Quarter: 2016-09-30
10-Q	2016-06-30	Quarter: 2016-06-30
10-Q	2016-03-31	Quarter: 2016-03-31
10-K	2015-12-31	Annual: 2015-12-31
10-Q	2015-09-30	Quarter: 2015-09-30
10-Q	2015-06-30	Quarter: 2015-06-30
10-Q	2015-03-31	Quarter: 2015-03-31
10-K	2014-12-31	Annual: 2014-12-31
10-Q	2014-09-30	Quarter: 2014-09-30
10-Q	2014-06-30	Quarter: 2014-06-30
10-Q	2014-03-31	Quarter: 2014-03-31
10-K	2013-12-31	Annual: 2013-12-31

8-K	2019-08-08	Earnings, Exhibits
8-K	2019-06-25	Enter Agreement, Off-BS Arrangement, Exhibits
8-K	2019-06-20	Regulation FD
8-K	2019-06-18	Regulation FD, Exhibits
8-K	2019-05-02	Earnings, Exhibits
8-K	2019-05-01	Officers, Shareholder Vote, Exhibits
8-K	2019-02-21	Earnings, Exhibits
8-K	2018-11-01	Earnings, Exhibits
8-K	2018-09-14	Officers
8-K	2018-09-10	Amend Bylaw, Shareholder Vote, Exhibits
8-K	2018-08-20	Enter Agreement, Off-BS Arrangement, Exhibits
8-K	2018-08-14	Regulation FD
8-K	2018-08-14	Regulation FD, Exhibits
8-K	2018-08-02	Earnings, Exhibits
8-K	2018-05-02	Shareholder Vote
8-K	2018-02-22	Earnings, Exhibits

ROP	Roper Technologies	36,600
ATO	Atmos Energy	11,780
NNN	National Retail Properties	8,520
ESGR	Enstar	3,170
SYKE	Sykes Enterprises	1,120
HBB	Hamilton Beach Brands Holding	232
FENC	Fennec Pharmaceuticals	85
JMU	JMU	1
MFCO	Microwave Filter	0
DGTW	Digitaltown	0

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EX-31.2	ccoi-20190630ex3129e1e7e.htm
EX-32.1	ccoi-20190630ex321e00a52.htm
EX-32.2	ccoi-20190630ex3227e9b82.htm