Cogent Communications Holdings Inc (CCOI) 2019 Q2 法說會逐字稿

Good morning, and welcome to the Cogent Communications Holdings, Inc.

Second Quarter 2019 Earnings Conference Call.

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

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

Sir, you may begin.

Thank you and Good morning to everyone.

Welcome to our second quarter 2019 earnings call.

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

Now for some highlights from our second quarter 2019, we continue to be optimistic about the underlying strength of our business and the outlook for the remainder of 2019 and beyond.

Our gross margin for the quarter increased by 170 basis points from the second quarter of 2018 to 59.8%.

Our cash flow from operations increased by 41.9% from the first quarter of 2019 and an increase of 29.9% from the second quarter of 2018 to a total of $40.6 million for the quarter.

On a constant currency basis, we achieved sequential revenue growth of 0.7% and year-over-year revenue growth of 5.4%.

Our quarterly sales rep productivity at 4.9 units installed per full-time equivalent rep per month was a productivity rate slightly below our long-term historical average of 5.1 units per rep per month for full-time equivalents.

Our year-over-year traffic growth was up 31% and we achieved sequential traffic growth of 1% in what is traditionally a slower traffic period of the year.

During the quarter, we returned $27.7 million to our shareholders through our regular dividend.

We did not purchase any stock during the quarter.

At quarter end, we had a total of $34.9 million available for stock buybacks under our stock buyback program which our Board has authorized to continue through December of 2019.

In June of this year, we issued a EUR 135 million or $153.7 million of senior secured notes with net proceeds of $152 million.

These notes accrue interest at the rate of 4.375% and mature in June of 2024.

Our gross leverage ratio increased to 5.08, but is in fact 4.92 as measured under our indenture.

This is an increase from the 4.28 we had at the end of the previous quarter.

Our net leverage ratio remained essentially flat and was 2.93 at the end of Q2 versus 2.92 at the end of Q1.

Our consolidated leverage ratio as defined under our indenture is 4.92 and it was 4.18 last quarter.

Cash held at our parent company, Cogent Holdings is a $167.7 million at quarter end.

This cash is unrestricted and available to use for dividends and/or stock buybacks.

Cash held at our operating company is $241,600,000 and our combined cash holdings, both at the holding and the operating company level are $409,300,000 at quarter end.

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

As a result, as indicated in our press release, we have announced yet another sequential $0.02 increase on our regular quarterly dividend from $0.60 per quarter per share to $0.62 per share per quarter, representing our 28th consecutive sequential quarterly increase in our regular dividend.

Throughout this discussion, we will highlight several operational statistics.

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

Following these prepared remarks, we'll open the floor for questions and answers.

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

Thank you, Dave, and good morning, everyone.

This earnings conference call includes forward-looking statements.

These forward-looking statements are based upon our current intent, belief and expectations.

These forward-looking statements and all other statements that may be made on this call that are not historical facts are subject to a number of risks and uncertainties, and actual results may differ materially.

Please refer to our SEC filings for more information on the factors that could cause actual results to differ.

Cogent undertakes no obligation to update or revise forward-looking statements.

And if we use any non-GAAP financial measures during this call, you will find these reconciled to the GAAP measurement in our earnings release, which is posted on our website at cogentco.com.

I'll turn the call back over to Dave.

Hey, thanks, Tad.

Hopefully, you've had a chance to review our earnings press release.

Our press release includes a number of historical quarterly metrics that have been reported on a consistent basis for a number of years.

Our corporate business, which represents 68% of our revenues in this quarter, has been growing above our targeted long-term guidance for full total revenue growth of 10%.

In fact, it grew 10.8% from the second quarter of 2018.

However, our NetCentric business has been underperforming compared to historical averages, and declined 7.7% from the second quarter of 2018.

The impact of foreign exchange primarily impacts our NetCentric business.

On a constant currency basis, our NetCentric business did however decline at 4.4% from the second quarter of 2018.

Our quarterly cash flow, as defined by EBITDA minus CapEx minus principal payments on our capital leases, for the first 6 months of 2019, grew by 13.3% from the first 6 months of 2018.

Due to the excellent operating leverage in our business, we expect our cash flow growth to continue at similar rates.

Our long-term EBITDA annual margin expansion guidelines are for an annual improvement of approximately 200 basis points.

Our multiyear constant currency revenue growth target is approximately 10%.

Our revenue and EBITDA guidance targets are intended to be multiyear goals and are not intended to be specific quarterly guidance.

Now Tad will handle some additional operational and financial details for the quarter.

Thank you, Dave.

And again, good morning, everyone.

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

On corporate and NetCentric revenue and customer connections, we analyzed our revenues based upon network type, which is on-net, off-net and non-core, and we also analyze our revenues based upon customer type and we classify all of our customers into 2 types NetCentric customers and corporate customers.

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

Revenue from our corporate customers for the quarter grew sequentially by 2.4% to $92.3 million and grew year-over-year, as Dave said, by 10.8%.

We had 47,650 corporate customer connections on our network at quarter-end, which was an annual increase of 11.7% over the second quarter of last year.

A reduction in the USF rate reduced our corporate revenue sequentially by about $200,000.

Quarterly revenue from our NetCentric customers declined sequentially by 3.4% to 42.5 million and declined year-over-year by 7.7%.

FX primarily impacts NetCentric customers.

So on a constant currency basis, our quarterly revenue from our NetCentric customers declined by 2.8% sequentially, instead of the 3.4% and declined year-over-year by 4.4% instead of the 7.7%.

We had 36,404 NetCentric customer connections on our network at quarter-end, an increase of 8.6% over the second quarter of last year.

Our NetCentric revenue growth experiences significant more volatility than our corporate revenues due to the impact of foreign exchange, customer size and other seasonal factors.

On revenue in connections by customer type, our on-net revenue was $97.5 million for the quarter, a sequential quarterly increase of 0.3% and year-over-year increase of 4.8%.

Our on-net customer connections increased by 1.9% sequentially and by 10.7% year-over-year.

We ended the quarter with 72,415 on-net customer connections on our network in our 2,737 total on-net multi-tenant office buildings and carrier-neutral data center buildings.

Our off-net revenue was $37.2 million for the quarter, which is a sequential quarterly increase of 0.9% and a year-over-year increase of 3%.

Our off-net customer connections increased sequentially by 1.6% and by 8% year-over-year.

We ended the quarter serving 11,321 off net customer connections and over 6,760 off-net buildings and these off-net buildings are primarily in North America.

Some comments on pricing.

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

However, the average price per megabit for our new customer contracts was again, relatively stable with a modest decline.

The average price per megabit for our installed base declined sequentially by 6.2% to $0.63 and declined by 27.1% from the second quarter of 2018.

The average price per megabit for our new customer contracts from the quarter was relatively flat sequentially and year-over-year and declined by 2.1% from $0.39 to $0.38 and declined by 1.4% from the second quarter of 2018.

Comments on ARPU.

Our on-net ARPU and off-net ARPU both decreased sequentially for the quarter.

Our on-net ARPU, which includes both corporate and net centric customers, was $453 for the quarter, which was a decline of 2.3% sequentially.

Our off-net ARPU, which is comprised of predominantly corporate customers, was $1,104 for the quarter, which was a decrease of 0.6% from last quarter.

Churn rates.

Our on-net churn and off-net churn rates increased slightly during the quarter.

Our on-net churn rate was 1.1% for the quarter, that's a unit churn rate, and was 0.9% last quarter and our off-net unit churn rate, was 1.2% this quarter and was 1.1% last quarter.

Comments on NetCentric change orders.

We offer discounts related to contract term to all of our corporate and NetCentric customers.

We also offer volume commitment discounts to our NetCentric customers.

During this quarter, certain NetCentric customers took advantage of our volume and contract term discounts and entered into long-term contracts for over 2,400 customer connections, increasing their revenue commitment to Cogent by over $25 million.

Some comments on EBITDA and EBITDA as adjusted.

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

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

These seasonal factors typically increase our SG&A expenses in our first quarter from our fourth quarter.

Our SG&A expense increased from the first quarter in this quarter primarily to an increase in our headcount of 29 employees, primarily in our sales force and a $770,000 increase in our bad debt expense.

The bad debt increase was primarily due to the last 2 days of the quarter falling on a weekend, which reduced our customer cash collections and impacted our cash to billings ratio, which we use in determining our general accounts receivable reserve.

Our quarterly EBITDA declined by 1% sequentially and was $47.1 million.

Our EBITDA increased year-over-year by $1.2 million or by 2.6%.

On an FX adjusted basis, our quarterly EBITDA increased by 0.3% sequentially and increased year-over-year by $1.8 million or by 3.9%.

Our quarterly EBITDA margin decreased by 60 basis points sequentially to 34.9% and declined year-over-year by 60 basis points.

Our EBITDA as adjusted includes gains related to our equipment transactions.

Our equipment gains were only $185,000 for the quarter, which was a decrease from $357,000 for the second quarter of last year and $536,000 for the first quarter.

Our quarterly EBITDA, as adjusted, decreased by $807,000 or by 1.7% sequentially to $47.3 million and increased year-over-year by $1 million or by 2.2%.

Our quarterly EBITDA as adjusted margin decreased sequentially by 80 basis points to 35.1% and decreased by 70 basis points year-over-year.

EPS; our basic income per share was $0.16 for the quarter compared to $0.20 last quarter and $0.15 for the second quarter of last year.

Some comments on foreign exchange.

Our revenue reported in U.S. dollars and earned outside of the United States was about 22% of our total revenues, about 16% of our revenues this quarter were based in Europe, and about 6% of our revenues were related to our Canadian, Mexican, Asia-Pacific and Latin American operations.

Continued volatility in foreign currency exchange rates do materially impacts our quarterly revenue results and our overall financial results.

The foreign exchange impact on our reported quarterly sequential revenue was a negative $260,000 and the year-over-year foreign impact on our reported quarterly revenue was a negative $1.5 million.

Our quarterly revenue growth rates on a constant currency basis were 0.7% sequentially and 5.4% year-over-year.

The impact of foreign exchange, again, primarily impacts our NetCentric revenues.

The average euro to U.S. dollar rate so far this quarter is about $1.12 and the average Canadian dollar exchange rate is about $0.76.

Should these average foreign exchange rates remain at the current average levels for the remainder of our third quarter of this year, we estimate that the foreign exchange conversion impact on our sequential revenues will not be material.

However, the year-over-year conversion impact on our revenue is estimated to be negative $800,000.

Customer concentration; we believe that our revenue and customer base is not highly concentrated.

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

Capital expenditures; our capital expenditures declined by 11.8% sequentially and by 2.2% decline year-over-year.

Our capital expenditures were $11.7 million this quarter compared to $12 million for the second quarter of last year and $13.3 million for the first quarter of 2019.

Comments on capital leases and capital lease payments.

Our capital lease IRU obligations are for long-term dark fiber leases and typically have initial terms of 15 to 20 years or even longer, and often include multiple renewal options after the initial term.

Our capital lease IRU fiber lease obligations totaled a $168.2 million at quarter-end.

And at quarter end, we had IRU contracts with a total of 240 different fiber suppliers.

Our capital lease principal payments under our dark fiber IRU agreements declined by 34.8% sequentially and declined by 47.4% year-over-year.

Our capital lease principal payments were $2 million for the quarter compared to $3.8 million from the second quarter of last year and $3 million for last quarter.

Our expenditures on capital lease principal payments combined with our capital expenditures improved both sequentially and year-over-year.

Our capital lease principal payments combined with our capital expenditures were $13.7 million this quarter compared to $16.3 million for the first quarter and $15.7 million for the second quarter of 2018.

Comments on cash and operating cash flow.

At quarter end, our cash and cash equivalents, including the $152 million net proceeds from the issuance of our 2024 notes totaled $409.3 million.

For the quarter, our cash increased by $150.1 million.

We returned $33.1 million of capital to our stakeholders this quarter, which included $27.7 million for our regular quarterly dividend payment and $5.3 million was spent on our semi-annual interest payment on our debt.

Our quarterly cash flow from operations improved materially and increased by 41.9% sequentially and increased by 29.9% year-over-year.

Our cash flow from operations was $40.6 million for the quarter compared to $31.3 million for the second quarter of last year and $28.6 million for last quarter.

Debt ratios; our total gross debt at par, including capital lease obligations, was $967.9 million at quarter end and our net debt was $558.6 million.

Our total gross debt-to-trailing last [month] EBITDA as adjusted ratio was 5.8 at quarter end and our net debt ratio was 2.93.

Finally, some comments again on bad debt and days sales outstanding.

Our bad debt expense increased by $770,000 this quarter from last quarter and was 1% of our revenues from the quarter, an increase from 0.5% of our revenues for the first quarter and 0.6% of our revenues for the second quarter of last year.

Our days sales outstanding or DSO was the same at last quarter.

That's a worldwide ratio and that was 23 days.

And again, I want to thank and recognize our billing and collections team, who are continuing to do a fantastic job in serving our customers and collecting from our customers.

And I will turn the call back over to Dave.

Hey, thanks, Tad.

Now for a few comments on Cogent's scale and network expansion.

The size and scale of our network continues to grow.

We have over 951 million square feet of multi-tenant office space in North America on net.

Our network consists of over 34,100 miles of metro fiber connected to over 57,400 intercity route miles of fiber.

The Cogent network is the most interconnected network in the world and we are directly connected to over 6,760 networks at quarter-end, of which, less than 30 are settlement free peers.

The remaining 6,730 networks are paying Cogent transit customers.

We are currently utilizing approximately 27% of the lit capacity in our network.

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

For the quarter, we achieved sequential traffic growth of 1% and year-over-year traffic growth of 31%.

We added another new Cogent-controlled data center and sales office to our network in Charlotte, North Carolina.

We now operate 53 Cogent-controlled data centers with 592,000 square feet of raised floor space, and these facilities are operating at approximately 32% of capacity.

Our sales rep turnover for the quarter was 5%.

Again, better than our long-term average rep turnover of 5.7% per quarter.

Our quarterly rep productivity at 4.9 units per full-time equivalent per month is a productivity rate slightly below our long-term average of 5.1 units per full-time equivalent rep per month.

But this is partially due to the increased rate in hiring in our sales force.

We ended the quarter with 519 sales reps selling our services, which is a significant increase from the 501 sales reps we had at the end of Q1, 2019.

And most of the sales reps we have had -- this is the largest number we've ever had in our history.

We ended the quarter with 478 full-time equivalent sales reps selling our services, which again is a significant increase from the 464 full-time equivalent reps we had at the end of Q1, 2019.

So in summary, Cogent remains the low cost provider of Internet access transit services and our value proposition remains unmatched in the industry.

Our business remains completely focused on the Internet, IP connectivity and data center co-location services and these are necessary utilities for our customers.

Our multiyear constant currency long-term revenue growth target is approximately 10% and our long-term EBITDA margin expansion rate is expected to be approximately 200 basis points per year.

Our Board of Directors approved yet another sequential increase in our regular quarterly dividend, increasing our dividend by $0.02 a share to $0.62 per share per quarter.

Our dividend increase demonstrates our continued optimism regarding the increasing cash flow generating capabilities of our business.

We will be opportunistic about the timing of purchase of our common stock in the open market.

At quarter's end, we had a total of $34.9 million remaining under our current buyback authorization, which remains in place through year-end.

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

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

(Operator Instructions) Our first question is going to come from Philip Cusick from JPMorgan.

This is Reed on for Phil.

Thanks for taking my question.

We've seen 2 consecutive quarters with really strong growth in sales headcount.

Naturally, there is going to be a trade-off with less tenured sales folks.

But can you talk about, again the rep productivity trends and maybe some of the progress seen from the investment in training?

And then, was 2Q a full quarter of sales opportunities?

Yes, sure.

Thanks for both questions.

So we are significantly ahead of last year's pace of rep hires.

Last year we did most of the additions to the sales force in the latter part of the year.

This year we were really focused on getting ahead of the curve and continuing our hiring at the same rate we exited last year in the first half of this year.

Our average rep tenure has declined as a result of this increased hiring and we have a large increase in the number of reps in the 6 to 12 month maturity category, which has negatively impacted rep productivity.

As we have mentioned in the past a rep is counted as a full-time equivalent after being on the job for 3 months.

However, rep productivity linearly continues to increase for approximately the first 30 months of a rep's career at Cogent.

So this increase in the percentage of our reps in this formative part of their career at 6 to 12 months has had a slightly depressing effect on our rep productivity, but it's fairly benign at taking rep productivity from an average of 5.1 to 4.9.

These investments in the sales force recognize the increased demand from customers in our buildings.

In fact, our increase in penetration rates in our corporate buildings has accelerated over the past year due to heightened levels of use of Cloud and SaaS software and we feel it's necessary to have the reps available to meet those customer's requirements.

We have significantly invested in training over the past several years.

That investment strategy continues.

It did have an impact on our SG&A in the quarter, but we do think that the 200 basis points of margin expansion that we will deliver, will continue to come from about half operating leverage on the network side, i.e.

gross margin improvement and about half SG&A efficiency.

In this most recent quarter, as you saw, virtually all of our operating leverage was coming from our network efficiency being up 190 basis points, and in fact, we saw some negative leverage due to this increase in hiring.

But the investment in our sales force is going to continue to pay dividends for many years as our cost of revenue acquisition remains the lowest in the industry.

And our next question comes from Colby Synesael from Cowen and Company.

Maybe just following up on that a bit, as you guys mentioned in your prepared remarks, SG&A was up quarter over quarter where it's typically down and you mentioned bad debt expenses being part of that.

Would you expect that to reverse in the third quarter?

And then, as it relates to that 200 basis point long-term goal, where do you think you'll be as it relates to margin expansion in 2019 now that we have just 2 quarters left?

And then secondly on CapEx, it's been a while since you've just refresh us on that.

Where do you see CapEx going longer term for the business?

Sure.

Thanks for the 3 questions, Colby.

I'm going to let Tad take the bad debt one first and then I'll grab the other questions.

Yes.

Hey, Colby.

Unfortunately, this hasn't happened in a while, but the last 2 days of the quarter were on the weekend, and we had a material reduction in cash collections from our U.S. customers.

For the quarter for the month of June, that reversed in July.

In fact, we collected $9 million more in cash in July than we did in June.

And one of our calculations to determine our bad-debt expense is a general reserve for ratio of cash collections to billings.

So if cash collections are lower that results in our required to increase that reserve under the -- just the mechanics of the math and that really resulted in abnormal increase in SG&A.

And to directly answer your question, I do expect that to revert in the third quarter since the cash came in kind of that following week in July.

Yes.

And you know our bad debt expense and DSOs remain much better than the rest of the industry, and while there could be some fluctuations, as Tad pointed out, due to the calendar, we feel pretty comfortable that the bad debt experienced at Cogent will remain in line with historical averages.

Now for your question around margin, we will probably be below 200 basis points of expansion full year just because we have 2 quarters in at this point and have not achieved 200 basis points and it would require, I think an extraordinary amount of margin expansion in the latter half of the year.

With that said, we do expect to see substantial improvement in our margin expansion in the second half of the year.

However, arithmetically, it will probably not be enough to take us to that full 200 basis points for the year.

But again, that's a multiyear trend and we've delivered that now over a 17-year period and expect to continue to have another 7 or 8 years of roughly 200 basis points a year over that 7 or 8 year period having our long-term EBITDA margins continue to expand from about 35% today, up to about 50%.

Now to your CapEx question, you know our CapEx shows up 2 different places on our cash flow statement, as both CapEx and the principal payments on capital leases.

We will be down from last year where that combined number was about $16 million.

This year, we were down for the first half of the year and will continue to be down probably $3 million or $4 million from that combined number for the full year.

We do expect that continue reduction in absolute capital both principal payments and capital leases, to extend beyond this year into next year and to next several years and expect that total number to continue to go down.

And our next question comes from Nick Del Deo from MoffettNathanson.

You know the NetCentric growth, both year-over-year and sequentially, was the lowest, I think in at least a dozen years if we forget about the mega upload.

What are you seeing in the market?

Were there any large customers that hit pricing break points in the quarter?

And I guess in a more general sense, how long does this have to persist before we conclude that something is fundamentally different about the market today versus historically?

Yes, so, a couple of points, Nick.

Clearly, our NetCentric revenues have underperformed now for 6 years against long-term trends beginning with the loss of mega.

But then, continuing through net neutrality and then continuing on as we've seen accelerated price declines from some of our Orange's customers with a mix shift going to growth from our largest customers versus our more broadly represented smaller customer base.

We think that it will stabilize and improve.

As we have said on previous calls, we do not view this as a straight line to improvement from rather a lumpy road where the NetCentric revenues will bottom.

We think we are either at or near that bottoming of the rate of decline now and will gradually improve.

Transit remains the primary method for companies who either have a regional network who distribute Internet to connect and get access to the greater Internet.

We have 6,730 networks, in fact, doing that.

And then secondly, for companies that generate content, while they may look at using CDNs or direct connections, those alternatives are typically more expensive and may be more difficult to manage.

In fact, many of the CDNs in turn are just intermediaries buying transit from us.

Now clearly they get aggregated buying power because they're aggregating multiple customers.

But whether you're a content producer pushing an application out or an access network, allowing your customers to pull applications down.

Transit is the easiest-to-use, most ubiquitous and lowest-cost cost way to access the public Internet and you know the depth of the Internet, the substitution of alternate technologies have been predicted multiple times.

Clearly, the volatility and low performance of the NetCentric business is not what we expect long-term or we would comment on a permanent change in the market and we are seeing signs that the market is slowly bottoming out and beginning to heal.

Did any large customers hit pricing breakpoints in the quarter or was the performance more broad based?

It was more broad-based, Nick.

There were some price breaks for several large customers, but none that were material enough that we could point to that would say that was the under-performance this quarter.

There were some price breaks.

And as Tad mentioned in our prepared remarks, we had approximately 2,400 NetCentric customers get lower prices having existing contracts and repriced, and a few of those were Orange customers, but again, not a specific customer this quarter.

Okay.

And then, network expense has been a bright spot.

To what degree has that been attributable to the falling off that excess costs and to what degree has it been attributable other factors, because I'm trying to get a sense for what it might look like if pricing for off-net circuit starts to stabilize?

Yes.

So our off-net pricing model is typically to get the very best price we can in the roughly 1,030,000 locations where we can sell off-net services delivered via fiber from one of our 90 vendors and then double that.

We have been able to use the competitive tension between cable companies and telcos to drive down that pricing and we capture some of that benefit short term, and then when contracts come up for renewal, we pass those along and obviously we pass those on immediately for new customers.

But we're also getting operating leverage out of the fixed network, and the rate at which we have been expanding the network, whether it'd be incremental multi-tenant office buildings, we've gone from a long-term average of adding over 8% a year down to only about 2.5% a year, whether it'd be data centers or new markets, have all slowed.

So that slowdown in the rate of expansion has also helped us improve gross margins with the on-net business.

And then finally, in a low-inflation world, where our fixed maintenance payments have CPIs; in some cases, we've been able to pay less than the capped CPI and that has also helped us in terms of improving gross margin.

So we think all of these factors are likely to continue going forward.

And again, we expect the 200 basis points of EBITDA margin to come from a roughly equal split of SG&A efficiency and network efficiency over the long term.

Clearly, the quarter specifics of increasing the rate of salesforce hiring and the mechanic of the increase in bad debt that Tad addressed did hurt our SG&A this quarter, but we don't view that as a long-term trend, but rather more as a single quarter anomaly.

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

So what is the current churn with your reps?

And I'd be curious what the trend has been both in the NetCentric and in the corporate?

And then, how long do you expect the NetCentric salespeople to get up to kind of full productivity?

Yes.

So multiple questions there, Frank.

So first of all, as we commented on, our long-term average turnover of the entire sales force is 5.7% of the force per month.

This quarter it was 5.0%.

So significant, almost 20% below long term averages, and we have been bending that curve lower due to better training and some of the management tools that we have put in place.

Almost all of that turnover is on the corporate side.

Over half of our NetCentric reps are outside of the U.S. where there is usually a greater cost for turnover.

Secondly, those reps, all NetCentric reps tend to have substantially more tenure.

They make more money.

Some have been internally promoted.

Some have come from the outside.

But most of our effort has been on the corporate side.

We're roughly 72% corporate reps approximately 28% NetCentric and the bulge in reps that have tenure between 6 and 12 months is almost exclusively on the corporate side.

And as I commented in answering a previous question, it's really this uptick in the demand environment that has us encouraged on the corporate side, where we're seeing increasing rates of Cloud adoption and an increasing utilization of SaaS software, and it is those 2 catalysts that are the greatest catalyst for a customer switching to Cogent.

We have about 14.3 customers per multi-tenant office building, buying about 23.5 circuits from us in total per building or execute -- yes circuits per building and we are seeing an increase in penetration rates in our buildings.

Even though the rate of building additions to the network has slowed and it's that increased penetration that has us optimistic about the heightened level of investment we're making in the sales force.

And as I said last year, we got behind it.

We were a little slow in the first half of the year and pretty aggressive in the last half.

This year we were committed to making sure that we did not fall behind.

In fact, we're at about a 12% growth rate today year-over-year that is higher than our stated goal of 7% to 10%.

So I suspect we'll see a slight slowing of the growth rate in the corporate sales force in the latter part of the year to meet our year target.

And our next question comes from Michael Rollins from Citi.

Two questions if I could.

First, David, if you look at the success in selling the services because you give such a value proposition, what are the biggest barriers to adoption by customers, especially on the NetCentric side, but also maybe you could touch on the corporate side as you're just referencing some of the progress you're making in the buildings.

And then secondly, just a follow-up on some of the disclosures around the instalment payments to a vendor, is that considered CapEx at the time it's conceived or should that be something that gets considered in the free cash flow calculation?

Sure.

Let me -- I'll take the first one and part of the second one and Tad will finish up because he is a much better accountant than I am.

So in terms of our value proposition, it is very different for each of our customer bases.

On the NetCentric side, we guarantee potential customers to undercut competitors by 50%.

That value proposition has been consistent for a number of years.

We also have standard rate cards, which we adjust usually on an annual basis that are volume and term driven.

Now virtually all NetCentric customers will multi-home, meaning they use multiple networks.

As we have stated more networks buy from us than anyone else in the world.

But because we're #2 in traffic, it's showing us that we don't have the majority of traffic from the majority of our customers.

And for that reason, we offer these additional inducements to help them shift traffic.

We will never have a 100% of that market.

But our market share continues to increase while our competitors continue to lose market share and we feel that the value proposition that we deliver to a NetCentric customer is superior to alternate ways to connect, whether it'd be a CDN or through a direct connect.

We hear that from multiple customers in multiple locations and as witnessed by the fact that our traffic growth rates are higher than industry models for internet traffic growth, showing that we are in fact gaining market share with our transit product.

Now shifting to our corporate customers; the impediment to sales is typically the inertia of not having a problem.

The 3 quarters of the potential customers in an on-net multi-tenant office building all have internet connectivity today from some other provider other than Cogent.

It is typically inferior, lower throughput, longer install time and less reliability.

That service, however, is not able to keep up with the requirements when the IT infrastructure moves to SaaS and to the Cloud.

And what is our sales challenge is to be in front of that customer when that change occurs.

And for that reason, we continue to grow our sales force and make sure that we have enough corporate reps.

That's why our penetration rate continues to increase at an increasing rate and we feel that there are still a lot of addressable market there for us to capture in that 3 quarters of the tenants in the building that are not buying from us.

And then secondly, with the deployment of SD-WAN and VPLS, we also have the ability to add a second connection to those corporate customers.

Now through the, I'll give a little of the history of the instalment program and then Tad will touch on how it's accounted for.

That program was implemented when we were required to implement new software from our primary vendor that was outside of our previous contract and [Warner] to support that, the vendor allowed us to purchase that on this instalment sale program that was zero interest.

And that has continued in place for a portion of our infrastructure requirements.

Tad, do you want to touch on the accounting?

Sure.

Now I think you were also -- wanted to know basically the instalment costs associated either with adding new customers or expanding the network and there's really 3 main buckets there and they are accounted for differently.

So when we add a new capital lease and we have an upfront payment, that upfront payment is included with the monthly payments if there are and that's recorded as principal payments on capital lease in the amortization table.

So that goes in the financing section of the cash flow statement.

If we are paying a third-party to install a new customer and the amount is over our threshold to do that, that is recorded as CapEx and that's amortized to depreciation expense.

If we are installing an off-net customer and there is a non-recurring charge upfront, that is recorded as a prepaid asset and amortized to cost of goods sold under circuit costs.

So those 3 components are -- actually wind up in 3 different areas on the financial statements.

Does that help?

It does, but -- and then specifically, now that this instalment amount, so Dave was talking about in the balance sheet -- Yes, for the software upgrades and the equipment is that -- was that included in CapEx or is that treated more like a capital lease, and it was not included in the initial CapEx at the time that was incurred?

No, that is not included in CapEx, and then the payments on the amortization of the associated notes is in the financing section, you know principal payments under the installment agreement.

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

Dave, I guess on the NetCentric business, should we be embedding any expectations for some of the new streaming launches that are coming from Disney and AT&T next year into our assumptions for traffic growth?

And do you think those products can ultimately accelerate NetCentric traffic growth?

Then, I guess I'm curious -- I'm not sure, I might have missed this, but you issued some bonds, European bonds, curious about the thought process in terms of issuing European debt?

I'm assuming this is just lower cost of financing, but what are your -- also your intended use of that proceeds?

Sure.

Thanks for both questions, Brandon.

I'll take them in reverse order.

On the Euro bonds, roughly 22% of our revenues are outside of the U.S. We have about equal profitability outside of the U.S., so there is a natural hedge in our business.

European base interest rates are substantially lower than North American rates.

Spreads are slightly wider but the all-in cost of debt was lower in Europe, than it is here in the U.S.

So our 2 North American bonds, which have very short duration, trade at about 4.9%.

If we added a new North American instrument, it would probably have been in the low 5s because it would have had longer duration.

We looked in Europe and we're able to save about a 100 basis points by issuing in Europe.

So it was truly just a cost of capital question and then we've repatriated that cash immediately to the U.S. because we didn't want to suffer the negative carry in Europe, with negative or very low interest rates.

And then we will service that out of the profitability in euros.

So there is a natural hedge built in and it just gave us some additional balance sheet flexibility and also broadened our bondholder investor base that I think as we continue to grow our revenues and continue to naturally delever through margin expansion, we'll continue to look at the debt markets as a low cost of capital to supplement our returns to equity through buybacks and dividends.

Now to the operating question.

Over 90% of our NetCentric business is somehow tied to streaming of video.

The market has been dominated for the last few years by one major player.

I think some of these new launches broaden the content choices, are an acknowledgment that streaming has gone mainstream and in fact some of these companies are already Cogent customers and we anticipate they will continue to take advantage of our quality and value and expand the relationship as their products become successful.

You know, as we've said in the past, we're not here to pick winners and losers in the streaming war.

We're here to support all of the streaming providers.

The more they buy, the lower their price gaps and we want them all to grow rapidly.

And today, with only about 16% of video delivered via streaming in the developed world, we think there is a long way to go over the next several years and we view Disney and AT&T as a step towards a world where eventually 80% or 90% of video was streamed as opposed to in some kind of broadcast or stored media.

So all of these are encouraging trends for our NetCentric business and to layer on what was asked earlier, listen, if they could get to their customers in a cheaper, easier way than transit they should do that.

And in fact, all of the major streaming companies use transit and increasingly use it.

So we remain encouraged about the long-term transit market.

Of course then, we're not happy about the short-term underperformance, but long term, we feel that transit is here to stay and will improve.

And our next question comes from James Breen from William Blair.

Dave, can you just talk about the balance sheet and given the notes you just raised and the cash you have, how you're thinking about leverage levels and I'm assuming that returning all that capital to shareholders hasn't changed?

It has not changed and thanks for the question.

Jim.

So first of all, the fact that we raised our dividend again $0.02 sequentially a quarter for the 28th consecutive quarter is, I think an indication that the Company and the Board are committed to returning capital to shareholders.

We were very clear with the European purchasers of our debt that we had no use of proceeds, other than to return the money we were borrowing to equity through an increase in the dividend and through buybacks opportunistically.

We have a leverage target range of 2.5x to 3.5x EBITDA on a net basis.

We effectively remained flat even though we raised the dividend and increased our interest expense with these additional bonds.

We were at 2.93x this quarter, 2.92x last quarter, slightly below the midpoint of the range.

I think we remain in a low interest rate environment, and for that reason, the Company remains committed to supplementing free cash from operations with borrowed capital for our equity holders' benefit.

Now as we get volatility in our stock, we'll be more aggressive in buying back stock.

But the $409 million of cash is far more than the Company needs to carry on its balance sheet and we are committed to slowly disbursing that cash to shareholders.

And I'm showing no further questions.

I would now like to turn the call back over to Dave Schaeffer, Chairman and Chief Executive Officer of Cogent Communications Holding for further remarks.

Well, I just want to thank everyone.

Thanks for the support and we'll see you soon at a couple of conferences.

Take care, everyone.

Thanks.

Bye-bye.

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

This conclude today's program.

You may all disconnect.

Everyone have a great day.