Cogent Communications Holdings Inc (CCOI) 2016 Q3 法說會逐字稿

Good morning and welcome to the Cogent Communications Holdings third-quarter 2016 earnings conference call. As a reminder this conference call is being recorded and it will be available for replay at www.CogentCo.com. I would now like to turn the call over to Mr. Dave Schaeffer, Chairman and Chief Executive Officer of Cogent Communications Holdings.

Thank you and good morning. Welcome to our third-quarter 2016 earnings conference call. I am Dave Schaeffer, Cogent's Chief Executive Officer and with me on this morning's call is Tad Weed, our Chief Financial Officer. We are pleased with our results for this quarter and continue to be optimistic about the strength of our business and the outlook for the remainder of 2016 and for the years beyond.

For the quarter, we achieved sequential quarterly revenue growth at an accelerated constant currency rate of 3.1%. For the quarter, we achieved year-over-year traffic growth of 37% and sequential traffic growth on our network of 8%. Our EBITDA increased by 11.9% from the third quarter of 2015 and by 6.4% sequentially from the second quarter of 2016 to $37.2 million.

Our EBITDA margins increased by 70 basis points from the third quarter of 2015 and increased by 110 basis points from the second quarter of 2016 to 32.9%. Our EBITDA margins as adjusted, increased by 10 basis points from the third quarter of 2015 but decreased by 230 basis points to 33.5%, from the second quarter of 2016 from a $3.8 million reduction in the amount of gains recognized through equipment sales.

Our gains on equipment transactions were $700,000 for Q3 of 2016 as compared to $4.4 million for the second quarter of 2016 and $1.2 million for the third quarter of 2015. We do anticipate gains on equipment transactions in the fourth quarter of 2016 that will be similar to those of the third quarter of 2016. However, we anticipate our total equipment gains for the full-year 2016 will be greater than that of 2015 and will continue into 2017.

Our sales force rep productivity was 5.7 units per full-time equivalent rep per month, a productivity rate that is significantly above our long-term historical average of 4.9 units per full-time equivalent rep per month. During the quarter we returned $17.2 million to our shareholders through our regular quarterly dividend and we repurchased 46,000 shares of our common stock for a cost of approximately $1.7 million. As of September 30, 2016, we have $46.1 million remaining in our existing repurchase program, and our board has extended the program to continue through the end of calendar year 2017, to December 31, 2017.

We continue to remain confident in the growth and our business and the growth potential and the cash flow generating capabilities of our business. As a result as indicated on our press release, we announced another increase to our quarterly dividend of $0.02 per share, raising our quarterly dividend from $0.38 a share to $0.40 per share per quarter. This represents our 17th consecutive quarterly increase to our regular quarterly dividend.

Throughout this discussion, we will highlight several operational statistics. I will review in greater detail certain operational highlights and trends and Tad will provide some additional details on our financial performance. Following our remarks we'll open up the call for questions and answers.

Now I'd like to turn it over to Tad to read our Safe Harbor language.

Thank you Dave and good morning everyone. This earnings conference call includes forward-looking statements. 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. Cogent undertakes no obligation to update or revise forward-looking statements. If we use any non-GAAP financial measures during this call you will find these reconciled to the GAAP measurement in our earnings release, which is posted on our website at CogentCo.com.

Turn the call back over to Dave.

Thanks, Tad. Hopefully you've had a chance to review our earnings press release. Our press release includes a number of historical quarterly metrics as well as our performance in the current quarter.

On a constant currency basis, our quarterly revenues increased by 3.1% from the second quarter of 2016 and by 9.7% from the third quarter of 2015. For the first nine months of 2016, we achieved year-over-year EBITDA as adjusted margin expansion of 170 basis points from the first nine months of 2015. We expect to continue to achieve approximately 200 basis points year-over-year EBITDA as adjusted margin improvement for full-year 2016 over full-year 2015.

For the first nine months of 2016, on a constant currency basis, our revenues increased by 11% from the first nine months of 2015. We continue to anticipate our full-year revenue growth for 2016 over 2015 on a constant currency basis, will be within our long-term guidance range of 10% to 20%.

Our revenue and EBITDA guidance targets are intended to be long-term goals and are not intended to imply quarterly guidance. Our EBITDA is adjusted as impacted by the amount of equipment, sale gains that we recognize, and also is impacted by the legal fees that we have been spending related to our support of net neutrality.

Now I'd like Tad to read some additional details related to our quarter.

Thank you, Dave. And again good morning to everyone. I'd also like to thank and congratulate the entire Cogent team for the results this quarter and their continued hard work in their efforts to another very busy and very productive quarter for the Company. Some details on Corporate and NetCentric revenue.

As a reminder, we analyze our revenues based upon product class, which is On-Net, Off-Net, and Non-Core and we also analyze and report our revenues based upon customer type. We classify all of our customers into two types NetCentric customers and Corporate customers. Our NetCentric customers buy large amounts of bandwidth from us and carry our neutral data centers. And our Corporate customers buy bandwidth from us in large multi tenant office buildings.

Revenue from our Corporate customers grew by 3% from the second quarter to $68.5 million and grew by 13% from the third quarter of last year. At quarter end, we had 31,199 Corporate customer connections on our network. The revenue from NetCentric customers increased from the second quarter by 2.6% to $44.5 million an increase by 5.1% from the third quarter of 2015. At the end of the quarter, we had 28,525 NetCentric customer connections on the network.

Some details on revenue by product class. Our On-Net revenue was $81.8 million for the quarter, which was a sequential increase of 2.9% and an increase of 9% from last year. Our On-Net customer connections increased by 3.7% sequentially and increased by 17.8% from the third quarter of last year. And we ended the quarter with over 51,000 On-Net customer connections on our network and our 2,334 total On-Net multi tenant office buildings in carrier-neutral data center buildings.

Our Off-Net revenue was $31 million for the quarter, which was a sequential quarterly increase of 2.7% and an increase of almost 12% from the third quarter of last year. Off-Net customer connections increased sequentially by 3.6% an increase by 19.7% from the third quarter of last year. And we ended the quarter, serving over 8,200 Off-Net customer connections and over 5,100 Off-Net buildings, these buildings are primarily in North America.

Some information on pricing. Consistent with our historical trends, the average price per megabit of our installed base decreased this quarter; however, the average price per megabit for our new customer contracts increased for the quarter. The average price per megabit for our installed base declined by 5.9% from $1.36 for the second quarter to $1.28 and declined by 18.4% from $1.57 for the third quarter of 2015.

The average price per megabit for our new customer contracts for the quarter was $1.03, which was actually a 35% increase from the $0.77 price per megabit for new customer contracts that were sold in the second quarter and also an increase of 3.1% from the $1 price per megabit for new customer contracts that were sold in the third quarter of last year. On average revenue per unit or ARPU, our On-Net and Off-Net ARPUs both decreased sequentially about 1% for the quarter. Our On-Net ARPU, which includes both Corporate and NetCentric customers, was $544 for the quarter, which was a 1% decrease from $550 for the second quarter.

Our Off-Net ARPU, which is comprised predominately of Corporate customers, was $1,272 for the quarter, which was a decrease of 1.1% from the $1,286 for the second quarter of 2016. Some details on churn. Our unit churn rates for our On-Net and Off-Net customers was relatively stable during the quarter. Our On-Net unit churn rate was 1.3% compared to 1% last quarter, that's within our historical norms. And our Off-Net unit churn rate, again was 1% which was the same rate as last quarter.

Some information on NetCentric move out change orders. We offer discounts related to contract terms to all of our Corporate and NetCentric customers and we also offer volume commitment discounts to NetCentric customers. During the quarter, certain NetCentric customers took advantage of our volume and term discounts and entered into long-term contracts. This represented over 2,400 customer connections and these NetCentric customers increased their revenue commitment to the company by over $18.6 million.

Some details on gross margin. Our gross profit margin was 57% for the quarter, which was an increase of 40 basis points from the second quarter and an increase of 70 basis points from the third quarter of last year. USF excise taxes that are included in our cost of network operations expense and included in our revenues, were $2.4 million for the quarter compared to $2.4 million last quarter. If you exclude the impact of these USF excise taxes, our gross profit margin expanded this quarter by 100 basis points from the third quarter of last year and expanded by 50 basis points from the second quarter.

Further details on EBITDA and EBITDA as adjusted. Our EBITDA and EBITDA as adjusted, as a reminder are reconciled to our cash flow from operations and all of our press releases for each period. Our EBITDA as adjusted includes gains related to our equipment transactions. Our EBITDA was $37.2 million for the quarter and our EBITDA margin was 32.9%. As Dave said that was an increase of 110 basis points from the second quarter and an increase of 70 basis points from the third quarter of last year.

If you exclude the impact of USF, our EBITDA margin expanded by 80 basis points from the third quarter of last year. Our EBITDA as adjusted, was $37.9 million for the quarter and our EBITDA as adjusted margin was 33.5%. Net neutrality fees and asset related gains have a material impact on our EBITDA and EBITDA as adjusted calculations and could also vary materially quarter-to-quarter.

Our legal fees associated with defending net neutrality were $1.3 million for the quarter, which is an increase of $300,000 from the $1 million we spent in the second quarter. These fees are primarily due to our ongoing peering litigation with Deutsche Telekom and from the fees associated with the calculation of the size of our claim for damages we are claiming against ENT. Our equipment gains this quarter were $700,000 and that was a significant decline from the $4.4 million we concurred or achieved in the second quarter.

Seasonal factors that typically impact our SG&A expenses and consequently our EBITDA, include the resetting of payroll taxes in the US the beginning of each year, the cost of our sales meeting typically held annually each January, and annual cost of living or CPI increases, and also the timing and level of our audit and tax services. These seasonal factors typically increase our SG&A expenses in our first quarter. For this quarter, if you exclude the $300,000 increase in net neutrality fees, our SG&A expenses actually declined by $400,000 from the second quarter.

EPS; our basic and diluted income per share was $0.08 this quarter, compared to $0.09 for the second quarter, and $0.07 for the third quarter of last year. Gains on equipment transactions materially impact EPS and since they were significant last quarter and contributed $0.10 to our EPS in the second quarter, but only $0.02 this quarter. If you exclude the impact of equipment gains, our EPS for this quarter increased by $0.07 from the second quarter.

Some details on foreign currency, the impact of foreign currencies has reduced a portion of our business reported in US dollars, outside of the US to about 21%. Out of that amount, about 16% of our third-quarter revenues are based from Europe and 5% of the revenues related to our Canadian, Mexican, and Asian operations.

Continued volatility in foreign exchange rates can materially impact our quarterly revenue financial results. The average euro to US dollar rate for the quarter was $1.12, which was slightly less than the $1.13 in the second quarter. The foreign-exchange impact on our revenue from Q2 to Q3 was a decrease of about $300,000. The average euro to US dollar rate for the third quarter of last year was $1.11.

From the third quarter of last year to the third quarter of this year, the FX impact on our revenue was not material but it was increase of about $100,000. The average euro to US dollar rate so far this quarter is about $1.11 and the average Canadian dollar exchange rate is about $0.76. If those rates remain at current levels, for the fourth quarter, we estimate the FX impact on sequential quarterly revenues, so from Q3 to Q4, would be a negative impact of about $300,000 and the year-over-year impact will be positive but only about $200,000.

Details on customer concentration, we believe that our revenue in customer base is not highly concentrated. For the third quarter of 2016, no customer represented more than 1.3% of our revenues and our top 25 customers represented less than 7.2% of revenues for the third quarter. CapEx; our CapEx for the quarter was $8.7 million compared to $6.8 million for the third quarter of last year, and $14.3 million for the second quarter of 2016.

Capital lease payments, our capital lease principal payments are for long-term dark fiber IRU agreements and these payments were $2.4 million for the quarter compared to $6 million for the third quarter of last year and $3.9 million for the second quarter of this year. Capital lease principal payments; if you combine them with our CapEx, that total was $11.1 million this quarter, compared to $18.2 million the second quarter and $12.8 million for the third quarter of last year, so it has declined. If you combine the first nine months of 2016, capital lease payments with our CapEx it was $47.7 million and then for the first nine months of last year it was $47.6 million so relatively flat.

Cash in operating cash flow, at quarter end our cash and cash equivalents were $148.2 million and for the quarter our cash decreased by $6.8 million as we returned $25.6 million of capital to our stakeholders through a combination of our dividend, stock buybacks, and debt interest payments. During the quarter, we paid $17.2 million for our third-quarter dividend, $6.7 million was spent on interest payments on our debt, and we spent $1.7 million on buying back stock. Our cash flow from operations was $22.8 million this quarter, compared to $23.7 million last quarter and $23.4 million the third quarter of last year.

Capital lease IRU obligations again are for long-term dark fiber leases and typically have initial terms of 15 to 20 years or longer and we often have multiple renewal options after the initial period. The total of our long-term and short-term capital lease obligations was $140.4 million at quarter end.

Debt ratios; our total debt including capital lease obligations was $582.3 million at quarter end and our net debt was $434.2 million. For ratios; our total gross debt to trailing last 12 months EBITDA as adjusted ratio decreased to 3.89% at quarter end and our net debt ratio was 2.9%.

Finally our bad debt expense for the quarter, was less than 1% which is our target. It was only 0.9% of our revenue. And our day sales outstanding or DSO for worldwide accounts receivable, was again at a historically low level and was only 23 days at quarter end. And again I want to thank our worldwide billing and collections team for continuing to do a great job with our customers and on collections.

And with that I will turn the call back over to Dave.

Thanks Tad. Let me take a moment and talk about the scale and scope of our network. Our network continues to grow. We have over 847 million square-feet of multi tenant office space today On-Net another substantial increase from the previous quarter. Our network consists of over 29,300 metro fiber miles and over 56,700 inner-city route miles of fiber.

The Cogent network is one of the most interconnected networks in the world and directly connects to over 5,820 networks, approximately 30 of these networks are settlement free peers. The remaining networks that connect to Cogent that is 5,790 are Cogent transit customers.

We are currently utilizing approximately 25% of our lit capacity. We routinely augment capacity in parts of our network to maintain low utilization rates, particularly as we have been upgrading significant portions of our network to multiple hundred gig wavelengths. We operate 51 Cogent controlled data centers, with approximately 565,000 feet of raised floor space, roughly operating at 30% utilization.

So in summary we believe Cogent is the low-cost provider of Internet access transit services and our value proposition remains unparalleled in the industry. Our business remains completely focused on the Internet and IP connectivity and data center colocation services. We provide a necessary utility to our customers.

We expect our annualized constant currency long-term revenue growth rate to be consistent with our historical annualized growth rates of 10% to 20% revenue growth and our long-term EBITDA as adjusted annual margin expansion rate to be approximately 200 basis points per year. We've incurred material, legal, and economic analysis expenses related to supporting net neutrality. We spent over $1.3 million in the third quarter of 2016 and $3.7 million for the full year 2015. We will continue to incur some of those fees for the remainder of this year.

Our board of directors has improved yet another increase on our regular quarterly dividend. This time increasing the pace of that dividend increase to $0.02 per share, raising our dividend to $0.40 per share per quarter. Our dividend increases represent our continued optimism regarding the increased cash flow and cash flow generating capabilities of our business. We remain committed to returning capital to our shareholders and effectively utilizing our balance sheet.

We will be opportunistic in the timing of purchase of our common stock. At the end of the quarter, we had $46.1 million remaining under our current buyback authorization. And that buyback program has been extended through the end of December 2017. Again, we remain committed to growing our top-line revenue, expanding our margin, and returning capital to our shareholders both through dividends and buybacks.

With that I would now like to open the floor for questions.

(Operator Instructions)

Colby Synesael with Cowen and Company.

Thank you. Two questions if I may. Number one, on CapEx I think including cap leases the expectation earlier in the year had been to get CapEx for all 2016 below that of 2015. I appreciate the meaningful reduction in the third quarter. But I'm curious if that is still your expectation? Then secondly, capital return policy, now that the restrictions have come off, I think there's been an expectation that you would start to spend more money in terms of giving capital back to investors, be it buyback or dividend. We saw the dividend go up $0.02.

Is that where the Board is going to come out at in terms of their thinking? Should we expect that instead of a typical $0.01 increase that we have been seeing that we should really should start thinking is now more of $0.02 on a consistent basis? And also post the 2Q disappointment around the results, the stock did come off quite a bit.

Surprised you didn't buy more stock back when it got depressed. I am curious if you give some more color around why that might have been. Thanks.

Yes, sure Colby. There were little more than two questions there but let's try to get those answered. First of all (multiple speakers).

Two south-side questions.

(Laughter), okay fair enough. With regard to CapEx and principal payments on capital leases, we do expect that number to continue to decline on a sequential basis from Q3 to Q4. And we do expect that for full-year 2016, that combined number, will be lower for 2016 then it was in 2015. As Tad indicated it was effectively flat for the first nine months of the year at $47.7 million. But for the full year, we should be under the roughly $55 million we spent last year.

Now with regard to return of capital, we are absolutely committed to returning capital at an accelerating rate to our shareholders. The Board looked at our performance and our balance sheet and decided to increase the pacing of the growth in the dividend.

While there is no absolute guarantee of dividend increases in the future, the 2017 quarter sequential track record that we have, I think should give investors confidence that we are committed to regularly trying to grow the dividend. I do think the $0.02 per quarter pacing is an appropriate way to think about the increments that are appropriate against a base quarterly dividend of $0.40 per share that we have at this time.

With regard to the buybacks, we will continue to be opportunistic. We've extended our buyback program. We did buyback some stock in the quarter. We also have done some buybacks this quarter. We will disclose the magnitude of those when we report next quarter. We chose not to put a formal program in place committing the Company to a certain level of buybacks in any one quarter.

But we do have a track record of being opportunistic. I think investors should expect us to continue to return capital both through an increase in our dividend and through buybacks.

Thank you.

Frank Louthan with Raymond James.

Talk to us a little bit about some of the transactions we've seen this week. Was there any network divestitures that might happen at a Century Level 3 deal that would be interested -- that you might be interested in? And talk to us a little bit about the fiber of that asset that traded. Why was, or was that not of interest to you?

First of all, with regard to various combinations in our industry, I think we'll continue to see that. Particularly as many of the companies that have legacy revenue streams continue to struggle, to demonstrate growth organically, M&A is a technique to at least grow scale.

With regard to the announced CenturyLink Level 3 transaction, you know we currently have IRU's with both of those companies. We would expect those IRU's to continue as we have long-term rights associated with them. I do believe regulators may look at the increased concentration in backbone assets now under CenturyLink after Level 3 has done a number of acquisitions and CenturyLink had also acquired the Qwest backbone.

Really placing virtually all of the NexGen networks now with one particular carrier. We feel comfortable that we have sufficient term left and extension options in our IRU's with those companies that we see no direct impact on Cogent and our operation and maintenance expenses are in fact governed by those contracts. So we're somewhat indifferent.

With regard to the FPL FiberNet assets that were acquired by Crown Castle, we again have a dark fiber IRU with FPL FiberNet. We've had that for some time and have significant term left on that. We also have dark fiber agreements with Crown Castle, both through their organic builds as well as some of their other acquisitions. We would expect to continue those relationships and expand them.

We have chosen to be a purchaser of dark fiber through IRU's being both more capital efficient and more operationally efficient than necessarily buying the whole company. And I think Cogent remains extremely focused on generating free cash and growing its business organically. And we've seen the capital intensity of some of these more construction oriented companies continue to increase and have chosen not to be a buyer of those types of assets.

Okay great. Thank you and then just a follow-up on your spending on net neutrality. Just give us some insight on what exactly your spending on that's kind of been the law of the land for a while and curious what exactly you're finding that you still need to spend to defend or what exactly you are doing there?

Sure, Frank. So probably defense is maybe not the best term in a sense that we're actually taking an offense of position at this time. We have reached agreements with seven of the eight parties that had been violating the principles of net neutrality and have increased network capacity with all seven of those parties, and they continue to increase that capacity.

We also have an agreement in place with Deutsche Telekom that requires both parties to increase capacity at no cost. Deutsche Telekom has chosen to violate or breach its agreement. So we offensively have chosen to litigate against them, sue them because of that breach of contract.

In that breach of contract dispute, we needed to had to have a third party validate the magnitude of our economic claims against Deutsche Telekom. This is a contractual not a regulatory suit and that suit is underway and the bulk of the spending in this most recent quarter, was to help us validate the magnitude of that claim.

Great. Thank you.

Nick Del Deo with Moffett Nathanson.

Thanks for taking my question. First Level 3's had a rough couple quarters in the marketplace and assuming that deal closes they'll have a long period of integration with CenturyLink. Has your recent growth benefited from their underperformance in any measurable way? And in the past when there have been major mergers and reorganizations like this, how much success have you had in picking off revenue and talent?

Thanks for the questions Nick. A couple points; first of all we wish none of our competitors ill and I think our growth has in fact been a result of our network, our product set, and our marketing and sales model. Which are all very different than virtually any of the other companies in our space. As a reminder Cogent remains entirely focused on IP and in fact a more narrow part of the IP market the Internet and that has allowed us to grow.

There is this structural transformation that is continuing throughout telecommunications. And if you look globally at the enterprise businesses of any of the carriers, whether it be AT&T or Verizon, Sprint or CenturyLink, DT or BT or Telefonica, Level 3 as a competitive player; every single one of these companies has had negative revenue growth. Yet Cogent in that environment continues to grow. And that is because the Internet is continuing to replace the products and services that these companies have traditionally relied on for their revenue.

Now our experience has been that whenever multiple networks are combined, there are disruptions to customers, customers looking for diversity and that has usually been helpful to Cogent as a completely diverse and independent network.

Secondly, you know these companies when they combined, typically go through a series of waves of cost cutting and in those cost-cutting efforts it's usually headcount reduction and sometimes we are able to add to our staff effectively in many cases many of those people are not a good fit for Cogent.

So we tend to be a net beneficiary, but I think our ability to deliver our 10% to 20% revenue growth and 200 basis points of margin, isn't really dependent on what those around us do but really it's dependent on how well we continue to execute.

Okay. That's helpful. And if I can get one in on churn, Tad noted that On-Net churn was 1.3% this quarter and if I look back it's been 1.0% plus or minus 10 Bps for the last three years or so.

So it's a noticeable difference. Is there anything worth noting behind that increase or any reason to think it's going to persist?

No. I think it was just a little bit of an anomaly in the quarter. We actually again went through a process of cleaning up some underutilized ports and continue to migrate people to larger ports. Just as seven or eight years ago we went through a process to take people from gigabit, when they had multiple gigabit ports in a data center on the NetCentric side and put them onto 10.

We're continuing to do that, at an accelerating rate on the NetCentric side. And I think more of our customers have realized that the cost of those 100 gig interfaces has come down and the payback that they can achieve by converting those ports is pretty material as they can save a lot on cross connect. So I think it's nothing more complicated than network grooming.

Okay. That's great. Thanks guys.

Walter Piecyk with BTIG.

Dave, can you refresh my memory on how this NetCentric business works? Because I think the unit number was down 400 and I know that it was down last year as well so, what's the ebb and flow of how that works? And similarly my favorite question is to ask about these hyper-scale [guides in net], activity if you could just comment on their growth rate relative to the overall growth rate of the Company that would be helpful. Thank you.

Absolutely, Walt. First of all the way to think about our NetCentric business is actually by bits and price per bit. The ports that they flow through isn't how we generate the revenue. We generate it on the traffic volumes. Now on the corporate business, it's very different.

The corporate customer buys a fixed port and if they use more or less of that capacity there's no change in revenue. In fact, on the corporate side of our business we saw corporate utilization continue to ratchet up from roughly 17.1% of the 100 meg average port to 18.4% in the quarter. So a pretty material step up in utilization rate and I think that's an indication of corporate users using some of these hyper scale cloud-based solutions, and SaaS solutions.

On the NetCentric side, we did see the port count go down and it was really in response to the question that Nick just asked, which is we have continued to encourage customers to reduce the money they spend on cross connects and carrier-neutral data centers. And increasingly more and more of our customers are able to groom multiple 10-gig interfaces at a facility into a fewer number of 100-gig interfaces.

But I think what's important to note is that in our NetCentric business, several things occurred in the quarter. One, that our traffic grew sequentially 8%, 37% year over year. Two, the average price of a new sale in the quarter actually materially went up. It went up 35% and it went up 3% on a year-over-year basis.

I wouldn't read too much into that and get too excited about that because last quarter the average new sale declined by 31% and I tried to counsel investors that was a bit of an aggressive change as a single customer hit a pricing threshold.

While we continue to have customers hit those types of pricing threshold reductions in the quarter and Tad spoke about the number of customers that ended up changing or extending their contracts at lower prices with Cogent, the net result of all these effects was that our NetCentric revenues grew on a sequential basis 2.6%. Probably about 2.9% on a constant currency basis since roughly half of that revenue is outside of the US.

And then finally on a year-over-year basis we saw that NetCentric revenue accelerate to a 5.1% year-over-year revenue growth number, driven by the traffic growth rate and the rate of price decline.

Now with regard to the hyper scale customers, we serve virtually all of the very large customers, many of the names that you've mentioned are customers that we serve and I would say that on average, our NetCentric large customers grow at about the same pace as our entire base. I think it's probably inappropriate for me and I think some of my customers would be upset, if I gave a lot of real specific granularity to a specific customer's growth rate but we've seen social media sites, videos-to-sharing sites, video sites, search sites, more traditional companies, e-commerce companies, they all remain Cogent customers.

They are all benefiting from an increased traffic volume as a result of these net-neutrality issues getting resolved and consumers increasingly getting comfortable that the quality they are getting from their last mile provider is increasing as a result of the decongestion of the ports on the networks.

So is that just a detailed answer of the follow-through on the issues from earlier this year about these, what you were talking about as far as these repricing on the volume that we're now seeing the usage growth kick through? So that should theoretically continue into the December quarter than as well right?

Until we hit that same type of, we lapped over into our new annual contract next year. So if we have already seen this growth in the September quarter that should -- I would guess that that's got to flow-through even to a greater extent in the December quarter yes?

The answer is we don't want to give quarterly guidance but we feel very good about the continued trends and growth in our NetCentric business into the fourth quarter and throughout next year. Also just as a reminder, almost all of our contracts have a fixed term on them but very few of the contracts, probably only a twelfth of the contracts actually renew with the calendar year. We have no real kind of correlation between calendar year and contract year.

Got it but I thought in the last call or maybe it was the one before they tend to blend together, you're talking about when you start a new year there's this fixed amount of these guys always under buying and then they have to come back after they blow through the initial cap. Am I misremembering that?

No. You remembering absolutely correctly Walt but that happens every single quarter.

That's my point break. Oh every quarter, got it. Okay. I'm sorry. Okay, thank you Dave.

Barry McCarver with Stephens Incorporate.

Thanks for taking my question. You've got most of them I just wanted a little bit more color around fourth-quarter margins and if your outlook for 2017 for margins remains pretty much the same. Thanks.

Yes, sure Barry. We expect to see continued sequential improvement in gross margins and EBITDA margins. EBITDA as adjusted is heavily dependent on equipment sales and on a sequential basis we feel they'll be similar to what they were last quarter. They will not be at that very elevated level that we saw in Q2.

With regard to capital spending, as I said in the answer to Colby's question, if you look at our cash expenditures for principal payments on capital leases and CapEx, we expect that to be down. Again I don't want to give specific quarterly guidance but I feel very good about the trends for the remainder of the year.

More importantly, for investors we anticipate the 200 basis points of EBITDA as adjusted margin improvement to continue in the 2017, 2018 and beyond. We actually saw our contribution margins continue to improve in the quarter, and our -- they've long-term averaged about 44% they are above 50% today. I think you'll continue to see margin expansion going forward. And that's part of what's given the Board I think so much comfort in increasing the pacing of our dividend increases.

Thanks Dave.

Scott Goldman with Jefferies.

Dave I wonder if you just talk a bit about revenue growth. Now that we've lapped the USF from a year ago, you know you're right at that 10% low end of the long-term target. Just wondering what you think the path is here to be able to accelerate revenue growth?

Maybe you can discuss it in the context of corporate and NetCentric and then within that answer maybe discuss the salesforce? It looks like quarter-bearing headcounts has been pretty stable for the last few quarters. And then I may have a follow-up after that thanks.

Great question Scott, thanks. First of all we are at the lower end of our long-term guidance range. We've averaged about 13% top-line growth as a public Company over the past 12 years and we're at 9.7% today.

Our corporate business is performing quite well, growing sequentially at 3% and year over year 13%. We continue to see strong demand from our corporate customers as they take more of their business processes and computing and do it remotely, either in a proprietary or a shared environment through some of these hyper-scale cloud operators. We think that trend is going to continue.

We think we will continue to moderately grow our salesforce. Moderately see their productivity continue to remain at elevated levels and that corporate growth should continue in that mid-teens range. That's what it's been doing and that's what it should continue going forward.

On the NetCentric side, that's the part of our growth that tends to be more volatile. It's been impacted heavily by FX. I'm not smart enough to tell you where currencies are going but hopefully we found some stability. Then with regard to the underlying growth, we've seen seven of the eight networks that have been trying to block their customers ability to access the public Internet, all change their pattern of behavior, at least with regard to Cogent, enter into contracts and rapidly upgrade ports.

Now there are some of them that are still works in progress. FT and CenturyLink have been a little slower than some of the other carriers and I think it's been due to some of their network issues and Deutsche Telekom entered into agreement and then chose to breach it. We hope that that is a bit of an aberration and it goes away but we feel that the underlying trend of over-the-top, for end-users as well as businesses, will continue for every application and every service and Internet traffic growth will continue to accelerate.

We remain the price leader but our rate of price decline has been fairly consistent. Yes there can be quarterly fluctuations as we saw last quarter but we feel quite comfortable that that business will also continue to improve from the 5.1% year-over-year growth rate we demonstrated last quarter. And as a result of that we feel comfortable that we'll get into the higher end or above the floor in our growth.

Then finally, with regard to capital spending, we continue to be very efficient in the operation of our network and we think that will continue to see our capital expenditures [boast] principal payments on capital leases and our straight CapEx decline. So again these were all inputs to our Board's analysis to accelerate our return of capital.

Great and on the follow-up, one and a half follow-ups if I may. On the previous question on the margins, if you look at the margin performance for this year, the quarters where you've exhibited greater than 200 basis points of margin growth has always coincided with the gains on equipment sales that you've done and you've laid out what the fourth quarter's going to look like and it looks like it will be relatively light vis-a-vis the first half.

Just give a little bit more detail then before in terms of what the drivers of being able to get from 170 basis points year over year to over 200 year over year will be absent some of those gains. And very quick housekeeping if you could just comment on whether the Olympics impacted the traffic growth in 3Q.

So I'm sure there was some impact from the Olympics because we carry so many worldwide events, carrying traffic related to the election this quarter. Every quarter there's some event, there will be World Cup soccer, there's always something so I don't want people to think there's any kind of event driven changes to our traffic growth rate. I think it's more broad than that.

With regard to the margin expansion, two things, one, yes we grew 9.7%. That's great compared to anyone else selling to businesses in the telecom ecosystem but yes Cogent has and will do better than that. With regard to margins, our margin expansion is really better than any other company in our comps universe as well and our margin expansion has not come from firing people and reducing cost, but rather through growth and operating leverage.

You know we have a high fixed-cost network, with very little incremental costs as we sell On-Net revenues and roughly 75% of our sales are on net. That's why our contribution margins continue to improve and while we've averaged 44% EBITDA contribution margins over a 12-year period, we're actually doing better than that now and had over 50% this most recent quarter. That's what gives me confidence that we'll continue to see our aggregate margins expand at that roughly 200-basis-point range.

Great. Thanks for taking the questions Dave.

James Breen with William Blair.

Thanks for taking the question. Just two, one Dave, can you tell us or remind us what percentage revenue your largest customer was this quarter? Then secondly with respect to CenturyLink and Level 3, can you talk about the dynamics that you see from each of those in both the NetCentric and corporate business? There has to be some buildings where you're competing against both those companies, which will be reduced now and then from the NetCentric side, in the data center environment, are they both being aggressive on pricing? Is Level 3 more so than CenturyLink? Your thoughts there. Thanks.

Sure. Let's talk about our largest customers. At 1.3% of revenues their growing about comparable to our base. Their percentages remain relatively consistent. They have, like all of our customers, some variability in their growth rate but we feel very comfortable that they are going to continue to give us more and more of their traffic and continue to grow with Cogent.

We think that's true of all of the major OTT video companies either those that do it directly themselves or those that use aggregator's or third-party CDM's that also buy bandwidth from Cogent. So we feel pretty comfortable that our NetCentric growth trends are going to continue to improve.

Moving to CenturyLink and Level 3 and I'm going to take both parts of our business. On the NetCentric side quite honestly, we almost never saw CenturyLink in the market. They have pretty much walked away from the NetCentric market. Level 3 is a vigorous competitor globally. While we're in just under 900 carrier-neutral data centers around the world, I would say Level 3 is in the vast majority of them and is our most ubiquitous competitor.

I think it's really up to the managements of those two companies and then the combined company to decide whether transit will continue to be an important product for them going forward. I think for CenturyLink, they had chosen to deemphasize that product.

Now on the corporate side, two very different answers. We compete with CenturyLink, but almost exclusively within the CenturyLink footprint. We do not see CenturyLink outside of CenturyLink's incumbent footprint as a competitor and don't anticipate that changing.

With regard to Level 3, we occasionally see them in our corporate space but it's really rare. It was interesting that in their most recent disclosure for the first time they broke down their corporate customers by customer size. They had never done that before. And as you can see, they are really focused on a different segment of the market than Cogent. There really focused on building custom networks for very large companies, typically into single-tenant locations. So we just don't see them as a significant competitor in our corporate business.

Great thanks.

Tim Horan with Oppenheimer

Just a couple follow-ups. Maybe I missed it but line growth was a little lighter this quarter on the NetCentric side and we were expecting a little bit below last quarter. It sounds like you're confident it's going to accelerate. Any color around that? And I had a follow-up on CenturyLink.

Yes sure, Tim. So two things. First of all our NetCentric growth on a sequential basis improved quite a bit. It was 8% sequentially up from the 2% the previous quarter on a sequential basis. On a year-over-year basis it was 37%. Remember in Q3, you really have two relatively low traffic growth months and then one fairly significant growth month in September.

As we move further into the cooler weather in the northern hemisphere, we'll see people spend more time on OTT applications and I think that will drive continued growth.

Great. And then my sense is on Qwest/CenturyLink, you know historically they've kept prices a little bit high. They've not been a real price competitor. Level 3 they've seem to have changed a little bit from that. Do you think -- Level 3 sounds like they've been your primary competitor on the NetCentric side.

Do you think they could be a little less price aggressive? And related to that, your prices are about half of what Level 3's are, your closest seems like price competitor. Can that gap start to close a little bit at this point. Thanks.

Ultimately the decision on their pricing strategy is theirs not ours. It would probably be inappropriate for me to speculate. You are correct in what you said about CenturyLink's strategy with the Qwest network and it's why Qwest has become relatively insignificant in the NetCentric market.

For large capacity customers, there are really four choices in the market. Level 3 and Cogent, NTT and Telia. Telia and NTT tend to be a little more geographically challenged not everywhere but those are really the market choices. We continue to be the choice that most companies choose who use a lot of bandwidth and it's why our traffic growth rates are substantially faster than the Internet.

With regard to the rate of price declines, we're today down to only utilizing 25% of the lid capacity in our network. We feel very comfortable that we have a lot of room to be aggressive on pricing and do what it'll take to grow our business.

And then just last on CenturyLink, Level 3 as you pointed out they're going to have essentially a monopoly in next-generation networks. How much of a concern do you have with that with your business or do you think the government might have? And is there a certain cures that you would like to see to protect you over the longer term? Thanks.

So first of all I feel we're quite well protected by contract and we have agreements with both CenturyLink and Level 3 and both of those companies have been very honorable in honoring the contracts that were entered into a long time ago and have renewal options that we have exercised. So I have no doubt that Cogent is in a good space.

I think it's probably premature for me to talk for the regulators. If I was a betting person I think this transaction will happen but I think there probably are areas of concern in any type of horizontal merger such as this, that regulators are going to take a look at. And I think as we have discussions and others do, with the FCC and the DOJ, we'll end up figuring out what needs to be done.

Thank you.

Michael Bowen with Pacific Crest.

Thanks for taking the question. A couple here Dave, sorry if you already answered them. Salesforce churn I think it was 5.9% last quarter but I wanted to see if you had given that number? Also customer penetration of your On-Net buildings would be helpful as well. And your last comment around utilizing 25% of the capacity, I want to say correct me if I'm wrong, that this was 30% last quarter? If you could let us know what changed there? Thanks.

Yes sure. So salesforce churn was 5.3% in the quarter, down from 5.8% the previous quarter. So there was an improvement there. And again, it's not perfectly linear but we're still running below long-term historical trends and we continue to feel that the training programs that we put in place are doing what they're supposed to do. And our salesforce productivity is good.

With regard to penetration, we have seen our corporate MTOB penetration continue to increase and it's about 16 connections per building up from about 15.5. So we are continuing to see good consistent improvement in that penetration rate.

And then on the lid capacity percentage?

On capacity, last quarter we were at 28% utilization. Even though traffic grew sequentially 8% percent in the quarter, we saw our utilization rate fall to 25%. A large part of that is as a result of this very aggressive rollout of 100 gig replacing multiple 10 gig. So it's multiple hundreds, replacing multiple tens.

And today, nearly 70% of our long-haul bits today flow over 100-gig waves versus tens and again we have multiple hundreds. Some cases we'll have several terabit's between different city pairs and I think as the cost to move a bit a mile continues to fall we've tried to be very efficient in staying ahead of that. And any given route once it reaches about 40% utilization we begin an upgrade program.

Okay thanks and one last one. How far through the (inaudible) paring of the NetCentric salesforce.

Yes I think on the NetCentric salesforce, we're still adding people and we're still working on account segmentation as we have talked about on previous calls. It's hard to put a percentage. I think there's a lot of room to do better. We are doing better than we had done in the past. We're going to do better going forward.

And I think the NetCentric sales organization has a good foundation. It has the right tools and the right number of people at the core level but we are adding people particularly to serve some of these peripheral markets.

Michael Rollins with Citigroup.

Just a question on the pace of penetration in some of the buildings. I was wondering if you could break down by some cohorts of age and help us understand in some of the buildings that you have been in a long time how you look at incremental penetration gains in that segment versus the results you're achieving in some of the newer buildings. Thanks.

Hi Mike, thanks. First of all the pace at which we have been adding new corporate buildings has continued to decelerate. And today it's about a 3% annual increase and footprint as opposed to say five years ago when that was nearly 10% per year. Two, we're just slightly over 16 connections per building, sold to about 12 unique businesses in those buildings.

So we are continuing to see a good increase in number of businesses as well as number of connections per building. When we look at the age of the buildings, I think we continue to see even older buildings, exhibiting pretty consistent rates of additional connections per building to new buildings being added.

And roughly 87% of the growth on our network continues to come from buildings that have been On-Net for more than 18 months. It's really this change in consumer behavior that people are putting more of their computing into the public space and on cloud platforms that is driving our corporate users to need more bandwidth.

And to me an important statistic in the corporate side, is that the average corporate utilization rate, went from about 17.4% to 18.5% in one quarter. It's big base. There's 30,000 connections out there and for them to use that much more bandwidth across the board, is what's driving us to get better penetration.

Thanks very much.

Phil Cusick with JPMorgan.

Thanks. I found it interesting that Level 3 is taking up CapEx for dark fiber. Has your interest in committing capital for dark fiber evolved at all?

It has not, Phil. So after Level 3 acquired Time Warner Telecom, I think they saw their CapEx as a percentage of revenue of a much larger company, go from about 12% to nearly 18%. And I think they were spending that capital and expanding their footprint, in large part to help mitigate the decline in revenue from the existing footprint due to the product substitution phenomenon that is industry wide.

As we look at dark fiber, we are a buyer not a builder of dark fiber. We buy from 215 different suppliers around the world. We did buy some more in the quarter. Our mileage has increased. 29.3 thousand metro miles and 57.6 on the long-haul side, so we'll continue I think to moderately expand our footprint. But when we look at new builds, we have concluded that the economics don't work for Cogent, for fiber to the tower they may for others.

And then in corporate buildings we remain very disciplined in only going after the biggest buildings, that are the tightest cost (inaudible), with the right types of businesses, and enough businesses in those buildings. And then finally, on the data-center side, that is the one area where we've probably seen a bit of an acceleration in our footprint expansion and that's been as a result of more data centers being built.

We've seen the pace of new facilities coming online accelerating and Cogent's in 880 data centers around the world and expect that number to continue to increase at an accelerating rate for the nearer term. So we'll be connecting to virtually all of them.

Got it. And you mentioned the Level 3 breaking out the different business size. Can you help us by breaking at your corporate customers by size as well? Not as big as Level 3 but maybe in a few different buckets for us.

Sure. So a couple different points. First of all, we don't really think of the world in that respect and quite honestly I couldn't even tell you the revenue scale of the businesses that buy from me because I'll sell to anyone who happens to be located in one of our On-Net buildings. They can have a single office in one building or they could be part of a large multinational and we do both. Our ARPU's are relatively low. Our corporate ARPU's are about $700.

Our total On-Net ARPU's are about $550 and on the Off-Net ARPU's, which are almost entirely corporate they are about $1,250. We report by connections. The average customer probably takes a couple of connections from Cogent. On the corporate side about 2.2, 2.3 connections. It's a blend of On-Net and Off-Net so you're looking at total revenue per customer in the $2,000 to $2,500 range. But the businesses could have a much bigger spend, we're only selling Internet access to them.

Thanks. And last thing if I can. CenturyLink's filed again in it's fight against the BDS rules this week. Any insight you can give us into the process in DC? Thanks.

First of all, the BDS drama is tangential to Cogent in that we bought nothing under regulatory rates but rather through negotiated contracts. And we have been comfortable with the rates we have been able to negotiate. I do believe the current regime at the FCC is committed to ensuring that the business data service market is technology agnostics. So the inclusion of cable as well as Telco into that.

And two, that no provider uses their monopoly position to extract non-market based pricing from competitors. CenturyLink does have a very rural footprint for the most part and there's generally a lack of competition. So it doesn't surprise me that they've raised their hand and tried to protest the inability to extract a monopoly price.

And it's usually the RLEK areas that tend to have the worse pricing environment and quite honestly the worst service delivery metrics. I know when we buy Off-Net, the more rural the supplier and the location and that is sometimes required by our corporate customers, the longer the installation window is and the higher the price is. So companies that have a big rural footprint are going to be very opposed to this type of regulation.

Thanks, Dave.

At this time I'm showing no further questions. I'd like to turn the call back over to Dave Schaeffer for closing remarks.

I want to thank everyone. We're very pleased with our results for the quarter and most importantly we're pleased with the continued improvement trends in our business. And we remain completely focused on the Internet and I think our growth is tied to the ascendancy of the Internet over other technology platforms. Thank you everyone.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect.