Cogent Communications Holdings Inc (CCOI) 2013 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Cogent Communications Group fourth-quarter and full-year 2013 earnings conference call.

(Operator Instructions)

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

I will now turn the call over to your host, Dave Schaeffer. Please go ahead.

Good morning, and thank you, everyone, for joining us on the call. Welcome to our fourth-quarter 2013 earnings conference call. I am Dave Schaeffer, Cogent's Chief Executive Officer. And with me on this morning's call is Tad Weed, our Chief Financial Officer.

We are pleased with the results for the quarter, and are optimistic about the strength of our Business and the outlook for 2014. During the quarter, we experienced accelerated sequential revenue growth, EBITDA margin expansion, significant network traffic growth, sales force productivity that was again far above our historical averages. Due to an established history of earnings, we recognized an income tax benefit of approximately $50 million related to our US deferred income tax assets during the quarter, representing about $1 of earnings per share.

We returned a total of $17.2 million to our shareholders in the quarter. This amount includes our regular quarterly dividend for the third quarter of $0.15 a share, and an additional $10 million that was initiated under our return-of-capital program, for a total dividend, which was paid in December, of $0.37 a share. We paid a total of $35.4 million in dividends for the full-year 2013, or $0.76 a share. As posted on our website, 56.1% of this dividend will be treated as a return of capital, and 43.9% will be treated as taxable dividends for US tax purposes.

We continue to remain confident in the cash-generating capabilities of our Business. As a result, as we have indicated in our press release, we've announced a further 5% increase in our quarterly dividend this quarter to $0.39 a share, our sixth sequential increase of the dividend, to be paid on March 27, 2014, to holders of record as of March 7, 2014.

The first quarter of 2014 dividend includes $0.16 in our regular dividend, which is a $0.01 sequential increase, as well as a $500,000 increase in our commitment to return capital, taking that return-of-capital program from $10 million a quarter to $10.5 million a quarter. As you remember, our return-of-capital program is expected to continue until we reach a debt-to-EBITDA target, as adjusted, of 2.5 times.

Our net debt to EBITDA as adjusted in the end of 2013 was 1.57%, actually down from the 1.58% that we ended the third quarter of 2013. Our return-of-capital program is subject to change as conditions warrant.

Our fourth-quarter 2013 revenue grew sequentially from the third quarter by 2.4%. Our EBITDA margins expanded by 220 basis for the full-year 2013, versus full-year 2012, to 34.5%.

During the quarter, traffic on our network grew sequentially 13% from the third quarter of 2013, and 72% on a year-over-year basis from the fourth quarter of 2012. For the full year, traffic on our network year over year grew 86%.

Our sales force productivity at six units of installed business per full-time equivalent rep per month is significantly above our historical average of 4.5 units installed per full-time equivalent rep per month. Since the end of the third quarter, we continued to expand our footprint by adding another 35 buildings to our network. And over the previous 12 months, we added 123 buildings to our network. We recently lit our 2,000th on-net building, which includes both multi-tenant office buildings, as well as carrier-neutral data centers.

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

I will review in greater detail certain operational trends in the Business. Tad will provide some additional details on our financial performance. And following our remarks, we will open the floor for questions and answers.

Now, I'd like Tad to read our Safe Harbor language.

Thank you, Dave. And good morning to everyone.

This fourth-quarter 2013 earnings report and this earnings conference call discuss Cogent's business outlook, and contain forward-looking statements within the meaning of sections 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 will 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 risk 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 will find these reconciled to the GAAP measurement in our earnings release and on our website at Cogentco.com.

Now, I will turn the call back over to Dave.

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

Our sequential revenue growth for the quarter was 2.4%, an improvement from the 2.3% sequential growth rate we experienced from the second quarter of 2013 to the third quarter of 2013. Our fourth-quarter 2013 revenue was $89.8 million. And for the full year, our revenues were $348 million, an increase of 9.8% from 2012.

We evaluate our revenues based on product class. That is on-net, off-net, and non-core, which Tad will cover in greater detail.

We also classify all of our revenue by the type of customer that purchases our services. We classify our customers into two primary categories: NetCentric and Corporate. Our NetCentric customers generally buy large amounts of bandwidth from us, and carrier-neutral data centers, and buy that product by the megabit. Our Corporate customers buy bandwidth from us in multi-tenant office buildings, and typically buy their services on a fixed commitment per month.

Revenues from our Corporate customers grew 1.3% from the third quarter of 2013. These Corporate customers represent 48.4% of our total customer connections, and represent 51.7% of our Q4 2013 revenues. Our Corporate customer connections grew sequentially by 3.4% for the quarter.

Revenue from our NetCentric customers grew by an accelerated 3.6% from the third quarter of 2013. Our NetCentric customers represent 51.6% of total customer connections at the end of the fourth quarter, and represent 48.3% of our fourth-quarter 2013 revenues. Our NetCentric customer connections grew sequentially by 4.5%.

Now for a couple of trends on pricing. Our most widely sold Corporate product continues to be a 100-megabit-per-second, or FastE, ethernet product, that is sold to customers in multi-tenant office buildings. And our most widely sold NetCentric product continues to be a 10-gigabit connection, which is generally sold in a carrier-neutral data center.

We offer discounts related to term on all of our Corporate and NetCentric customers. We also offer volume commitment discounts to our NetCentric customers. During the quarter, certain of our customers took advantage of our volume and term discounts, and entered into longer-term contracts with Cogent, representing over 2,140 customer connections, and increasing their contractual commitment to Cogent by over $14 million.

The average price per megabit of our installed base in the quarter declined. The average price per megabit of our installed base declined by 7.3% from $2.52 a megabit in the third quarter of 2013, to $2.34 a megabit in the fourth quarter of 2013, a decline of 23.5% from the $3.05 that we reported in Q4 of 2012.

The price per megabit of our new customer contracts entered into in the quarter was $1.31 per megabit, a 7.3% decline from the $1.41-per-megabit price that we registered in the third quarter of 2013, and a 27.5% decline from the $1.80 price per new customer contracts sold in the fourth quarter of 2012. Both of these rates of decline are in line with our historical average metric. Our price per megabit for new customer contracts and our installed base are partially impacted by our promotional programs.

Before Tad provides some additional details on the quarter, I'd like to address our results and expectations against announced revenue and EBITDA targets. Our revenue increase for the full-year 2013 over 2012 was 9.8%, a growth rate that was just below our guidance range of 10% to 20%. We expect that our new sales initiatives that we've launched in the fourth quarter will help us return to growth well within our range.

Our EBITDA margin was 34.5% for the full-year 2013, an expansion of 210 basis points from our EBITDA margins in 2012. This increase is in line with our annual expectations of margin expansion of being greater than 200 basis points. We anticipate our full-year revenue growth for 2014 versus 2013 will be within our range of 10% to 20%, and our EBITDA margin expansion for 2014 over 2013, again, will be greater than 200 basis points.

Now I'd like Tad to provide some additional details on the quarter and for the year.

Thank you, Dave. And, again, good morning to everyone. I'd also like to thank and congratulate the entire Cogent team for their results, and the hard work and efforts for the quarter and also for 2013. I will begin my discussion by providing additional details on our revenue by product class, which is on-net, off-net, and non-core.

Our on-net revenue was $66 million for the quarter, which was a sequential increase of 2.3%, and an increase of 9.4% from the fourth quarter of 2012. Our on-net revenue was $255 million for the full year, which was an increase of 9.6% from 2012. Similar to prior quarters, about 85% of our new unit sales for the quarter were for on-net services.

Our on-net customer connections increased by 4.1% sequentially, and increased by 16.1% from the end of 2012. We ended the quarter with about 34,670 on-net customer connections on our network, in our 1,990 on-net buildings at the end of the year.

Our off-net revenue was $23.4 million for the quarter, which was a sequential increase of 2.9%, and an increase of 8.3% from the fourth quarter of 2012. Our off-net revenue was $91.1 million for the year, which was an increase of 11.2% from 2012.

Our off-net customer connections increased by 4.1% sequentially, and increased by 14% from the end of 2012. We ended the quarter serving about 5,100 off-net customer connections, in over 4,000 off-net buildings.

Our non-core revenue was approximately $0.4 million, and now represents less than 0.5% of our revenues, and about 415 customer connections.

On ARPU, both our on-net and off-net ARPUs declined slightly from the third quarter to the fourth quarter of 2013. Our on-net ARPU for both Corporate and NetCentric customers combined was $660 for the third quarter, and declined to $648 from the fourth-quarter 2013. Our on-net ARPU declined by 5.5% if you look back to the fourth quarter of 2012, when it was $686.

Our off-net ARPU, which includes predominantly Corporate customers, was $1,579 for the third quarter, and declined to $1,567 for the fourth quarter of 2013. If you look back to fourth quarter of 2012, when the off-net ARPU was $1,654, that's a decline of 5.3%.

Our churn rate for both our on-net and off-net customers improved slightly during the quarter. Our on-net churn rate was 1.1% last quarter, and declined to 1% for the fourth quarter. And our off-net churn rate was 1.5% for the third quarter, and declined to 1.2%, an improvement for the fourth quarter of 2013.

EBITDA and gross margin -- our EBITDA margin percentage for the quarter increased sequentially. It also increased over the prior-year quarter and increased for the year, as Dave said, by over 200 basis points. Our EBITDA margin for the quarter increased by 50 basis points from the fourth quarter of 2012, and increased sequentially from the third quarter by 10 basis points. Our EBITDA margin for the year increased by 200 basis points.

Our EBITDA margins were 34.6% for the fourth quarter of 2012, 35% for the third quarter of 2013, 35.1% for the fourth quarter of 2013. And our EBITDA margin was 34.5% for the full year of 2013. EBITDA as adjusted was $31.5 million for the quarter, which was an increase of 2.8% from the third quarter, and an increase of 10.5% from the fourth quarter of 2012. And for the year, EBITDA as adjusted was $120.2 million, which is a 17.1% increase from 2012.

Our gross profit margin increased by 200 basis points from the fourth quarter of 2012, and decreased slightly sequentially by 10 basis points from the third quarter of 2013. Our gross profit margin was 54.6% for the fourth quarter of 2012, 57.5% for the third quarter of 2013, and increased to 57.4%, or the 10-basis-point decline, to the fourth quarter of 2013.

Our gross profit margin for the full year increased similar to our EBITDA margin by 200 basis points. And our gross profit margin for 2012 was 54.9%, which increased to 57% for the full-year 2013.

Our on-net revenues continue to carry a nearly 100% incremental direct gross profit margin. And our off-net revenues continue to carry a 50% incremental direct gross profit margin.

Variability in our EBITDA and gross margin expansion can and does occur. If you examine our quarterly metrics for the last 35 quarters included in each of our press releases since we became a public company, you'll notice some unevenness in our quarterly margin expansion. This can occur due to seasonal and other factors, which can vary from quarter to quarter, including the timing and scope of our network expansion activities, and our sales organization expansion.

Seasonal factors that impact our SG&A expenses include the resetting of payroll taxes in the United States, the cost of our annual sales meeting, cost of living increases, and the timing of our audit and tax and other professional services. These changes and events typically increase our SG&A expense in our first quarter, and that will occur again in the first quarter of 2014. Despite quarter-to-quarter lumpiness, our long-term margin trend has demonstrated that our business model generates increasing EBITDA margins.

Interest expense: Interest expense results from the interest on our $240 million of senior notes, our $92 million remaining of convertible notes, and interest on our capital leases related to IRUs. Our interest expense was $10.6 million for the third quarter, and $11.1 million for the fourth quarter of 2013.

The components of the interest expense for the fourth quarter were as follows: $4.9 million related to the senior notes; $1.9 million was related to the convertible notes; and $1.7 million of that is non-cash amortization of the note discount. And finally, $4.3 million was related to our capital leases.

If you look at the year, we had $41.8 million of interest expense, and that breaks down as follows: $17.6 million was related to the senior notes; $7.4 million related to the convertible notes; $6.5 million of that being non-cash amortization of the note discount. And finally, $17.6 million was related to our capital leases for the year.

Earnings per share: Our basic income per share was $1.14 for the quarter, and diluted income per share was $1.10 for the quarter. As Dave mentioned, during the quarter we met the US GAAP requirements by demonstrating a consistent history of cumulative earnings, and recognized certain deferred federal income tax assets in the US totaling $49.3 million. This income tax benefit added $1.06 to our basic income per share, and $1.01 to our diluted income per share for the quarter. If you exclude the impact of this income tax benefit, our basic and diluted income per share for the quarter would have been income per share of $0.07.

Our basic income per share was $1.22 for the full year, and diluted income per share was $1.21 for the year. If you exclude the impact of the federal income tax benefit, our basic and diluted income per share for 2013 would have been $0.16.

Tax treatment of dividends: We paid four quarterly dividends in 2013 totaling $35.4 million, or $0.76 per share. The expected tax treatment of these dividends is generally that 56.1% are treated as return of capital, and 43.9% are treated as dividends for US federal income tax purposes.

However, please note that while the above information includes general statements about the tax classification of dividends paid on Cogent common stock, these statements do not constitute tax advice. The taxation of corporate distributions can be complex. And stockholders are encouraged to consult their tax advisors to determine what impact the above information may have on their specific tax situation.

Foreign currency impact: Consistent with prior quarters, about 27% of our Business is located outside of the US. About 21% of our revenues are based in Europe. And 6% of our revenues are related to our Canadian, Mexican and Japanese operations.

Continued volatility in foreign currency exchanges can materially impact our quarterly and annual revenue and financial results. The foreign exchange impact on our revenue from the third to fourth quarter was an increase of approximately $0.5 million. Our revenue increased from the third quarter by 2.4%, and on a constant-currency basis that was 1.9%.

The foreign currency impact on our revenue from the fourth quarter of 2012 to the fourth quarter of 2013 was an increase of about $600,000. Our revenue increased from the fourth quarter of 2012 to the fourth quarter of 2013 by 8.8%, and on a constant-currency basis that was 8%. Lastly, for the full year, the foreign exchange impact on the full year was an increase of about $1.8 million, a revenue increase from 2012 to 2013 by 9.8%, and on a constant-currency basis that was 9.2%.

Looking ahead, the average euro-to-US-dollar rate so far in the fourth quarter is about $1.36. If that average remains at the current level for the rest of the quarter, we estimate that the foreign exchange impact will be a decrease of about $200,000. The average euro-to-USD rate for the first quarter of 2013 was $1.32. So, on a comparable quarter basis, should the average exchange rates, again, remain at current levels, we estimate that the impact on a year-over-year quarterly basis will also be about $200,000.

Customer concentration: Our revenue and customer base of about 40,200 customer connections was not highly concentrated. For the fourth quarter of 2013, no customer represented more than 1.7% of our revenues. And our top-25 customers represented less than 7.5% of our fourth-quarter revenues. For the full year, no customer represented more than 1.4% of our revenues. And our top-25 customers represented less than 7% of the revenues for the year.

Capital expenditures: On a quarterly basis, we can and have historically experienced seasonal variations in CapEx, pre-paid capital lease payments, and construction activities. Our quarterly CapEx and capital lease payments are primarily dependent upon the number of buildings we connect to our network each quarter, and the timing and scope of our network expansion activities.

Our CapEx decreased for the quarter by 0.7%, to $10.1 million from $10.2 million for the third quarter. And for the year, CapEx was $49 million, which was an increase of 10.6% from last year. Our CapEx principal payments for long-term dark fiber IRU agreements was $2.2 million for the fourth quarter compared to $1.9 million for the third quarter.

For the year, capital lease principal payments declined by 33.5%; was $11.2 million this year as compared to $60.8 million for 2012. If you combine our capital lease principal payments and CapEx expenditures, in the aggregate, the total declined by 1.5% for the year. The amounts combined were $60.2 million for this year compared to $60.1 million last year.

We added 35 buildings to our network in the fourth quarter, and added 123 buildings to our network over the year. We expect to continue our network expansion in 2014, but at a slightly more moderate pace than we experienced in 2012 and 2013, with continued moderation in 2015.

On some balance sheet items, at the end of the year, our cash and cash equivalents totaled $304.9 million. And for the quarter, our cash increased by $100,000 after and including all interest payments and dividends.

Our cash flow from operations was $29.3 million for the fourth quarter compared to $14.9 million for the third quarter and $32.3 million for the fourth quarter of 2012. Our cash flow for the quarter of $29.3 million of operating cash flow was partly offset by the $10.1 million of CapEx, $2.2 million of IRU capital lease payments, and finally, our $17.2 million fourth-quarter dividend payment.

If you exclude our returns to our stakeholders, which are made through dividend and interest payments, we were cash-flow positive by $17.8 million for the fourth quarter of 2013. Excluding our returns to our stakeholders through our dividend and interest payments, and some stock purchases we had in 2012, the net proceeds from the issuance of our senior notes as well -- so, excluding those items, we were cash-flow positive by $38.6 million for the full year of 2013, which was an 8.9% increase from $35.5 million for last year.

Our operating cash flow will continue to be impacted by our $10 million semi-annual interest payments on our $240 million of senior notes. And we make those interest payments in February and August, and they continue through February 2018, when the notes are due. 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.

With respect to the convertible notes, we have about $92 million of the original $200 million face value of those notes remaining. They do mature in June of 2027. However, they may be redeemed either by us or put by the holders beginning in June of this year -- so, June of 2014. The notes are reported on our balance sheet at $88.9 million, which is net of their unamortized discount. Since the notes may be put by the holders beginning in June, they are classified as a current liability on our balance sheet at the end of the year.

Our capital lease IRU obligations are for long-term dark-fiber leases, typically have initial terms of 15 to 20 years or longer, and often include multiple or newer options after that initial period. The total capital lease obligations at the end of the year were $161.8 million.

So, our total debt, including capital lease obligations, was $496.1 million at the end of the year, and our total net debt was $191.2 million. Our total-debt-to-trailing-last-12-month-EBITDA ratio was 4.1 at the end of the year. And our net-debt-to-trailing-last-12-month-EBITDA ratio, as Dave said, was 1.57.

Our bad debt expense for the quarter was 1.2% of our revenues. It was 1% of our revenues for the third quarter and also for the full year of 2013.

Finally, our days sales outstanding for our accounts receivable was only 28 days at the end of the year. And, again, I want to personally thank and recognize our worldwide billing and collections team members for continuing to do a great job on customer collections, customer service, and monitoring the credit of our customers.

Now I will turn the call back over to Dave.

Thanks, Tad. I'd like to spend a moment on our sales force productivity and activity.

We began the fourth quarter with 296 reps selling our services, and ended the quarter with 308 quota-bearing reps. We hired 74 sales reps in the quarter, and 62 reps left the Company during the quarter. Our monthly rep turnover was 6.8% for the fourth quarter, below our long-term average historical rate of about 7%. We began the fourth quarter of 2013 with 272 full-time equivalent sales reps, and ended the quarter with 289 full-time equivalent sales reps.

Productivity on an FTE basis for the fourth quarter was 6.0 units per FTE per month. Our increase in number of FTE reps this quarter was one of the largest in the Company's history.

Our rate of organic rep productivity was significantly better than our long-term average historical rate of approximately 4.5 units per FTE per month. As a reminder, our sales rep productivity numbers are based not upon contract signing or sale, but rather upon the actual delivery of service and the commencement of revenue from the customer.

Now for some notes about our network, scale and scope. The size and scale of our network continues to grow. We added 35 buildings to our network in the fourth quarter. And we're pleased to announce that actually in the first quarter we crossed a significant milestone, and have over 2,000 on-net buildings connected to our network.

Our network now consists of 27,200 miles of metro fiber, and over 57,500 inter-city route miles of fiber. The Cogent network is one of the most interconnected networks in the world, where we today connect to over 5,030 networks, of which approximately 40 are settlement-free peers. The remaining approximately 5,000 networks that connect to Cogent are our customers.

We are currently utilizing approximately 26% of the lit capacity in our network. We routinely augment capacity along segments of the network to maintain these low utilization rates. We currently serve only approximately 13% of the NetCentric opportunities in the carrier-neutral data centers that we connect to, and approximately 22% of the Corporate opportunities in the multi-tenant office buildings that are on-net for Cogent.

We have a well-diversified revenue stream with low revenue concentration. No customer represents more than 1.7% of revenues, and our top-25 customers represent less than 7.5% of our revenues. We believe our network has substantial available capacity to accommodate our future growth needs.

In summary, we believe that Cogent, as the low-cost provider of Internet access and transit services, and the value proposition that we deliver to our customers, is truly unmatched in the industry. Our pricing strategy continues to attract many new customers, resulting in substantially better productivity per salesperson, and increased volume commitments from existing customers.

Our Business remains completely focused on the Internet, and the Internet is increasingly a necessary utility for all of our customers. We expect our annualized revenue growth and EBITDA margin expansions to be within our historical ranges. That is, 10% to 20% top-line growth, and greater than 200 basis points of EBITDA margin expansion.

For 34 out of the past 35 quarters as a public company, we have produced organic sequential revenue growth, and are encouraged by the cash flow that our Business is generating. We are also encouraged by the levels of traffic growth on our network, which is a result of our sales initiatives, targeted promotional activities, and the productivity of our sales force, as well as our order pipeline.

We are confident that our network reach, our product set, our addressable market, and operating leverage are all industry-leading. In short, we like our Business. We feel that we have an underserved, ample addressable market on-net in our footprint to grow revenues at our historical average rates.

We are committed to providing annualized top-line revenue growth of 10% to 20%. The sales initiatives that we've launched and talked about in the past are helping us return and get well within that range, expanding our EBITDA margins and generating increasing amounts of free cash flow for our equity holders.

We are opportunistic in the timing and purchase of our common stock. At the end of the fourth-quarter 2013, we had purchased 307,000 shares of common stock for $4.2 million under our authorization program. We still have $45.8 million remaining under that program. That program was due to expire this month, and our Board extended it for an additional year, to February 2015.

Our Board of Directors also increased an increase in our regularly quarterly dividend from $0.15 a share to $0.16 a share, and also an increase in our commitment to return capital under our return-of-capital program by $500,000, increasing that quarterly return-of-capital program to $10.5 million. This resulted in a combined total dividend for the first quarter of $0.39 a share. This dividend will be paid on March 27, 2014. This demonstrates our increasing optimism in the cash flow capabilities of our Business, and our commitment to returning that cash flow back to our shareholders on a regular and consistent basis.

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

(Operator Instructions)

Colby Synesael with Cowen.

It's actually Greg Williams sitting in for Colby. Thanks for taking my questions.

Dave, in previous meetings and conferences, you've mentioned getting to a head county of about 360 by year end. It sounds like, with the trend going on now, you should hit that on the mark by year end. Is that trajectory still accurate?

And, as a follow-up, can you just talk about the actual changes you've implemented in your sales teams in trying to retain additional headcount? And if that means more commissions, how does that hit up against your goals for 200-basis-point-expansion in EBITDA? Thanks.

Sure. We are very encouraged by our sales force growth. We are at the highest number of reps in the Company's history. We are at the highest number of full-time equivalents in the Company's history. And as I stated, we added a near record number of full-time equivalents in the quarter.

Based on the growth in hiring and the number of reps that we are bringing on this quarter, we will probably hit that number much earlier in the year than at the end of the year. We also feel that the additional training that we put in place is helping us bend the turnover curve and reduce the rate at which reps are leaving the Company.

In addition to that, we've looked at our quotas and realigned them as part of Ernie's new sales initiatives, but actually did not lower quotas.

What we did in the beginning of the year, and actually starting in the fourth quarter, was on our Corporate sales force, realigned those individuals, taking our newer reps and focusing them on smaller accounts, and taking our more tenured and seasoned reps and dividing more large account opportunities on the Corporate side to those reps. These changes, we feel, will help accelerate our rep productivity, as well as revenue growth.

On the NetCentric side of the business, we had very strong growth, growing 3.6% sequentially, driven by traffic growth and the continued moderating rates of price decline. All of those things are resulting in us seeing an acceleration in sequential revenue growth, as I stated earlier. We need to be well within our guidance range, not at the bottom of that range. And I think these initiatives are all getting us there.

The cost of these sales are actually not increasing our SG&A. And we feel comfortable that we will be able to continue to deliver that better than 200-basis-point margin expansion.

So, quotas remain consistent. They were realigned. The sales force has been realigned. We are hiring at probably the greatest pace in the Company's history. And fortunately, the training is resulting in less people leaving the Company.

All of those trends give us a great deal of confidence that we should be able to deliver that better than 200 basis points, as well as also hit that headcount goal earlier in the year.

Great, thanks.

James Breen with William Blair.

Just two questions.

One, Dave, wondering if you could comment on the balance sheet, given where leverage is now on how much cash you have work, and convert coming due soon -- what your thoughts are around that.

And then, secondly, I'm not sure if I missed it, but share count jumped quite a bit in the fourth quarter relative to third quarter and year over year. Just wondering if you could talk about that. Thanks.

Sure, Jim. Thanks a lot for the questions. First of all, with regard to the balance sheet, we are in a great position. We returned almost $18 million to our shareholders and stakeholders, and at the same time increased cash on our balance sheet in the quarter.

Our net leverage actually declined, which was counter to the goal that we laid out, which was to increase our net leverage until we reached 2.5 times our EBITDA on an annualized basis. So that was what motivated the Board to increase the Return of Capital program.

With regard to the convert, we are operating under the assumption that with a 1% current coupon, the convert holders will be putting that convert to us. It is also highly likely if they choose not to put, that we will go ahead and call that convert on the first call date, which is June 20 of this year. So, we expect to use $92 million of cash on our balance sheet.

We are also considering possibly raising additional debt -- whether that be senior or unsecured debt has not yet been totally determined -- and use that debt to both replace the monies that go out for the convert, and also add some additional liquidity on the balance sheet that would then give us additional flexibility to return cash to shareholders.

We are committed to that. And I think the steps we are taking in terms of growing the recurring dividend and adjusting the Return to Capital program reaffirm that commitment.

Now, with regard to the share count, I'm going to let Tad take that one.

Sure. We had no material grants of shares at all during the quarter. I think you probably are looking at the shares used in the earnings-per-share calculations.

At the end of the third quarter, the basic number was 46.2 million and it only increased by 100,000 to 46.3 million. That's just the vesting of stock where there's more included there.

However, maybe you're looking at the diluted shares, which were 46.8 million used in that calculation for the third quarter. And that did go up to 48.8 million. That's not additional grants of shares. It's just the way that calculation is performed under US GAAP.

And actually, the shares that could be diluted under the convert had to be included in the diluted earnings per share calculation, partly because of the large amount of net income we had for the quarter from the tax benefit.

I don't want to get too much in the weeds here, but there were no material share grants at all during the quarter. It's just the math and the requirements for the EPS calculations.

Right. In fact, our burn rate or dilution of shareholders was probably one of the lowest in the Company's history last year. We are very conscious of making sure that our shareholders, the current shareholders, get their share of the free cash flow and not are diluted by additional share grants.

Great. That's great clarity.

On the converts, the shares that are associated with convert, if those were all the convert, what would the additional share count be from that?

1.9 million if it's converted.

Remember, that convert is at $47.52. It was actually higher than that, but it has to take into account the dividends that we've paid. Because of the mechanics of how that convert calculation will be done, we believe it's unlikely that those 1.9 million shares will be issued.

Great. Thanks.

Frank Louthan with Raymond James.

Looking at some of the other things in the news lately, particularly the Comcast/Time Warner Cable merger, and some of the net neutrality things that came up yesterday out of the FCC, how do you see those impacting your business, longer-term peering disputes in the industry?

Do you see that as an opportunity for you in these kinds of merger? Is this a plus for you? A minus? And how does that factor into how you view the business going forward?

Sure, Frank. Thanks for the question.

First of all, our business is highly leveraged to the Internet. The Internet is dependent on networks' ability to connect to one another.

We have the most level of connectivity, whether it be networks connected to us or capacity between networks, of any network in the world, any single provider.

Some of the regional access providers have used the inability or unwillingness to increase their connectivity in order to grade certain types of traffic guests into customers. That's been quite in the press lately because of some of the video streaming sites and their reported reduction in the quality that they are able to deliver.

The FCC has come out and clearly reaffirmed its commitment to an open Internet, one that is based on principles of net neutrality. Unfortunately, the first venue that the FCC chose to use to enforce its rules was ruled inappropriate; and in the Verizon case against the FCC, Verizon prevailed.

The FCC recently has come out and said they're going to re-address this issue and most likely craft a set of rules that meet the guidelines set down by the appeals court. I hope they are able to do that.

I believe, ultimately, they will be forced into focusing on Title II of their Code, which gives them clearer jurisdiction over the Internet. They've been reluctant to do that.

I also believe some of the M&A activity will require justice to opine on market concentration.

And whether Comcast has to reaffirm its consent decree that it signed with NBC Universal, or strengthen that with a potential combination with Time Warner, I think we are going to get an opportunity, along with others, to speak up for an open, unrestricted Internet, where companies that sell service to their customers have an obligation to ensure that those services can actually be delivered.

And part of that obligation is ensuring that there is adequate connectivity between other networks.

So, I wish this was an issue that never came up. I wish everybody in the industry played fairly and was focused on their customers' experience, as opposed to trying to extract monopoly-type taxes on other networks or other customers.

Ultimately, this is a customer service issue. And I believe that it is in the customers' best interests and ultimately the network operators' best interests to have a quality experience.

But this is a matter that ultimately should be settled both by adjudication and regulation.

Okay, thank you. And then what are some of the top one or two things that give you the most confidence that after a sub 9% topline growth quarter you are going to be back above 10% and get higher than that going forward?

A combination of good sales force productivity towards the end of fourth quarter, record productivity in January of this year. The initiatives that Ernie put in place are taking hold. The realignment of the sales force is showing actual results that we feel comfortable will show that continued reacceleration.

We think we hit a trough in sequential growth. That was a result of the changes that were made earlier in the year and the new sales leadership coming in, the new programs being put in place.

We also saw a substantial acceleration in our sequential rate of NetCentric revenue growth. This is a result of continued traffic growth acceleration and moderating price declines.

All of these factors give us a great deal of confidence that we can continue to see sequential improvement in our growth rate each quarter. And with that sequential improvement, we will also trend over the long term -- Tad was very accurate in saying that it's going to be lumpy on EBITDA margin.

And, in fact, we typically see declining margins in the first quarter because of those extraordinary expenses.

But we feel comfortable -- to go back to the first question -- that we will be able to deliver the better than 200 basis points of EBITDA margin expansion, and get well within the range as opposed to being at the bottom end of our guidance range for topline growth.

Okay. Thank you.

Michael Bowen with Pacific Crest.

Curious if you could talk to us a little bit about how you are balancing sales force productivity per rep and also adding new reps. The new rep adds were very strong. I'm trying to figure out, in 2014, how you are thinking about sales rep productivity.

We have it trending down. But I keep seeing your results showing pretty good rep productivity, here. So how are the new reps that are coming on board, in your mind, going to get layered in? And how will that affect productivity numbers going forward, here?

Sure, Michael. First of all, thanks for the question. And you are correct.

Sales force and sales force efficacy and productivity is the key to Cogent's success -- or its potential failure, if we don't do a good job on that.

So, we've taken a number of steps, some of which we talked about on the last call. Some I've expanded on at various conferences.

But, in summary, we've increased the rate of hiring. We've dramatically increased the resources that are focused on training those reps. We've put in place a number of intermediary milestones that allow reps to get tenure bonuses and raises on a very regular basis, to retain those that are performing.

We also looked at our Corporate sales force and did a very major realignment. It's actually the first time that we've segmented the Corporate sales force, where we've taken the newer raps and had them focus only on smaller accounts and reassigned certain larger accounts to more tenured reps.

We are already seeing the benefits of this bifurcation of the Corporate sales force. In that realignment, we actually lowered the quota for the newer, less-tenured rep, but we raised the quota for the more seasoned rep who can now focus on the larger accounts.

We've also introduced some products that are aimed at larger Corporate customers. Late last year, we introduced a full gig E product for Corporate customers that was designed to help us focus on larger Corporate customers. And we saw some uptick in our Corporate on-net ARPU as a result of that.

We also have launched our multi-site products that are MPLS based; our virtual private line products, or VPLS products, that also are attracting large customers with 20, 30, 50 sites.

So, it's the combination of having additional products and a sales force now focused on these types of customers that also give us confidence that we are going to see reaccelerating and continued accelerating growth in both parts of our business, both Corporate and NetCentric.

And, Dave, with regard to the regional learning managers, I think you told me a couple of months ago you were going to double that, double those folks from three to six. I was wondering if you have those people in place.

And, then, as you mentioned that you are raising quota for seasoned reps, what gives you the confidence for the seasoned reps that they will be able to meet that quota? Are the seasoned reps in need of extra training? Or is this just something where they've been blowing through their quota already and this is a layup for them?

Sure. We have increased our training resources. I think there's still one open headcount spot for one of those training managers. And I think we are in the finalists for picking someone for that role.

With regard to the quotas, what we did for the more tenured reps is give them one additional product to sell. We gave them better training. So it's not a question of just training the new hires; but it's continuous training, both for managers and tenured reps.

We've implemented a much more structured program that is almost a monthly program where training courses are required. Kind of like a continuing education program. That has really paid some dividends.

And then with regard to quotas, we are actually, today, having the highest percentage of individuals in the Company at or above quota that we've ever had, even though for the more tenured Corporate reps, the bulk of the Corporate reps, quotas actually were increased.

Now, again, we did lower them for the most junior or brand new reps. But we also implemented a rule that a rep can't stay in that junior role for a long period of time. They have to graduate or they will be asked to leave the Company.

So it's these combinations of training and incentive programs, as well as the actual results. Since Ernie's come onboard, the percentage of reps that are at or above quota has gone up every month sequentially, with the highest in the Company's history in January.

And while February is not over, we are expecting a substantial increase in February from January in terms of number of reps that will be at or above quota.

Those factors give us a great deal of confidence that you will see a sequential improvement in our growth rate in Q1 versus what it was Q4 versus Q3. Q4 to Q1 will show consistent improvement.

And you should expect to see that each and every quarter through the year, as we return to well within or even to the midpoint of our guidance range.

Okay. And, then, lastly, with Internet traffic growth, I think it was up 72% year over year. I believe that's down from the low 90%s the low last couple of quarters. Can you talk to that, if I'm right on that?

Yes, sure. Aggregate traffic growth is ultimately dependent on number of broadband users; how much time they spend per usage; and then, finally, what the bid intensity of that usage is. This goes back to Frank's question.

With some of the access network operators limiting their customers' ability to get to certain content, some of the content providers have actually put in software that degrades the resolution of their content.

So, rather than streaming video at 4K, even though the customer requested a 4K stream, they will reduce that stream to either regular high def, standard def, or even something below that, resembling VHS quality.

A big part of that reduction in traffic growth has been a result of the requirement for the streamers to reduce pixel count and stream quality as a result of access networks manipulating traffic volumes going to their customers.

Okay. Thanks a lot.

Mike McCormack with Jefferies.

It's Scott on for Mike.

There's been a lot of focus, Dave, on the sales force side of things. I had a follow-up on that.

But just trying to understand, when you look at the revenue growth and the expectations to get back into the 10% to 20%, what you are embedding from a pricing perspective. And if you could break that down between the on-net and the off-net side of the equation.

And then the clarification that I had on the sales force productivity, I just wanted to make sure. It sounds like the overall quotas haven't really changed. But what you have done is introduced a lower quota for some of these newer reps and increased it for the higher reps.

But if you were to compare this to, say, where you guys were a year ago on a per-rep basis, the overall quota has not changed. Is that correct?

That is correct, Scott. Let me take the quota question first.

Yes. We are very focused on our cost of revenue acquisition, whether it be measured on a unit basis or a dollar of revenue. And we did adjust the quotas, but did not lower them or increase them.

We just realigned them to make sure that our total cost of revenue acquisition remained constant, but really tried to get our salespeople aligned more clearly with our Corporate objectives.

We also changed the payout ratio on a particular sale. So while we increased the amount we paid out on each sale, we actually removed what was a unit bonus. So we had previously a two-part commission structure that paid you both on units and on dollars.

What we wanted to do is actually eliminate the unit bonus and increase the amount paid on dollars to more closely align the sales reps with our stated goal of getting back to the midpoint of our guidance range.

We think that all of these quota adjustments have helped us get the sales force better aligned with our Corporate objectives, and have been a contributor to why a record number of individuals are at or above quota. It's not because the quotas got lower; it's because they become more productive and have produced more.

What's really encouraging is, even though we grew the FTE count in the Company by roughly 20% last year, full year, and will do that again this year, we have been able to do that with productivity per FTE remaining consistent. Even though there is declining pricing, as well as a less-tenured sales forces, we're hiring at a faster rate.

Now, with regard to the revenue growth part of your question, there's two pieces to that. On the Corporate side of our business, we do expect moderate price declines, but very moderate, both on-net and off-net for those Corporate customers, as on the off-net side, virtually all of the base is now using Ethernet. And we do not expect any significant uplift from TDM customers to Ethernet that we've gotten in the past.

And then we've also been able to negotiate better loop pricing from major incumbent providers, which has allowed us to lower our price to our customer, as our off-net Corporate product, as Tad said, a 50% gross margin contribution. So we effectively double the price of the loop.

With regard to the on-net product, we do have more data center space. And our Corporate on-net customers do take rack and power which lowers our ARPUs. But also the introduction of GigE products are actually pulling ARPUs up.

And, as I stated earlier, for the first time in several years, we saw our Corporate on-net ARPU actually tick up slightly. I think we are expecting a relatively flat to extremely moderate price decline on the Corporate side per connection.

On the NetCentric side, it's really a price-per-megabit question. And, there, we have basically had an annual rate of price decline over the past seven years of about 22.5% per year. The 23.5% that we experienced last year was very much in line with what we've historically seen.

And we expect those rates of price declines to continue. But we also expect our rate of traffic growth to continue to be 2 to 3 times that of the market, allowing us to grow revenues.

And, again, we were encouraged by the fact that in the fourth quarter, our sequential revenue growth from the NetCentric portion of our business was actually much better than our aggregate. I think the Corporate side suffered for some of the realignments that we were doing in the quarter. We think that's behind us now. And we hope to see both parts of our business perform equally as well.

Listen, that 3.6% sequential NetCentric growth rate was probably the best we've seen in several years.

That's very helpful. And then maybe you can just give a quick comment.

It sounds like you expect maybe some of the network expansion to perhaps moderate a touch in 2014. I wonder if you could just give some comments on what that implies for capital spending.

Yes. We have said that our capital spending, which is CapEx and principal payments of capital leases, will decline. And we are targeting a steady-state number of $35 million for those combined numbers.

It was $60 million, down from $61 million the year before. We hope and expect that that rate of decline will accelerate a little bit and we will be able to get to that $35 million over the next couple of years.

We will see less new routes being added. We are currently operating in 38 countries, and we've dramatically slowed the number of new markets we are going into. We are in over 190 markets.

We are in 1,381 multi-tenant office buildings, representing 755 million square feet of office space. We will add probably less than 60 new MTOBs this year to our network.

And, then, with regard to data centers, we are opportunistic and are always looking for new data centers that are being built that have a significant potential for new revenue. We will probably add 50 or so of those. So I think our building additions will be down 10% or so from the previous year.

Those factors -- less new routes, less new buildings -- should result in the combined capital and principal payments portion of our capital leases declining, helping us get from the peak we were at of $73 million, we are at $60 million today, and we need to get to $35 million. And we feel comfortable we will get there.

Great. Thanks a lot, Dave. Appreciate it.

Michael Rollins with Citi Investment Research.

Just curious to explore a little bit more on the revenue model side.

Have you looked actively at the opportunities to host, whether it's small cells in the Corporate building that you connect to for wireless carriers, or look to partner with those companies that are trying to sell more of the value-added services, whether it's IP PBX or just a total telecommunications solutions on top of the Internet pipe, as a way of either getting incremental revenue on a wholesale basis or allowing those companies to distribute and sell access to your network? Thanks.

Sure, MIke, thanks for the questions.

First of all, with regard to our footprint, which obviously has embedded backhaul built into it because they are on-net buildings, that represents about 10% of the rentable office space in North America. We have done pilot or test cases with third-party antenna operators who are looking to do DAS or small-cell systems in our buildings.

We've also worked with some of the wireless carriers on a test basis. I think, as those carriers look to enhance their LTE footprint and realize small cell needs to be a significant part of that strategy, I think these test cases could become a more material part of our business. But today, they are really science projects; they're not material contributors to revenue.

We are very open to it, but ultimately, as someone who doesn't own any spectrum, it's really dependent on the spectrum owner to come to us, and then us to solve the problem.

Now, we are not going to go out and build the cell sites in rural or very suburban markets. But in dense urban areas, we can offer a mobile operator a very cost-effective way to enhance their coverage and use our network.

With regard to the value-add piece, we today sell to hundreds of VOIP, VPN, security, and private closed network firms that are running proprietary networks over our network. Some of the architectural changes that we put in place last year, particularly the ability to have a VPLS product, allowed us to, I think, serve those customers in a more seamless and easier-to-manage way than we previously had.

We are getting traction. We are very open to that model. We do have a group that focuses on these types of initiatives. We call them our premier sales team.

And actually one of Ernie's initiatives was, he's actually doubled the size of that team and put some additional management in place over it. So we are expecting, as part of our growth initiatives, to get some contribution from these types of customers.

Thanks.

Michael Funk with Bank of America.

A quick question, again, just on the revenue growth guidance for 2014.

I know you said you want to get back in the range of 10% to 20%, and hopefully towards the mid-point. You've been running at around, say, $2 million in sequential revenue, more or less, the last few quarters. The guidance you gave obviously implies a significant step up from that $2 million sequential run rate.

So hoping to get some more color on your expectation for how revenue ramps throughout 2014. Maybe some more commentary on your confidence around that guidance.

And then just finally, historically you talked about potential buildings you could connect that made economic sense. Maybe just update us on what that number is and how you think about the shrinking number of incremental buildings in relation to your longer-term guidance for revenue growth.

Sure, Michael. Thanks for the questions. Let me take them in reverse order.

Let me start with the addressable market, the buildings. We today have the highest penetration in our Corporate buildings in our history at 11.3 customers per building out of 51 opportunities. We have 1,381 buildings, 755 million square feet.

We will add Corporate buildings at a slower pace. As I indicated earlier, probably 50 to 60 is a reasonable target for this year. And we remain very disciplined about which buildings we build into.

Now, to the question Mike Rollins asked, other business opportunities in smaller buildings that make sense, we may look at them. But right now, we expect most of our growth to come by continuing to increase penetration in those buildings.

The good news is that we have 40 potential customers per building on our Corporate footprint that are not customers. We are adding to our sales force, which will allow us to increase our penetration.

In the data centers, the average data center connected to our network has about 200 unique opportunities. We are at about 26.1 or 13% of those unit number of customers per facility. Yet we probably have a greater percentage of bandwidth and also a greater percentage of potential revenue to be able to get out of those facilities.

We will continue to add salespeople and keep productivity at or above where it is today, continuing to see increases.

So, now, transitioning into the sales force ramp. We've added sales people. We grew our sales force in 2013 20%. We actually grew our full-time equivalents slightly faster than that, about 24%.

Those individuals, coupled with an improvement in productivity, whether measured on a unit basis or dollars-sold basis, is giving us a great deal of confidence that we will be able to grow more gross revenue.

As Tad indicated, our churn rates, which are already low by industry standards, actually ticked down. We saw a reduction in both on-net and off-net churn in the quarter.

Tying back into the quota adjustments, the fact that we have the greatest number of reps in the Company's history at or above quota, all give us confidence that we are going to see sequential improvement.

Again, we improved last quarter from 2.3% to 2.4%. Slow, but there was improvement. We should see even better improvement, hopefully accelerating improvement, throughout the year.

Our goal is to exit the year on a sequential basis, where it is clear to people that we've achieved what we've said we have.

I don't want to mislead investors. We are probably not at the midpoint of our range this year. We will be well within the range.

I think we have taken all of the necessary sales realignment adjustments that were necessary, and today have all the foundations in place.

And I think you are seeing that. We are still growing faster than any company that we are typically compared to. We are getting better penetration and a better footprint with better contribution margins. So we feel pretty comfortable about our trajectory.

Thank you very much, Dave.

Donna Jaegers with Davidson.

I was just curious -- you don't offer a wavelength product currently. Are you thinking about that, given that you are moving more to a full gig E product on the Corporate side?

We have chosen not to. We felt that our core competency is in delivering Internet. And we are not trying to be all things to all people.

We actually do have a few wavelengths that get counted in our non-core products. And they're actually legacy, some long-term agreements in Europe. We don't offer any in North America; and, actually, we don't actively sell them going forward.

I think we are going to look at offering higher and higher capacity layer 2 services, MPLS-based services, that will actually offer a more cost-effective and higher-quality service than traditional wavelengths.

In the past, companies trying to build networks on top of someone else would buy SONET-protected services. As those services became relatively expensive, companies migrated to a less expensive product, buying unprotected wavelengths. They are less expensive, but they are also more prone to failure.

We believe that with a properly architected layer 2 network, such as ours, we can offer a product that substitutes for waves, provides protection, and yet prices below where waves are. We've had a great deal of success with that.

And we have some new initiatives, engineering initiatives, that actually increase the throughput level of those VPLS services even more. So I don't see us going into the wavelength business.

Okay. And then one other follow up.

On European growth, I jumped on the call a little late, but I don't know if you are seeing accelerating growth there because of the rollout of the LTE networks and maybe some of the smaller carriers using you guys for more Internet connectivity?

And then any thoughts of entering the corporate market in Europe?

First of all, our business in Europe is entirely NetCentric. Our growth rates in Europe are comparable to those in North America, both in terms of traffic and bit volume. The rate of price declines are also comparable.

We did see our entire NetCentric business accelerate in the quarter to that 3.6% sequential growth, some of that coming out of Europe.

I think in terms of the Corporate market, we don't believe that's our core competency. We don't have the on-net Corporate footprint to launch a Corporate business in Europe. And we don't believe that the building demographics provide adequate returns on capital.

I know there's one struggling Corporate Pan-European operator that has about 14,000 buildings on that, and have been unable to generate returns on capital in those buildings. And it's not because they are a poor operator, it's because the buildings are too small with too few tenants. You have to be realistic about the demographics of the market you work in.

If everything was like the financial district or the city in London, yes, we would have a European multi-tenant office building strategy. But that type of footprint is very rare in Europe.

Whereas here in North America, there are dozens of cities where in the central business districts you can find dozens, if not hundreds, of large multi-tenant office buildings. So, I think our Corporate business will remain US and Canada.

Great. Thanks, Dave.

Thank you. I will now turn the call back to Dave Schaeffer for closing remarks.

I just want to thank everyone.

Relatively long, but hopefully we answered everyone's questions. Again, thank you for your support and we will talk soon. Take care. Bye-bye.

Ladies and gentlemen, that does conclude today's conference. You may all disconnect. And have a wonderful day.