Cogent Communications Holdings Inc (CCOI) 2019 Q3 法說會逐字稿

Good morning and welcome to the Cogent Communications Holdings Third Quarter 2019 Earnings Conference Call.

As a reminder, this conference call is being recorded and it 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 at Congent Communications Holdings.

Thank you and good morning to everyone . Welcome to our third quarter 2019 earnings conference call.

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

We are pleased by the results of the quarter and continue to be optimistic about the underlying strength of our business and our outlook for the remainder of 2019 and beyond.

Our EBITDA margin and EBITDA margin as adjusted both increased to the greatest margin percentages in our 20-year corporate history.

Our EBITDA margin for the quarter increased by 200 basis points to 36.9% from the second quarter of 2019 and our EBITDA , as adjusted margin increased by 190 points to 37.0%.

Our SG&A expense declined sequentially by $2 million or 6.1% from the second quarter of 2019.

Our gross margin for the quarter increased year-over-year by 170 basis points from the third quarter of 2018 to 59.9%.

On a constant currency basis, we achieved sequential revenue growth of 1.7% and year-over-year revenue growth of 6%.

Our year-over-year quarterly traffic growth was up 32% and we achieved a sequential increase and traffic growth to 11%.

During the quarter, we returned $28.6 million to our shareholders through our regular dividend program.

We did not purchase any stock in the quarter.

At quarter's end , we had a total of $34.9 million available for our buyback program, which our Board has authorized to continue through December of 2020.

Our gross leverage ratio decreased to 4.97 from 5.08.

Our net leverage remained essentially flat and declined slightly to 2.92 as compared to 2.93 in the last quarter.

Cash held in our parent company Cogent Holdings was $140 million and $300,000 at the end of quarter.

This cash is unrestricted and available for used for dividends and-or stock buybacks.

Cash held at our operating company was $256 million and our combined cash held both at the holding company and operating company level is $396.3 million at quarter's end.

We continue to remain confident on our growth potential and cash flow generating capabilities, more business as a result as indicated in our press release, we announced another $0.02 increase in our regular quarterly dividend from $0.62 to $0.64 per share per quarter representing our 29th consecutive sequential increase in our regular dividend.

Throughout this discussion, we will highlight several operational statistics.

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

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

Now I'd like to turn it over to Tad to read the safe harbor.

Thank you, Dave, and good morning everyone.

This earnings conference call includes forward-looking statements.

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

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

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

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

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

Now I will 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 metrics.

Now for some views on our expectation against our long-term goals, our corporate business, which represents 69% of our revenues for the quarter has been growing above our targeted guidance of long-term corporate growth of approximately 10% and grew in fact 10.4% from the third quarter of 2018.

However, our net-centric business has been underperforming compared to our historical average and declined 4.7% from the third quarter of 2018.

The impact of foreign exchange primarily impacts our net-centric business.

On a constant currency business, our net-centric business declined by 2.3% from the third quarter of 2018.

However, on a constant currency basis, our net-centric business did return to sequential growth and increased revenues by one half of 1% from the second quarter of 2019.

Our quarterly cash flow as defined by EBITDA minus CapEx minus principal payments on our capital leases.

Our quarterly cash flow for the first 9 months of 2019 grew by 12.6% as compared to the same 9 month period in 2018.

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

Our long-term EBITDA annual margin expansion guidance is to have an improvement of approximately 200 basis points per year.

Our multi-year constant currency revenue growth target is approximately 10%.

Our revenue and EBITDA guidance targets are intended to be multi-year in nature and are not intended to be either quarterly or specific annual guidance for 2019.

Tad will now cover some additional details about the operation and financial results from our quarter.

Thank you, Dave.

And again, good morning to everyone.

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

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

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

Our NetCentric customers by and large amounts of bandwidth from us and carry under 2 data centers.

Our corporate customers by bandwidth from us large multi-tenant office buildings.

Revenue from our corporate customers for the quarter grew sequentially by 2.3% to $94.4 million and grew year-over-year by 10.4% as Dave mentioned.

We had 48,179 corporate customer connections on our network at quarter end, which is an annual increase of 8.1% over the third quarter of last year.

Quarterly revenue from our NetCentric customers increased sequentially by 0.1% to $42.5 million and declined year-over-year by 4.7%.

On a constant currency basis, our quarterly revenue from our NetCentric customers increased by 0.5% sequentially and declined year-over-year by 2.3%.

We had 37,513 NetCentric customer connections on our network at quarter end, which was an increase of 10.9% over the third quarter of last year.

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

Revenue by network type, our on-net revenue was $99.4 million for the quarter, which was a sequential quarterly increase of 2% and a year-over-year increase of 6%.

Our on-net customer connections increased by 2% sequentially and by 9.6% year-over-year.

We ended the quarter with 73,870 on-net customer connections on our network in our 2,771 total on-net multi-tenant office buildings and carrier-neutral data center buildings.

Our off-net revenue was $37.4 million for the quarter, which was a sequential quarterly increase of 0.6% and a year-over-year increase of 3.4%.

Our off-net customer connections increased sequentially by 1.6% and by 7.5% year-over-year.

We ended the quarter serving 11,503 off-net customer connections in over 6,850 off-net buildings and these buildings are primarily in North America.

Some comments on pricing consistent with historical trends, the average price per megabit for our installed base and our new customer contracts decreased for the quarter.

The average price per megabit for our installed base declined sequentially by 4% to $0.61 and declined by 22.2% from the third quarter of last year.

The average price per megabit for our new customer contracts for the quarter declined sequentially by 13.8% to $0.33 and declined by 21% from the third quarter of 2018.

Some comments on ARPU.

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

Our on-net ARPU, which includes both corporate and NetCentric customers was $453 for this quarter, which was the same ARPU as last quarter.

Our off-net ARPU, which is comprised of predominantly corporate customers was $1,093 for the quarter, which was a decrease of 1% sequentially.

Some comments on churn and both are on-net and off-net churn unit churn rates both improved this quarter.

Our on-net unit churn rate was 0.9% for the quarter, which was an improvement from 1.1% last quarter and our off-net unit churn rate was 1.1% this quarter which was an improvement from 1.2% last quarter.

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

We also offer volume commitment discounts to our NetCentric customers.

During the quarter, certain NetCentric customers took advantage of our volume and contract term discounts and entered into long-term contracts for over 2200 customer connections increasing their revenue commitment to Cogent by almost $25 million.

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 to beginning of the year.

Annual cost of living or CPI increases, seasonal vacation periods, the timing and level of our audit and tax services, the timing and amount of our gains on equipment transactions, our annual sales meeting costs and benefit plan annual cost increases.

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

Our quarterly EBITDA increased by 7.2% sequentially to $50.5 million.

Our EBITDA increased year-over-year by $3.6 million or by 7.6%.

On an FX adjusted basis, our quarterly EBITDA increased by $3.8 million or by 8.2% sequentially and year-over-year by $4 million or by 8.5%.

Our quarterly EBITDA margin increased by 200 basis points sequentially to 36.9% and year-over-year by 80 basis points.

Our EBITDA as adjusted, which is EBITDA and adding in gains on our equipment transactions.

Our equipment gains were only $87,000 for this quarter, a decrease from $416,000 from the third quarter of last year and $185,000 last quarter.

Our quarterly EBITDA as adjusted, increased by $3.3 million or by 7% sequentially to $50.6 million and increased year-over-year by $3.3 million or about 6.9%.

Our quarterly EBITDA as adjusted margin increased sequentially by 190 basis points to 37% and increased by 60 basis points year-over-year.

Earnings per share.

Our basic and diluted income per share was $0.30 for the quarter compared to $0.16 last quarter and $0.18 for the third quarter of last year, impacting our earnings per share this quarter were unrealized foreign exchange gains on our 135 million of Euro notes and that gain was $6.1 million this quarter and that represented $0.13 per basic and diluted income per share.

Some comments on foreign exchange.

Our revenue reported in US dollars and earned outside of the United States was about 22% of our total revenues consistent with prior quarters.

Approximately 16% of our revenues this quarter were based in Europe and 6% of our revenues were related to our Canadian, Mexican, Asia-Pacific and Latin American operations.

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

The foreign exchange impact on our reported quarterly, sequential revenue was negative 176,000 in the year-over-year, foreign exchange impact on our reported quarterly revenue, was a negative $1.1 million.

Our quarterly revenue growth rates on a constant currency basis were 1.7% sequentially and 6% year-over-year.

The impact of foreign exchange primarily impacts our NetCentric revenues.

The average Euro to US dollar rates so far this quarter is about $1.10 and average Canadian dollar exchange rate is $0.76, should these average rates remain at the current levels for the remainder of our fourth quarter, we estimate that the FX conversion impact on our sequential quarterly revenues for the fourth quarter will be about a negative 0.1 million and the year-over-year foreign exchange conversion impact is estimated to be a negative 700,000.

We believe that our revenue and customer base is not highly concentrated and our top 25 customers represented less than 6% of our revenues this quarter.

Our capital expenditures increased by 2.8% sequentially and were flat year-over-year.

Our capital expenditures were $12.1 million this quarter, the same $12.1 million in the third quarter of last year and $11.7 million for the second quarter of 2019.

Capital leases and capital lease payments.

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

Our capital lease IRU fiber lease obligations totaled $168.1 million at quarter end and at quarter end, we had IRU contracts with a total of 242 different dark fiber suppliers.

Our capital lease principal payments under our dark fiber and IRU agreements were flat sequentially and declined by 3.3% year-over-year.

Our capital lease principal payments were $2 million for the quarter compared to $2.1 million for the third quarter of last year and $2 million for last quarter.

Our capital lease principal payments combined with CapEx totaled 4.14 rather $0.1 million this quarter compared to $13.7 million last quarter and $14.2 million for the third quarter of last year.

Cash and operating cash flow, at quarter end, our cash and cash equivalents totaled $396.3 million.

For the quarter, our cash decreased by $13 million.

We returned $40.5 million of capital to our stakeholders this quarter.

During the quarter, we paid $28.6 million for our regular quarterly dividend payments and $12 million was spent on semi-annual interest payment on our debt.

Our quarterly cash flow from operations decreased sequentially by 17.7% due to the sequential increase in interest paid this quarter.

However, our quarterly cash flow from operations increased 5.3% year-over-year.

Our cash flow from operations was $33.4 million for the quarter compared to $31.7 million for the third quarter of last year and $40.6 million for the second quarter of this year.

Debt ratios, our total gross debt at par, including our capital lease IRU obligations was $962.5 million at quarter end and our net debt was $566.2 million.

Our total gross debt to trailing last 12 months EBITDA as adjusted ratio was 4.97 at quarter end and our net debt ratio was 2.92.

Finally, comments on bad debt and days sales outstanding on accounts receivable.

Our bad debt expense significantly improved from last quarter, as expected and decreased by 404,000 in this quarter from last quarter where the calendar impact in our customer collections with the last 2 days of the quarter being on the weekend.

Our bad debt expense was 0.7% of our revenues for the quarter, which was an improvement from 1% of our revenues last quarter and the same percentage of 0.7% at the third quarter of last year.

Finally, our days sales outstanding or DSO for worldwide accounts receivable was the same as last quarter and was 23 days.

And as always, I want to thank and recognize our worldwide billing and collections team members for continuing to do a fantastic job in serving our customers and collecting from our customers.

And now with that, I will turn the call back over to Dave.

Thanks, Thad.

Now for a few comments on the scale and scope of our network.

We have over 954 million square feet of multi-tenant office space in North America on net.

Our definition of on-net is literal, meaning we have fiber into the building up the riser to each of our tenants or into a data center to a common meet point.

Our network consists of over 34,980 metro fiber miles and over 57,400 intercity route miles of fiber.

Our network remains the most interconnected network in the world.

It directly connects with 6840 networks.

Less than 30 of these networks are settlement-free peers.

The remaining over 6810 networks are Cogent customers purchasing transfer service from us.

We are currently utilizing approximately 26% of the [width] capacity in our network and we routinely augment segments of our network to maintain these low utilization rates.

For the quarter, we achieved accelerated quarterly traffic growth of 11% quarter-over-quarter and 32% year-over-year.

We now operate 54 Cogent control data centers with 609,000 square feet of raised floor space and these facilities are operating at approximately 32% occupancy.

We have added 2 data centers to our network this year in 2019.

Our sales rep turnover in the quarter was 5.3% better than our long-term average rep monthly turnover of 5.7%.

Our quarterly rep productivity, however, was 4.4 units per full-time equivalent per rep.

Productivity rate that is below our long-term average of 5.1 full-time equivalent reps per month.

However, our Rep tenure has decreased and approximately 55% of our reps have been with Cogent for one year or less.

We ended the quarter with 530 sales reps selling our services, a significant increase from the 519 at the end of second quarter 2019 and the most sales reps we have ever had.

We ended the quarter with 488 full-time equivalent sales reps.

These reps that have been in seats for more than 3 months selling our services and increase from the 478 full-time equivalent sales reps we had at the end of Q2.

Cogent remains the low-cost provider of Internet access transit services.

Our value proposition remains unparalleled in the industry.

Our business remains completely focused on the Internet, IP connectivity, and data center co-location services.

We are providing a necessary utility to our customers.

On a multi-year constant currency basis, our long-term EBITDA margin expansion should be approximately 200 basis points and our revenue growth will be approximately 10%.

Our Board of Directors has approved another increase on our regular quarterly dividend of $0.02 per share, bringing that quarterly dividend to $0.64 per share per quarter.

Our dividend increases demonstrate our continued optimism in our business and the historical and prospective cash flow generating capabilities of our business.

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

At quarter's end, we had $34.9 million remaining under our current buyback program and that program is intended to continue through December 2020.

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

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

(Operator Instructions) Your first question comes from the line of Philip Cusick from JPMorgan.

This is Reed for Phil.

Thanks for taking my question.

Two if I may, first within NetCentric you've called out the mix shift is transitory, but can you talk about the actual visibility you may have especially in streaming with both new entrants emerging but also as the largest services get larger.

And second, could you talk about the step up in USF rates.

Why were it's benefits so much higher year-over-year in this quarter, and if it benefits any one part of the business disproportionately?

Yeah, sure.

Thanks for both questions.

Let's start with the NetCentric business.

That business is a business that is usage based.

While we charge for a fixed commit on most of our NetCentric ports, the price is determined on a price per megabit and virtually all of those ports have a usage component associated with them.

We expect to see traffic continue to grow on the Internet at historical range driven in large part by over the top streaming services.

Most of the existing streaming services utilize Cogent and many of the proposed new entrants in the market also intend to use Cogent.

We also supply bandwidth to virtually every content delivery network globally and in doing so, we will be providing indirectly bandwidth to many of those streaming services as they will both build out their own CDNs and utilize existing third-party CDNs.

It is impossible for us to project the success of each of these different offerings there, different and the quality of their product, their pricing models, their targeted markets.

But we do anticipate that to continue and drive most of our traffic growth and as Tad has mentioned our price per megabit rate of decline is very much in line with historical averages.

With those 2 factors, we expect our NetCentric business to continue to improve and return to more or less historical growth rates as opposed to the underperformance that we have been experiencing more recently, and in fact the 0.5% sequential constant currency growth rate this quarter is a good indication of that improving trend starting to take hold.

Now to the USF question.

The USF, our charge does not apply to our Internet services, so it does not apply to Transit or dedicated internet.

It does apply to VPN services whether delivered over SD-WAN or VPLS.

Those products are primarily corporate products and almost all of that increase was as a result of pass-throughs to our corporate customers.

We do not set the rate for USF.

Other companies in the industry have also reported changes and increases in USF.

The way those charges are determined is Congress dictates a level of broadband subsidies that it wants to have for schools, hospitals and other municipal organizations.

From that, the FCC outsources the calculation and collection of that tax to USAC.

USAC quarterly adjusts the rate charged on applicable services in order to meet the congressionally mandated target.

So what we saw was an unusually low rate earlier this year and a bit of a catch up this year, but you know this applies to all non-exempt services.

Your next question comes from the line of Nick Del Deo from MoffettNathanson.

First, a follow-up on the USF.

You said it's mostly corporate.

Can you quantify the exact split between corporate NetCentric because from my math if I apply most of it to corporate, there was a pretty meaningful step down in corporate growth curve [AQ] year-over-year.

So I want to better understand that.

Yeah.

You did see a slowdown in our off-net corporate growth rate, Nick, approximately 40% of our corporate revenues, 20% of our connections are corporate and we did see continued reduction in loop costs, which we pass on to customers.

So the deceleration in corporate growth is almost exclusively as a result of the off-net ARPU declines.

In terms of the layer 2 services that are subject to USF over 90% of those services are to corporate customers not to NetCentric customers.

On a limited basis, we do sometimes have NetCentric customers that buy VPN services to extend their own networks to data centers that they are not present in because we have the largest footprint of carrier-neutral data centers of any service provider globally with over 1200 unique data centers.

Sometimes, some of our competitors even buy Layer 2 services as a way to reach some of those smaller markets.

But it is a very small portion of our total Layer 2 or VPN services.

Okay.

Regarding sales productivity.

If we were to look at that in dollar terms rather than unit terms, would the trend lines looked pretty similar.

And I guess what I'm trying to get at is whether lower unit priced installs like EPLS are disproportionately responsible for the change?

Yeah, I think they would look relatively comparable with the exception of the decline and Off-Net corporate ARPUs as a result of lower Group costs.

So the lower productivity on a dollar basis would be slightly larger than on a unit basis, most of the step-down in productivity has come as a result of our increased hiring rate.

So while we have an increase of 10 additional full-time equivalents, we take a wrap and count them as a full-time equivalent after 3 months of service.

Yet, our average rep tenure slightly declined, but probably the most important data point is the fact that 55% of our total quota bearing sales reps.

Those 530, have a tenure at Cogent of less than 12 months and we have previously stated and remains true that rep productivity based on maturity linearly improves till about month 30 and then plateaus.

So with this decline in both the average and median rep tenure, it did have a negative impact on rep productivity on units and on a dollar basis slightly worse for the corporate reps.

Now, there are actually was one slight positive offset and that is that this quarter for the first time, we actually sold more corporate gig connections than 100 meg connections.

Our primary product corporate customers has always been a fast Ethernet connection or 100-megabit symmetric service.

But in this quarter, we actually saw more customers taking a full gigabit connection as opposed to a 100 meg and actually our on-net corporate ARPU actually ticked up slightly as a result of that.

That's interesting.

One quick accounting one for Tad.

Can you confirm that there was a full 800,000 reversal of the calendar driven bad debt.

I mean at the last quarter?

The quarter-to-quarter change in bad debt was 400,000.

Okay.

If I remember correctly last quarter you said that the calendar effect was hundred 770,000.

Well, that was the impact from Q1 to Q2.

But Q2 to Q3, it declined by 400,000.

Okay.

So we should think of 400 as being attributable to the calendar effect.

Essentially, that's fine.

We reverted back to kind of our normal rate, which is about 0.6%, 0.7% of revenues.

Your next question comes from the line of Mike McCormack from Guggenheim.

Maybe just a quick comment on the pricing environment out there.

We have heard the potentially some of the bigger carriers are going to have a little bit better on retention.

What you're seeing as far as aggressiveness in some of those RFPs.

And then secondly, I guess just a couple of these companies out there that are larger looking to divest assets.

I'm presuming that you have no interest.

Anything out there that could spark your interest there.

Thanks.

Thanks for the 2 questions.

Mike.

So first of all, let me answer the competitive question looking both at the corporate and NetCentric market separately because I think our competitors think of them differently.

On the NetCentric side, we continue to say pricing declines for the industry in line with our rate of pricing decline and our willingness to undercut competitors by 50% has allowed us to continue to gain market share and virtually all of our competitors have de-emphasized Transit as a product and are not incenting their sales teams to focus on that product segment.

So I think our NetCentric competitive environment continues to improve and become more benign.

Now on the corporate side, it's very much competitor specific.

Our competitors really have 2 challenges.

The first is a large portion of their revenues come from legacy services like MPLS and voice and other managed services that are migrating to Internet.

So there is some internal product substitution as well as the opportunity to switch to other carriers.

Secondly, on a pure DIA offering, we see different carriers reacting differently.

I think Verizon has tended to be less aggressive, AT&T a little more aggressive.

I think the cable companies tend to focus more on very small customers and suburban environments, but can not to be very aggressive in competing on larger customers are particularly those that straddle multiple geographies.

So in general, I would say the corporate environment is similar to what it has been.

I do think though that across the industry, we're going to continue to see multiple years of headwinds to traditional wireline carriers.

Now to the asset acquisition question, you know Cogent was a very active acquirer in building its networks and since 2005, we have actually looked at over 760 potential acquisition targets and have not done any.

That doesn't mean we're not interested.

It means that most of those assets are either irrelevant to our business or are priced inappropriately.

At some point the markets will become rational and there may be assets that make sense for us.

So it makes total logical sense for us to continue to look.

But there is no acquisitions on our horizon at this time.

Your next question comes from the line of James Breen from William Blair.

Just a couple.

One on the off-net side you have given sort of the impact of the loop costs, have those come down.

How does that impact margin?

I am assuming that those are lower margin revenue dollars for you.

Does it actually help as some of that revenue comes out (inaudible) or you don't see as much of a decline in EBITDA from that.

So we typically on a new deal double the cost of the loop so as the loop comes down, we just become more competitive.

The gross revenue number becomes smaller but the margin remains the same.

If we are able to negotiate loop discounts, while a customer is still in term, we capture that benefit and in fact, that does improve margins until that customers term has matured and we will then re-rate the customer.

Our belief is that we need to constantly offer value to customers, both on-net and off-net and by being proactive in going out and lowering prices for existing customers, we typically win their trust and confidence as part of the reason why our net promoter scores remain in the mid 60s, which is extremely high about 5x higher than telecom service provider averages.

And we think with the continued overbuilt of both cable and Telco for different reasons.

Cable to address a new market for telcos oftentimes to lay the foundation for their small cell backhaul, we will see continuously lower prices for those loops.

But remember our off-net ARPU is still over double what our corporate ARPU is for a comparable product so much about 2.4x more.

So there is still a lot more value that Cogent delivers to its customers on-net than off.

Great, thanks.

And then can you just talk about where that you certainly now from a debt perspective of the balance sheet, how do you think about leverage ratios?

Yeah, so I mean, our net leverage declined only minimally from 2.93 to 2.92 were within the range that we have out outlined, we did raise some euro-denominated debt this year.

We have adequate capital at the holding company and nearly $400 million of total capital on the balance sheet 148 Holdings, 256 at OpCo.

We will be measured and returning that capital.

Our expectation is that we will probably not raise any more debt this year, early next year some of our debt becomes callable with no premium, we will evaluate that may elect to call some of that and then increase our total leverage.

We have about $58 million available in our builder basket at OpCo today, that will continue to increase and we will probably breach the 4.25 returns of gross leverage to [score] additional builder basket from OpCo to HoldCo and then look to add additional leverage.

And this is all contingent on the interest rate environment, but it does appear we are in a low interest rate environment and therefore strategically using our balance sheet to amplify equity returns makes logical sense.

Your next question comes from the line of Michael Rollins from Citi.

Dave, wondering if you could talk a little bit about how you see the strategic opportunities for your business to other entities, just as we've seen the evolution of the cloud and just the way the Internet has also evolved.

Where do you see Cogent in a long run fitting in strategically?

So, we are fortunate and that our business is entirely focused on the Internet.

Approximately, 80% of revenues come from Internet access, about 18% of revenues come from over the top VPN services and only about 2% from co-location.

As computing and software move off site, the Internet is the primary input and output mechanism.

Over 98% of connectivity to public cloud occurs over the Internet.

As the world's second largest Internet carrier, we obviously have a strategic role to play in that.

Secondly, VPNs are increasingly migrating away from purpose-built networks like MPLS to some form of over-the-top and Cogent is uniquely positioned to help on that.

Finally, the 954 million square feet of on-net office space represents the third largest amount of office space on net in North America.

That is strategic.

Now could a cloud provider, could a software company, could someone else look at this asset and place a value greater than the cash flow potential of the business.

That's really their decision to make.

You know, we have always been transparent with shareholders that are comfortable with our business and executing it, generating increasing amounts of free cash flow.

But if any strategic operator ever wanted to pay a premium to our DCF, we would recommend to shareholders that makes logical sense.

But at this point, we fully intend to just execute our business at it currently exists.

Your next question comes from the line of Tim Horan from Oppenheimer.

And taking on how much of your NetCentric traffic is outside the United States.

Do you, think, I don't know if you've ever given that number.

We have, Tim.

Thanks for the question.

So roughly 47% last quarter was outside of the US, 53% while US and Canada.

North America versus the rest of the world.

It's been roughly about 50-50.

The traffic is slightly different in each of the regions.

The US tends to have more application and content generation.

So more of our traffic in North America tends to be outbound and with over 6800 access networks around the world buying upstream from us.

Most of the rest of the world tends to draw down North American content.

That doesn't mean there is no non-US content, but you know it tends to be more access outside the US, and we do have significant access network here in North America as well.

But our Net Centric is heavily and international business and increasingly becoming more of a global business, as we expand in the markets.

We have now opened up in Brazil, both in Rio and in Sao Paulo, we're constructing metro networks in those markets by buying direct fiber.

We've recently launched in Taipei in Taiwan and we are in the process of actually turning up probably at the beginning of the year in Columbia, South America.

So we continue to look at international markets, which are primarily NetCentric markets for us.

Well, and it would seem like a lot of those markets are still adopting LTE.

I mean, some of them are 5G, but it seems like a wireless has been a huge impact to you historically, but it seems like it could be a larger impact going forward on the international basis.

That is correct.

So remember, over 80% of the people globally, who have ever used the Internet have only used it wirelessly and have no fixed line connections.

Wireless accounts for only about 2.5% of global traffic and is growing at about twice the pace of fixed-line growth.

So as we look at traffic growth going forward, I think 2 things are true.

One, more if it will come from outside of the US than inside.

And then secondly more of it will come from wireless than fixed line.

And I guess lastly, the traffic growth is the last 2 quarters is a bit below what we saw last year kind of more in line with '17.

Any color on that.

What's causing that.

And what you think might change that trajectory.

Yeah, I think there's been a little bit of a slowdown in the growth of current OTT operators and a bit of a expectation of the next generation of OTT offerings that are today mostly in test phase, so kind of beta with limited, applicability.

But I think there are a number of products that are set to launch right at the end of the year that will have a major impact.

Your next question comes from the line of Brett Feldman from Goldman Sachs.

So Dave, you noted that your sales force is the highest that's ever been and it's not merely growing, it's growing at an accelerated rate.

I think your full-time equivalents are up 17% over the last 12 months.

Last year, you only grew the workforce about 2%.

The only way it could make any sense to make such a significant investment in a workforce as you noted can take up to 30 months to hit full productivity.

It is as if you feel like you just have great visibility into an absolute tsunami of new business opportunities in front of you and you obviously understand this business very well.

So I was hoping you could maybe explain what do you see coming.

What's driving that.

And ultimately when should your shareholders expect to see some type of improvement in your revenue trends to reflect the investment you've made in the sales force?

Thank you.

So Cogent is a sales-centric organization.

We have 667 people in the sales organization, 530 of those are quota bearing.

We have only about a 1,040 total employees.

We fully admit that probably in 2017 and 2018, we were not hiring at the optimal rate and we've looked to increase that hiring.

We've opened additional physical sales offices, ticket closer to customers to have a greater source of talent.

We needed to hire and develop that management talent.

And our sales process is not meant for every new person who joins us.

We have turnover, we've worked on trying to reduce that, but it's still over 5% of sales force a month, so we expect to continue to say turnover while we are constantly working on bringing it down, it's just the nature of an outbound telesales organization.

Now to our addressable market.

We have sold 23 connections per multi-tenant office building to about 15.2 customers out of the 51 potential, we see more and more of those corporate customers needing our types of products as they move to the cloud and move to SaaS.

We also see those same customers needing our products as they turn off MPLS and look at either SD-WAN or VPLS.

So we see a tremendous opportunity to continue to further penetrate our buildings and to selectively add other buildings.

On the NetCentric side, it's really just continued migration of video consumption and gaming, moving to the Internet and that will drive growth.

We have always been under staffed relative to our addressable market and we remain so.

But there is a limit to how quickly Cogent can hire, train and incorporate new hires into our culture.

And you saw a little bit of this quarter with our Rep Productivity dipping.

It dipped a large part because of this bulge and hiring.

It's not that the market has changed.

It's rather that our sales force is a little less mature and we are taking all of the steps appropriate from management attention and training to make those people as productive as possible as quickly as possible, but you need to be realistic.

Sales is a process and building a funnel takes time.

And we feel very comfortable that we have plenty of market opportunity ahead of us.

That's helpful.

If you don't mind, if I guess a follow-up question on what you were just previously discussing about the forthcoming direct consumer video services.

If you think back to the experience you had when the most recent generation with DirecTV now and YouTube, when they came to market, what type of effect that ended up having on your NetCentric traffic growth, just as a way of maybe thinking through what we could see play out over say the next 18 months or so, as these new products come to market?

Thank you.

It actually had a step function increase and it did 2 things.

One, it allowed us to replace the traffic lost from the shutdown of mega upload in early 2012 within a couple of months.

So we literally lost the largest website in the world that was sole source to Cogent.

And, we represented nearly 20% of our traffic, a rebound within a quarter.

Secondly, we saw a spike up in traffic growth for a short period of time to nearly a 100% year-over-year.

But that thing quickly became muted, because of the net neutrality issues.

I don't believe we will see those types of violations with this next generation of products.

These are much better capitalized companies.

So yes, I think we will continue to benefit.

Your next question comes from the line of Brandon Nispel from KeyBanc Capital.

Great.

I missed the traffic growth numbers.

So Dave or Tad, could you please provide those?

And then maybe Dave just are you seeing any new applications driving traffic growth beyond video gaming, et cetera.

And then maybe which markets are you seeing the greatest traffic growth?

Separately, then you mentioned, seeing a lot of customers shift to gigabit connections.

I was hoping you could help us understand how fast you are seeing your customer base migrate to gigabit services and what that means from an incremental ARPU perspective to you?

Thanks.

Sure.

So our traffic growth was 11% sequentially, 32% year-over-year.

I think the applications that are driving traffic growth on the content side are OTT video and gaming.

I think on the recipient side, it's the continued decline in broadband mobile pricing and the improvements that come from LTA and from 5G, as it begins to be rolled out that will allow people to get much bigger bucket plans, even though they are unlimited, there are unlimited in name only with typically carriers slowing down, they are unlimited plans to unusable rates, once customers have a certain cap, but those caps are going off.

So I think we will continue to see both greater access and greater content, driving accelerating growth.

Now to the corporate business.

We chose 100 megabit 20 years ago as our interface, because that's what corporate lands could accept.

Almost universally, the wide area connections available on CPA and corporate clients are now gigabit.

What's interesting is that while we saw more gigabit connections being sold in the quarter, than Fast Ethernet to corporate on-net customers are average corporate utilization rate actually fell from 18% down to about 13.5% of a port.

And the reason is, they weren't event using the 100 and now they have a port that's 10x bigger.

But what it does, is it allows them to future proof and allows them effectively unlimited burstability, if there are searches in traffic.

So since the cost differential is de minimis, I think we will see more-and-more gigabit interfaces.

We have your next question coming from the line of Colby Synesael from Cowen & Company.

Great.

First one on pricing, you noted it was down 21% year-over-year, that's probably the best improvement we've seen probably in the 5 quarters or so.

Curious if you think that this level is sustainable or do you think it will continue to bounce around with the levels we've seen maybe the last more recent few quarters.

Secondly, as it relates to USF based on the tax increase and when it occurred assuming that those do stay constant, did we get a full quarter benefit or impact in 3Q or is there more of incremental benefit, if you will, that we'll see on a full-quarter basis in 4Q.

And then lastly, just a housekeeping item.

I was curious, and you may have said it just through all the different numbers, but can you give us the corporate on-net connections.

And I think the comparable number in 2Q just as a reference was 40,025.

Thank you.

So I'll take the first one.

I'm going to give Tad the second.

On pricing, the average rate of price decline over the past 15 years for Cogent has been about 22.2%.

I think the 21% is very much in line with historical averages.

Yeah, it's not a spreadsheet, it's a business.

The bigger customers get lower pricing that can sometimes distort even those averages and then it is also based on the actual sales on a unit basis not volume weighted.

So you've got a lot of variables that will happen, but I think the underlying rate of price decline in the low 20s is what you should expect over the long run going forward.

Now I'll let Tad take the USF and corporate connections.

Sure.

Yeah.

The USF rate is set quarterly and its calendar quarters that mirrors our quarter.

So, July 1, October 1 et cetera.

So the impact is for a full quarter for us on the USF change up or down, however, it adjusts.

The corporate on-net connections at quarter-end were 40,469.

Your next question comes from the line of Rob Palmisano from Raymond James.

This is Rob on for Frank actually.

You had mentioned earlier in your prepared remarks that you guys have about $34.9 million still available for buybacks that will continue through December of 2020 and I was wondering if you could provide some color on when specifically within that remaining time frame might heavily focus on the buybacks.

Thank you.

So we have had 5 buyback programs and I'm always exhausted them.

We've also been opportunistic and taking advantage of market volatility.

Our view on buybacks is twofold, we must always buy the discount to DCF, we've always done that and could do that today.

But secondly, we should always be buying in the down market.

So I can't answer the question, because we're smart enough to know when the market will go up or down.

I probably wouldn't be on this call.

Yes.

So I mean, all I can say is, if the market becomes volatile, we'll be more aggressive and lack of volatility, will continue to just methodically grow our dividend and chances are we will have the opportunity to do both.

Your next question comes from the line of Walter Piecyk from LightShed.

Welcome back, Wal, congratulations on your new firm.

Thanks, pal.

SG&A, and I was just kind of a picky to even question.

But it looks like it was going a little, even if you strip out the employee comp stuff, it looks like that came down this quarter abnormally.

Is there anything going on there one-time in nature or is this kind of a new run rate for you?

Now Thad will take it.

I think it's pretty much as --

Sure.

There is a little bit of seasonality in the third quarter.

So I can give you some components of the reduction.

Sure, you're a little bit, if it seem a little bit more exaggerated this quarter.

I was just wondering, if you had any like, any type employee costs or maybe one time credits that were helping you in the quarter.

I wouldn't necessarily characterize anything as one-time, but there is a little seasonality.

So I'll give you the components.

First, there was bad debt as we mentioned, which was $400,000 and it reverted back to our normal percentage of revenue and that was to change for the quarter.

We do typically get a benefit in the third quarter, when a lot of people take vacation, so you're charging the buildup of the vacation accrual, as opposed to just regular compensation expense.

That seasonal that always happens that was about another $400,000.

We do get as more employees hit their FICO limit, the benefit rate comes down and that's seasonal, but that always happens each quarter that was about $300,000.

And then there is an adjustment that we need to make under the new accounting pronouncement to prepaid commissions, which is difficult to estimate, some quarters it's sequentially, some would say decrease and that happens to be a decrease this quarter of about $400,000.

So, it's kind of a normal run rate with the exception of some here and there is some seasonality in the third quarter.

Does that help?

Got it.

Thanks.

And Dave, do you expect any revenue from Disney Plus or Apple in 2020?

And do you have any indications from them at any traffic growth that is going to occur in 2020 is going to benefit your NetCentric business?

So, yes, a lot of my customers don't like me to be too explicit about our relationships, but we do have relationships with those companies and I believe their products are going to be very successful.

I also believe that some of my existing OTT customers will also be successful, but this should be additive, as I think it will accelerate the core cutting phenomenon and the switch to more minutes over the top.

Cogent is generally the preferred provider globally of OTT operators just because it's -- is it the same material cost, we have the lowest price.

But we also have more networks directly connected and more geographies, which ends up producing latency, so there's a lot of reasons why as a new entrant to OTT evaluates different providers.

They choose Cogent.

We should never take that for granted, but I think we will win a disproportionate share of that business.

I mean it seems like a pretty material event, a lot of times when you're asked about the NetCentric business over the past couple of years, you're like well, I can't predict the next app.

And here we have in front of us an entire industry responding to Netflix.

So, even if you're kind of maintaining our share, it would seem like something that's material enough to help your NetCentric revenue growth.

Listen, I hope so.

I just don't want to go out and predict what these guys are going to do.

I hope they're all wildly successful and I think if I have a couple of more quarters of experience from several of these other operators.

I'll be more comfortable in making predictions.

We have a follow-up question coming from the line of Nick Del Deo from MoffettNathanson.

I just wanted to follow-up on your comment that the lower Off-Net loop costs were responsible for the step down in USF adjusted corporate revenue growth.

Is it.

My understanding has been at the lower Off Net cost have been an ongoing trend for many years.

So is there something specific that happened this quarter on that front, because again the break in the corporate revenue growth trend was pretty meaningful.

If you adjust for USF, I want to ensure that I fully understand what's going on there.

We were able to negotiate some pretty significant discounts from the 2 largest suppliers of Off Net loops to us this flat actually earlier in the year that had the impact in the quarter.

So it was a little more pronounced this quarter than normal.

Okay.

So your view is that absent that large than normal reduction in your corporate growth trend would be consistent with recent history.

That's right.

Okay, terrific.

And you saw that in the deceleration of Off Net corporate growth was only 3.4% year-over-year versus 10.4 for the entire corporate business.

Thank you.

I am showing no further questions at this time, I would now like to turn the conference back to Mr. Dave Schaeffer.

Well, first of all, I'd like to thank everyone.

I apologize for going a few minutes longer, but I think they were great questions.

And again thank the entire Cogent team and we'll talk soon take care, bye-bye.

Ladies and gentlemen, this concludes today's conference.

Thank you for your participation and have a wonderful day.

You may all disconnect.