Cogent Communications Holdings, Inc. (CCOI) Q3 2013 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Cogent Communications Group Inc. Third Quarter 2013 Earnings Conference Call and Webcast. [Operator Instructions] And as a reminder, this call is being recorded. And it will be available for replay at www.cogentco.com. I would now like to turn the conference over to your host, Dave Schaeffer, Chairman and Chief Executive Officer. Please go ahead.

Thank you, and good morning to everyone. Welcome to our third quarter 2013 earnings conference call. I'm Dave Schaeffer, Cogent's Chief Executive Officer. With me on this call this morning is Tad Weed, our Chief Financial Officer. We are pleased with our results for the quarter and we are optimistic in the strength of our business and the outlook for the remainder of 2013 and for full year 2014. During the quarter, we experienced sequential revenue growth, gross margin and EBITDA margin expansion, significant network traffic growth and another increase in our sales force productivity to the highest level in the company's history. Additionally, we returned $6.5 million to our shareholders, through our regular recurring dividend of $0.14 a share that we paid in September. We continue to remain confident in the cash generating capabilities of our business. As a result, as we've indicated in our press release, we announced a further 7.1% sequential increase in our quarterly dividend to $0.15 per share, our fifth consecutive sequential dividend increase to be paid on December 20, 2013 to shareholders of record as of November 27, 2013. As also mentioned in our press release, we'll return an additional $10 million this quarter via dividend, or $0.22 a share to our shareholders under our return of capital program. As a result, our total dividend to be paid on December 20, 2013 to shareholders will be $0.37 a share. Under our return of capital program, we plan to distribute an additional $10 million each quarter to our shareholders in the form of either stock buybacks or a special dividend. Since we did not purchase any stock in the third quarter of 2013, the dividend paid in the fourth quarter under the return of capital program will be the full $10 million. As a reminder, our return of capital program is planned to continue in place until our net debt-to-EBITDA as adjusted ratio reaches 2.5. Our net debt to EBITDA as adjusted ratio as of now was 1.58 as of September 30, 2013. Our plan is subject to change if conditions warrant. On August 19, 2013, we issued $65 million of senior secured notes at a premium of $109 per $100 of note for $70.9 million, resulting in net proceeds to the company, net of fees, of $69.9 million. These senior notes were issued under the indenture of our January 2011, $175 million senior secured notes offering. Our cash and cash equivalents, including the proceeds from these notes, were $304.8 million at the end of the quarter. Our revenues grew from the second quarter of 2013 sequentially by 2.3%, and grew on a year-over-year basis by 10.2% from the second quarter of 2012. Our gross margin expanded by 60 basis points from the second quarter of 2013 and by 320 basis points from the second quarter of 2012 to 57.5%. Our EBITDA margins expanded by 50 basis points sequentially from the second quarter of 2013, and expanded by 210 basis points on a year-over-year basis from the second quarter of 2012 to 35%. During the quarter, traffic on our network grew sequentially by 16% from the second quarter of 2013, and traffic on our network on a year-over-year basis grew 93% over the third quarter of 2012. Our sales force rep productivity increased by over 3% from the second quarter to 6.2 units per full-time equivalent rep per month. This is the highest level of organic sales activity in the company's history. Since the end of the second quarter, we continued to expand our footprint by adding 34 buildings to our network and over the past 12 months, we added 123 buildings to our footprint. Throughout this discussion, we will highlight several operational statistics that we believe demonstrate our increasing market share, expanding scale, size and scope of our network and the leverage of our business model. We are the lowest-cost, most efficient operator in our sector. We remain focused on connecting our network to the most traffic rich locations, which we bring on-net, and selling the highest quality, dedicated Internet service to our customers at the lowest price in the market. I will review, in greater detail, some of the operational highlights and trends. Tad will provide some additional details on our financial performance, and following our remarks, we'll open it up for questions-and-answers. Now I'd like Tad to read our Safe Harbor language.

Thank you, Dave, and good morning to everyone. This third quarter 2013 earnings report and this earnings conference call discuss Cogent's business outlook and contain forward-looking statements within the meaning of Section 27A and 21E of the Securities Act. These forward-looking statements are based upon our current intent, belief and expectations. These forward-looking statements and all other statements that may be made on this call that are not historical facts are subject to a number of risks and uncertainties, and actual results may differ materially. Please refer to our SEC filings for more information on the factors that could cause actual results to differ. You should also be aware that Cogent's expectations do not reflect the potential impact of mergers, acquisitions, other business combinations or financing transactions that may be completed after today. Cogent undertakes no obligation to release publicly any revision to any forward-looking statement made today or otherwise update or supplement statements made on this call. Also during this call, if we use any non-GAAP financial measures, as defined by the SEC and Reg G, you will find these reconciled to the GAAP measurement in our earnings release and on our website at cogentco.com. I'll turn the call back over to Dave.

Okay. Thanks, Tad. Now for some highlights from our third quarter results. Hopefully, you've had a chance to review our earnings press release. As with previous quarters, our press release includes a number of historical quarterly metrics. These metrics will be added to our website. Hopefully, you find the consistent presentation of these metrics informative and helpful in understanding our financial results and our trends from operations. Our sequential revenue growth for the quarter was 2.3%. Our third quarter 2013 revenue was $87.8 million, an increase of 10.2% from the third quarter of 2012. On a constant currency basis, our third quarter revenues increased sequentially by 2.1% from the second quarter, and by 9.2% from the third quarter of 2012. We evaluate our revenues based on product class, that is on-net, off-net and non-core, which Tad will cover in greater detail. We also evaluate our revenue by type of customer. We classify our customers in 2 primary categories: NetCentric customers and Corporate customers. NetCentric customers buy large amounts of bandwidth from us in carrier-neutral data centers. Corporate customers buy bandwidth from us in large multi-tenant office buildings. Revenues from our Corporate customers grew sequentially by 3.3% from the second quarter of 2013. These Corporate customers represent 48.7% of our total customer connections at the end of the third quarter, and 52.2% of our third quarter 2013 revenues. Our corporate customer connections grew sequentially by 3.4% for the quarter. Revenues from our NetCentric customers grew by 1.2%, sequentially, from the second quarter of 2013. Our NetCentric customers represent 51.3% of our total customer connections at the end of the quarter and represent 47.8% of our third quarter 2013 revenues. Our NetCentric customer connections grew sequentially by 5.1% in the quarter. Now for some trends in pricing. Our most widely sold corporate product continues to be a 100-megabit symmetric non-oversubscribed dedicated Internet connection and our most common NetCentric connection remains a 10-gigabit connection. We offer discounts related to contract term to both our Corporate and NetCentric customers. We offer volume discounts to our NetCentric customers. During the quarter, certain of our customers took advantage of our volume and term discounts and entered into longer-term contracts with Cogent, representing over 2,140 customer connections, and increasing their aggregate revenue commitment to Cogent by over $16 million. Customers continue to express their confidence in Cogent by entering into longer-term contracts with us. Our average contract term increased, again, by another 0.4% sequentially in the quarter. The average price per megabit in our installed base decreased in the quarter. The price per megabit of our installed base declined 10.5% from $2.82 in the second quarter of 2013 to $2.52 in the third quarter of 2013, a decline by 21% -- 22.1% from the $3.24 in the second quarter -- or excuse me, third quarter of 2012. The price per megabit of our new customer contracts in the quarter was $1.41, an 18% decrease from the $1.72 per megabit of customer contracts that were sold in the second quarter of 2013, and a 32.2% decline from the $2.08 for our new customer contracts sold in the third quarter of 2012. Both of these rates have declined are in line with our historical experiences. Our price per megabit for our new contracts, as well as our installed base, are partially impacted by our targeted promotional activities. Before Tad provides some additional details on the quarter, I'd like to address our results against expectations and our announced revenue and EBITDA targets. Our revenues increased from the third quarter by 10.2% for the first 9 months of -- and for the first 9 months of 2013 versus the comparable period in 2012, by 10.1%. These growth rates are in line with our growth guidance of 10% to 20%. Our EBITDA margin for the quarter was 35% and expanded by 210 basis points from our EBITDA margin of 32.9% in the third quarter of 2012. Our EBITDA margin expanded by 50 basis points from the second quarter of 2013. Our EBITDA margin was 34.3% for the first 9 months of 2013, which is a 270 basis point increase from our EBITDA margin of 31.6% for the first 9 months of 2012. These increases are in line with our expansion guidance of greater than 200 basis points on a year-over-year basis. We continue to anticipate our full year revenue growth for 2013 over 2012 to be within the range of 10% to 20%, and our EBITDA margin expansion for 2013 over 2012 to be greater than 200 basis points. Tad will now cover some additional details on our results for the quarter and for the year.

Thank you, Dave, and again, good morning to everyone. I'd also like to thank and congratulate the entire Cogent team for the results and for their hard work and efforts during this quarter. I'll begin my discussion by providing additional details on our revenue by product class, which is on-net, off-net and non-core. Our on-net revenue was $64.5 million for the quarter, which was a sequential increase of 3%, and an increase of 11% from the third quarter of 2012. Similar to prior quarters, approximately 85% of our new sales for the third quarter were for on-net services. Our on-net customer connections increased 4.5% sequentially, and increased 15.5% from the third quarter of 2012. We ended the quarter with about 33,310 on-net customer connections on our network and our 1,955 on-net buildings. Our revenue from our off-net business was $22.8 million for the quarter, which was a sequential increase of 0.7%, and an increase of 8.9% from the third quarter of 2012. Our off-net customer connections increased by 3.3% sequentially, and increased by 14.7% from the third quarter of 2012. We ended the quarter serving about 4,900 off-net customer connections in about 4,000 off-net buildings. Our non-core revenues were approximately $0.4 million and represent less than 1% of our revenues and about 44 -- 440, rather, customer connections. On ARPU. Both our on-net and off-net ARPUs declined from the second quarter of 2013. Our on-net ARPU, for Corporate and NetCentric customers combined, was $666 for the second quarter, and declined to $660 for the third quarter. Our off-net ARPU, which includes predominately Corporate customers, was $1,617 for the second quarter and declined to $1,579 for the third quarter of 2013. Churn rates. Our net churn rate for our on-net customers improved during the quarter and our net churn rate for off-net customers was flat. Our on-net churn rate was 1.3% for the second quarter, and 1.1% for the third quarter. Our off-net churn rate was 1.5% for both the second and third quarter. EBITDA and gross margin percentages for the quarter, both increased sequentially and also both increased year-over-year. Our EBITDA margin for the quarter increased by 210 basis points from the third quarter of 2012 and increased sequentially from the second quarter of 2013 by 50 basis points. Our EBITDA margin was 32.9% for the third quarter of 2012, 34.5% for the second quarter of 2013 and for the current quarter was 35%. EBITDA, as adjusted was $30.7 million for the quarter, which was a 3.6% from the second quarter, and an increase of 17.3% from the third quarter of 2012. Our gross profit margin increased by 320 basis points from the third quarter of 2012, and increased sequentially by 60 basis points from the second quarter. Our gross profit margin was 54.3% for the third quarter of 2012, 56.9% for the second quarter of 2013 and 57.5% for the current quarter. Our on-net revenues continue to carry a nearly 100% incremental direct gross profit margin and our off-net revenues continue to carry a 50% incremental direct gross profit margin. Occasional lumpiness in our EBITDA and gross margins can and does occur. If you examine our quarterly metrics for the last 34 quarters included in each of our press releases since we became a public company, you'll notice some unevenness in our quarterly margin expansion. This can occur due to seasonal and other nonrecurring factors, including the timing and scope of our expansion activities which can vary from quarter-to-quarter. Seasonal factors include SG&A expense increases, such as the resetting of, and the increase in payroll taxes in the United States, the cost of our annual sales meeting, annual cost of living increases and the timing of our audit and tax and other professional services. Despite quarter-to-quarter variations, our long-term margin trend has demonstrated that our business model generates increasing EBITDA margins. Interest expense. We incurred interest expense related to our $65 million of new senior notes that were issued in August, our $175 million of senior notes that we issued in January 2011, our $92 million of convertible notes and interest on our capital lease obligations. Our interest expense was $10.2 million for the second quarter of 2013 and increased to $10.6 million for the third quarter of 2013, primarily related to the issuance of the new $65 million of senior notes. The breakdown of the components of the $10.6 million of interest for this quarter were as follows: $4.3 million related to our now $250 million of par value of senior notes, including $0.5 million of the impact from the new $65 million of notes; $1.8 million was related to our convertible notes, and of that $1.8 million, most of that, $1.6 million is for the noncash amortization of the note discount; and finally, $4.4 million was related to our capital lease obligations. Our basic and diluted income per share was $0.05 for the third quarter and our basic and diluted income per share was $0.03 for the second quarter of 2013. Foreign exchange impact. About 27% of our business is located outside of the United States, with about 20% of our revenues based in Europe and about 6% of our revenues related to our Canadian, Mexican and Japanese operations. Continued volatility in foreign exchange rates can materially impact our comparable quarterly and annual revenue and financial results. The foreign exchange impact on our revenue from the second quarter to the third quarter of 2013 was an increase to our revenues of about $0.2 million. Our revenue increased from the second quarter by 2.3% and on a constant currency basis, it was 2.1%. The foreign exchange impact on our revenue from the third quarter of 2012 to the third quarter of 2013 was an increase to our revenues of about $0.8 million. Our revenue increased from the third quarter of 2012 to the third quarter of 2013 by 10.2%, and on a constant currency basis, that was 9.2%. The average euro to U.S. dollar rate, thus far, for the quarter is about $1.36, which is about a 3% increase from the average from the third quarter of 2013, which was $1.32, as revenues and expenses are translated at the average rate for the period. Should the average exchange rate for the fourth quarter remain at that level, we estimate that the FX conversion impact on sequential quarterly revenues from the third quarter to our fourth quarter 2013 will be an increase of about $0.5 million. Average euro to U.S. dollar rate for the fourth quarter of 2012 was $1.30. So if that average -- if the average -- current average rates remain at current levels, we estimate that the foreign exchange impact on year-over-year quarterly revenues will be an increase of about $0.7 million. Customer concentration. Our revenue and customer base of about 38,600 customer connections is not highly concentrated. For the third quarter of 2013, no customer represented more than 1.6% of our revenues and our top 25 customers represented less than 7.5% of the third quarter 2013 revenues. CapEx. On a quarterly basis, we can and have historically experienced seasonal variations in our CapEx, prepaid capital lease payments and construction activities. Our quarterly CapEx and prepaid capital lease payments are primarily dependent on the number of buildings we connect to our network each quarter and the timing and scope of our network expansion activities. Our CapEx decreased for the quarter by 18.4% to $10.2 million versus $12.5 million for the second quarter of 2013. As Dave said, we added another 34 buildings to our network in the third quarter, and we added 123 buildings to our network over the past 12 months. Capital lease principal payments for long-term dark fiber IRU agreements were $1.9 million for the third quarter, compared to $2.1 million for the second quarter of 2013. We continue to -- our network expansion -- expect to continue network expansion in 2013, but at a slightly more moderate pace than we experienced in 2011 and 2012, with continued moderation in 2014. On balance sheet items. At the end of the quarter, our cash and cash equivalents totaled $304.8 million. For the quarter, our cash increased by $67.4 million after and including our dividend and all interest payments and the net proceeds of $69.9 million from the issuance of our new senior notes. Cash flow from operations was $14.9 million for the quarter compared to $22.7 million for the second quarter of 2013, and $15.5 million for the third quarter of 2012. $14.9 million of operating cash flow for this quarter was partly offset by $10.2 million of CapEx, $1.9 million of IRU capital lease payments and $6.5 million for our third quarter 2013 dividend payment. Our operating cash flow for this quarter included $7.3 million semiannual interest payment on our senior notes that was paid in August. Excluding our cash returns to our stakeholders through our dividend and interest payments, and excluding the net proceeds from the issuance of our senior notes, we were cash flow positive by $11.4 million for the third quarter of 2013, as compared to $9 million for the previous quarter, which is the second quarter of 2013. Our operating cash flow will be continued to be impacted by our $10 million of semiannual interest payments on our $240 million of par value of senior notes. These interest payments occur in February and August through 2018. Our operating cash flow was also impacted by our $0.5 million semiannual interest payments on our convertible notes. Those interest payments occur in June and December. We have about $92 million of our original $200 million of face value of our convertible notes remaining. Those notes mature in June of 2027, and may be redeemed by us or put by the holders beginning in June 2014. The notes are reported on our balance sheet at $87.2 million, which is net of the unamortized discount. Since the convertible notes may be put by the holders beginning in June of next year, they are classified as a current liability on our balance sheet. Our capital lease IRU obligations are for long-term, dark fiber leases and typically, have initial terms of 15 to 20 years or longer, and often include multiple renewal options after that. Total capital lease IRU fiber obligations were $157.4 million at the end of the quarter. Our total debt, including capital lease obligations, was $490.3 million at quarter end and our net debt was $185.6 million. Our total debt to trailing 12 months EBITDA as adjusted ratio was 4.2 at the end of the quarter and our net debt to trailing 12 months as adjusted EBITDA ratio was 1.58. Our bad debt expense decreased for the quarter and was 1% of revenues for the third quarter, declined from 1.1% for the second quarter and 1.3% for Q3 2012. And finally, our days sales outstanding for worldwide accounts receivable was 26 days at quarter end, a slight increase below plan of the 25 days we had at the end of the second quarter of 2013. And again, I want to personally thank and recognize our worldwide billing and collections team members for continuing to do a fantastic job on customer collections, customer service and credit monitoring. Now, I'll turn the call back over to Dave.

Yes, hey. Thanks, Tad. Now for a few minutes around our sales force activity and productivity. We began the third quarter of 2013 with 269 sales reps, and ended the quarter with 296 sales reps. We hired 75 sales reps in the quarter, and 48 sales reps left the company during the quarter. Our monthly rep turnover rate was less than our historic average, averaging about 6% for the third quarter, an improvement from our long-term average historical sales force turnover rate of about 7% per month. We began the third quarter of 2013 with 249 full-time equivalent sales reps and ended the quarter with 272 full-time equivalent sales reps. Productivity on an FT rep basis for the third quarter was 6.2 units or connections per FT per month. This rate of organic sales force rep productivity was significantly better than our long-term historical average of approximately 4.5 connections per rep per month, and a 3.3% improvement from the 6 units per full-time equivalent rep per month we experienced in the second quarter of 2013. As a reminder, our sales force rep productivity rates are not based upon contract signing, but are derived from completed, installed customer connections. Now to Cogent's network scale and expansion. The size and scale of our network continues to grow. We added 34 buildings to our network in the third quarter, and now have over 1,955 buildings directly connected to our network. Our network now consists of over 27,000 metro fiber miles and over 57,000 intercity fiber route miles. The Cogent network is one of the most interconnected networks in the world and today, we connect to directly over 4,870 networks. Approximately 40 of these are settlement-free peers. The remaining networks that we connect to are Cogent customers. We are currently utilizing approximately 22% of the lit capacity in our network. We routinely augment capacity in parts of our network in order to maintain these low utilization rates. We currently serve only 13% of the NetCentric customers and 22% of the corporate customers available for service in our footprint. In our average corporate building, we, today have 11.1 customers per building. We have a well diversified revenue base with low revenue concentration. With no revenue from any 1 customer representing more than 1.6% of our aggregate revenues, and our top 25 customers cumulatively represent less than 7.5% of our revenues. We believe our network has substantial capacity to accommodate our future growth objectives. We believe that Cogent is the lowest-cost provider of Internet access and transit service, and our value proposition to customers remains unmatched in the industry. Our pricing strategy has continued to attract many new customers, resulting in increased sales force productivity, average longer contract term, increased volume and revenue commitments from our existing customers. Our business remains completely focused on IP and the Internet, and provides a necessary utility to our customers. We expect our annualized revenue growth and EBITDA margin expansion rates to be consistent with our historical rates of 10% to 20% revenue growth, and at least 200 basis points per year of annual EBITDA margin as adjusted expansion. For 33 of the past 34 quarters as a public company, we have produced organic, sequential revenue growth, and are encouraged by the free cash flow generation of our business. We continue to be very encouraged by the growth in traffic on our network, the results of our sales initiatives, our targeted promotional programs, our increased sales force productivity and our order pipeline. We like our confidence that our network reach, our product set, our addressable market and our operating leverage are the best in the industry. In short, we continue to like our business. We feel that we have an underserved, ample addressable market in our on-net footprint, enabling us to grow revenues at our historical growth rates. We are committed to provide an annualized top line revenue growth of 10% to 20%, expanding our EBITDA margins, and continuing to increase the amount of free cash flow that we generate for our equity shareholders. We are opportunistic about the timing and purchase of our common stock. As of the end of the third quarter 2013, we have purchased 307,000 shares of common stock for $4.2 million. We currently have $45.8 million remaining under our current authorization program and the board has extended this program through February of 2014, and we'll evaluate it again prior to that date. Our Board of Directors has approved an additional 7.1% increase on our regularly quarterly dividend to $0.15 a share. We have increased this dividend every quarter sequentially since initiating it and our $10 million quarterly return of capital program has resulted in an aggregate dividend total for this quarter of $0.37 per share to be paid to our shareholders on December 20, 2013, demonstrating our optimism regarding our increased cash flow capabilities and our business' commitment to returning this cash to our shareholders on a regular basis. With that, I'd like to open the floor for questions.

[Operator Instructions] And our first question is from Frank Louthan of Raymond James.

This is Alex here for Frank. Just wanted to touch on the new sales leadership. Can you talk to any of the new sales initiatives that may have been made over the next few months? And any change in the pace of hiring that we can expect going forward?

Yes, sure, Alex. So Ernie has been on the job now about a 100 days. We reported to the board earlier this week and I think the board and myself are extremely pleased by the initiatives that he's put in place. There are more initiatives to come. The initiatives that have been rolled out initially and are in place today, include 5 discrete programs that Ernie has implemented. The first of those is a much more detailed on boarding process for our new hires in their first 180 days with the company. The second has been a lowering of the rep to manager ratio and a continuing target to reach 7 reps per manager across the company. The third has been the establishment of some new sales offices in markets where Cogent has on-net services but has previously not had a sales office. The fourth initiative has been the establishment of a regional training manager for each of 3 North American regions, to do continuous training with the reps to supplement the online training activities that we have, as well as the initial training programs that we have when a rep is first hired. And then finally, and I think a bit of a unique model, Ernie implemented a individual business plan for each rep. So what that does is requires each rep in the company to outline what their objectives and goals are, to construct a business plan and have that business plan reviewed by their manager and then are held accountable to their metrics against that plan. I think this level of kind of individual participation in planning will be critical in us continuing to accelerate our revenue growth. And we have our annual sales meeting coming up. It's actually going to be in New Orleans this year, in January. It will be preceded by manager training for several days and then the entire sales organization will be put together. And at that time, I think, Ernie has a number of additional initiatives that he plans to rollout. So, in aggregate, we feel good. We're seeing the benefits of these programs early on, and I think, there's a lot more good initiatives to come.

All right. Great. And then one other question. Can you talk about the targeted promotions from the new customers. What's going to determine how long you keep the promotions -- aggressive promotions in place. Is there a specific percentage of network utilization you're targeting?

We do not target a specific network utilization target as we constantly upgrade and expand the network. The targeted promotions that we are running remain very effective. We continue to gain new networks connected to Cogent, adding over a 100 new networks in the most recent quarter. Again, making us the most interconnected network in the world by even a wider margin. And as long as these programs remain effective, we will continue to implement them. When we see their effectiveness degrading or being reduced, we will then evaluate them. And with all sales, part of the sales effort is to keep our message to the sales force and to the customers fresh and create a sense of urgency. So our goals are to continuously have various targeted promotional efforts going forward.

Our next question in queue is from Barry McCarver of Stephens Inc.

I guess, first off, on the guidance, I know you talked about a little bit, looking at the first 9 months of the year, it's just over your 10% rate. As we look at 4Q, you had a very strong fourth quarter in 2012, and thinking about that, in order to have -- hit that minimum -- the low end of your range of 10% growth for the year, you're going to have a pretty strong 4Q this year as well. I'd just like you to speak to the confidence level in being able to do that?

Yes. Sure, Barry. So first of all, we issue a range of 10% to 20%, and I've spoken publicly on this and we are not happy about being at the lower end of that range. That was part of what made us change out our sales leadership and Ernie's mandate is to get us to the higher end of that range, not to the lower end of that range. And that will take some time because there's over 300 salespeople in Cogent. We're hiring people and these initiatives take time to rollout. Now, with regard to the fourth quarter, traditionally, the fourth quarter is a very good sales quarter for Cogent. That's been the pattern over the past 8 or 9 years and we expect that to continue. We had very strong sales activity last month. We feel very encouraged about what is probably the largest backlog again in the company's history, in terms of orders that are sold but not yet installed. And we feel pretty comfortable that we'll see some continued acceleration in our sequential rate of traffic growth. Now, in all fairness, we will probably still be at the lower end of the range. I think it's going to take Ernie several quarters to get us back up to the middle or upper end of the range.

Okay. That's very helpful. And then, this is second question, I think, we understand the business inside the U.S., but could you talk to your international business? I know some markets tend to be a little bit more volatile. Anything unusual that you saw during the third quarter? Just color in general?

Sure. So outside of the U.S. and Canada, our international business is all NetCentric. So, while there is volatility around currency, we do not have a direct exposure to corporate end users outside of the U.S. and Canada. And our NetCentric customers incorporate our bandwidth into the final good or service they sell. They tend to be much more stable. They tend to buy because they need the service not because its discretionary and they can either be content companies or access companies. So we actually saw good strong growth in unit volume and revenue internationally in the last quarter, and we are seeing that continue heading into this next quarter. So while there could be some country specific or even customer specific volatility, in aggregate, Europe, Japan, Mexico remain growing at about the same rate as Cogent's North American business. And the relative mix of 73-27, 73% being U.S., 27% being international, has been fairly consistent for the past 8 or so years, and we expect that to continue.

Our next question is from Colby Synesael of Cowen and Company.

Great. I have two questions. The first one has to do with your capital return policy. In the press release, you've talked about the 2.5% target leverage. You broke out that you're 1.58% as of the third quarter. And if we simply just assume the $10 million continues on a per quarter basis and you raise your dividend by about $0.01 every quarter, you don't get to 2.5%, it just, actually, keeps coming down. So, I was wondering if you could just talk to us about how you actually in plan on getting to the 2.5% and maybe some time parameters on how quickly you think you end up getting there? And then, the second question just has to do with the actual off-net business. Off-net, the last several years have been benefiting from the migration from effectively T1 to 10 megabit Ethernet, and that's obviously past now, so we're are not seeing ARPU increase like it was before. But I'm a little surprised that they're actually been decreasing the last 3 or 4 quarters the way it has, and when you think about your guidance of 10% to 20%, what growth rate are you anticipating the off-net business growing at on a go-forward basis?

Hey, sure. Let me start with the return of capital policy. Listen, first of all, it's a great problem to have that we're generating the capital, we're growing revenues and watching our margins expand and growing the amount of free cash flow that's available to be returned to shareholders every quarter. The capital return policy was something new. It was a little less conventional than many other companies had and we really wanted to see how investors responded to it. When I met with the board earlier this week, they were obviously, pleased that investors understood what we were trying to do and also understood that they're going to have a responsibility to review every quarter how we're doing against that plan. The goal of setting a target of 2.5% is to eventually meet the target. It's not to put a target out there we're going never going to reach. So what that's going to require the board to do is every quarter, look at both the recurring dividend, look at our buybacks that occurred during the quarter, and look at what we need to return. There's no specific timeline that's been laid out by the board today in terms of hitting that 2.5%, but we will every quarter, try to be moving towards it as opposed to away from it. So we do need to make sure that we're returning the capital. We also believe that market volatility could potentially give us opportunities to be more aggressive in our buyback, and particularly, kind of where our stock is today versus the cost of our debt capital, it becomes more logical to borrow more, to potentially buy back stock even at an elevated price as it becomes accretive and that our cost of debt capital can actually be equal or slightly below at times, our equity return and our equity return also reflects the underlying growth in the business. So long winded answer to your question, a commitment to review it every quarter, and I think what we need to do is build a pattern and practice much as we've done with our regular recurring dividend to give people comfort that we're serious about it. Now to the off-net

If I could just add a quick follow-up to that. So I mean assuming a stable market environment, assuming the business continues to perform like you expect it to, let's call that, that 10% to 20% range, is it fair to assume that every few quarters, we should expect to see some type of update to that? It's not going to be years, it's going to be measured in quarters?

Yes. I think that's a fair way to think about it, Colby. Now, to the off-net question. You are correct that we were getting a huge uplift from the migration of TDM off-net customers to Ethernet. And while that's continuing and virtually all new off-net sales continue to be Ethernet, we're not getting as much of that uplift. The second thing that's actually been very positive for us is that the off-net providers. These are typically the lacks [ph] in the regions where we provide off-net. About 10% of our off-net circuits come from an alternate provider or competitive provider, about 90% come from the incumbent. And what we've seen as they have made ethernet more ubiquitous in their territories, they've actually lowered the price of some of those loops to us and our model is always to mark up those loops, effectively maintaining a 50% gross margin. So if we have a lower cost of the loop, we're able to sell at a lower price, and therefore, the ARPUs have come down slightly. I think it's also encouraging that as you look at our growth in the quarter, we actually grew the best revenue at the fastest rate. Our corporate revenue grew 3.3%. Our off-net revenues were primarily Corporate, only grew 0.7%, so our on-net operate rate of growth was the highest, followed by our NetCentric growth rate and our least profitable revenue, our off-net, was at the lowest rate. On a unit basis, we grew our off-net business in line with our unit growth and on-net Corporate business, which has been the trend in the past. So, I think, in getting to our growth targets, you should expect the off-net and on-net mix to remain about the same. Both businesses to grow. Clearly, we can do better on margin expansion if we see faster growth rates in on-net versus off-net. And remember, the sales force is incented and quoted and comped by selling on-net at a greater payout ratio than off-net.

So it sounds like the off-net would continue to grow at somewhere around its current rate of, I think, just above 10%? And the acceleration that you're referring to in terms of getting from, call it, 10% at the low end of your guidance to the midpoint around 15%, that's going to come from the acceleration in the on-net?

I think that's a fair way to think about it, Colby. Yes.

Our next question is from Michael Bowen of Pacific Crest.

So I guess following-up on that, I want to make sure I understand, with regard to off-net, if the pricing to you is coming down, I think, you said from perhaps some of the incumbents. Am I correct in assuming that as the ARPU comes down in off-net, you're maintaining the same margin at about that 50% range? That's the first question. And then secondly, with regard to rep productivity at 6.2. Can you give me an idea of how quickly is the typical rep getting this 6.2? And maybe, if you wouldn't mind, if you can, give us a spread as far as -- what is a top performing rep? Are they at 15 per month? Is it 10? Maybe a median or something to help us out there?

Yes, sure. Those are both good questions, Michael. So first of all, with regard to off-net. It is not our core business. It is meant to supplement the on-net Corporate product for customers in locations that do not have enough addressable market for us to justify the expenditure of capital to build out those footprints. We typically buy that off-net facility and double it, creating a 50% gross margin, and then offer that to the customer who is also buying on-net from us. That business has done well and we expected to continue to do well because many of our on-net customers do like coaching service and have supplemental locations that we cannot justify the deployment of capital to serve. As both AT&T and Verizon, primarily expand their Ethernet available footprint, they've also been willing to lower the cost. When they lower the cost, we pass that lower cost onto our customer, maintaining that 50% margin. So I think, we're going to continue to see more Ethernet available, maybe prices on a per connection will continue to come down, and therefore give us the opportunity to sell more off-net. And we would, obviously, love to see more competitive providers, also, expanding their footprint. But to date, it's only been about 10% of our off-net sales. Now switching to your rep productivity question. Our average rep tenure is about 21 months. After reps been here 6 months, they tend to see a continuous rise in their productivity, probably for about 3 years and then plateau. Reps also have the ability to be promoted, so some of better reps, eventually, become managers. So that kind of weeds out some of the most tenured reps, but they still remain with the company. It's critical for us to make sure that reps have a career path and have a way into management. I think rep productivity can continue to increase even beyond that 3-year period but it does seem to plateau. And then if you look at the variability in the reps, there's clearly some monthly anomalies that occur when you can get a very large multisite customer or a large NetCentric customer building a CDN, that can create 20 or 30 orders per rep per month. But If you look at the most productive reps in the company on a consistent basis, they're probably in that 10 to 12 orders per month on a pretty consistent basis.

And then, just a quick follow up, I think, you've said in the past on Corporate penetration, correct me if I'm wrong, in the past, have you said 5 to 7 years getting to 40%, if I'm correct or incorrect? Any thoughts on pacing of that going forward, Dave?

Yes. Sure, Michael. So today, we're at the highest penetration in our Corporate buildings in our history, at 11.1 connections per building. We're adding about 1.8 connections per existing building, per year. To get to 40% penetration, we need to get to about 20. That means from where we're at today, we have about another 6 years or so of continued growth to get to that penetration. Listen, in some of our best buildings, we've got as much as 50% penetration. 40% is a reasonable company-wide goal but, I was in a conference the other day, and a CEO of another company made a great quote. He says, "I don't like market share. I like markets." I thought that was a great quote. I want to own the market. Our goal is to get every single customer in the building, and one of Ernie's talks to the sales forces is, there is no reason why someone should not be a Cogent customer. So we should expect to see us continue to grow our penetration from what is already a high-level and, quite honestly, I'm hoping that I could be here saying that 40% was just a stepping stone to even greater penetration.

Our next question is from James Breen of William Blair. James D. Breen - William Blair & Company L.L.C., Research Division: Just a couple of questions, Dave. One, can you just talk about your CapEx trajectory and how you continue to see that come down, if that still seems reasonable. And then, secondly, just around sort of the leverage discussion, any plans in the convert? Can you just remind us where that converts and sort of what the timing is on having some action there?

Yes. Hey, sure. So first of all, on CapEx, as we've conveyed to investors, our CapEx is recorded in 2 places on our cash flow statement, principal payment of capital leases, as well as traditional CapEx. Those principal payments are, typically, for fiber. That number has come down. It came down sequentially. It will be down year-over-year. We expect it down again next year. And we expect that number to continue to moderate. So our ability to generate increasing amounts of free cash flow will be driven by top line growth margin expansion and declining capital intensity in absolute terms, not just as a percentage of revenue. And we feel very comfortable, actually, about all 3 legs of that stool in our cash flow growth. And we continue to take advantage of efficiencies in technology, both routing and transport. And as we've said, repeatedly in the past, we're expanding our network into the markets that make sense, but we also know that there are markets and locations where the return on capital just is not there and therefore, we're willing to use off-net or not sell into those markets. And then, with regard to leverage and the convert. Our convert has a conversion price of about $48 a share. It was slightly higher than that but it's come down as the dividend call back has been in place, and also, there is an embedded warrant in that convert. So it is likely that the company will call the convert when it's callable in June of next year. Also, it may be put-able by the holders and with a 1% current coupon, I would suspect that the holders would like to put, the company would like to call. Now, we're fortunate enough to have enough liquidity, as Tad mentioned, we had $304.8 million of cash on our balance sheet at the end of the quarter. We're building cash and that's a good thing. We can easily pay out the convert out of that. We will also continue to look at the credit markets. We look at the call-ability of our senior secured as well as other forms of capital, whether it be a revolver or a term loan bay [ph], as other ways to add liquidity to the balance sheet because liquidity does give us flexibility. So it's a combination of remaining prudent in our leverage and we've shown that, maintaining liquidity and making sure that while we're meeting our debt obligations, most of our free cash, we want it to go to our equity holders. So long-winded answer, Jim.

Our next question is from Donna Jaegers of D.A. Davidson. Donna Jaegers - D.A. Davidson & Co., Research Division: One of Ernie's strong suits in the past is that he was -- had really strong wholesale connections. I was just curious, you mentioned earlier that your NetCentric growth continues to be sort of in line with trends. But with the rollout of LTE in Europe on a number of networks, you would think that they would need more Internet connectivity in the wireless market. So I was just curious, if you think that will be -- that will help stimulate growth in the next year or so?

Clearly, any access technology, wire-line or wireless, that increases Internet connectivity is a net positive for Cogent. And listen, our traffic growth at 93% quarter-over-quarter is pretty amazing in a market where the markets growing at below 30%, we're gaining share. LTE is a component of that. You are absolutely correct that for a large portion of Ernie's career both at MCI and XO, he had wholesale or carrier sales as part of his responsibility. 1/3 of our sales force is NetCentric sales people. We are looking to accelerate the growth there. It's -- again, one of the initiatives and areas that we're focusing on. So we're looking for good growth in all on-net business. And as I said earlier, we're expecting the off-net to kind of come along with that. Europe has had its economic challenges, but quite honestly, Cogent's revenue growth has been unaffected by those challenges and we expect things like LTE, as we sell to a lot of the second and third wireless carriers in those markets, to continue to drive traffic and revenue growth for us. Donna Jaegers - D.A. Davidson & Co., Research Division: Okay. And then, if you could -- you commented on pricing and it looks like you guys are getting a little more aggressive with pricing to new customers. What are you seeing as far as competition because one of your large competitors with a new CEO is saying he's getting more disciplined on pricing.

As I said last quarter, it was a bit of an anomaly when we saw the average price per new sale go up. The long-term trend is about what it's been. The market continues to consolidate. And the reality is, now, while there are a number resellers and Tier 2 providers, the market is really consolidated down now to 4 providers. We being one of them selling NetCentric in data centers across a wide geographic footprint. We are the second largest of those. We are the most aggressive and, I think, if you talk to any of the CEOs of companies we compete with, they will all say Cogent is the most aggressive and we remain committed to that strategy. As I said earlier, my goal was not to gain market share but to gain market, if at all possible. And with the operating leverage that we have, we are just the lowest-cost producer of bandwidth and with the high incremental on-net margins, we absolutely need to just drive top line revenue kind of irrespective of price. So I can't comment on what my competitors do. All I can comment is that we're gaining share.

And with that, I'm showing no further questions in queue. I'd like to turn it back to Mr. Dave Schaeffer for final comments.

Hey, again, Tad and I would both like to thank you. I'd like to thank the entire Cogent team for a great quarter and we're looking forward to great results in the fourth quarter. Thank all of the investors for their interest, and again, thanks, everyone. Take care. We'll talk to you in a couple of months. Bye-bye.

And again, thank you ladies and gentlemen for joining today's conference. You may now disconnect. Have a great day.