Cogent Communications Holdings Inc (CCOI) 2018 Q1 法說會逐字稿

Good morning, and welcome to the Cogent Communications Holdings First Quarter 2018 Earnings Conference Call.

As a reminder, this conference call is being recorded and will be available for replay at www.cogentco.com.

I would now like to turn the call over to Mr. David Schaeffer, Chairman and Chief Executive Officer of Cogent Communications Holdings.

Hi, good morning, and thank you all for joining us.

Welcome to our first quarter 2018 Earnings Conference Call.

I'm Dave Schaeffer, Cogent's CEO, and with me on this morning's call is Tad Weed, our Chief Financial Officer.

We are pleased with our results for the quarter and continue to be optimistic about the underlying strength in our business and the outlook for the remainder of 2018 and the years beyond.

This quarter, we achieved sequential quarterly revenue growth of 2.8% and year-over-year quarterly revenue growth of 9.8% in the first quarter.

Year-over-year, our on-net revenue grew by 10.5% and our off-net revenues grew by 8.3%.

Our quarterly sales rep productivity was 5.7 units per full-time-equivalent rep per month.

Productivity rate that, again, is significantly above our long-term historical average of 5.1 installed orders per full-time-equivalent rep per month.

Our EBITDA for the quarter increased year-over-year by $6.4 million, which is an increase of 16.9% from the first quarter of 2017.

Our EBITDA margin for the quarter, increased by [210].

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2017.

For the quarter, we achieved sequential traffic growth of 8%, and an improvement in our year-over-year traffic growth for the quarter from 29% to 35% year-over-year.

During the quarter, we returned $22.8 million to our shareholders through our regularly quarterly dividend.

At quarter-end, we had a total of $41.5 million available for stock buybacks under our stock buyback program, which our board has authorized to continue through the end of 2018.

We did not purchase any stock in the quarter.

We ended the quarter with $236 million in cash on our balance sheet.

Of this cash, $40.5 million is being held at our holding company, Cogent Holdings, and this cash is unrestricted and available for dividends and buybacks.

Our gross leverage improved from 4 point -- to 4.33x EBITDA from 4.44x in the previous quarter and our net leverage remained unchanged at 2.94x.

Our gross leverage cash flow ratio as defined under our indenture improved to 4.26 from 4.44.

This ratio is extremely close to the 4.25 threshold that is included in our indentures that once we have passed that 4.25 threshold, it will allow us to utilize the accumulated builder basket.

Our accumulated builder basket at the end of Q1 was slightly over $142 million.

We will transfer the majority of this builder basket to our holding company once the ratio test under our indenture is met.

Of the $236 million of cash at quarter-end, $40.5 million is currently held at holdings and $195.5 million is being held at the operating company.

We continue to remain confident about our growth potential and cash generating capabilities of our business.

As a result, as indicated in our press release, we announced another $0.02 sequential increase in our quarterly dividend, which brings our regular quarterly dividend from $0.50 per share to $0.52 per share.

This represents the 23rd consecutive quarterly increase in our regular quarterly dividend.

Throughout this discussion, we will highlight several operational statistics.

I will review in greater detail some of the operational details, and Tad will provide some additional color and detail on our financial performance.

Following these remarks, we will open the floor for questions and answers.

Now I would like to have Tad 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'll find these reconciled to the corresponding GAAP measurement in our earnings release, which is posted on our website at www.cogentco.com.

I'll turn the call back over to Dave.

Thanks, Tad, and hopefully, you've had a chance to review our earnings press release.

As in previous quarters, these press releases include both our current and historical quarterly metrics.

Now for a couple of words on expectations and our guidance targets.

Our guidance targets are for long-term full year revenue growth on a constant currency basis.

This target of growth continues to be between 10% and 20%.

Our long-term EBITDA as adjusted annual margin expansion is targeted to grow at approximately 200 basis points per year.

Our revenue and EBITDA guidance targets are intended to be long-term in nature and are not intended to be used as specific quarterly guidance.

Our EBITDA as adjusted is impacted by the amount of our equipment gains, net neutrality fees and certain seasonality and SG&A expenses.

Now I would like Tad to cover some additional details on the financial performance of -- for the previous quarter.

Thanks, Dave, and again, good morning to everyone.

I'd also like to thank and congratulate our team for the results and continued hard work and efforts during another very busy and productive quarter for Cogent.

Corporate and NetCentric revenue and customer connections.

We analyze our revenues based upon network type, which is on-net, off-net and noncore, and we also analyze our revenues based upon customer type.

We classify all of our customers into 2 types, NetCentric and Corporate customers.

Our NetCentric customers buy large amounts of bandwidth from us in carrier-neutral data centers, and our Corporate customers buy bandwidth from us in large multi-tenant office buildings.

Revenue and customer connections by customer type.

Revenue from our Corporate customers grew sequentially by 3% to $81.1 million and grew year-over-year by 12%.

We had 39,186 Corporate customer connections on our network at quarter-end.

Quarterly revenue from our NetCentric customers grew sequentially by 2.4% and 6.2% year-over-year.

We had 34,728 NetCentric customer connections on our network at quarter-end.

Our NetCentric revenue growth experiences more volatility than our Corporate revenues due to the impact of foreign exchange and certain seasonal factors.

Revenue and customer connections by network type.

Our on-net revenue was $92.4 million for the quarter, which was a sequential quarterly increase of 3.4% and a year-over-year increase of 10.5%.

Our on-net customer connections increased by 3.3% sequentially and 15.6% year-over-year.

We ended the quarter with over 63,300 on-net customer connections on our network in our 2,541 total on-net multi-tenant office buildings and carrier-neutral data center buildings.

Off-net revenue was $36.1 million for the quarter, which was a sequential increase of 1.4% and a year-over-year increase of 8.3%.

Our off-net customer connections increased sequentially by 2.9% and 13.1% year-over-year.

We ended the quarter serving over 10,200 off-net customer connections in over 6,400 off-net buildings, and these buildings are primarily in North America.

Some comments on pricing, pricing per megabit.

Consistent with historical trends, the average price per megabit of our installed base and for our new customer contracts decreased for the quarter.

The average price per megabit for our installed base declined sequentially by 8.6% from Q4 2017 to $0.90 and declined by 24.5% from the first quarter of last year.

The average price per megabit for our new customer contracts declined sequentially by 3.3% to $0.40 from Q4 of last year and declined by 44.4% from our new customer contracts that were sold in the first quarter of 2017.

Some comments on average revenue per unit or ARPU.

Our on-net ARPU was flat for the quarter, and our off-net ARPU decreased sequentially.

Our on-net ARPU, which includes both Corporate and NetCentric customers, was $494 for the quarter, which was exactly the same as the ARPU from the fourth quarter.

Our off-net ARPU, which is comprised predominantly of Corporate customers, was $1,193 for the quarter, which was a sequential decrease of 1.2%.

Some comments on churn rates.

Our on-net and off-net churn rates both improved during the quarter.

Our on-net unit churn rate was 1% this quarter, which was an improvement from 1.1% last quarter.

Our off-net unit churn rate was 1.1% this quarter, which was also an improvement from 1.2% last quarter.

Some comments on NetCentric [move/add/] change orders.

We offer discounts related to contract terms to all of our Corporate and NetCentric customers.

We also offer volume commitment discounts to our NetCentric customers.

During the quarter, certain NetCentric customers took advantage of our volume and contract term discounts and entered into long-term contracts for over 2,600 customer connections, which increased their revenue commitments to Cogent by over $25.7 million.

Some comments on EBITDA and EBITDA as adjusted.

Our EBITDA and our EBITDA as adjusted are reconciled to our cash flow from operations in all of our press releases.

Seasonal factors that typically impact our SG&A expenses, and consequently impact our EBITDA and EBITDA as adjusted, include the resetting of payroll taxes in the United States at the beginning of each year, annual cost of living or CPI increases, the timing and level of our audit and tax services and net neutrality fees, and the timing and amount of our gains on equipment transactions and benefit plan cost increases.

Our SG&A expense increased by $1.8 million or 5.6% from these seasonal factors, which was partially offset by the new U.S. GAAP requirement to capitalize and amortize certain of our commissions.

Our EBITDA as adjusted, which include -- is our EBITDA plus gains related to our equipment transactions.

Our quarterly EBITDA as adjusted increased by $0.6 million or 1.5% sequentially to $44.2 million and increased year-over-year by $4.4 million or 10.9%.

Our EBITDA as adjusted margin decreased sequentially by 50 basis points, primarily due to the seasonal SG&A increases, to 34.3% and increased by 30 basis points from the first quarter of last year that decreased less from a decline in equipment gains year-over-year.

Our equipment gains have recently been declining and were only about $100,000 this quarter compared to $2.1 million for the first quarter of last year and $300,000 last quarter.

Our quarterly EBITDA increased by $0.8 million or 2% sequentially to $44.1 million and increased year-over-year by $6.4 million or 16.9%.

Our quarterly EBITDA margin decreased by 20 basis points sequentially, again, primarily due to certain seasonal SG&A factors, to 34.3%, but increased by 200 basis points from the first quarter of last year.

Some comments on earnings per share.

Our basic and diluted income per share was $0.15 for the quarter.

That compared to a basic and diluted loss per share of $0.14 for the fourth quarter of last year and income per share of $0.09 for the first quarter of last year.

As a reminder, the fourth quarter of 2017 included a onetime income tax expense from the impact of the tax reform act of $11.3 million.

If you exclude this amount from our basic and fully diluted income per share for the fourth quarter of last year, our earnings per share would have been $0.11 instead of a loss per share of $0.14.

Some comments on foreign exchange.

Our revenue reported in U.S. dollars and earned outside of the United States is about 23% of our total revenues.

About 18% of our first quarter revenues were based in Europe and 5% of our revenues were related to our Canadian, Mexican and Asian operations.

Continued volatility in foreign exchange rates can materially impact our quarterly revenue results and our overall financial results.

The foreign exchange impact on our reported quarterly sequential revenue was a positive $1 million, and the year-over-year foreign exchange impact on our reported quarterly revenue was a positive $3.3 million.

Our revenue growth on a constant currency basis improved to 2% for the quarter sequentially from 1.8% last quarter and improved year-over-year from 6.6% last quarter to 7% this quarter.

The average euro to U.S. dollar rate so far during this second quarter is $1.23 and the average Canadian dollar exchange rate is $0.79.

Should these average foreign exchange rates remain at current levels for the remainder of our second quarter of 2018, we estimate that it will not be a material foreign exchange impact on our sequential quarterly revenues, but the year-over-year foreign exchange impact will be a positive $2.7 million.

Customer concentration.

We believe that our revenue and customer base is not highly concentrated.

Our top 25 customers represented less than 6% of our revenues this quarter.

CapEx.

Our CapEx for the quarter was $14.9 million.

That compared to $12.2 million for the first quarter of last year and $10.6 million for the fourth quarter of last year.

Capital leases and capital lease payments.

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 the initial term.

Our long-term and short-term capital lease IRU obligations totaled $157.9 million at quarter-end, and at quarter-end, we had a total of 232 different suppliers of dark fiber.

Our capital lease principal payments under these agreements were $2.3 million for the quarter.

Capital lease principal payments, if you combine that with our CapEx, increased sequentially and was $17.2 million this quarter compared to $12.5 million last quarter and $16.1 million for the first quarter of last year.

Some comments on cash and cash flow.

At quarter-end, our cash and cash equivalents totaled $236 million.

For the quarter, our cash decreased by $11 million, and we returned $32.9 million of our capital to our stakeholders.

During the quarter, we paid $22.8 million for our first quarter 2018 dividend and $10.1 million was spent on a semiannual interest payment on one of our debt obligations.

Some comments again on ratios.

Our total gross debt, which includes capital leases, was $733.5 million at quarter-end, and our net debt was $497.5 million.

Our total gross debt to trailing last 12-months EBITDA as adjusted ratio improved to 4.33 from 4.44 last quarter, and our net debt ratio, as Dave mentioned, was unchanged at 2.94.

Our gross leverage cash flow ratio, which is the ratio as defined in our indenture agreements, was 4.26 and needs to be reduced to 4.25 or less for us to meet the covenant test in our indentures, and then we will have full access to our accumulated builder basket.

Some comments on bad debt and day sales.

Our bad debt expense again was only 0.5% of our revenues for the quarter.

And our day sales outstanding for worldwide accounts receivable significantly improved to 23 days, down from 25 days at the end of last year.

As in every quarter, I want to again thank and recognize our worldwide billing and collections team members for continuing to do a fantastic job.

I will now turn the call back over to Dave.

Hey, thanks, Tad.

I would like to take a moment and speak a little bit about the scale and scope of our network.

We have over 911 million square feet of multi-tenant office space in North America, directly on our network and completely fiber wired.

Our network consists of over 31,800 metro fiber miles and over 57,400 intercity route miles of fiber.

The Cogent network remains the most interconnected network in the world, and we directly connect to over 6,240 networks, of which less than 30 of these networks are settlement-free peers.

The remaining over 6,200 networks are Cogent transit customers.

We are currently utilizing approximately 30% of the lit capacity in our network at peak.

We routinely augment capacity in parts of our network to maintain low utilization rates.

For the quarter, we achieved sequential traffic growth on our network of 8%, that is Q1 of 2018 versus Q4 of 2017, and had a significant improvement for year-over-year traffic growth as measured in the first quarter of 2018 versus 2017.

That growth rate was 35%.

We operate 53 Cogent-controlled data centers with over 603,000 square feet of raised floor space, and these facilities are operating at approximately 32% of capacity.

Our sales force turnover rate was 4.9% in the quarter.

This is, again, better than our long-term average of 5.7%, and we ended the quarter with 432 quota-bearing reps selling our services.

So in summary, Cogent is the low-cost provider of Internet access and transit services.

Our value proposition continues to remain unmatched in the industry.

Our business remains completely focused on Internet and IP connectivity and data center colocations, and our services are a utility to our customers.

Beginning on April 1st of this year, we began offering SD-WAN services, in addition to our other VPN services based on VPLS, to our customers.

We expect our annualized constant currency long-term revenue growth rates to be consistent with our historical averages and to be in the 10% to 20% constant currency growth rate that is our long-term guidance range, and we expect our long-term EBITDA as adjusted margins to expand at approximately 200 basis points per year annually.

Our Board of Directors has approved yet another increase in our regular quarterly dividend of $0.02 per quarter per share, bringing that quarterly dividend to $0.52.

Our dividend increases demonstrate our continuing optimism regarding our business and the significant cash flow capabilities of our business.

We will be opportunistic in the timing and purchase of common stock in the market.

At quarter's end, we had $41.5 million remaining under our current buyback authorization and that program is extended through the end of this year.

We are committed to returning an increasing amount of capital to our shareholders on a regular basis.

With that, I'd like to open the floor for questions.

(Operator Instructions) And our first question comes from Philip Cusick with JPMorgan.

Dave, we saw revenue growth closer to 10% than we have in a long time.

I know there's a little FX in there, but is the underlying business really accelerating?

Yes, Phil, thanks for the question.

Yes, our business continues to improve.

As we commented previously, our Corporate business, which is selling directly to end-users in North America, has very little FX and continued to perform at historical growth rates, 3% sequentially and 12% year-over-year.

The greatest swing in growth came in our NetCentric business.

Now, approximately 52% of that business is outside of the U.S., but we saw the year-over-year growth rate and sequential growth rates in that business improve.

And that improvement is a direct result of the growth in traffic and the acceleration in that traffic growth rate.

While some of that can be seasonal, with 8% sequential growth rate, I think the 35% year-over-year growth rate in traffic as compared to the 29% in the previous quarter on a year-over-year basis and the continued improvement over the last 5 quarters in that year-over-year traffic growth rate continues to show that the underlying business is accelerating and the Internet continues to grow faster than any other part of telecom services.

And then on-net revenue accelerated this quarter and off-net was slower than it's been in some time.

Is it a trend that we can expect, sort of shifting more toward on-net, or is it more random than that?

It is more random than that.

We have some volatility in our off-net business because we are at the mercy of a third party to deliver the local loop.

As Tad mentioned, we have about 10,200 off-net circuits.

Those circuits are delivered by 90 different vendors.

Our core business is on-net, but many of our Corporate on-net relationships often require services at locations that don't meet our return-on-capital criteria, so we use off-net vendors.

In general, the Corporate on-net and Corporate off-net businesses will grow at about the same rate.

In any given quarter, there can be a little bit of volatility, but I think long-term investors should expect both the off-net business and the Corporate on-net business to grow at approximately the same rate, which is about 12% year-over-year, which it's been doing pretty consistently for more than a decade.

Our next question comes from Scott Goldman with Jefferies.

I guess a couple of questions.

One, you talked about the introduction of an SD-WAN product.

Maybe give a little bit of background there in terms of what you're seeing as far as the pace of adoption goes within the industry, whether that's been faster than you've anticipated, and talk a bit about how maybe Cogent differentiates in the SD-WAN market, where a lot of people seem to be also playing in that space.

And then secondly, if you could talk about the drop in the quota-bearing reps this quarter.

It looks like the sales force turnover picked up a little bit, but hiring also slowed.

So just give some context around what's there and what the expectations are for the year on that.

Yes, sure.

Thanks for both questions, Scott.

First of all, SD-WAN continues to gain customer mind share and continues to be used as a technology to build virtual private networks.

Most SD-WAN deployments to date have been to supplement existing MPLS networks, but increasingly customers are tearing out those MPLS networks and replacing them with software-defined wide area networking.

Cogent has offered a virtual private line service for 3.5 years.

That service has become extremely successful for us, representing about 25% of our Corporate revenues.

We still predominantly sell Internet access, but increasingly customers are taking 2 ports, one for a private network and the other for public Internet connectivity.

SD-WAN is an alternate technology that allows the customer to deploy a piece of equipment in their premise, which will be provided by Cogent.

That equipment gives the customer 2 distinct advantages, one being that they get enhanced security, so that equipment operates using IPSec and it basically encrypts every packet to 2 to the 128th power, and then on the other side of the transmission, de-encrypts it.

That additional security is important to customers.

Secondly, it allows customers to create classes of service within their traffic flows.

That could be important if the customer is trying to prioritize different applications within their own network.

So we see customers increasingly using SD-WAN in 2 ways: one, to replace other technologies; and two, to improve security using existing technologies.

So our product will be available to be deployed either over an Internet connection or over a VPLS connection for customers that want 2 levels of security and isolation.

Again, this is very different than other service providers, who have been marketing SD-WAN as a supplement to MPLS.

To remind investors, Cogent never has sold an MPLS service and this represents a completely additional addressable market to us.

Switching to your second question about reps.

We generally, and you can look at our historical trends, don't do a lot of grooming of the sales force towards the end of fourth quarter around the holiday season.

We typically use the opportunity in the first quarter, when we have sales meetings and our people are back from holiday, to manage out some less productive reps.

We did have a drop in the number of reps, but actually the number of full-time equivalents dropped very insignificantly from 429 to 427.

So that was a very modest drop off, and we were taking out some newer hires that were less productive.

We also again were distracted in some of our training and sales management conferences that slowed our hiring down, but we fully expect to continue to add somewhere between 7% to 10% to our total sales force for full year calendar 2018 versus 2017.

And we continue to have an ample supply of candidates.

So we feel very comfortable that we will continue to grow the sales force.

Our next question comes from Nick Del Deo with MoffettNathanson.

First, a quick one for Tad.

Can you quantify the impact of ASC 606 in the quarter and what you're expecting from the year?

You referred to it in the prepared remarks, but I didn't catch a number.

Sure.

First on the top line -- and you can follow this when we file the 10-Q, there is additional disclosures that are required -- there was no -- virtually no impact on our revenue.

In fact, it was $39,000 sequentially, the impact of the adoption of ASC 606.

So for revenue, it's clearly immaterial and not a significant impact.

On the SG&A front, the change is the requirement to capitalize and amortize certain of our commissions, and it was about $1 million reduction to SG&A during the quarter, which is about 80 basis points.

For the year, it will ramp down as we're -- you get kind of that initial impact.

So the impact for subsequent quarters will be less than that on SG&A.

Okay.

One for Dave.

I saw you were recently interviewed for an article in Ars Technica about you and Comcast and you noted that Comcast was starting to drag its feet again when it came to augmenting capacity.

It made me think of 2 questions.

The first, I may be mistaken, but I don't remember you signing a deal with Comcast after the interconnection fight from a couple of years ago and instead had a "gentlemen's agreement" with them.

Is that, right?

or was that referring to the original (inaudible)?

And then second, and more generally speaking, is this a leading indicator of what the environment's going to look like with the last-mile providers as the -- in the wake of the Open Internet Order going away?

So we do have a formal written signed agreement with Comcast.

We have had that agreement and quite honestly, Comcast's timeliness in honoring the agreement has always been within the 4 corners of the agreement, but there's been a fair amount of variability.

And after the proposed repeal of the Open Internet Order and the reclassification of the Internet as a Title I service, Comcast started to push towards the outer bound of their obligation to upgrade capacity.

They continue to do it, but they were dragging their feet and they were truly an outlier.

Other companies like AT&T, Verizon, Spectrum, no problems whatsoever and have been extremely supportive of net neutrality.

Comcast, miraculously, right after I had the opportunity to testify in front of the California State Senate, which has passed 2 committees now in its adoption of its net neutrality rules, miraculously pulled their provisioning times in now to the shorter end of the boundary and are provisioning at almost record speed.

So it's clear that Comcast is monitoring the regulatory environment.

They would -- I think their behavior says they would like to not honor net neutrality, but they are observant of regulators looking over them.

And just recently, New York also introduced a sister bill cosponsored by 42 of the 63 senators in New York in the state Senate that exactly mirrors the California bill.

We remain optimistic that both of these bills will ultimately be passed.

I think that, coupled with additional oversight from other jurisdictions, will probably keep people honest.

So I do not anticipate a reversion to the bad behavior that existed in 2013 and '14.

Our next question comes from the line of Walter Piecyk with BTIG.

I guess I want to follow up to that last question and answer.

If you have a contract and they're within the contract, why does that matter?

It's not like people pay their bills as soon as they get them.

They pay them on the last day they're due.

So there is no payment due in this contract.

I understand, but that was a metaphor for like if they're operating with the confines of the contract, you set the contract, I mean why wouldn't you expect that they're going to add that capacity at the last possible moment that they have to?

So 2 reasons.

The first reason and the most important reason is what the contract defines as the reason is to provide quality service to each company's respective customer base.

So if you're selling services, typically, you would want to deliver the highest-quality service at the earliest possible date, not at the last possible date, if that's possible.

Secondly, the agreement provides a window of -- meaning, kind of a maximum and minimum amount of time, and there is [people] that oscillate, but if they operated at the maximum boundary for us, and they operated at the same boundary for their customers, no one would sign with them because that outer boundary is beyond industry norms for provisioning.

So it all comes down to intent, and since there is almost no cost to either party, I mean, it's literally 50% of the cost for the cross-connect is the only incremental cost to either party, and the purpose of the contract is not to benefit the other party, but to actually benefit your own customers, it would seem like they should be incented to do this in as short a period as possible.

We have seen other last-mile providers dramatically improve their provisioning times of these additional ports, where there is absolutely no window in which there is ever congestion.

I mean if you're signing the contract and it's impacting your ability to deliver traffic, I wouldn't assume any ISP is going to behave in a way that you could predict.

You just have to -- you should have set the contract better, I guess, if that outer bounds is something that you are not now comfortable with.

But we are comfortable with it.

So the article that Nick was referring to was a particular customer in a particular location.

It was actually a customer in Seattle that was trying to exchange traffic locally, and instead of exchanging it locally, some of that traffic was diverted to another market, San Francisco, and the customer noticed the greater latency in the transmission.

And it was just because of the inability of Comcast to turn up those additional ports quickly enough in Seattle.

There was still adequate capacity between the networks.

The contract was being honored.

It was just this particular customer was experiencing a slightly prolonged latency when trying to reach Comcast from a Seattle-to-Seattle location.

Got it.

So the bottom line is that the way the contract was structured, even if all of these ISPs started behaving in this manner, that this should not have an overall impact in your -- how your view is on the NetCentric growth.

Is that accurate or not?

That is accurate, Walt.

Okay, great.

And then let's get to the question I wanted to ask is the builder basket.

Can you just kind of walk us through the timeline?

Obviously, you are very close to being able to down flow that money.

Does it happen immediately in terms of like, okay, now you have -- the cash has moved and then you can start buying stock back?

And even if that's not the case -- or not start, but like obviously, you have plenty of cash available for stock repurchase.

And even if it's an end-of-quarter type of test, since you now have the visibility that you're going to hit that 4.25 target, shouldn't that free your board up to say like "All right, Dave, you're good to go on share repurchase this quarter"?

So it is a test that is met at the end of the quarter as defined in the indenture.

While we do have a great deal of visibility and feel quite comfortable that we will breach this 4.25 substantially and be below that, what will mechanically happen is we will effectively have a dividend from the operating company to the holding company, moving that cash.

And at that point, that cash is outside of the covenant package, outside of the indenture and is fully available for any mechanism of return to shareholders, or any other use that we have that could be precluded in the indenture.

It will probably not happen until we have our reviewed financial statements complete at the end of the quarter.

That has been our practice.

While the indenture probably would allow us to prospectively do it, I don't think we would feel comfortable doing it until we have those financials in hand and we have no need to do it until then.

And our next question comes from the line of Mike McCormack with Guggenheim.

Dave, maybe just a comment on what you're seeing out there on the Corporate side with respect to decision-making.

I'm hearing a couple of little crosswinds this quarter on decision-making slowing down a little bit.

And then secondarily, on the competitive landscape, just thinking about the newly combined Century/Level 3. Have you seen any change in any behaviors there on -- whether it be pricing or promotional activity?

And if you could just finish maybe, Dave, a comment on 5G and how 5G builds will affect Cogent.

Yes, sure.

Let me try to take all 3 of those.

I'm going to start with -- I'll take them in order.

In the corporate landscape, I think businesses continue to look to groom their networks and reduce their overall telecom spend.

The percentage of GDP that's spent on telecom services continues to decline.

I think that decline will actually accelerate.

Just as we saw a significant cost savings for customers as they migrated away from POP services to VoIP services, we're seeing a similar migration as private networks move from MPLS to these alternate technologies like VPLS and SD-WAN.

I think decision-making is predicated on 3 factors: one, a need for more services; two, the ability to extricate yourself from your current relationship, that means contract expiration; and third, and maybe most importantly, a clear benefit to the customer from the migration, because migrations are always painful no matter how simple you make it for the customer.

And in our case, we have 2 things that have been driving Corporate demand pretty consistently.

One is the increased need for Internet connectivity as Cloud and SaaS applications continue to replace other types of computing and software.

The second being the desire for those companies that have a private network to reduce costs and get off of those cumbersome expensive ports.

So we feel very comfortable that the roughly 3% sequential growth and 12% year-over-year growth that we have experienced for the past decade or so should continue or even improve going forward.

So we see no degradation or material acceleration in Corporate growth rates.

Others, I think, are really seeing these crosswinds because of these product substitution phenomena.

Now to your second question about M&A and particularly Level 3/CenturyLink.

We compete with the CenturyLink incumbent portion in their footprint, and they remain, I think, constrained by their network and by their legacy product set.

So Cogent's Corporate sales continue strong across the board, and geographically, we perform about the same in CenturyLink footprint as we do in Verizon or AT&T or Bell Canada footprint.

On the NetCentric side, CenturyLink was never a significant competitor.

Level 3 is our #1 competitor.

I think since the combination was announced and now has been consummated, Level 3 continues to deemphasize transit as a product and seems to be less focused on the NetCentric market.

They remain a significant force, they're the largest player.

The 2 other major global backbones, NTT and Telia, are competitors in that market.

But Cogent, as demonstrated by our 35% traffic growth as compared to a market that's probably growing in the low '20s, is gaining market share, and I think some of that share is coming from the combined Level 3/CenturyLink.

To your final question of 5G, anything that promotes greater data usage and more Internet usage is a good thing for Cogent, whether we are providing upstream to the 5G provider or we're providing access to the Internet to the content that is going to those 5G customers.

I think 5G will be very capital intensive, will be a long implementation, but it will continue to drive mobile data usage.

Data usage is today still dominated by fixed line.

I think that will continue, but I think mobile will continue to grow probably at about twice the rate of fixed line, becoming more and more significant, and 5G is an enabler of that.

And our next question comes from Matthew Niknam with Deutsche Bank.

Just 2 if I could.

One, following up on NetCentric, so Dave, you mentioned maybe Level 3 backing off somewhat in terms of transit in the quarter post-consummation of the deal.

Was that really what drove that the reacceleration, do you think?

Or are there other tailwinds or factors to consider?

And then secondly, on CapEx, maybe you took a little bit of a bigger step up than we would've expected this quarter.

Can you talk to what's driving this?

And then maybe more broadly, what your expectations are for CapEx for the year?

Yes, sure.

Two very different questions.

So NetCentric growth accelerated because of Internet traffic growth accelerating and a broad set of market factors.

While we continue to gain market share from Level 3 and other providers, I don't think there was a material shift in our wins over Level 3 versus, say, previous quarters.

I think this is more of a multi-quarter trend, but I do think the acceleration is continued healing of the Internet from the damage that was caused a couple of years ago through violations of net neutrality.

And while I have repeatedly indicated to investors, it will continue to improve, it may or may not improve in a perfect straight line.

To the CapEx question, if you take CapEx and principal payments on capital leases, the difference this year versus last year was up about $1 million.

So about $16 million to $17 million.

And you really need to add the 2 numbers together because there could be a relative shift in any quarter between what is recorded as CapEx and what is recorded as principal payments on capital leases.

But the 2 are cash out the door for effectively the same product.

Part of that increase was actually some test equipment we needed to buy to be able to roll out SD-WAN.

There was equipment we didn't have in our labs.

I mean, that was probably the biggest single component of that delta.

Clearly, on a percentage basis, it came down, but in absolute terms, our CapEx this year should be similar to last year.

We did have this slight onetime expenditure on a little bit of test gear.

And our next question comes from Brandon Nispel with KeyBanc Capital.

I was wondering if you could just comment on what you've seen from some of your customers in terms of their purchase behaviors for dark fiber versus lit services.

And then I might've missed this, but just on SG&A for the quarter, is this the run rate that we should expect?

And I guess can you quantify the impact of ASC 606 to your numbers for the full year that you're expecting?

I'm going to give the accounting questions to Tad, but I will take the dark fiber question.

We typically do not go after customers who would potentially buy dark fiber.

That is either other service providers who are attempting to build their own network or the very largest corporate customers.

Now many of our content hyperscale customers have and continue to buy dark fiber, but don't use that fiber necessarily to compete with Cogent or substitute for our service, but use it for a very different purpose, which is to construct a network to connect their proprietary data centers together and then connect those data centers to major exchange points.

We are a purchaser of dark fiber, so we're a customer in that market.

And as Tad indicated, we buy from 232 different suppliers around the world.

We have nearly 89,000 miles of fiber, and this last quarter added about 400 miles of metro fiber, spread across the 199 markets that we operate in.

We sell primarily Internet services, that is roughly 82% of Cogent's revenues, whether the Corporate or NetCentric, and dark fiber is not substitutable for that product because Internet access includes more than just transport.

It includes transport, routing and interconnection.

We also do derive about 15% of our revenues from VPN services for Corporate customers, and dark fiber could be used as a substitute, but typically our Corporate customers buy relatively small volumes of traffic at any location, either 100 meg, or 1 gig, or even 10 gig connections and cannot cost justify fiber.

So really these private networks built on fiber are the purview of maybe the Fortune 100, and that is definitely not Cogent's customer base.

Now I'm going to switch over to Tad and he will answer the ASC 606 question.

Sure.

So this pronouncement had the impact on us in 2 areas: one is with revenue recognition, and second is with the accounting for our commissions.

On the revenue recognition front, there was no impact on our recurring revenue recognition.

The only impact on the company was the recognition of how we defer and recognize installation fees.

The impact at adoption was a reduction to our accumulated deferred revenue, which lowers future revenue that we could recognize.

On the other hand, the time that we are recognizing current deferrals from installation fees was slightly reduced.

Net-net, the impact was only $39,000 for the quarter, and it's not going to be materially different than that for the year.

So on the top line, this had virtually no impact on the company.

On the SG&A front, we are now required to capitalize certain of our commissions.

So we had to take previously expensed commissions at adoption and record that on the balance sheet, and that was about $17 million.

So those commissions, while they were previously expensed, will need to be expensed going forward.

On the other hand, current commissions are partially capitalized and then amortized.

So the net-net of that impact during the quarter was a reduction to SG&A about $1 million.

The impact in subsequent quarters, while difficult to forecast, will be less than that.

Your question on the run rate of SG&A this quarter, it will be similar in the subsequent quarters of 2018, dependent upon our level of hiring, bad debt expense.

Those are the expenses that typically will have some variability to them.

And our next question comes from Frank Louthan with Raymond James.

Discuss just a little bit about the SD-WAN rollout and talk just about how this differs maybe from the IP product you've traditionally offered.

Or are you just looking to deliver that same product via an SD-WAN type architecture?

And who's the target market for this?

Is this mostly the Corporate or NetCentric, or are you going to be able to sell this to both?

Sure, Frank.

So first of all, it's almost exclusively a Corporate product.

We don't see any real applicability to our NetCentric customers.

It is using a fundamentally different technology than the VPN services we sell today.

So the VPN services we sell today are delivered over a virtual private line service, using encapsulization through network-based equipment.

So what are doing is taking packets from customers, putting them in a wrapper, sending them across our network and then stripping those wrappers off of them.

And that is all done through equipment in our network.

The SD-WAN solution uses a fundamentally different architecture.

It requires a piece of customer premise equipment.

It encrypts rather than encapsulates the packet, sends it across the network and then de-encrypts on the other side.

We expect some customers to actually use both technologies concurrently.

Some will use 1 or the other.

The downside to the encryption is that approximately 15% of the payload or bandwidth gets utilized in that encryption process.

So the net effect of throughput is only 85% of line rate, whereas with the VPLS service, you get 100% of line rate.

You also, as a customer, get the added benefit with SD-WAN of being able to establish class of service within your payload and prioritize traffic.

So there are pluses and minuses to each technology, and we think this gives all customers who have a private network, a technology that is both superior to MPLS, lower cost and can meet their specific needs.

So it's really meant to be additive, not replacement to what we have.

I'm showing no further questions at this time.

I would now like to turn the call back to Dave Schaeffer, CEO, for any further remarks.

First of all, I want to thank everyone.

We kept it just to about an hour and obviously, we will be available to answer any questions.

But thanks for your support, and thanks, everyone, at Cogent for a great quarter.

And we look very optimistically towards rest of the year, continuing to deliver great results.

Thanks a lot everyone.

Bye-bye.

Ladies and gentlemen, thank you for participating in today's conference.

This concludes today's program.

You may all disconnect.

Everyone, have a great day.