Cogent Communications Holdings Inc (CCOI) 2013 Q2 法說會逐字稿

Good day, everyone, and welcome to the Cogent Communications Group second-quarter 2013 earnings conference call and webcast. Today's call is being recorded. This call will be available for replay at www.cogentco.com. At this time I'd like to turn the call over to your host, Dave Schaeffer, Chief Executive Officer. Please go ahead.

Thank you and good morning. Welcome to our second-quarter 2013 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 2013. During the quarter we experienced sequential revenue growth, gross margin expansion, EBITDA margin expansion, network traffic growth, increased cash flow, and increased sales rep productivity to the highest level in the Company's history.

Additionally, we returned $6.1 million to our shareholder through our regular recurring quarterly dividend of $0.13 a share which we paid in June of 2013. We continue to remain confident about the growing cash flow generation capabilities of our business. As a result, and as indicated in our press release, we've further announced an increase of 7.7% in our quarterly dividend to $0.14 per share per quarter, a fourth sequential increase in our dividend since we began paying dividends. And this will be paid on September 25, 2013, to holders of record as of September 5, 2013.

As also mentioned in our press release, our Board has approved an additional regular return of capital program. This program is in addition to our regular recurring dividend payments. Beginning this quarter, in the third quarter of 2013, we intend to return an additional $10 million per quarter to our shareholders, either through a stock buyback effected in the quarter or a special dividend each quarter.

For example, by the end of the third quarter, if we have spent $3 million on stock buybacks then, in the fourth quarter, we would issue and pay a $7 million special dividend in addition to our recurring dividend. If we did not purchase any stock in the third quarter, the special dividend paid in the fourth quarter would be $10 million. Any special dividend will be paid on the date that our normal recurring dividend is paid, as well. This return of capital program is planned to continue until our net debt to EBITDA as adjusted ratio reaches 2.5 to 1. Obviously with any plan it is subject to change if conditions change.

Our revenue growth from the first quarter of 2013 grew by 1.5% sequentially. And on a constant currency basis, our revenue growth sequentially was 1.8%. Our gross margins expanded by 80 basis points from the first quarter of 2013 to 56.9%. And our EBITDA margin expanded by 100 basis points from the first quarter of 2013 to 34.5%. During the quarter, traffic grew sequentially on our network by 11% from the first quarter of 2013. And on a year-over-year basis, our traffic grew 93% from the second quarter of 2012.

Our sales force productivity continued to increase. Our sales rep productivity increased over 3% from the first quarter to six installed units per quota-bearing rep, full-time equivalent, per month. This is the highest level of organic sales force productivity in the Company's history. And I'm very proud of the progress the sales force is making. Since the end of the first quarter we continue to expand our footprint by adding another 31 buildings to our network. And for the last 12 months we've added 122 buildings to our network.

Throughout this discussion we will highlight several operational statistics that we believe demonstrate our increasing market share, expanding scale and size and footprint of our network, and most importantly, the operating leverage of our business model. We are the lowest-cost, most-efficient operator in our sector. We are focused on the most traffic-rich locations, which we bring on-net. And we sell the highest quality Internet service to our customers at the lowest price in the market.

I will review in greater detail some additional operational highlights and trends. Tad will provide some additional details on our financial performance. Following our remarks, we will open the floor for questions and answers. Now I'd like Tad to read the Safe Harbor Language.

Thank you, Dave, and good morning, everyone. This second-quarter 2013 earnings report and this earnings conference call discuss Cogent's business outlook and contain forward-looking statements within the meaning of Section 27A and 21E of the Securities Act. These forward-looking statements are based upon our current intent, belief and expectations. These forward-looking statements and all other statements that may be made on this call that are not historical facts are subject to a number of risks and uncertainties, and actual results may differ materially. Please refer to our SEC filings for more information on the factors that could cause actual results to differ.

You should also beware 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 will find these reconciled to the GAAP measurement in our earnings release and on our website at CogentCo.com. Now I would like to turn the call back over to Dave.

Thanks, Tad. Now for some highlights from the second-quarter results. Hopefully you've had a chance to review our earnings press release. As in previous quarters, our press release has a number of historical quarterly metrics. These metrics will be added to our website. We will hope you find these consistent presentation of these metrics informative and helpful in understanding our financial results and the trends from operations. We experienced sequential revenue growth for the quarter. Our second quarter of 2013 revenue was $85.8 million, an increase of 1.5% sequentially from the first quarter of 2013 revenue, and an increase of 10.3% from the second quarter of 2012. On the constant currency basis, our second-quarter 2013 revenue increased sequentially from the first quarter by 1.8%, and increased by 10% from the second quarter of 2012.

We evaluate all of our revenues based on product class -- on-net, off-net and non-core -- which Tad will cover in greater detail. We also evaluate all of our revenue by customer type. We classify our customers in two major categories. Net-centric customers and corporate customers. Net-centric customers buy large amounts of bandwidth from us in carrier-neutral data centers. Our corporate customers buy bandwidth from us in multi-tenant office buildings.

Our revenues from our corporate customers grew 3.2% from the first quarter of 2013. These corporate customers represent 49.1% of our total customer connections in the second quarter, and 51.7% of our Q2 2013 revenues. Our corporate customer connections grew sequentially by 2.9%. Our revenue from our net-centric customers was essentially flat for the quarter. Our net-centric customers represent 50.9% of our total customer connections at the end of the quarter. And represent 48.3% of our 2013 revenues. Our net-centric customer connections grew sequentially by 3.1%.

Now for some trends around pricing. Our most widely sold corporate product continues to be a 100-megabit per second non over-subscribed and non-blocked dedicated Internet access connection. And our most widely sold net-centric product continues to be a 10-gigabit port for transit services. We offer discounts related to contract term to all of our corporate and net-centric customers. We also offer volume commitment discounts to our net-centric customers. During the quarter, certain of our customers took advantage of our contract discounts for volume and term, and entered into longer-term contracts with Cogent, representing over 1,950 customer connections. And increasing their commitment to Cogent by over a $6.3 million.

Customers continue to express their confidence into Cogent by entering into longer-term contracts with us. Our average contract term increased by yet another 0.04% in the quarter. Our average price per megabit of our installed base for the quarter decreased, but our average price per megabit for new sales sold in the quarter actually slightly increased. The price per megabit of our installed base declined sequentially climbed sequentially by 1.7% from $2.87 per megabit in the first quarter of 2013 to $2.82 in the second quarter of 2013. And declined by 18.2% from the $3.44 for the average price per megabit in 2012.

The price per megabit for new customer contracts in the quarter was $1.72, a 1.4% increase from the $1.70 per new megabit customer contracts sold in the first quarter of 2013. And a 5.6% decline from the $1.82 for our new customer contracts sold in the second quarter of 2012. The price per megabit for our new contracts and installed base is partially impacted by our continued targeted promotional programs. Before Tad adds some additional color, I'd like to address our results and expectations for both revenue and EBITDA margin targets.

Our revenue increased from the second quarter of 2012 by 10.3%, and for the first six months of 2013 over the comparable period in 2012 by 10.1%. This growth rates lie is within our guidance range of 10% to 20%. Our EBITDA margin was 34.5% this quarter. And expanded by 190 basis points from the EBITDA margin of 32.6% for the second quarter of 2012. Our EBITDA margin expanded by 100 basis points from the first quarter of 2013. Our EBITDA margin was 34% for the first six months of this year in 2013. And this represents a 300 basis point increase from our EBITDA margin of 31% for the comparable six-month period in 2012. We continue to anticipate our full-year revenue growth of 2013 over 2012 will be in our 10% to 20% range. And our EBITDA margin expansion for 2013 over 2012 will be greater than 200 basis points.

Now I'd like Tad to cover some additional details on the quarter and the year so far.

Thank you, Dave, and again good morning to everyone. I'd also like to thank and congratulate our entire team for the results and their hard work and efforts on the quarter. I will begin by discussing and providing additional details related to our revenue by product class, which is on-net, off-net and non-core. Our on-net revenue was $62.7 million for the quarter, which was an increase of 1.6% from the first quarter of 2013. Similar to prior quarters, about 85% of our new sales for the quarter were for our on-net services. Our on-net customer connections increased by 3.1% for the quarter. And we ended the quarter with about 31,900 on-net customer connections on our network in our 19,021 on-net buildings.

Our revenue from our off-net business was $22.6 million for the quarter, which was a 1.3% increase from the first quarter of 2013, as we continue to add off-net customers to the network, as well. Our off-net customer connections increased by 3% for the quarter. And we ended the quarter serving about 4,700 off-net customer connections in about 4,000 off-net buildings. Our non-core revenues were about $0.5 million and represent less than 1% of our revenues, and about 450 customer connections.

On ARPU statistics, both our on-net and off-net ARPUs declined from the first quarter of 2013. Our on-net ARPU, which includes corporate and net-centric customers combined, was $676 for the first quarter as compared to $666 for the second quarter of 2013. Our off-net ARPU, which includes predominantly corporate customers, was $1,642 for the first quarter. And declined to $1,617 for the second quarter of 2013, as off-net ARPU begins to stabilize.

Our numbers regarding churn, our net churn rates for both our on-net and off-net customers were flat during the quarter. Our on-net churn rate was 1.3% from the first and second quarter. And our off-net churn rate was 1.5% for the first and second quarter. Regarding EBITDA and gross margin, as Dave mentioned, our EBITDA margin for the quarter increased by 190 basis points from the second quarter of 2012, an increase sequentially from the first quarter of 2013 by 100 basis points. Our EBITDA margin was 32.6% for the second quarter of 2012, 33.5% in the first quarter of 2013, and for the current quarter was 34.5%. EBITDA as adjusted was $29.6 million for the quarter, which represented a 4.7% increase from the first quarter of 2013, and a 17% increase from the second quarter of 2012.

Our gross profit margin significantly increased for the quarter by 80 basis points from 56.1% for the first quarter to 56.9% for the second quarter of 2013. Our on-net revenues continue to carry a nearly 100% incremental direct gross profit margin. And our off-net revenues continue to carry an approximate 50% incremental direct gross profit margin. Occasional lumpiness in our EBITDA and gross margins can and does occur. If you examined our quarterly metrics for the last 33 quarters included in each of our press releases since we became a public company in 2005, you will notice lumpiness in our quarterly margin expansion.

This can occur due to seasonal and other nonrecurring factors, including the timing and scope of our expansion activities, which can vary from quarter to quarter. And seasonal factors which include SG&A expense increases, such as the resetting of an increase in payroll taxes in the US, cost of our annual sales meeting, the annual cost-of-living increases, and the timing of our audit and tax services. Severance costs and an increase in bad debt expense added to our SG&A expense in the second quarter of 2013. Despite quarter-to-quarter variations, our long-term margin trend has demonstrated that our business model generates increasing EBITDA margins.

Interest expense -- interest expenses results from interest incurred on our $175 million of senior notes that we issued in January 2011, our $92 million-face of convertible notes, and interest in our capital lease obligations. Our interest expense was $9.9 million for the first quarter, and $10.2 million for the second quarter. Components of our $10.2 million of interest expense for the second quarter of 2013 were as follows $3.8 million was related to our senior notes, $1.8 million was related to our convertible notes, and of that $1.8 million, $1.6 million is non-cash amortization of the note discount. With the remaining $0.2 million was paid in cash. And $4.6 million of our interest expense was related to our capital lease obligations.

Earnings per share -- our basic and diluted income per share was $0.03 for the quarter as compared to $0.01 for the first quarter of 2013. Foreign currency impact of our business -- about 27% of our business is located outside the United States. And, as in previous quarters, about 20% of our revenues are based in Europe. And about 7% of the revenues are related to our Canadian, Mexican and Japanese operations. Continued volatility in foreign exchange rates can materially impact our comparable quarterly and annual revenue and financial results. The foreign exchange impact on our revenue from the first quarter to second quarter was a decrease to revenue of approximately $0.3 million.

Our revenue increased from the first quarter by 1.5%. And on a constant currency basis, the increase was 1.8%. The foreign-exchange impact on our revenue from the second quarter of 2012 to the second quarter of 2013 was an increase to our revenue of about $0.2 million. Our revenue increased from the second quarter of 2012 to the second quarter of 2013 by 10.3% and adjusted for currency was 10%.

The average euro to US dollar rate thus far for the third quarter of 2013 is about $1.31, although currently trading at about $1.33. And the $1.31 was the same as the average rate for the second quarter of 2013. If the average exchange rates at current levels remain, there would be no material impact on sequential revenues from Q2 2013 to Q3 2013. The average euro to US dollar rate for the third quarter of 2012, however, was $1.25. So, should the average rates for the current quarter remain at current levels, the foreign exchange conversion impact on a year-over-year quarterly revenue basis would be an increase of about $0.5 million.

Customer concentration -- our revenue on customer base of about 37,000 customer connections is not highly concentrated. For the second quarter of 2013, no customer represented more than 1.5% of our revenues. And our top 25 customers represented less than 7% of our revenues.

CapEx -- on a quarterly basis we can and have asked historically experienced seasonal variations in our CapEx prepaid capital lease payments and construction activities. Our quarterly CapEx and prepaid capital lease payments are primarily dependent upon the number of buildings we connect to our network during the quarter, and the timing and scope of our network expansion activities. CapEx decreased for the quarter by 23.7%, to $12.5 million versus $16.3 million for the first quarter of 2013.

As Dave said, we added another 31 buildings to our network in the quarter. And we've added 122 on-net buildings to our network over the past year. Our capital lease principal payments from long-term dark fiber IRU agreements were $2.1 million for the quarter, as compared to $5 million for the first quarter of 2013. We expect to continue our network expansion in 2013, but a slightly more moderate pace than we experienced in 2011 and 2012, with continued moderation in 2014.

On some balance sheet statistics -- at the end of the quarter our cash and cash equivalents totaled $237.4 million. And for the quarter, our cash increased by $2.4 million after and including our dividend and all interest payments. Cash flow from operations was $22.7 million for the quarter, as compared to $15 million for the first quarter of 2013, and $19.5 million for the second quarter of 2012. A $22.7 million of operating cash flow this quarter was partly offset by $12.5 million of CapEx, $2.1 million of IRU capital lease payments, and $6.1 million for our second-quarter 2013 dividend payments.

Our operating cash flow for the second quarter included our $0.5 million semi-annual interest payment on our convertible notes. And that was paid in June. Excluding our cash returns to our stakeholders through dividend and interest payments, we were cash flow positive by $9 million for the second quarter of 2013. Our operating cash flow will continue to be impacted by our $7.3 million semi-annual interest payments on our senior notes. And those 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 semi-annual interest payments on our convertible notes. And those payments occur in June and December.

We have about $92 million of our original $200 million of face value of our convertible notes remaining. The notes mature in June of 2027 and may be redeemed by us or put by the holders beginning in June of next year. The notes are reported on our balance sheet at $85.6 million, which is net of the unamortized discount. Since the convertible notes may be put by the holders beginning in June of 2014, which is within a year from the balance sheet date, they are now classified as a current liability on the June 30, 2013 balance sheet.

Our capital lease IRU obligations are for long-term dark fiber leases. And typically have initial terms of 15 to 20 years or longer, and often include multiple renewal options after that. Capital lease IRU obligations were $151.9 million at June 30, 2013. Our total debt, including capital lease obligations, was $412.5 million at the end of the quarter and our net debt was $175.1 million. Our total debt to trailing last 12 months EBITDA as adjusted ratio was 3.7 at June 30. And our net debt was $175.1 million. Our total debt to trailing last 12 months EBITDA as adjusted ratio was 3.7 at June 30. And our net debt to trailing last 12 months EBITDA as adjusted ratio was 1.6.

Our bad debt expense increased for the quarter, and was 1.1% of our revenues for the quarter, as compared to 0.6% for the first quarter and 1.1% of our revenues for Q2 2012. The first quarter of 2013 included some debt recoveries which lowered the bad debt expense to a rate below our historical average. Our days sales outstanding, or DSO, for worldwide accounts receivable was at a very low level, and only 25 days at the end of the quarter, compared to 26 days at the end of the first quarter. And, as with previous quarters, I want to personally thank again and recognize our worldwide billing and collections team members for just continuing to do a fantastic job on customer collections, customer service and credit monitoring.

Now I'll turn the call back over to Dave.

Okay, thanks, Tad. Now for a few words about our sale rep activity and productivity. We began the second quarter of 2013 with 262 sales reps, ended the quarter with 269 sales reps. We hired 56 sales reps in the quarter and 49 sales reps left the Company during the quarter. Our monthly sales force turnover rate was 6% for the second quarter, slightly better than our long-term average of 7%. We began the second quarter of 2013 with 248 full-time equivalent sales reps and ended at 249 full-time equivalent sales reps.

Productivity on an FDA or full-time equivalent basis for the quarter was 6 reps -- or units per rep per month. This rate of organic productivity is significantly better than our long-term historical sales force productivity average of 4.4 units per rep per month. And a 3% improvement from the 5.8 units per rep. Again, ahead of the long-term trend line that we experienced in the first quarter of 2013. As a reminder, our sales rep productivity rates are not based on contract signings but rather are derived from completed installed customer orders. We are very pleased to announce that last week Ernie Ortega joined Cogent as our Chief Revenue Officer. We are looking for Ernie to help us accelerate the expansion of our sales team and accelerate the rate of our revenue growth.

Now for a few words about our network expansion. The size and scale of our network continues to grow. We added 31 buildings in the second quarter of 2013, and now have over 1,920 buildings directly connected to our network. Our network now consists of over 27,000 miles of metro fiber and over 57,000 miles of intercity fiber. The Cogent network is one of the most interconnected networks in the world. Today we connect to over 4,660 networks. Approximately 40 of these networks are settlement-free peers, and the remaining 4,620 networks are paying Cogent customers.

We are currently utilizing approximately 20% of our lit capacity. We routinely augment capacity in sections of our network to maintain these low utilization rates. We currently serve only 12% of the net-centric customers in our footprint, and 21% of our corporate customers that are available for service in our on-net footprint. We have a well diversified revenue base with the low customer concentration. No customer represents more than 1.5% of our revenues, and our top 25 customers represented less than 7% of our revenues. We continue to believe that our network has substantial capacity to accommodate our future growth.

In summary, we believe at Cogent that we are the low-cost provider of Internet access and transit service. And our value proposition to our customers is unmatched in the industry. Our pricing strategy has continued to attract many new customers resulting in increased sales force productivity, average contract lengths continuing to increase, customer volume and revenue commitments to Cogent continuing to increase. Our business remains completely focused on the Internet, and the Internet is increasingly becoming an absolute necessity for our customers. We expect to continue to see our annualized revenue growth and EBITDA margin expansion rates to be consistent with our historical rates of 10% to 20% revenue growth, and greater than 200 basis points of EBITDA margin expansion on a year-over-year basis.

Four 32 out of 33 quarters as a public company, we have produced organic sequential revenue growth. And continue to be encouraged by the cash flow generation derived from this growth. We continue to be encouraged also by the growth in traffic on our network and our network connectivity. As a result of our sales initiatives and targeted promotional programs our sales force productivity and order backlog continue to be at record levels. We like and are confident in our network reach, our product set, our addressable market, and the operating leverage that we demonstrate. In short, we are pleased with our business.

We continue to feel that we have an under-served ample addressable market in our on-net footprint, enabling us to grow our revenues at our historical growth rates. We are committed to providing top line revenue growth of 10% to 20%. And continue to see expanding margins as well as increased cash flow being return to our equity holders. We are very opportunistic about the timing purchase of our common stock. At the end of Q2 2013, we have purchased 307,000 shares of our common stock for $4.2 million under our current buyback program. We have $45.8 million remaining under this program and the Board has extended this program through February 2014.

Our Board of Directors approved an additional increase in our quarterly dividend of 7.7%, raising that quarterly dividend to $0.14 per share, which will be paid on September 25, 2013. And we have formalized the return of capital program, assuring investors that we will return $10 million per quarter above our recurring dividend, demonstrating the optimism we have around the growth and growth in cash flow in our business, as well as our ability to return that capital to shareholders.

With that, that concludes our prepared remarks. And I'd like to now open the floor for questions.

(Operator Instructions)

Colby Synesael with Cowen and Company.

Great, thank you. The first line of questioning I just want to talk about the return of capital. You've previously talked about how, as we move towards 2014 you had aligned the dividend with free cash flow, something -- we'll just make it up -- something around 75% of free cash flow being returned -- or higher, I think you said -- back in the form of a dividend. Does what you announced today replace that? Or is that still the expectation and therefore what was announced today is going to be on top of that? Just a little bit of color. And then also, maybe some color on how you're going to go about deciding whether you should be using that for the buyback or for the dividend?

And then, just my second line of questioning, you talk about record rep productivity but you're at the lower end of your targeted revenue growth of 10% to 20%. Just trying to understand why that is and what we could expect going forward? Thanks.

Sure, Colby, it is Dave. First of all, we are absolutely committed to growing our recurring regular dividend. And continue to use that dividend to return the majority of our cash flow that we generate from operations to shareholders. In addition to that, we realize that we have an underutilized asset on our balance sheet. And the Board has committed to take advantage of the current interest rate environment and allow us to return the excess capital we have on the balance sheet until we reach a prudent leverage ratio of 2.5 to 1, and do that in a measured manner. So we intend to return $10 million per quarter, every quarter, above our recurring dividend. Now, we retain the flexibility to be able to buy our stock back if, or the markets correct, and we have the opportunity to buy a large amount of stock back at what is a market discount due to market dislocation, not due to Cogent. And we also have the ability under our buyback program to buy more than $10 million in a quarter. But we are guaranteeing to do that.

If we do not spend the $10 million on a buyback, we are committed to proving to shareholders that we are serious about returning the capital. And therefore will return whatever portion of the $10 million is not spent in a quarter in the form of an additional dividend above our recurring dividend, to help make sure that they know we are serious about that return of capital. And we think the 2.5 to 1 net leverage test that we've outlined allows us to maintain adequate, if even not excessive liquidity on our balance sheet, and still have a prudent amounts of leverage relative to others in our space. With regard to additional increases in the recurring dividend both next quarter and in 2014, we will evaluate that each quarter with the Board and adjust that dividend appropriately.

Now, in terms of rep productivity and revenue growth, our corporate growth was actually quite strong in the quarter at 3.2% sequentially, and virtually no FX impact in that. Our net-centric growth was a bit weaker, coming in basically flat, making our constant currency sequential growth rate 1.8%, and our year-over-year growth rate of 10.3%. We need to do better on that. What is happening is we are seeing many of our net-centric customers become more efficient in utilizing the bandwidth that they purchase. A slightly greater percentage of our net-centric revenue is coming from burst traffic, meaning people are paying by the megabit, not a fixed commit. So we actually saw our burst revenue for the first time in the Company's history exceed 5% of our aggregate revenue. And we also saw our average net-centric customer utilization rate during the quarter actually exceed 100%. Meaning that if we added up all of our net-centric customers, they were using more than they had committed to.

That increased efficiency has been what has probably slowed down our rate of net-centric growth. We do feel pretty comfortable that it should begin to accelerate and that the relative mix in our business of 50/50 corporate in net-centric will continue. And we do believe we will be able to achieve the long-term average growth rates going forward that we have historically. And if you look since the Company's gone public, over an eight-year period, that growth rate, that eight-year, or 33 quarter average now, is about 12.9%, right in our range.

Okay. I apologize for taking so much time, but it does sound like you are not committing to tying the dividend to free cash flow like you were before. Is that accurate?

We said we would evaluate it and announce a program. If you look historically we are actually returning about close to 100% of our free cash flow. And with this added program we will actually be most likely returning more than 1% of our free cash flow for a period of time as we take our net leverage up from 1.6 to 2.5.

Okay, thank you.

Barry McCarver with Stephens Inc.

Good morning. This is Brad Henry in for Barry. A couple questions. I just wondered, Dave, if you could talk a little bit about your peering relationships and how those stand today. And then also if you could provide a little additional color on the sales team ramp, if you have a specific number in mind, or if that ramp will have a meaningful effect on costs going forward. Thanks.

Yes, sure Brad. Thanks a lot. First of all, with regard to your peering question, Cogent today is interconnected to 4,660 networks. Actually, making us the most interconnected network in the world. 4,620 of them are paying customers. Roughly 60% of the exiting traffic from our network goes to those paying customers. About 40% of our exiting traffic goes to those 40 peers. Globally we interconnect to other Tier 1 backbones and very large super-regional backbones. Many of those peers have been somewhat resentful of the type of customers that Cogent has attracted, particularly some of the over-the-top video operators. And, as a result, they have been slower than they historically have been in increasing capacity. Today we have no peer which we have de-peered, or they have de-peered us and we've not had a significant de-peering since 2008. Because we carry nearly 20% of the world's traffic, I think it makes that option almost inconceivable for any major network.

We have in Europe had discussions with regulators. And it is public knowledge that the European Commission has started a formal investigation and raided the offices of three major European operators. We've had similar discussions with US regulators. And they are evaluating the procrastination at some of the access networks peers have had to upgrading capacity because of over-the-top video. We remain committed to carrying all types of traffic. Our network traffic in aggregate is relatively balanced in and out across our network. But some of our peers have slowed down the rate at which they are willing to upgrade those connections because of the nature of some of our customers' business models. And we think that is wrong.

In fact, we've had one particular peer call us up and say -- please have your customers send our customers less traffic. And our response was -- we cannot do that, the only traffic that is exiting our network to your network is traffic that was specifically requested by your customer base. So in general, I feel pretty good about where we are at on peering. We have more interconnection capacity than any other network in the world. And we are in a good competitive position to see these connections continue to increase.

Now switching over to your sales force question, we are accelerating the ramp in our sales force. As I mentioned on the call, we ended the quarter at 269 reps. Actually since the end of the quarter we've had significant hiring and are at an all-time high. Today we have 304 reps hired and expect that number to continue to grow. We do, however, expect our cost of revenue acquisition to remain extremely low. We do not anticipate any material increase in our sales cost. And therefore our SG&A in total should remain flat on a going-forward basis, allowing us to deliver that greater than 200 basis point quarter-over-quarter EBITDA margin expansion.

Thank you.

Tom Seitz with Jefferies.

Yes, thanks for taking the questions. Two, if I could. Dave, I know you've been disappointed in the corporate sales efforts, and you've changed leadership. But is there any possibility at all that the market for just raw bandwidth that you sell has just reached a point where the majority of the remaining tenants in any particular building want some level of managed services. And as a consequence revenue growth is going to remain at this lower level going forward, just depending on the trajectory of the net-centric business? Do you need another hook like a unified communications platform potentially? And then the second question is, customer concentration is increasing just a bit. Can we assume that that's Netflix?

So let me take the first one first. The penetration in our corporate buildings continues to increase, as well as the number of buildings. In the quarter we saw our customer connections per building grow from 10.5 to 10.9 per building. Our corporate revenue growth sequentially was 3.2%. So, while it is still a little below where it has been over an eight-year period, it did pretty well, and accounted for the majority of our growth. We do believe we can do better on that. That's, in fact, why I asked Jeff to leave the Company a period of time ago, and we conducted an extensive search. And that is a big part of Ernie's mandate as he comes on, to help us grow the sales force and accelerate that rate of corporate growth. We believe there is ample addressable market in our corporate buildings for us to continue to grow our penetration per building. In existing buildings we tend to add about 1.8 customers per building per year. We expect that rate to continue.

Now, we ourselves do not sell a unified communications product, or managed product. But we support hundreds of different providers of those unified services on top of our network. I think the trend for customers is almost the exact opposite of what you've outlined, Tom, which is I think the customers like to be able to buy the bandwidth from one provider, and then either deploy their own applications or hire a specialist in the applications that they are looking to provide. So we see great opportunity on the corporate side, both to continue at a moderate pace to add buildings -- and that is going to slow -- and then continue to see good increases in penetration in the building. On the net-centric side of the business, it is clearly traffic growth and price declines that drive our revenue growth. We have seen continued improvement from our customers in terms of their utilization of the bandwidth that they purchase. I think we are near the end of that, so we expect to see that net-centric part contributing, as well, to our top-line growth getting us hopefully to the midpoint of the guidance that we laid out. We feel pretty good about that.

Now to the customer concentration topic. We generally don't name specific customers, but it is fair to state that our largest single customer is probably the largest provider of over-the-top video. We are their primary bandwidth provider and expect to continue to grow traffic with that customer. But also with a broad set of customers. We have over 37,000 customer connections. We have nearly 18,000 net-centric customers. And we expect to continue to have a very diversified customer base. And, in fact, if you looked at our top five customers it is pretty evenly split between over-the-top content and large access networks who are downloading that content. Most of that content being over-the-top video. On the unit volume side, we expect over-the-top to be the primary driver of unit volume growth for the foreseeable future. And we expect both regional access networks who rely on us for the upstream as well as the publishers of that content to continue to drive our revenue growth. But I don't expect to see any material increase in revenue concentration.

Thanks very much for the color.

Barry Sine with Drexel Hamilton.

Good morning, gentlemen. A question on your CapEx strategy and what you're doing in terms of your building expansions. I know you've said you are looking to moderate that a little bit. Where are you going in terms of the new buildings that you are connecting? And then how can we think about that? If I look at the ratio of revenue you are getting from on-net versus off-net, it has been relatively constant. Do you see an opportunity to put more traffic on-net, and in so doing, increase margins?

Sure, thanks for the questions, Barry. First of all, the 12 buildings that we added to our network over the past 12 months, it was about equally divided between corporate buildings in North America and data centers globally. We expect to continue to add about 60 data centers a year to our footprint, both in North America and internationally, primarily in Europe, because that seems to be about the rate at which those new facilities are being commissioned and brought online. We need to be in that footprint in order to be available to serve our net-centric addressable market.

On the corporate side of our business, we are very selective about the buildings we go into. We look at the size, we look at the proximity to fiber, we look at the diversity of the customer base or potential customer base in the building as we make that investment decision. Today we have 1,333 multi-tenant office buildings connected to our network. Those buildings average about 550,000 feet with 51 potential customers. As I mentioned earlier, we have 10.9 in those buildings. We do expect to add additional corporate buildings, but there's a very limited universe of buildings that meet our criteria that are not yet connected to Cogent. For that reason we expect that 60 or so a year on the corporate side to continue to taper off and eventually go to zero over the next several years.

In our off-net business we serve 4,700 customer connections in about 4,000 buildings or, about 1.17 connections per building as opposed to the 10.9. It is not cost effective for us to deploy capital and connect those smaller buildings with few or potential customers that are further from fiber. We instead have chosen to use that capital to return capital to shareholders. Going forward, you should expect to see our total capital expenditures moderate, as we've outlined in the past, they have done for the past four years. And then, secondly, our mix of on-net and off-net to remain relatively constant.

Great. Thank you.

James Breen with William Blair.

Great, thanks for taking the question. Dave, just in terms of the numbers, I was looking at the on-net revenue per connection and the off-net revenue per connection. It seemed like on-net revenue on a sequential basis accelerated down a little bit. And additionally, off-net had gone down probably more than it has in a number of quarters on a year-over-year basis. Can you just talk about the pricing in the off-net side? Obviously you had good margin, so are you seeing both the cost, as well as revenue per unit, coming down there, and that's what's allowing the pricing at the lower point?

Sure. Let me take the on-net side first. On-net ARPU did decline from $676 to $666, about a 1.7% sequential decline. And pretty much in line with the rate of decline that we've been experiencing. Actually, our corporate ARPU increased slightly. What has happened is we are getting a continued amount of smaller net-centric connections pulling down that ARPU. And all of those numbers are derivable from the numbers that we give out publicly. On the off-net side, we actually were able to go in and negotiate a significant reduction in our two major off-net provider circuit cost to us for ethernet services, as we are either their largest or one of their largest purchasers of ethernet services in North America. Part of that is reflected in our reduction in cost of goods sold, and therefore our margin expansion. And some of that is reflected in our ability to sell the off-net ethernet services at a lower price.

Just to remind the attendees on the call, the goal here is for us in any off-net product to effectively double our cost of the underlying circuit, achieving a 50% gross margin in that product. And because we are paying less for the off-net circuit, we are able to pass some of those savings onto our customers and still see the margin expansion. We hope over time that the major off-net providers will continue to reduce their prices to us, allowing us to serve even a larger footprint. Because we are going to remain very disciplined about where we deploy capital as a Company bringing on-net only the very best buildings. But I wouldn't draw anything into it in terms of margins -- hurting our margins. The lower prices are actually helping our margins.

The off-net ARPU, if you look back, let's says we go back to the first quarter of 2010, back that far, it was about $1,250. And we saw that ARPU increasing through the third quarter of 2012, fourth quarter of 2012, as the mix of customers in there with T1s being replaced by ethernet circuits. Essentially the basis stabilized and it is primarily in circuits at this time. So that's why we are seeing the off-net ARPU really stabilize, although we did have a 1.5% decline from the first quarter of 2013.

Terrific. Thank you.

(Operator Instructions)

Frank Louthan with Raymond James.

Great, thank you. Can you comment a little bit on the Internet terrific trends? Growing about 11% sequentially. That's down from maybe 18% in the first quarter and in the 20%s in the fourth quarter. Any concerns in Internet traffic growth and your ability to continue to see the top line hit your targets? And then can you give us a little more color on the new Head of Sales and any changes that he might be making to the overall sales quotas, or approach to the business, that will be different than in years past? And when we might start to see some positive impacts from that change? Thanks.

Yes, Franks, thanks. First of all, we typically see in the summer months a deceleration in the rate of traffic growth. In fact, we have seen Q1 to Q2 actually be negative some quarters. So 11% is not a problem. Typically Q2 to Q3 also tends to be a weaker quarter and we tend to see the stronger quarters in the cooler months. 93% year-over-year growth is actually the best year-over-year number that we have delivered since 2006. Now, with that growth in traffic -- so I'm not at all worried about growth in traffic. As I said, our customers did become more efficient in utilizing the bandwidth that they purchased. Our revenue growth was not as great as I would like it to be.

Remember, traffic growth only impacts our net-centric revenues as our average corporate customer buys a fixed connection and uses only about 12% of the connection that they utilize. So, the 3.2% sequential growth that we delivered on the corporate side really wasn't impacted at all by traffic growth. Quite honestly, the 93% year-over-year growth, which is the best we've had in seven years, didn't really help us as much as I'd like it to on the net-centric side. But I do think going forward we are going to see some pickup as those customers have reached the technical limit of how efficient they can run their purchases to us.

Now, with regard to Ernie. We went through an extensive search. We were a bit frustrated that our sales force growth was not -- in terms of headcount -- was not growing as fast as we'd like. We saw some decent growth in the quarter going from 262 to 267. Ernie just joined us at the first of this month. We are already up to 304 quota-bearing reps, so real good progress there. Ernie comes to us with a very extensive 20-plus year track record in the industry and actually had only worked at two companies over that entire period. Roughly about a 10 or 11 year career in a number of senior positions at MCI and then for the last 10 years or 11 years of his career has been in a number of positions at XO and actually led XO's sales force. Now, that was a much larger sales force, selling a very different set of products, much more voice focused.

I think he's bringing a lot of discipline in terms of managing a bigger and more geographically diverse sales force, and I think we will benefit from. We've already implemented some changes in our training programs from his short tenure here. We are reviewing all of our quota and hiring and management programs. To be fair to Ernie, he's only been on the job about 10 days -- not even 10 days -- so we've got to give him a little more time to get his feet wet. But we fully expect to see both acceleration in the number of people as well as acceleration in the productivity per individual. We are doing that off of a record high in terms of productivity. So, we feel pretty good about the changes he's bringing in. My guess is you will see the impact of that over the next several quarters.

Okay, great. Just to follow-up, with the high product per rep, it's definitely a positive. Is there any sign there that maybe you need to change the quota as things shifted? Should we expect that productivity to grow? Or are we going to -- maybe you have to make some changes, so just don't want to see an abrupt change in that, it was really more a function of a quota target change than necessarily a bad sign of the business? How should we think about rep productivity that we will see in the coming quarters?

Nothing would make me happier than to pay every Cogent sales rep more because they are more productive. The more they sell, the more we want them to make, and I think that's a good thing. I do think we are still the lowest cost of revenue acquisition in the industry. And we are continuing to focus on that cost of revenue acquisition, in large part by making the individuals more productive that are here, as well as getting more individuals in seats. I do think there may be some quota adjustments. I think probably the one thing that Ernie's identified quickly is we may need to do some work on the new hires, and try to maybe give them either a longer ramp or a little more relief to get them more seasoned.

We had been on a three-month ramp and that may need to extend a little bit. And we also have a program that's been in place for some time, and I think we are going to continue, which says that every rep who achieves quota every six months that they are able to do that, gets an increase in their base salary. And that's helped us with retention in the most productive reps. So, I think there's a number of tweaks that we are going to make to the sales model. I do not anticipate any material increase in costs and I expect a gradual continued improvement in productivity.

Okay, great. Thank you.

Michael Rollins with the Citi.

Good morning. Thanks for taking the question. A couple things. First, I was just wondering if we can get an update on the possible backlog of business you have -- the customers who are on promotions but might eventually come off and release some additional ARPU or some additional revenue into the business. Can that be a catalyst for the back half of the year and is there a way for you to size that?

And then, secondly, just taking a step back, have you recently explored the idea of adding additional products to the portfolio beyond what do you have today, trying to leverage all the customer relationships? I know in the past when you've looked at this you've stuck primarily to your core strategy, but any new thoughts on that subject would be great.

Sure, thanks for the questions, Mike. Let me start with backlog. We actually have the largest backlog of orders signed but not installed -- again, in the Company history -- by units. Nearly 2,000 on-net and just slightly over 1,000 off-net orders that are in the provisioning queue to be installed. So, these are orders that will turn into revenue once they are activated. Secondly, on the promotions, I'm going to break it down to corporate and net-centric. We are not running, and have not run any real aggressive corporate promotions probably for the past four or five months.

We did have a promotion that allowed customers to have us effectively replace their existing provider, at not double pace. So we were buying out contracts by providing free service for a period of time, and then that service would go to our standard rate once their current contract expired. We are seeing some benefit from that program in the second quarter. And you will see probably more benefit from that in the third quarter. I think that was partially attributable, or one of the reasons it attributed to our 3.2% sequential corporate revenue growth. I think we do have a pretty good backlog of those buy-out orders that are rolling off on the corporate side.

On the net-centric side, we continue to run promotions, but they are not general in nature but rather targeted at specific carriers and specific customers. We picked up roughly 120 additional ASs connected to us this quarter versus last quarter, going from 4,540 to 4,660, almost 4,670, this quarter. So I think we are getting some good traction in getting our foot in the door with more accounts. Secondly, many of these customers have initially come in with no commitment to us, and are now moving to committed products because they are sold at a lower price. I do feel optimistic that on the net-centric side we should start to see some reacceleration in revenue growth. If I had to look at the quarter, quite honestly the net-centric side was the more disappointing side this quarter, even though I think the productivity improvements can be the greatest on the corporate side. On the net-centric side we had good unit volume growth, but not the revenue growth that I would've hoped for. But in general, I think we will see some reacceleration.

Now to the product side. That really impacts the corporate business, not the net-centric side, because our corporate customers use our bandwidth to run their voice applications, their video conferencing, their disaster recovery, and their VPN services. Whereas our net-centric customers are just buying bulk bandwidth to connect to the public Internet, either as an access network or as a content publisher. So, on the net-centric side not a lot of product augmentation even possible to think about. On the corporate side, we remain committed to being the most efficient bandwidth provider. And have no interest in providing additional services -- i.e. higher level applications. But as I mentioned earlier, we intend to do that with hundreds of various partners or providers who provide the application on top of our network.

The one significant product augmentation that I think will materially impact our corporate customers is, we have always been willing to run tunnels for our customers for an additional $50 per month per connection on our network. Historically those tunnels have been to build point-to-point VPNs. And the technology we use did not scale well for point to multi-point. Recently there have been some significant router advances that have allowed us to deploy both new hardware and software at the edge of the network that are going to allow was to very aggressively roll out multi-point networks or fully meshed networks on a global scale. We do think this is a service that our corporate customers want and it is a bandwidth service, so it will help us sell more connections. It will help us also generate those additional $50 a month per connection management fees.

So it is not what I would consider a change in strategy of selling the application layer, but rather just an extension of our bandwidth business and listening to our customers. We do have customers who want this multi-site functionality that historically was provided with a bunch of point-to-point connections that had to be managed independently. Now, with this ability to build a mesh solution, it minimizes the amount of management the customer has. And we do think that's a significant augmentation to our product portfolio.

Thanks very much.

There are no further questions at this time.

Again, I want to thank everyone. We did pretty good on time. And again, hopefully everybody is supportive and we look forward to talking next quarter. Take care. Thanks.

This concludes today's presentation. We thank you all for your participation.