Cogent Communications Holdings Inc (CCOI) 2012 Q3 法說會逐字稿

Good day and welcome to the Cogent Communications Group Incorporated third-quarter 2012 earnings conference call and webcast. Today's conference is being recorded. It will be available for replay at www.CogentCo.com.

At this time, I would like to turn the conference over to your host, Chief Executive Officer, Dave Schaeffer. You may begin.

Thank you and good morning, everyone. Welcome to our third-quarter 2012 earnings conference call. I'm Dave Schaeffer, Cogent's Chief Executive Officer. With me on this morning's call is Tad Weed, our Chief Financial Officer. We are pleased with our results for the quarter and are optimistic about the strength of our business and the outlook for the remainder of 2012 and for the full year 2013. During the quarter, we experienced sequential revenue growth, EBITDA margin expansion, lower churn, and a significant increase in traffic on our network. Additionally, we returned approximately $4.5 million to our shareholders on our first quarterly dividend of $0.10 a share that was paid in September.

We continue to be confident in the cash flow generative capabilities of our business. As a result and as we indicated in our press release, we announced a 10% increase in our quarterly dividend to $0.11 per share to be paid on December 12, 2012 to holders of record as of November 21, 2012. On a constant currency basis, our revenue grew from the second quarter sequentially, 2.8%. On a constant currency basis, and adjusting for the loss of our largest customer in January of 2012, Megaupload, our revenue growth on a year-over-year basis would have been 11.9% from the third quarter of 2011. Our EBITDA margin expanded by 30 basis points sequentially from the second quarter to 32.9%. Since absorbing the loss of Megaupload in the first quarter, our EBITDA margin has expanded in the past two quarters by 360 basis points.

During the quarter, traffic growth on our network accelerated to 17% sequentially from the second quarter, and on a year-over-year basis, traffic grew 28% from the third quarter of 2011. Since the end of second quarter, we continued to expand our footprint by adding an additional 33 buildings to our network. During the quarter, our sales rep productivity was 4.9 installed orders per rep per month. This is significantly above our historical average of 4.1 installed customer connections per rep per month. Throughout this discussion, we will highlight several operational statistics we believe demonstrates our increasing market share, expanding scale and size of our network, and most importantly, the operating leverage of our business model. We continue to believe we have built a business with a significant barrier to entry anyone trying to replicate what we have assembled here at Cogent. We are the lowest cost, most efficient operator in our sector.

We remain focused on the most revenue-rich locations, which we then bring on that, selling the highest quality Internet service to our customers at the absolute lowest price and best value in the market. I will review in greater detail certain operational highlights and our continued expansion plans. Tad will provide some additional details on our financial performance. Following our remarks, we'll open 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 third-quarter 2012 earnings report and this earnings conference call discuss Cogent's business outlook and contain forward-looking statements within the meaning of Section 27A and 21E of the Securities Act. These forward-looking statements are based upon our current intent, belief and expectations. These forward-looking statements and all other statements that may be made on this call that are not historical fact are subject to a number of risks and uncertainties, and actual results may differ materially.

Please refer to our SEC filings for more information on the factors that could cause actual results to differ. You should also be aware that Cogent's expectations do not reflect the potential impact of mergers, acquisitions, other business combinations or financing transactions that may be completed after today. Cogent undertakes no obligation to release publicly any revision to any forward-looking statement made today or otherwise update or supplement statements made on this call. Also during this call, if we use any non-GAAP financial measures, you'll find these reconciled to the GAAP measurement in our earnings release and on our website at www.CogentCo.com.

Now I'd like to turn the call back over to Dave.

Thanks, Tad. Now for some highlights from our third-quarter results. Hopefully you've had a chance to review our earnings press release. As with in previous quarters, a press release includes a number of historical quarterly metrics. These metrics will be added to our website. Hopefully you find the consistent presentation of these metrics informative and helpful in understanding our financial results and our trends from operations.

Our third-quarter 2002 -- 2012 revenue was $79.7 million, an increase of 2.4% from our second-quarter revenues and an increase of 3% from our Q3 2011 revenues. On a constant currency basis, our revenues increased sequentially 2.8% from the second quarter, and increased 5.8% from the third quarter of 2011. On a constant currency basis, and adjusting for the shutdown of Megaupload in January 2012, our revenue increased by 11.9% from the third quarter of 2011. We evaluate our revenues based on product class. That is, On-Net, Off-Net and Non-Core, which Tad will cover in greater detail.

We also evaluate our revenues by the type of customer. Our customer types include two primary groups, NetCentric customers and corporate customers. All Cogent customers are categorized two ways, ether as corporate or NetCentric and is either On-Net, Off-Net or Non-Core. NetCentric customers buy large amounts of bandwidth from us, generally in carrier neutral data centers; corporate customers buy smaller amounts of bandwidth from us and large multi-tenant office buildings. Revenues from our corporate customers grew approximately 4% from the second quarter of 2012. These corporate customers represent 51% of our total customer connections at the end of the third quarter and represent 52% of our Q3 2012 revenues.

Our corporate customer connections grew sequentially from the quarter 1%. Revenues from our NetCentric customers grew approximately 1% from the second quarter of 2012. The negative impact of foreign exchange has a much greater impact on our NetCentric revenues. Our NetCentric customers represent 49% of our total customer connections at the end of third quarter 2012, and represent approximately 48% of our Q3 2012 revenues. Our NetCentric customer connections grew sequentially in the quarter by 9%.

Now for some pricing trends. Our most widely sold corporate product continues to be a 100 Meg non-oversubscribed, non-block Internet connection, and our most widely sold NetCentric product continues to be a 10 gigabit connection. We offer discounts related to contract terms to our corporate and NetCentric customers. We also offer volume discounts to our NetCentric customers. During the quarter, certain NetCentric customers took advantage of our volume and term contracts and entered into over 1100 long-term contracts with Cogent, increasing their revenue commitment to Cogent by over $10.4 million.

Customers continued to express their confidence in Cogent by entering into longer term contracts with us. Our average contract term increased again by another 1% in the quarter. More than one out of every three Cogent customer contracts entered into 2012 was for either two or three years. Now for some pricing on a per megabit basis, our average price per megabit of our install base decreased in the quarter. The price per megabit declined from $3.44 in the second quarter of 2012 to $3.24 per megabit in the third quarter of 2012. The price per megabit for new contracts in the quarter was $2.08, a 14% increase from the $1.82 per megabit for new contracts sold in the second quarter of 2012. Price per megabit for our new contracts are partly attributed to some of the targeted promotional activities that we've initiated in response to continued industry M&A activity.

Now for some ARPU numbers. Our On-Net ARPU, or average revenue per user, for corporate and NetCentric customers combined declined by 3.2% in the quarter. The decline in On-Net ARPU is partially attributed to the negative impact of foreign exchange and the promotional programs that we are running. Our On-Net ARPU was $711 for the second quarter and $688 per customer connection for the third quarter of 2012. Our Off-Net ARPU, which is predominantly corporate customers, increased by 1.5% for the quarter. Our Off-Net ARPU was $1643 in the second quarter of 2012 and $1668 in the third quarter of this year.

Before Tad provides some additional details on the quarter, I'd like to address our results and expectations against our announced revenue and EBITDA targets. On a constant currency basis, our increase in sequential revenues was 2.8%, annualized to about 12%. Our EBITDA margin increased by 30 basis points sequentially and has expanded by 360 basis points since the end of the first quarter of 2012. We continue to expect our EBITDA margins annualized to expand by approximately 200 basis points. On a calendar year basis, we continue to expect a reduction in our absolute level of capital expenditures in 2012 as compared to 2011 to be approximately 10%. We expect our revenue growth for full year 2012 versus full year 2011 will be below our annualized revenue growth targets of 10% to 20% due to the impact of the loss of Megaupload at the beginning of the year and the negative impact of foreign exchange. We continue to anticipate our revenue growth for 2013 versus 2012 to be well within our 10% to 20% range and our EBITDA margin expansion in 2013 versus 2012 to be at least 200 basis points.

Tad will now cover some additional metrics and details as a result of our quarter.

Thank you, Dave. Again, good morning to everyone. I'd also like to thank and congratulate the entire Cogent team on their hard work and efforts for the quarter. I'll begin by providing additional details on our revenue by product class, which is On-Net and Off-Net revenue. Our On-Net revenue was $58.1 million for the quarter, which was an increase of 1.4% from the second quarter sequentially. Similar to prior quarters, about 85% of our new sales in the quarter were for On-Net services. Our On-Net customer connections increased by 5% for the quarter, and we ended the quarter with about 28,800 On-Net customer connections on our network and our 1832 On-Net buildings.

Our revenue from our Off-Net business was $20.9 million for the quarter, which is an increase of 5.3% sequentially from the second quarter, as we continue to add Off-Net customers to our network. Our Off-Net customer connections increased by 3.9% for the quarter, and we ended the quarter serving about 4300 Off-Net customer connections in approximately 4000 Off-Net buildings. Our Non-Core revenues are approximately $0.6 million for the second and third quarter and represent less than 1% of our revenues at about 500 customer connections.

Regarding churn, which improved, our OnNet churn rate significantly improved during the quarter, and our Off-Net churn rate was stable. Our On-Net monthly gross churn rate improved to 2.1% for the third quarter as compared to 2.6% for the second quarter. Our gross churn rates include customers who remain with Cogent but enter into amended or moved add change Cogent contracts. Excluding the increase in these move add change contracts, our On-Net churn rate improved to 1% for the third quarter as compared to 1.2% for the second quarter. Our Off-Net gross monthly churn rate was 2.3% for both the third and second quarter, excluding the increase in move add change contracts, our On-Net churn rate was also stable at 1.4% for both the third and second quarters.

EBITDA and gross margin, our EBITDA margin sequentially increased by 30 basis points in the third quarter and was 32.6% for the second quarter and increased to the 32.9% for the third quarter. EBITDA as adjusted was $26.2 million for the quarter, which was an increase of 3.3% from the second quarter. Our gross profit margin decreased by 70 basis points from the quarter from 55% from the second quarter to 54.3% for the third quarter. Our On-Net revenues continue to carry 100% direct incremental gross profit margin, and our Off-Net revenues continue to carry a 50% incremental direct gross profit margin.

Occasional lumpiness in our EBITDA and gross margins can and does occur. If you examine our quarterly metrics for the last 30 quarters included in each of our press releases, you will notice lumpiness in our quarterly margin expansion. This lumpiness can occur due to seasonal and other nonrecurring factors. Seasonal factors include the resetting of payroll taxes, particularly in the US, our annual sales meeting costs and cost-of-living increases, the timing of our audit and tax services and the timing and scope of our expansion activities, which vary from quarter to quarter. Our long-term margin trend has demonstrated that our business model generates increasing EBITDA margins.

Interest expense results from interest occurred on our $175 million of senior notes that we issued in January of 2011 and our $92 million of 1% convertible senior notes and interest on our capital lease obligations. Our interest expense was $9 million for both the second and third quarters of 2012. EPS -- our basic and diluted loss per share was zero for the third quarter and our basic and diluted loss per share was a loss of $0.04 per share for last quarter. Reducing our loss per share during this quarter was an income tax benefit of $1.2 million. That tax benefit represents about $0.03 per share for the quarter, if you exclude that tax benefit from our EPS, the loss per share for the quarter would have been $0.03 a share.

Foreign currency impact -- about 27% consistent with prior quarters of our business is located outside of the US. About 20% of our revenues are based in Europe, and about 7% of our revenues are related to our Canadian and Mexican operations. Volatility and foreign exchange rates can materially impact our comparable quarterly and annual revenues and financial results. The foreign exchange impact on our revenues from the second quarter to third quarter was a decrease of about $0.4 million. Our revenue increased from the second quarter by 2.4% and on a constant currency basis, increased by 2.8%.

The foreign exchange impact on our revenues from Q3 2011 to Q3 2012 was a much more significant negative impact of about $2.2 million. Our revenue increased from the third quarter of 2011 to the third quarter of 2012 by 3%, but on a constant currency basis, that increase was 5.8%. The average euro to US dollar rate so far in the fourth quarter is about $1.30, which is a 4% increase from the average rate of $1.25 for the third quarter. Should the average exchange rates for the fourth quarter remain at current levels, we estimate that the FX conversion impact of sequential quarterly revenues from Q3 2012 to Q4 2012 will be an increase in sequential quarterly revenues of about $0.6 million.

Customer concentration -- our revenue and customer base of about 33,600 customer connections is not highly concentrated. For the third quarter of 2012, no customer represented more than 1% of our revenues, and our top 25 customers represented less than 6% of our Q3 2012 revenues.

Capital expenditures -- on a quarterly basis, we can and have historically experienced seasonal variations in our CapEx, prepaid capital lease payments and construction activities. Our quarterly capital expenditures and prepaid capital lease payments are in part dependent upon the number of buildings we connect to our network each quarter and the timing and scope of our network expansion activities. Our capital expenditures totaled $11.2 million for the third quarter versus $10.6 million for the second quarter of 2012. As Dave said, we had added another 33 buildings to our network in the third quarter and we've added 125 On-Net buildings to our network over the last 12 months. Our capital lease payments including prepaid capital leases were $5.7 million for the third quarter as compared to $1.7 million for the second quarter. We continue to expect to expand our network in 2012 but at a slightly more moderate pace than we experienced in 2010 and 2011 and with continued moderation in 2013.

Balance sheet amounts -- as of September 30, 2012, our cash and cash equivalents totaled $232.1 million, and for the quarter, our cash decreased by $5.2 million as our $15.5 million of operating cash flow was offset by the $11.2 million of CapEx, $5.7 million dollars of capital lease payments and $4.5 million that was paid on our first quarterly dividend in September. Our operating cash flow decreased to $15.5 million for the third quarter from $19.5 million for the second quarter. But our operating cash flow from the third quarter included a semiannual interest payment of $70.3 million that we paid in August on our senior notes. Our operating cash flow will continue to be impacted by the $7.3 million semiannual interest payments on our senior notes. These interest payments occur in February and August through the maturity date in 2018.

Our operating cash flow was also impacted by our $0.5 million semiannual interest payments on our convertible notes, and those interest payments occur in June and December. We have about $92 million of our original $200 million face value of our convertible notes remaining. Those notes mature in June of 2027 and may be redeemed by us or put by the holders beginning in June of 2014. The notes are reported on our balance sheet at $81 million, which is net of their unamortized discount. Our capital lease IRU obligations are for long-term dark fiber leases and typically have initial terms of 15 to 20 years or longer and often include multiple renewal options after that. These capital lease IRU obligations totaled $131.3 million at quarter end. Our bad debt expense was 1.3% of our revenues for the third quarter as compared to 1.1% of our revenues for the second quarter.

Our day sales outstanding or DSO for worldwide accounts receivable was 29 days at September 30 as compared to 27 days at the end of second quarter. The last two days of this quarter fell on a weekend which impacted the cash collected from our customers at quarter end. I want to again personally thank and recognize our worldwide billing and collections team members for continuing to do a fantastic job on customer collections, credit monitoring and handling our customers.

Now I'd like to turn the call back over to Dave.

Again, thanks, Tad. We're going to take a moment and talk about our sales rep activity and productivity. We began the quarter with 269 sales reps and ended the quarter with 273 reps selling our services. We hired 46 new sales reps in the quarter, and 42 sales reps left the Company during the quarter. Our monthly rep churn rate was 5% for the third quarter of 2012, better than our long-term average historical rep turnover rate of approximately 7% per month.

We began the quarter with 256 full-time equivalencies or fully ramped reps and ended the quarter with 263 full-time equivalent sales representatives. Productivity on a full-time equivalent basis for the third quarter 2012 was 4.9 units per rep per month. This performance was significantly better than our long-term historical average, where we've seen sales force rep productivity of approximately 4.1 units per rep per month. As a reminder, our sales rep productivities are not based upon contract signings, but rather are based only upon completed installed customer connections.

Cogent's scale and network expansion -- we continue to grow our network. We added 33 buildings in the third quarter of 2012 and have over 1830 buildings on our network, representing over 700 million square feet of multi-tenant office space as well as many carrier neutral data centers. Our network now consists of over 26,300 miles of Metro fiber and 56,700 intercity route miles of fiber. The Cogent network is the most interconnected in the world, and we directly interconnect with over 4180 other networks. Approximately 40 of these networks are settlement free exchanges of traffic. The remainder of the networks are actually paying Cogent customers.

We currently are utilizing approximately 17% of our capacity. We routinely augment parts of our network to maintain a low utilization rate. We have a well diversified revenue base with low customer concentration. No customer represents more than 1% of our revenues. Our top 25 customers represent less than 6% of our revenues. We believe our network has substantial additional capacity available to accommodate our revenue growth plans. We continue to evaluate additional markets and fiber routes. We take advantage of certain opportunities that have been presented to us by continuing volatility, particularly in the European markets.

We believe that Cogent is the lowest cost Internet access and transit service provider and that our value proposition remains unparalleled in our industry. Our pricing strategy has continued to attract many new customers, resulting in longer average contract terms, increased volume and increased revenue commitments from existing customers. Our business remains entirely focused on the Internet and provides a necessary utility to our customers, particularly as we've seen in the most recent outages in the Northeast, where our network has fared quite well. We continue to expect our annualized revenue growth rates and EBITDA margin expansion to return to their historical rates, that is, 10% to 20% annualized revenue growth and approximately 200 basis points of annualized EBITDA margin expansion.

We will opportunistically take advantage of timing to purchase our common stock. As of the end of third quarter 2012, we had purchased 307,000 shares of our stock for a total cost of $4.2 million at an average price of $13.79 under our most recent $50 million board-authorized buyback program. Our most recent stock purchase was on May 18 of 2012 at $16.89 a share. We have approximately $45.8 million available under this authorized repurchase program that is in place through February 2013.

We continue to be very encouraged by our accelerating traffic growth on our network, the result of our sales initiatives, our targeted promotional productivities, our rep productivity, and the size of our order backlog. We continue to like and are confident that our network reach, our product set, our addressable market and our operating leverage all result in a business that we feel very confident about. We continue to be committed to providing top line revenue growth of between 10% to 20%, expanding our EBITDA margins and most importantly, generating increasing amounts of free cash flow for our equity holders.

On November 5, 2012, our Board of Directors approved the payment of a 10% increase in our quarterly dividend to $0.11 per quarter per share to be paid on December 12, 2012, demonstrating our optimism regarding the increasing cash flow capabilities of our business and our commitment to returning capital to our shareholders on a regular basis.

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

Thank you.

(Operator Instructions)

Colby Synesael, Cowen and Company.

I have two questions. The first one, wondering if we can get an update on the Level 3 Global Crossing promotions. I think you had previously said you had already won 700 of the 1500 target customers you are going after. I wonder if you could tie that back into the price increase on a per megabit basis that we saw in the third quarter and how that's impacting that?

And then my second question has to do with the dividend. Obviously this is just your second quarter now with the dividend and you're already raising it $0.01 or about 10%. What's the message you're trying to provide to investors with this raise? And what does that imply about your intentions for raising the dividend over the next 12 months?

Thanks a lot for the questions, Colby. First of all, with regard to our targeted promotional activity specifically related to the combination of Global Crossing and Level 3, we have now been successful in winning almost over 800 of the 1500 targeted accounts. Virtually all of those customers do have their own autonomous system numbers, multi-home and are reflected in our network connectivity increases.

We continue to be extremely aggressive and offer prices as low as $0.50 a megabit to those targeted customers. We've also seen many of those customers that previously had taken advantage of those purchases come back for additional purchases, some of those at higher prices. So it is the combination of customers taking additional capacity at our standard pricing as well as existing people that we have won under the promotions taking additional capacity at higher prices, that has resulted in the 14% sequential increase in the price that we've been able to achieve on new sales going to $2.08 from $1.82.

We do expect however the long-term trend of price declines in the install base will continue as volumes increase, as contract terms increase, and as we continue to remain focused on being the most aggressive provider in the market on the NetCentric side of our Business. And for our corporate customers, what we typically see is a very stable pricing environment. However, the effective price per megabit for those customers continues to come down as those customers increase their utilization, and we've actually seen our corporate utilization on average and our installed base go up to over 11% from where it's been hovering between 9% and 10% historically.

To your second question around dividends strategy, we have been clear with investors that we have excess capital on our balance sheet. We feel very comfortable with our business and its ability to produce increasing amounts of free cash flow.

Now, in the past, we've used that cash flow to invest in the Business, whether it be growing the sales force or growing the footprint. We're going to continue to do that going forward, as Tad indicated we expect to grow both the sales force and the footprint. We, however, are producing more cash than we can deploy. We do look at M&A opportunities, but have chosen not to participate to date in the market, simply because we've not seen opportunities that would be accretive on a free cash flow per share basis to our equity holders.

With that, we are committed to returning that capital. We think that a regular dividend coupled with a methodical increase in that dividend is a good way to demonstrate our commitment to our equity holders, and then finally probably at some point in the future, we believe that we'll be -- it will be incumbent on us to go ahead and give investors a formulaic payout ratio. We think we're too new as a dividend paying company to do that, and we just need to demonstrate consistent dividend policy and the ability to grow the dividend when it makes sense. So, our board looked at the excess cash and felt that the 10% increase was the right signal to send the market.

Okay. Thank you.

Michael Funk, Bank of America Merrill Lynch.

Just a couple questions this morning. We heard from a few other carriers, AT&T, Verizon, TW Telecom, about some softness during the quarter. And in part, that was attributed really just to uncertainty. Perhaps around the election, the fiscal cliff, and I'm hoping you can comment broadly on that first. And then going back to your last comment about the dividend, and maybe providing a more formulaic way for us to think about it going forward, is the implication there that as we get more comfortable with the free cash flow and the rate of growth in the future we could see material step up in the dividend rate to X percent of free cash flow payout, or how should we think about that?

Thanks for the questions, Michael. First of all, what most other carriers classify as their enterprise revenue, we call our corporate revenue stream. And in fact, our corporate revenues increased sequentially 4% quarter over quarter. That's actually very good results. We've historically averaged about 3.5% sequential growth in that corporate revenue stream, so we actually saw some slight acceleration.

We continue to see strong productivity out of the sales force, a rapid growth in our customer connections, both On-Net and Off-Net, and feel very comfortable about the state of the market. Now, we are somewhat different than other carriers in that we only sell Internet conductivity and IP-based services. Those other carriers continue to fight the revenue attrition that is endemic in our industry where customers continue to migrate applications and services over to the Internet. So we expect our rate of corporate growth to continue to exceed that of other companies.

Now, that doesn't mean we're totally immune to economic conditions. Our NetCentric business is heavily impacted by currency fluctuations. And also even our Corporate business, if we went into a major recession back to '09 type rates of negative GDP growth, was impacted, but in a sluggish about growing environment, we feel very comfortable with our corporate growth rate continuing to remain strong.

With regard to the cash flow, I think it's too early for us to go ahead and give a payout formula. I think it's really incumbent upon us to demonstrate a consistent pattern of returning capital to shareholders, and I think probably maybe a year from now or so, the board will review that policy and maybe at that point, after four or six quarters of consistent dividend returns, we will then be able to come up with something that's more formulaic. I think what we're trying to message is what I echoed to Colby, which is our commitment to be equity friendly and return capital to equity in a very systematic and methodical way.

Great. Thank you for the time, Dave.

Barry McCarver, Stephens Incorporated.

Solid quarter, thanks.

Thanks, Barry.

Dave, can you give us an update on any of your network or data center assets that may have been affected by the hurricane?

Sure. So first of all, all of our thoughts go out to the people in the Northeast that were impacted, and particularly I'd like to thank our field team led by Rich Rademacher of Maurice Augustine in New York who have done a phenomenal job dealing with the devastation in New Jersey and New York City.

So, our impact was felt four ways. First of all, and probably most importantly, at the peak, we had 44 buildings that were taken off-line. These were buildings that lost power and had battery backup in the building with our equipment, but typically in corporate buildings, we only install about four hours of battery backup. So, at the height of the storm, we had lost 44 buildings.

We're still just below 10 buildings in lower Manhattan off-line. All of those buildings are still without power, and the majority of those buildings have actually some kind of prohibition on us entering them by the city, either a condemnation or structural integrity questions, or power questions. We do eventually expect over the next week or so to get all of those buildings back online that are habitable. But we're down to below 10 buildings out of 1288 buildings Company-wide that are off-line.

The second impact was our major hub site in Tribeca at 32 Avenue of the Americas. That particular building does not allow a permanent generator, so we had to bring a portable generator in, and because of road conditions, that hub was off-line for about four hours. Even though there was eight hours of back up, there was just the inability to get the backup generator that was designated to that site to the site quickly enough. Actually, the first generator was diverted to a hospital application, which we understood the contractors need to do that and we took the second generator. The buildings that were served by that location were also down. They were in that 44. So, there was no real issue.

The third and probably most significant impact was in our data center at 33 Whitehall. So Cogent operates 43 data centers across its footprint. The only data center that went down was the data center at 33 Whitehall, which is literally directly across the street from the entrance to Staten Island Ferry. That center is back online now, even though the building has limited access and the city is concerned about the structural integrity of the building. It's 46 story high rise building, and our data center is on the 30th floor. We have a permanent generator. We have a 4000-gallon fuel tank in the basement and a pumping system to power our generator, which is located on the roof.

Unfortunately, when the water breached the battery and came into the building, the basement was under 17 feet of water. The lobby actually had four feet of water. And our generator became -- generator fuel supply became contaminated. We then quickly mobilized -- brought in a portable generator and installed an emergency transfer switch, allowing us to tap in the exterior generator into the building and have now brought it back online, and virtually all of the customers in that facility are online and back up. A couple of them did receive damage to their particular server equipment, and a few servers are being replaced, but the customers are back and operational.

The fourth and final impact is to our Off-Net customers in lower Manhattan. Verizon is our primary loop provider in that case. And we have about 250 customer connections Off-Net in lower Manhattan that Verizon has no capacity to. So we're waiting for those to come up as Verizon continues to repair its infrastructure. The net impact of all of this is a relatively immaterial impact on our revenue stream going forward and our service level guarantees.

Because we operate in 35 countries around the world, we generally see some kind of a natural disaster each and every quarter. This one is particularly painful because it's so close to home, but we don't expect any material impact in our results for either fourth quarter or going forward.

Okay. That's very helpful. And good to hear. I guess my second question, if you look at your CapEx guidance for the year and what you've done in expenditures year to date, it would suggest that 4Q CapEx is going to be a little bit lower than the previous three quarters. Is that really relating to the number of buildings you'll be moving into, or are we starting to see that down shift as we move into 4Q and next year?

Barry, if you go back and look at the past four or five years, our capital expenditures typically tend to be the lowest in the fourth quarter, and that's because most major cities have construction moratoriums that some began as early as Columbus Day, some as late as Thanksgiving, and generally run through early January. And we generally don't start as many projects.

There are some projects that are underway that we do complete, but we do expect our fourth quarter CapEx to be lower than the average of the three previous quarters. That's been our historic trend. We expect our full year CapEx, as we said, to be at least 10% below last year inclusive of capital leases. And we expect those trends to continue in 2013. That is, continued more moderation in capital spending.

Okay. And last question, just in terms of pricing and competition, could you break out what you're seeing in Europe versus the US, and your market share take-aways there?

Sure. In Europe, to remind investors, our Business is exclusively NetCentric. Our Corporate business is North American. Our NetCentric business is global, US, Canada, Europe, Japan. Our competitive dynamic in Europe is different. We generally don't see the major US carriers, that is AT&T, Verizon and Sprint, we do see them more here in North America. We do ubiquitously see Level 3 and had previously seen Global Crossing in that market, and we see a number of regional players.

We see Telia in Northern Europe and Eastern Europe. We'll see Telefonica and Telecom Italiana generally in Southern Europe. We'll see France Telecom with some of our African opportunities and some Eastern European competition. So, it's a slightly different competitive dynamic. We continue to be as aggressive in Europe as we are here in North America. We continue to gain market share across our global footprint, and that's in fact why our traffic grew sequentially Q2 to Q3 17%.

If you go back and look, we've released those numbers every year now for the past seven years. And I think what you'll see is the Q2 to Q3 sequential growth rate is actually the greatest in the Company's history. And we expect to continue to see our NetCentric business grow. We've actually fully recovered from the loss of Mega in terms of traffic and are at an all-time high in terms of traffic area because of FX and because of price per megabit continuing to come down. We still have some ground to make up on revenue, but we expect to be fully recovered on the NetCentric portion of our revenue also by the end of next quarter.

Okay. Thanks, Dave. That's very helpful.

James Breen, William Blair.

Dave, could you talk about the traffic trends across the geographies? You just talked about pricing a little bit, but where are you seeing growth in Europe versus the US? Is it existing customers? Is it new connections into new data centers, et cetera? Thanks.

Thanks, Jim. So a couple things. First of all, 97% of our traffic comes from our NetCentric customer base, so really growth in the corporate base, while it's continuing, and I commented we've gone to average corporate utilization now of 11%, is immaterial compared to the NetCentric portion of our Business. The growth is actually geographically consistent North America, Europe, and the rest of the world. We continue to see strong growth in North America, but we also see strong growth out of Africa, which is a good market for us, less so in Asia. We do have a number of Asian carriers, but they generally need us in the US. And finally in Europe, even though there's been a great deal of economic turmoil, our NetCentric customers continue to buy.

I think the growth comes from existing customers taking more bandwidth and continuing to win new customers both from the targeted promotional activity, as well as from general marketing and sales efforts. We're seeing growth being driven by video as we talked about on the previous call. We're seeing ramp ups from companies like Netflix who are putting more and more of their traffic on their own CDN and using Cogent for bandwidth. We're also seeing our access network operators experience significant increases in bandwidth demand because their customers are spending more hours a day online and downloading more video per day. And we continue to be the low cost provider.

So, as unit volumes increase, for any customer, existing or potential new customers, they are more apt to give that traffic to Cogent. And that's why our rates of traffic growth are substantially ahead of where the industry is. And if you look at application, it's by far and away dominated by video. While cloud computing and business applications continue to grow, they are de minimis in scale compared to the bit loads that are placed on the network. Today, we're carrying between 55 and 56 petabytes a day of traffic. That's up substantially, 17% just in one quarter.

And do you see good traffic growth this quarter -- do you see it getting stronger in the fourth quarter? Is there seasonality in the fourth quarter just as it gets colder in the northern half of the US or is there anything around that? Thanks.

Sure, Jim. Normally the fourth quarter is a strong growth quarter for us in traffic. We're seeing that trend or even an accelerating fourth quarter trend. As I look at our weekly and daily traffic stats, while on a daily basis there can be some fluctuations a day or a week, I think every single week, this quarter so far, so we're six weeks in, we've seen records each week has broken the past -- the previous week. So, we're absolutely seeing strong growth in traffic in the fourth quarter. And that's part of the reason why we're comfortable that the NetCentric portion of our revenues will resume some decent year-over-year growth as we get past mega and the Business continues to grow even though price per megabit declines.

Terrific. Thank you.

Frank Louthan, Raymond James.

This is Alex Sklar for Frank. After the Level 3, Global Crossing promotion activity flushes through and -- how do you plan on keeping volume up? Is there any M&A opportunity that you see out there? Or do you think just the growth in video is going to be sustainable for the next several years? Thanks.

Sure, Alex. So, a couple of points. First of all, our corporate growth is just winning more customers in more buildings based on the value of our product versus what they previously had. And to the question earlier that Michael asked about others that we compete with seeing soft enterprise growth and we see strong growth, it's really we're delivering a better service for about the same price. And it's actually a service that people need.

On the NetCentric portion of our Business, we continue to gain market share carrying 16% or 17% of the world's bits. We want more of those. We're going to earn those customer by customer delivering the lowest price and the highest-quality to those customers.

So, we expect to see growth being driven by three things. One, winning new customers on the NetCentric side. Two, existing customers giving us more of their wallet. And then third, the aggregate growth in the entire market continuing to drive unit growth. And as unit volumes grow, customers become increasingly sensitive to price per megabit and tend to use Cogent.

So we feel for all of those reasons, organically we could achieve the revenue growth targets and margin expansion opportunities that we've outlined. In terms of looking at M&A, we looked literally at dozens of deals a month. We continue to evaluate them. We're not opposed them, but we have not seen any opportunities that are priced where we can feel comfortable that deploying our capital, we're going to get a return on capital that's greater than our cost of capital and not put our equity shareholders at risk. So, at this time, our growth trajectory and our confidence in growth is not in any way dependent on M&A.

Great. Thank you.

Jonathan Atkin, RBC Capital Markets.

I was interested in the sales force productivity stats and the retention stats, and is there any reason to think that would reverse to historical averages or maybe see some sort of a sustainable improvement? And then on the CapEx side for 2013, I'm wondering what's driving the moderation in route expansion. I think you addressed that a little bit earlier. Maybe you could provide a little bit more color?

Thanks for the two questions, Jon. Two points. First of all on the sales force, we're obviously encouraged by all of the efforts that the sales organization has put in, in terms of improving training, management, and typically we actually see lower turnover in the fourth quarter in our sales force. So these are all good and improving trends. The productivity per rep is actually driven more by pricing than anything else. And we continue to remain very focused on delivering to each of our respective customer bases, the absolute best value in the market.

On the corporate side, that's a better connection for about the same price. On the NetCentric side, it's a lower-priced per megabit with comparable quality. We think that our increasing scale and increasing market share and increasing rates of traffic growth all give potential customers increased confidence in Cogent's sustainability. And therefore, we feel very comfortable with our trending in the sales force. We're not ready to say the new normal is now 4.9, but we do think we're going to see a gradual trending up in our sales force productivity. And it's in large part by the value of our products and our pricing.

With regard to footprint expansion, we continue to evaluate new routes based on addressable market and availability of fiber. The reality is we are already in the densest markets and the most lucrative routes. We are the most interconnected network. And we will continue to look at new routes, but we have not seen very many routes that are as interesting to us this year as we did, say, the past year. So, for that reason, we expect this continued moderation in capital spending to continue where we're going to be judicious. On the corporate side, there's a finite number of buildings that are big enough to get us to the adequate return on capital to build into the buildings.

On the NetCentric side, we will continue to go to virtually every data center that is constructed. And what we've actually seen over the past probably year is an acceleration in data center construction activity. And the percentage of new facilities connected to our network is probably the greatest mix of data center versus corporate it's been in the past four or five years, where we're just seeing lots of new data centers get funded and built, and for our NetCentric market, we continue to need to be in all of those carrier neutral facilities. So, we expect that trend to continue. But the net result is this more moderate level of capital is where we expect to be.

And then finally, I wonder to what extent are you seeing customers deploy dark fiber? And maybe replace OpEx with CapEx? I know it doesn't solve their IP transit issues and they still need to use you or somebody else, but is that all something you're seeing, in terms of maybe some of the larger customers and any kind of migration that might affect your churn?

Sure. So for the largest NetCentric customers, they do deploy dark fiber to connect their proprietary data centers back to major aggregation points where they buy transit and buy upstream conductivity. I think that trend continues as many of those customers have outgrown the carrier neutral facilities and also benefit from the lower cost of owning the facility, as opposed to renting space. I think those trends will continue. That is very different than customers necessarily trying to build their own Internet backbone.

Yes, the absolute largest customers have built networks to connect multiple data centers, have interconnected those networks and have global footprint, but even for the very largest of the NetCentric customers, they are still sub scale in a business where scale is important. And the fact that we have almost 17,000 NetCentric customers allows us to draw traffic from a wide berth. And then finally a network is of no value if it's not interconnected.

The Internet works because of its interconnection to other networks, and we are the most interconnected, and by being the most interconnected and the lowest price, it's just cheaper to use us than to try to do it any other way. So we feel very comfortable that dark fiber just augments our market opportunity. Doesn't compete.

Makes sense. Thank you.

Thomas Seitz, Jefferies.

I've got two actually. Dave, you mentioned that price per megabit was going to continue to fall, but with the new contract price actually increasing, is that a one quarter anomaly? Or is there any sort of view that maybe the price per megabit deterioration may moderate just a bit? And then the second question is, I know gross margins are lumpy, but was there anything specific in this quarter that caused a little bit of the pressure?

Sure. I'll let Tad take the gross margin question, but I'll take the pricing question. So on pricing, the long-term trend is for prices to continue to decline. Now, our long-term average rate of decline in the install base has been hovering at around 22% year-over-year. It actually moderated some in the last couple of quarters and has only been around 13%. When we look at the year-over-year rate of decline in new sales, it is lumpier, but it did improve to about that 21%. So the moderation that we saw in the most recent quarter was kind of more of a reversion to the mean.

We continue to be very, very aggressive on these targeted promotional programs, but the addressable universe for that program continues to dwindle. So as I said earlier, we've got over 800 of the 1500 targeted customers, and the reality is some of them for whatever reason won't buy from Cogent or may be out of geographies that we can cost effectively serve. So I think there's a little less promotional activity that helped this quarter. I think investors should look at the past three or four years trends, look at the underlying improvement in technology and model in a price per megabit declined in the average base in the mid-20s. With that rate of decline, we feel very comfortable with our top line revenue growth targets both corporate and NetCentric achieving that 10% to 20% range and the ability to deliver margin expansion.

So there's some lumpiness in terms of the specific targeted programs. I wouldn't get too excited about the 14% increase in the new sales in the quarter sequentially. I think the long-term trend is down, but this was in part a reversion to the mean as we are, I think, nearing the end of what we can practically get out of the targeted programs we offered. But yet, I do think there's a lot of growth opportunity within those customers that we got connected. And now we'll be able to sell additional capacity to.

With respect to gross margin, I guess first, what is included in our cost of goods sold includes our circuit costs in particular associated with increases in Off-Net revenue, and we had about $1 million increase in Off-Net revenue for the quarter. Typically the gross margin there is about 50%, so you could infer about a $500,000 increase in certain costs associated with that. We have maintenance costs associated with our new fiber routes, and the timing of when those begin depends upon the timing of not only when the route is accepted, but when those maintenance costs begin as under the contract. And then cost of facilities which includes both new data centers and cost to the landlords of the new buildings we connect. As you dig underneath that, some of those have CP increases that the timing of when they can occur just vary based upon your contract. So depending upon the timing of when those things -- those costs begin, including price changes, acceptance of routes, et cetera is going to drive what is our level of cost of goods sold period over period. And depending upon that, you can get variations in gross margin. Also if you look further back, obviously the loss of Megaupload which carried essentially 100% gross margin certainly impacted our gross margin rate if you look back through January of 2012 when they canceled.

Great. Thank you very much.

Thanks, Tom.

Donna Jaegers, D.A. Davidson.

This is Nick here for Donna. Just a quick question on your new sales, could you give us a little bit of color on the verticals that you're seeing there, which verticals you're seeing most of your new sales coming from? And then the other question would be for your European -- we've seen that there's a lot more job postings for European sales positions and a little bit more of your strategy there on Europe? Thank you.

Sure, Nick. So first of all, I'm going to answer the verticals by dividing our two customer bases. On the corporate side, our largest vertical continues to be legal, followed by financial services and then general professional services. We've seen no real change in those verticals over the past several years. And quite honestly, that's predetermined for us based on the types of tenants that are in the buildings that we choose to connect to. So we don't expect to see any significant change.

What we do see on the corporate side is increasingly, the Internet is becoming the network that matters. We had many customers for example in Hurricane Sandy who lost phone service but continue to communicate to the world via Internet as our service stayed up and their parts provider failed to deliver for them. I think increasingly, for corporate customers, the Internet is an absolute necessity whereas other types of networks are not. On the NetCentric side, our business is divided between access providers and content and application providers. On the access side, I'll be honest, I can't really tell you what the access users are doing with the bandwidth. But when I look at cable companies, I look at PTTs, universities that distribute our bandwidth, governments that we did distribute it, it's predominately residential users and being driven almost exclusively by video over the top.

And on the content and application side, we sell to people like Skype and eBay and Yahoo and Microsoft. And they all generate different applications and different amounts of traffic and continue to grow. But the most significant driver of growth continues to be video on the content side. And whether it be CBS or Viacom or NBC, we continue to see good growth out of the content side to mirror the growth that's coming out of the access network side. So it's video as an application. The vertical is really a variety of business models of profit whether they be access network operators whose users buy more bandwidth from them or the content guys who have either more subscribers or more people paying to view those videos.

And on the European growth opportunities, Dave?

On Europe, our business is exclusively NetCentric. We continue to add sales reps in Europe. I will tell you that while we turn over 7% of our sales force a month, turn over in the sales force in Europe is much lower, it's just harder to turn over employees if you make a hiring mistake, so we try to put a lot more effort in on the front end. We are actively recruiting actually in every one of our European centers, whether it be London or Paris or Frankfurt, Madrid, Milan, Stockholm, we're looking for new reps in all those markets. There has been a lot of turmoil in the market. I think a lot of less productive reps particularly from legacy providers have been transitioned out of those businesses and have become available.

Not all of them are well-suited to our hunting model. A lot of very tenured reps expect to come in with a Rolodex, take people to lunch, and work that Rolodex. That doesn't work here at Cogent. We constantly need all of our salespeople out prospecting for new business. And were looking to grow our sales force. We'll grow it in Europe, but we need hunters, not farmers.

Great. Thank you for taking the questions.

Kevin Toomey, Citi.

Could you give us a sense of how much of your corporate sales were for 100 megabits versus more entry-level sub100 megabits services? And then also, did you provide the capital lease inception for the quarter?

Tad will take the capital lease question. In terms of our corporate sales, On-Net virtually 100% of the sales -- well over 95% of our corporate On-Net sales are the 100 Meg product. We do have a 2 meg product. We do have a gigabit product, but they are de minimis and continue to be very rare in our corporate base. Off-Net, the most common product, is actually a 10 meg ethernet circuit.

We do continue to sell T-1s and T-3s. We do sell 100 megabit and gigabit Off-Net services. They tend to be much rarer, and the dominant product is 10 meg, then followed by 100 Meg Off-Net. But TDM sales now account for less than 5% of our corporate Off-Net sales. And Tad, maybe you want to take the capital lease inception?

Sure. Actually if you look at the press release on the bottom of the cash flow statement, we give you the number for the nine months, which was essentially $10 million for the nine months, getting it for the quarter, you deduct what we disclosed for the six months which was $5.7 million, so the net for the three months of this quarter capital lease obligations incurred was $4.2 million.

Great. Thank you.

And there are no further questions in the queue.

I know we always say this, but we went a little bit longer than an hour, but we want to thank everyone for their interest and questions. I want to congratulate the entire Cogent team on another consistent and great quarter. And we look forward to chatting with you next quarter. Take care, everyone. Thanks. Bye-bye.

This does conclude today's conference. Thank you for your participation.