Cogent Communications Group Management Discusses Q1 2013 Results - Earnings Call Transcript

May. 7.13 | About: Cogent Communications (CCOI)

Cogent Communications Group (NASDAQ:CCOI)

Q1 2013 Earnings Call

May 07, 2013 8:00 am ET

Executives

David Schaeffer - Founder, Chairman, Chief Executive Officer and President

Thaddeus G. Weed - Chief Financial Officer, Principal Accounting Officer and Treasurer

Analysts

Frank G. Louthan - Raymond James & Associates, Inc., Research Division

Colby Synesael - Cowen and Company, LLC, Research Division

James D. Breen - William Blair & Company L.L.C., Research Division

Barry McCarver - Stephens Inc., Research Division

Michael Rollins - Citigroup Inc, Research Division

Donna Jaegers - D.A. Davidson & Co., Research Division

Operator

Good day, everyone, and welcome to the Cogent Communications Group Inc. Q1 2013 Earnings Conference Call and Webcast. Today's conference is being recorded and will be available for replay at www.cogentco.com. At this time, I would like to turn the conference over to your host, Chief Executive Officer, Dave Schaeffer. You may begin.

David Schaeffer

Okay. Good morning, and thanks, everyone, for joining the call. Welcome to our First Quarter 2013 Earnings Conference Call. I'm Dave Schaeffer, Cogent's Chief Executive Officer. With me on this morning's call is Tad Weed, our Chief Financial Officer.

We are pleased with our results for the quarter and are optimistic about the strength of our business and the outlook for the remainder of 2013.

During the quarter, we experienced sequential growth, material gross margin expansion, reduced churn, substantial growth at network traffic and a significant increase in our sales force rep productivity. Additionally, we've returned $5.5 million to our shareholders through a quarterly dividend of $0.12 per share, which we paid in March. We continue to remain confident in the cash-generating capabilities of our business. As a result, as we indicated in our press release, we have announced a further 8.3% increase on our quarterly dividend to $0.13 per share, our third dividend increase in less than a year, to be paid on June 18, 2013, to holders of record as of May 31, 2013.

Our revenue grew from the fourth quarter by 2.3%, and on a constant-currency basis, our revenues grew sequentially from the fourth quarter by 2.1%. Our gross margin expanded by 150 basis points sequentially from the fourth quarter to 56.1%.

During the quarter, traffic on our network grew sequentially by 18% from the fourth quarter of 2012. And on a year-over-year basis, our traffic grew 91% from the first quarter of 2012.

Our sales rep productivity increased by over 10% from the fourth quarter, which was also a very productive quarter, to 5.8 units of installed business per rep per month. This is the highest level of organic sales rep productivity since the second quarter of 2007.

Since the end of the fourth quarter, we also extended our footprint by adding another 23 buildings to our network. For the last 12 months, we added 121 buildings to our network footprint.

Throughout this discussion, we will highlight several operational statistics that we believe demonstrate our increasing market share, expanding scale, size of our network and the leverage of our business model.

We are the lowest cost, most efficient operator in our sector. We're focused on the most traffic-rich locations, which we bring on-net, and we sell the highest quality Internet services to our customers at the lowest price in the market.

I will review in greater detail certain operational trends and highlights. Tad will provide some additional details on our financial performance. Following our prepared remarks, we'll open the floor for questions and answers.

Now I'd like Tad to read the Safe Harbor Language.

Thaddeus G. Weed

Thank you, Dave, and good morning, everyone. This first quarter 2013 earnings report and this earnings conference call discuss Cogent's business outlook and contain forward-looking statements within the meaning of section 27A and 21E of the Securities Act.

These forward-looking statements are based upon our current intent, belief and expectations. These forward-looking statements and all other statements that may be made on this call that are not historical facts are subject to a number of risks and uncertainties, and actual results may differ materially. Please refer to our SEC filings for more information on the factors that could cause actual results to differ.

You should also be aware that Cogent's expectations do not reflect the potential impact of mergers, acquisitions, other business combinations or financing transactions that may be completed after today. Cogent undertakes no obligation to release publicly any revision to any forward-looking statement made today or otherwise update or supplement statements made on this call.

Also during this call, if we use any non-GAAP financial measures as defined by the SEC and Reg G, you will find these reconciled to the GAAP measurement in our earnings release and on our website at cogentco.com. Now I'd like to turn the call back over to Dave.

David Schaeffer

Okay. Thanks, Tad. Now for some highlights from the first quarter. Hopefully, you've had a chance to review our earnings press release.

As within previous quarters, our press release includes a number of historical operating metrics. These metrics will be added to our website. We hope that you find the consistent presentation informative and helpful in understanding our financial results and the trends from our operations.

We experienced strong revenue growth for the quarter. Our first quarter of 2013 revenue was $84.6 million, an increase of 2.3% from the fourth quarter of 2012 and an increase of 10% from the first quarter of 2012. We evaluate all of our revenues based on product class, that is on-net, off-net and non-core, which Tad will cover in greater detail.

We also evaluate our revenue by customer type. We classify our customers into 2 major categories, net-centric customers and corporate customers. Our net-centric customers buy large amounts of bandwidth from us in carrier-neutral data centers. Our corporate customers buy bandwidth from us on a fixed connection in a multi-tenanted office building.

Our revenues from our corporate customers grew 1.7% sequentially in the fourth quarter. These customers, corporate customers, represent 49.2% of our total customer connections at the end of our quarter and represent 50.8% of our Q1 2013 revenue. Our corporate customer connections grew sequentially by 2.5%.

Our revenue from our net-centric customers grew sequentially by 3% from the fourth quarter of 2012. Our net-centric customers represent 50.8% of our customer connections at the end of the quarter and represent 49.2% of our Q1 2013 revenues. Our net-centric customer connections grew sequentially by 4.1%.

Now for some comments on pricing within the industry and at Cogent. Our most widely sold corporate customer product continues to be 100 megabit per second non-blocked and non-oversubscribed Internet connection, and our most widely sold net-centric product continues to be a 10 bit -- 10-gigabit connection. We offer discounts related to contract term to all of our corporate and net-centric customers. We also offer volume discounts to our net-centric customers.

During the quarter, certain net-centric customers took advantage of our volume and term discounts and entered into longer-term contracts with Cogent, representing over 1,500 customer connections and increasing their commitment to Cogent by over $7.8 million.

Customers also continue to express their confidence in Cogent by entering into longer-term contracts with us. Our average contract length increased another 0.4% sequentially in the quarter. The average price per megabit in our installed base on our new customer contracts declined sequentially, both in the quarter and year-over-year.

The price per megabit in our installed base declined sequentially 6.1%, from $3.05 in the fourth quarter of 2012 to $2.87, and declined by 24.7% on a year-over-year basis from first quarter of 2012 from a price of $3.81 a megabit. The price per megabit of new contracts signed in the quarter was $1.70 per megabit, a 5.9% decrease from the $1.80 per megabit average price for new contracts sold in the fourth quarter of 2012 and a 28.1% decline from the average new sale in Q1 of 2012 of $2.36 per megabit. Declines in our price per megabit for new contracts on our installed base are partially attributable to the continued promotional activities that we run in the market.

Before Tad provides some additional details on the quarter, I'd like to address our results and expectations against announced revenue and EBITDA targets. Our revenue increased sequentially by 2.3% at a net annualized rate of 10%. This growth rate is within our guidance range of 10% to 20%. Our EBITDA margin was 33.5% in the first quarter of 2013. It expanded by 420 basis points from our EBITDA margin of 29.3% in the first quarter of 2012. We continue to anticipate our full year revenue growth for 2013 over 2012 will be within our 10% to 20% guidance range, and our EBITDA margin expansion for the full year of 2013 versus full year of 2012 will be greater than 200 basis points.

Now I'd like Tad to cover some additional details related to the quarter.

Thaddeus G. Weed

Thank you, Dave, and good morning, everyone. I'd also like to thank and congratulate our entire team on the results and their hard work and efforts for the quarter.

I'll begin by discussing and providing additional details on our revenue by product class. Our on-net revenue was $61.7 million for the quarter, which was an increase of 2.1% from the fourth quarter. Similar to prior quarters, about 85% of our new sales for the quarter were for our on-net services. Our on-net customer connections increased by 3.5% for the quarter, and we ended the quarter with about 30,900 on-net customer connections on our network and our 1,890 on-net buildings.

Our revenue from our off-net business was $22.3 million for the quarter, which was an increase of 3.1% sequentially as we continue to add off-net customers to our network. Off-net customer connections increased by 2.8% for the quarter, and we ended the quarter serving about 4,600 off-net customer connections and approximately 4,000 off-net buildings.

Non-core revenues were about $600,000 and represent less than 1% of our revenues and about 460 customer connections. On average revenue per unit or ARPU, both our on-net and off-net ARPUs slightly declined by about 1% sequentially from the fourth quarter of 2012. Our on-net ARPU, which includes both corporate and net-centric customers combined, was $686 for the quarter and declined to $676 for the first quarter. Our off-net ARPU, which includes predominantly corporate customers, was $1,654 for the fourth quarter and $1,642 for the first quarter.

On customer churn, our on-net and off-net churn rates both significantly improved during the quarter. On-net churn rate decreased to 0.9% for the first quarter, a reduction from the 1.2% we incurred in the fourth quarter. Our off-net churn rate was also 0.9%, and that was a decline from the 1.4% that we incurred in the fourth quarter of 2012. Our gross churn rates include churn from customers who remain with us but enter into amended or move at change Cogent contracts.

Our on-net monthly gross churn rate decreased to 2.5% for the first quarter from 2.6% for the fourth quarter. Our off-net monthly gross churn rate increased to 2.6% for the first quarter from 2.3% from the fourth quarter due to an increase in move at change off-net contracts.

EBITDA and gross margin. Our EBITDA margin for the quarter increased by 420 basis points from the first quarter of 2012 and decreased sequentially by 110 basis points, primarily from the expected impact of seasonal increases in our SG&A costs that we incurred in the first quarter, which I'll provide more details on in a minute.

Our EBITDA margin was 29.3% for the first quarter of 2012, 34.6% for the fourth quarter of 2012 and then 33.5% for the first quarter of 2013. EBITDA as adjusted was $28.3 million for the quarter, essentially flat from the $28.5 million for the fourth quarter, but an increase of 25.4% from EBITDA of $22.6 million for the first quarter of 2012.

Our gross profit margin significantly increased by 150 basis points for the quarter from 54.6% to 56.1%. Our on-net revenues continue to carry a nearly 100% incremental direct gross profit margin, and our off-net revenues continue to carry a 50% incremental direct gross profit margin.

Occasional lumpiness in our EBITDA and gross margins can and does occur, and if you examine our quarterly metrics for the last 32 quarters included in each of our press releases since we became a public company, you'll notice lumpiness in our quarterly margin expansion. And this lumpiness can occur due to seasonal and other nonrecurring factors, including the timing and scope of our expansion activities, which can vary from quarter-to-quarter.

Seasonal factors include SG&A expense increases, such as the resetting of and the increase in payroll taxes in the United States, the cost of our annual sales meeting, annual cost of living increases and the timing of our audit and tax services. All of these components of our SG&A expense increase or occur in our first quarter, as they have in prior years.

As mentioned on our year end earnings call, these SG&A costs were anticipated to increase in the first quarter, and our SG&A costs did increase by $1.8 million sequentially or 10.4% from the fourth quarter. This is essentially as planned. Our SG&A cost run rate, however, is expected to moderate and expected to decline in the second quarter of 2013. Despite quarter-to-quarter lumpiness, our long-term margin trend has demonstrated that our business model generates increasing EBITDA margins.

Interest expense results from interest incurred on our $175 million of senior notes that we issued in January 2011, our $92 million remaining of convertible notes and interest on our capital lease obligations. Our interest expense was $9.3 million for the fourth quarter and $9.9 million for the first quarter.

The components of our $9.9 million of interest expense for the first quarter of 2013 were as follows. $3.8 million was related to our senior notes; $1.8 million was related to our convertible notes; and of that $1.8 million, $1.6 million is noncash amortization of the note discount, which is being amortized through June 2014, which is the put date on those notes; and $4.3 million was related to our capital lease obligations.

In earnings per share, our basic and diluted income per share was $0.01 for the quarter on our basic diluted loss per share was a loss of $0.01 for the fourth quarter. However, increasing our loss per share for the fourth quarter was a nonrecurring income tax expense item of $0.9 million. That represented about $0.02 per share for the fourth quarter. If you exclude that amount from the fourth quarter, it would have been income per share of $0.01, the same as we -- the $0.01 that we incurred for the first quarter of 2013.

Foreign currency impact. Consistent with prior quarters, about 27% of our business is located outside of the United States. About 20% of our revenues are based in Europe and about 7% of our revenues are related to our Canadian, Mexican and Japanese operations. Continued volatility in foreign exchange rates can materially impact our comparable quarterly revenue and financial results.

The foreign exchange impact on our revenue from the fourth quarter of 2012 to the first quarter of 2013 was an increase to revenue of about $0.2 million. Our revenue increased from the fourth quarter by 2.3%, and on a constant-currency basis, that was 2.1%. The foreign exchange impact on our sequential revenues from -- on the -- sorry, from the first quarter of 2012 to the first quarter of 2013 was an increase of about $0.1 million, so a minor amount. Our revenue increased from the first quarter of 2012 to the first quarter of 2013 by 10%. On a constant-currency basis, that was 9.8%.

The average euro to U.S. dollar rate so far in the second quarter of 2013 is about $1.30. That's a 2% decrease from the average rate of $1.32 for the first quarter of 2013. Should the average exchange rates in the second quarter remain at current levels, we estimate that the foreign exchange conversion impact on sequential quarterly revenues from the first quarter of 2013 to the second quarter of 2013 will be a decrease in sequential quarterly revenues of about $0.3 million.

Customer concentration. Our revenue and customer base of approximately 36,000 customer connections is not highly concentrated. For the first quarter of 2013, no customer represented more than 1% of our revenues, and our top 25 customers represented less than 7% of our first quarter 2013 revenues.

Capital expenditures. On a quarterly basis, we can and have historically experienced seasonal variations in our CapEx, prepaid capital lease payments and construction activities. Our quarterly CapEx and prepaid capital lease payments are primarily dependent upon the number of buildings we connect to the network each quarter and the timing and scope of our network expansion activities. Our CapEx increased for the quarter to $16.3 million versus $10.3 million for the fourth quarter of 2012 and $12.3 million for the first quarter of 2012. We added another 23 buildings to our network in the first quarter, and we've added 121 on-net buildings to our network over the last year.

Our capital lease principal payments for long-term dark fiber IRU agreements were $5 million for the first quarter. That compares to $2.4 million for the fourth quarter and $7.1 million for the first quarter of 2012. We expect to continue our network expansion in 2013 but at slightly more moderate pace than we experienced in 2011 and 2012, and we expect continued moderation in 2014.

On some balance sheet items. At the end of the quarter, on March 31, our cash and cash equivalents totaled $235 million. For the quarter, our cash decreased by $12.3 million after dividend and interest payments. Cash flow from operations was $15 million for the quarter, that compared to $32.3 million for the fourth quarter of 2012 and $12.7 million for the first quarter of 2012. Our $15 million of operating cash flow this quarter was offset by $16.3 million of our CapEx, $5 million of our IRU capital lease payments and $5.5 million for our first quarter dividend payment.

Our operating cash flow during the quarter included a $7.3 million semiannual interest payment on our senior notes that was paid in February. We exclude our cash returns to shareholders through our dividend and interest payments, and we also experienced a negative impact of foreign exchange on cash this quarter. We were cash flow positive by $1 million for the first quarter of 2013.

Our operating cash flow will continue to be impacted by our $7.3 million semiannual interest payments on our senior notes, and those interest payments occur in February and August through 2018. Our operating cash flow is also impacted by our $0.5 million semiannual interest payments on our convertible notes, and those interest payments occur in June and December.

We have about $92 million of our original $200 million of face value of our convertible notes remaining. The notes mature in June 2027, but may be redeemed by us or put by the holders beginning in June of next year, so June 2014. The notes are reported on our balance sheet at $84 million, which is net of their unamortized discount. That discount's being amortized through June of 2014.

Our capital lease IRU obligations are for long-term dark fiber leases. We typically have initial terms of 15 to 20 years or longer and often include multiple renewal options after their initial term. These capital lease IRU obligations totaled $149.9 million at the end of the quarter. The increase in our capital lease obligations from year end was primarily due to acceptance of previously committed fiber routes during the quarter.

Our bad debt expense improved for the quarter and was 0.6% of our revenues. That compares to 1.2% for the fourth quarter of 2012 and 2.8% of our revenues for the first quarter of 2012.

Lastly, our days outstanding or days sales -- or worldwide DSO, rather, for worldwide accounts receivable was only 26 days at the end of the quarter. That compares to 25 days outstanding at the end of the year, which was a historical low for the company. And I want to again personally thank and recognize our worldwide billing and collections team members for continuing to do a fantastic job on customer collections, customer service and credit monitoring.

I'll turn the call back over to Dave.

David Schaeffer

Okay. Thanks again, Tad. Now for a few comments on our sales force and sales rep productivity. We began the first quarter of 2013 with 254 sales representatives and ended the quarter with a net increase of 8, with 262 sales reps selling our services. We hired 55 reps in the quarter and 49 -- or 47 reps left the company during the quarter. Our sales force rep turnover was 6% for the first quarter, slightly better than our long-term historical average of about 7%.

We began the first quarter of 2013 with 251 full-time equivalent reps and ended the quarter with 248 full-time equivalents reps. Productivity on a full-time equivalent basis for the first quarter was 5.8 units of installed business per full-time equivalent rep per month. This rate of organic rep productivity was significantly better than our long-term historical average of approximately 4.3 units per rep per month and also a 10% improvement from the high levels that we achieved in the first quarter -- or the fourth quarter of 2012 of 5.2 units per rep. As a reminder, our sales rep productivity rates are not based on contract signings, but rather are based on completed customer installations and the commencement of billing.

Now a little bit to our network scale. Our size and scope of our network continues to grow. We added 23 buildings to our network in the first quarter of 2013 and have over 1,890 buildings on our network. Our network now consists of 26,600 metro fiber miles and 56,600 intercity route miles of fiber.

The Cogent network is the most interconnected network in the world, which connects directly to 4,470 networks. Approximately 40 of these are settlement-free peers. The remaining 4,430 networks that Cogent connects to are Cogent customers. We are currently utilizing approximately 19% of our width capacity. We routinely augment capacity on parts of our network to maintain a low utilization rate.

We currently serve only 12% of our net-centric customers and only 21% of our corporate customers available to be served in our on-net footprint. We have a well-diversified revenue stream with low revenue concentration in our customer base. New customer accounts for more than 1% of our revenues, and our top 25 customers account for less than 7% of our revenues.

We believe our network has substantial available capacity to accommodate our future growth objectives. We believe that Cogent is a low-cost provider of Internet access and transit services. Our value proposition remains unmatched in the industry. Our pricing strategy has continued to attract many new customers, resulting in increased sales force productivity, average longer contract length, a reduction in churn and an increase in volume and revenue commitments from our existing customers.

Our business remains completely focused on the Internet and provides a necessary utility to our customers. We expect our annualized revenue growth rate and our EBITDA margin expansion to be consistent with our historical annualized growth rates of 10% to 20% on revenue and greater than 200 basis points of EBITDA margin expansion on a year-over-year basis.

For 31 out of 32 quarters as a public company, we have produced organic sequential growth, and we are encouraged by the cash flow performance of our business. We will be opportunistic in the timing and purchase of our common stocks. As of the end of Q1 2013, we have purchased 307,000 shares of common stock for $4.2 million under our current outstanding authorization. We have $45.8 million available under this authorization program, and the board extended this buyback program through February 2014.

Our board also is in the process of evaluating greater returns of capital to our shareholders. I'd like to personally thank the shareholders who did attend our annual meeting and express their views to the board.

We continue to be encouraged by the growth in traffic on our network, the results of our sales initiatives and targeted promotional programs and the sales force productivity and order backlog that we are experiencing. We're -- are confident in our network range, our product set, our addressable market and our operating leverage. In short, we like the business we have.

We feel that we have an ample underserved addressable market in our on-net footprint to enable us to continue to grow revenues at our historical growth rates. We are committed to providing annualized top line revenue growth of 10% to 20%, expanding EBITDA margins and generating increasing amounts of free cash flow for our equity holders.

On April 18, 2013, our Board of Directors approved the payment of an additional 8.3% increase on our quarterly dividend to $0.13 per share to be paid on June 18, 2013, demonstrating the optimism regarding our increased cash flow generation capabilities and our continued commitment to returning capital to shareholders on a regular basis.

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

Question-and-Answer Session

Operator

[Operator Instructions] We'll take your first question from Frank Louthan from Raymond James.

Frank G. Louthan - Raymond James & Associates, Inc., Research Division

I apologize if I missed this, but can you give us an idea of what percentage of the buildings that you added were data centers? And going forward, what is -- any clarity on the guidance for CapEx and the split between the capital leases in CapEx for the year?

David Schaeffer

Yes. Sure, Frank. Thanks for the questions. First of all, in terms of new additional buildings added to the network in the quarter, we added both corporate multi-tenant office buildings and data centers to the footprint. Going forward, we expect that mix to become more heavily focused on data centers. The split this quarter was about 50-50, so about half of the buildings added were multi-tenant, about half were data centers. With regard to capital leases and CapEx, we anticipate the combined capital lease and CapEx numbers to continue to trend down, both for the remainder of 2013 as well as into 2014 and 2015. As Tad mentioned, our capital lease expenditures did increase slightly in this quarter due to the fact that we took some acceptance of fiber that we had previously committed to and finally completed the testing of some new metro fiber. But we're near the end of those commitment acceptances, and you should expect to see the aggregate numbers continue to trend down.

Frank G. Louthan - Raymond James & Associates, Inc., Research Division

Okay, great. And just a follow-up. Are you seeing any changes in trends for content delivery networks? More -- you're seeing more customers building their own CDNs on top of your network or looking to build them, maybe moving up to larger CDNs? Any changes in trends there?

David Schaeffer

Yes. So as you observed, our net-centric revenues and traffic are coming from both access networks and content providers. We continue to see an increasing trend where companies who have produced large amounts of content end up insourcing or doing it themselves. We've had, obviously, several large video providers who are household names that have continued to build out their own CDN platforms and are using Cogent to provide the bandwidth. Traffic was up on a year-over-year basis by 91%. That's against a market that, at least according to third parties, is growing at about 29% year-over-year, demonstrating our accelerating gain in market share. And that's driven primarily by both companies producing content and by access networks consuming more content. Increasingly, though, I think the growth in the content side of Cogent's business is actually coming from companies doing it themselves, as opposed to some of the third-party CDNs that we also support.

Frank G. Louthan - Raymond James & Associates, Inc., Research Division

And is that 91% -- how much of that was helped by -- is that growth rate off an easier comp because the Megaupload was not in the first quarter of last year, and what would the difference have been?

David Schaeffer

Yes. So we did have 19 days of Megaupload included in the first quarter, so it hit us for about 20% of the quarter. The comp was easier because Mega was gone and, clearly, our other business continues to grow and fill in the capacity. But our customer base is very diverse and, as Tad pointed out, no one customer accounts for more than 1% of our revenue. So we feel that we have a very robust growth funnel in front of us.

Operator

We'll move next to Colby Synesael from Cowen & Company.

Colby Synesael - Cowen and Company, LLC, Research Division

Two questions, if I may. So first, I wanted to get a little bit more understanding, when you mentioned that the board was currently discussing greater returns to shareholders, and whether or not you're implying that, that was simply a higher increase to the dividend. I think you've talked about, at some point in time, to dividend to free cash flow growth, and is that what you're describing? Or are you actually thinking about potentially adding or doing more with the buyback? To that point, I would just point out that your leverage is going to be at less than 1x net debt-to-EBITDA versus -- by the end of this year according to our numbers. Just curious with how you think about leverage on a go-forward basis as it relates to potentially returning funds to investors. And then the second question, I just wanted to be a little bit more pointed on the CapEx. CapEx was $16 million, as you mentioned, this quarter, which was significantly higher than we were anticipating. You did about $44 million in CapEx last year. I think you had messaged that CapEx would be down on an absolute basis in 2013 versus '12, and we, actually, were seeing somewhere around $42 million. Just curious if that's what you're still expecting when you talk about CapEx coming down for the remainder of the year, if you can still get to that $42 million for the full year.

David Schaeffer

Sure, Colby. I'm going to take them in reverse order. First of all, we do continue to expect CapEx to come down. As I pointed out, we had some fiber that was previously committed to that was delivered and accepted in the quarter. That resulted in both a higher amount of capital leases and the capital needed to light and activate that fiber. We do expect to see that our capital number for 2013 will be below the $44 million that we did last year and in the range that you described. With regard to the return of capital strategy, the board did get some input from shareholders at our annual meeting, which I thought was very helpful. As we've communicated on previous occasions, we are committed to demonstrating a track record of good stewardship of capital and a systemic and regular return of capital. And I think the pattern that we're demonstrating of growing the dividend is helping to prove and give investors confidence in that. I think as we go forward, and looking at further returns of capital, I think there will most likely be 3 components to that. And the board, I think, will be in a position to formalize that by the end of the year, which, again, is the timeline that we had laid out. That will include a regular and hopefully growing dividend, a commitment to a percentage of free cash flow that will be returned on a regular basis. And that return can either be through buybacks or, if we don't hit the thresholds necessary to return capital through the regular dividend and the buyback, we may, in fact, have some episodic or special dividends to help us catch up. The third point would actually touch on the leverage on the balance sheet, and we are continuing to monitor the credit markets. We do realize that we have substantial borrowing capacity on the balance sheet and are evaluating both in the short term what to do and, more importantly, kind of looking at our total capital structure as we anticipate our converts to be put to us in 2013 in June, trying to make sure that we maximize the returns to equity. And we'll hopefully be in a position to look at the return in 2014, as Tad corrected me, not 2013, for the convert. But we will look to make sure that we are optimizing our balance sheet, and that's probably all I want to say.

Colby Synesael - Cowen and Company, LLC, Research Division

It's understood. To paraphrase some of that, so it sounds like you guys are looking to potentially raise debt in the short term in part to pay the convert when it comes due in -- or when you have the ability to pay it in 2014, and then perhaps even to raise additional debt beyond that to take leverage up to use for potentially a buyback or for some form of dividend?

David Schaeffer

Yes, I think that accurately summarizes where the board's thinking is at this time, but there is no firm commitment to do that as of yet. We are going to continue to monitor the market.

Operator

[Operator Instructions] We'll move next to James Breen from William Blair.

James D. Breen - William Blair & Company L.L.C., Research Division

Dave, can you talk about some of the trends in traffic, maybe U.S. versus some of the international markets, or where are you seeing particular strength? And then just on the -- some of the price declines on the unit pricing side and net-centric stuff this quarter, is there any seasonality to that? It seems as though you've beat a lot of metrics during the quarter, sales force productivity, traffic was up, margins were up and so forth. Revenue growth was probably towards the low end of the guidance range. So maybe could you sort of talk about how that -- the unit pricing may change on a sequential basis?

David Schaeffer

Yes. Thanks for the questions, Jim. Let me touch on the regional growth trends. The predominance of our business is in either North America or Western Europe. We do serve Eastern Europe. We have a number of Asian customers, African, Latin American customers. We see growth patterns similarly around the world. So if we look at traffic growth in North America and in Europe in the quarter and over the year, they were actually very similar. So the current economic turmoil in Europe has not resulted in a reduction in bandwidth demand. Remember, our bandwidth is coming from our net-centric customers. While we ourselves do not have any direct consumer business, virtually all of our net-centric traffic is a derivative of end-user consumer, not business usage. And the primary driver of that growth is video. We see our video customers globally continuing to put more content and make more content available on the Internet. And we do see our access network operators, who are our customers, continuing to consume more. So in many cases, those access network operators that have a global backbone are part of our supporting settlement for e-peers [ph] and therefore, in those cases, we only derive revenue from one side. For the more regional access providers, we have the opportunity to be paid both by the access provider as well as the content producer. There are less global access -- global network operators that also operate incumbent backbones in Europe than there are here in North America. So we tend to do, I think, a little better on getting both sides in Europe versus North America. With regard to the pricing declines, I'm going to touch on 2 parts of our business. On the corporate business, as Tad indicated, pricing was relatively flat, declining less than 1% sequentially, and we continue to see our corporate customers taking advantage of longer-term contracts. That 0.4% increase in average contract length was the primary driver of that decline in price for a corporate connection. The net-centric business is a different business. It's a business where volume growth is generated in part by price declines. We continue to be committed to being the most aggressive provider in the market. We do have a number of targeted promotional programs, which we've talked about in the past on these calls, with price points as low as $0.50 a megabit. Our average new sale in the quarter was $1.70. That was down from $1.80. That was in part because we had a greater uptick in these promotional programs at the very low price per megabit. We do believe that our rate of price decline is more moderate than the industry average, and our rate of traffic growth is substantially above the industry average. But as we've commented in the past, our growth in net-centric revenues, which sequentially was 3%, on a year-over-year basis closer to almost 12%, was as a result of our gaining market share. We feel that these trends will continue going forward, and both parts of our business, both our corporate and net-centric business, it will grow. And on the net-centric side, our growth will demonstrate that we will be gaining market share. So I hear you on sequentially being at the lower end of our 10% to 20% guidance range, but the reality is our -- was our corporate revenue that grew at only 1.7%, as opposed to the net-centric that brought us to the lower end of the range. But we do feel comfortable, based on the funnel, that both parts of our business will continue to grow at our historic rates.

Operator

Barry McCarver from Stephens, Inc. has your next question.

Barry McCarver - Stephens Inc., Research Division

I guess, a couple of questions. You've got most of mine, but number one, you've talked the last several quarters about your promotional programs. I'm wondering if we can get a little more color on how those performed during 1Q? And then on your net-centric business, we've seen over the past couple of years you've made pretty significant headway with some of the largest providers of content in that business. I'm wondering if there are opportunities during the year that you can point to that we might see another new large customer come online that you've been working on, if there's anything there that you're capable of sharing?

David Schaeffer

Thanks for the questions, Barry. So first of all, as we pointed out probably 5 quarters ago as we launched these targeted promotions, this was a long-term program, not a short-term promotion. And in the most recent quarter, we gained, again, over 100 new AS numbers as a result of these promotional programs. So these are brand-new customers to Cogent that had previously been using some other upstream provider. We still have between 700 and 800 very clear targeted promotional accounts that we are working that we have not yet been able to win over. So we think, again, that we will be persistent and not give up until we, at least, try to win every one of these accounts. With regard to large accounts, we generally try not to name specific customers. While it is true that Cogent has a number of large household customers, both as access network operators and content companies, there are also some very well-known names that, for whatever reason, have historically and continue not to use Cogent. The only way that we think we can ultimately win this business is by consistently staying in front of these customers, showing them our value proposition and using many of our existing reference customers to help convince them. We feel very comfortable that over the remainder of the year, we should win several more household names. I'd probably be a bit uncomfortable in disclosing any of those, and I surely don't want to jinx the sales force.

Operator

Michael Rollins from Citi Investment Research.

Michael Rollins - Citigroup Inc, Research Division

Two questions, Dave. First, can you just clarify, I think you may have said that capital lease inception was $5.5 million? Is that the right number?

David Schaeffer

Sorry, capital lease what?

Thaddeus G. Weed

Inception.

Michael Rollins - Citigroup Inc, Research Division

Inception.

David Schaeffer

The capital lease payments, principal payments on capital lease was $5 million.

Thaddeus G. Weed

For the quarter, it was $5 million. [indiscernible]

Michael Rollins - Citigroup Inc, Research Division

And what was the inception number?

Thaddeus G. Weed

I didn't hear the question.

David Schaeffer

How much was the capital lease inception?

Thaddeus G. Weed

Assumed for the quarter?

David Schaeffer

Yes.

Thaddeus G. Weed

That will be, on the 10-Q, it was about $18 million for the quarter.

David Schaeffer

Right, and that was primarily due to the acceptance of that large amount of previously committed fiber that I had mentioned earlier.

Michael Rollins - Citigroup Inc, Research Division

And Dave, can you talk a little bit more about the promotions that you've been using to get customers, where you've been discounting pricing or giving some free periods? Is there a way to think about what the total amount of that revenue backlog could be and when that revenue might get delivered into the financials?

David Schaeffer

Sure. So ultimately, the goal of any sales effort is to grow top line revenue. What we typically do is offer our promotions for a limited number of ports. So what we're trying to do is build credibility with the customer. The most current promotion that we have is a customer can take a 10-gig port, but they can only take one port. If they want more, they will have to commit to a fixed commit. And on that port, it is totally burstable, meaning there is no fixed commitment and we get paid only on the traffic that is used at $0.50 a megabit. Now, that is targeted towards these accounts that are not today Cogent customers. What we're then trying to do is use the credibility that we earn with that customer to then get them to shift a greater share of their traffic to Cogent and, as they do, commit a fixed commit on the additional ports that they have taken. I think the last quarter, i.e. Q4 over -- Q1 over Q4, we, in our net-centric business, which is where these promotional activities occurred, grew sequentially 3%. That would be at about a 12.5% annual rate. We think -- we hope that we can see some acceleration from that throughout the year, but it literally comes customer by customer as they get comfortable with the quality of our service, but we've seen that our churn rate is dropping. And I think that's a good indication of our net-centric customers getting more comfortable with our quality. I'm not prepared to give specific quarterly guidance, but I can say that we feel very comfortable with our long-term guidance ranges.

Operator

Donna Jaegers from D.A. Davidson.

Donna Jaegers - D.A. Davidson & Co., Research Division

Just a quick question on M&A. Obviously, you raised debt a few years ago to try to look at -- to be opportunistic on assets. Are you still looking for other reasonably priced assets?

David Schaeffer

The answer is yes, Donna. We have looked consistently, actually since 2005, at M&A opportunities. We maybe have a different threshold than others in the industry have, in that we measure our opportunities by the cash flow that they can produce, not the EBITDA. And we are obviously sitting on a lot of capital, $235 million at the end of the quarter, as we had talked about in answering Colby's question, are considering possibly raising additional capital at some point, and we feel, based on the credit markets that is available to us, if and when we want it. But we are absolutely committed to being disciplined about deploying that capital, and we have not seen any opportunities recently that reflect cash flow returns that are greater than our debt cost of capital.

Donna Jaegers - D.A. Davidson & Co., Research Division

Okay. And then just one other question. Obviously, you're really trying to pick up share of the net-centric. In the corporate, are you guys doing anything new as far as promotion in the buildings that you're connected to because you didn't call out your penetration rate, but I mean, it was, what, 11 customers per 50 in the building?

David Schaeffer

It's actually went up sequentially in the quarter from 10.5 to 10.7 customers per building, and we added, I think, 10 buildings in the quarter with 0 customers, roughly half of the 21 buildings that we delivered. So we continue to see increased penetration rates in our corporate buildings, where we're adding about 1.8 additional customer connections per building per year. Today, we are at 10.7 out of 51. The promotions that we use have not really changed. So on the corporate side of our business, we have always run promotions that generally average about a 7% or 8% discount off of list price. Those promotions are either in the form of lower pricing for an initial period, perhaps a contract buyout or waiving some install costs. Nothing has really changed there, and we feel that we still have a huge addressable market in front of us on the corporate side. And our corporate customers continue to consume more bandwidth, with our average corporate customer using today over 11 megs, the highest in the company's history for the average of its corporate customers. It makes it very difficult for those customers to go backwards to some of the inferior products in the market. And what we need to do is just go to those other 40 or so potential customers' buildings and show them that not only can they save money with Cogent, their businesses could be more productive because of the amount of bandwidth that they will consume over our connection versus what they can't consume because of capacity constraints on our competitors' connections.

Operator

And at this time, we have no further questions in the queue. I'd like to turn the conference back over to our speakers for any closing remarks.

David Schaeffer

Well, we want to just thank everyone joining us a half hour earlier than we normally do, but we have a pretty robust conference schedule. So again, thanks, everyone. Take care, and we'll talk on the next call. Thanks.

Operator

And that does concludes today's teleconference. We thank you all for your participation.

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Cogent Communications (CCOI): Q1 EPS of $0.01 misses by $0.01. Revenue of $84.6M (+10% Y/Y) misses by $0.93M. (PR)