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Cogent Communications Group Inc. (NASDAQ:CCOI)

Q3 2007 Earnings Call

November 7, 2007 8:30 am ET


Dave Schaeffer - Chairman and CEO

Tad Weed - CFO


Tom Watts - Cowen and Company

Jonathan Schildkraut - Jeffries & Co

Jonathan Atkin - RBC Capital Markets

James Breen - Thomas Weisel

Tim Horan - CIBC World Markets

Tom Seitz - Lehman Brothers

Jurgan Usman - Wachovia Securities

Scott Goldman - Bear Stearns

Andrew Bill - RSA Research

Andrew Tuttle - Crowe Point Partners


Good morning and welcome to the Cogent Communications Group's Third Quarter 2007 Earnings Call. As a reminder today's conference is being recorded, and we'll be available for replay at

I would now like to turn the call over to Mr. Dave Schaeffer, Chair and Chief Executive Officer of Cogent Communications. Please go ahead, sir.

Dave Schaeffer

Thank you, Melissa. Thank you and good morning. Welcome to our third quarter 2007 earnings call. I am Dave Schaeffer, Cogent's Chief Executive Officer. With me on today's call is Tad Weed, our Chief Financial Officer.

We are very pleased with the results from this quarter. Our third quarter revenue, EBITDA, and loss per share were either with in the range or better than the ranges that we had presented to you in our Q2 2007 earnings call, when we were giving our forward estimates. We expect our 2007 revenue, EBITDA, and loss per share they either be better or within the ranges for fiscal year 2007 as we originally presented them to you back on our Q3 2006 earnings call.

Since our last earnings call we have returned $4.5 million to shareholders as part of our second $50 million share buyback program, which was announced in August of this year. Under this program we repurchased the 194,000 shares with an average price per share of $22.85. I should point out that this is the $50 million buyback program that was put in place by our Board in addition to the initial $50 million buyback that was completed as part of and in conjunction with our 2007 $200 million convertible debt transaction.

During the quarter, we continued to increase our footprint. We added another 30 buildings to our network and expanded the network into three additional countries. During the quarter, we also significantly increased our sales resources and we added 23 net representatives to our sales team. As a result, we have 179 quota-bearing reps selling Cogent services in North America and in Eastern and Western Europe as of today.

We also achieved another significant corporate milestone in the third quarter by adding our 10,000th on-net customer connection to our network.

Finally, we again exceeded our provisioning guarantees and our service level guarantees by delivering our services to customers with an average on-net provisioning cycle of only 12 business days.

Again, I'd personally like to thank entire Cogent team, and particularly the sales force, for their efforts in helping us achieve these results. Involved in our provisioning and network expansion efforts many of our team members also deserve a great pat on the back.

Throughout this discussion, as in the past, we will continue to focus on results and impacts of our on-net business, which is in fact Cogent's growth business. We will also highlight several other operational statistics, we believe, which will demonstrate our increasing market share, expanding sales and the operating leverage of our business.

I will review certain operational highlights and also outline expansion plans and growth opportunities. Tad will provide additional details on our financial performance. Tad will also walk us through our expectations for fourth quarter 2007, updated and reaffirmed expectations for full year 2007 and provide our initial guidance for fiscal year 2008.

Not to steal Tad's thunder, but as Tad will present, we expect to achieve another significant corporate milestone in 2008. We anticipate having net income by the end of 2008, but this will not be taxable due to our significant NOLs.

Following our remarks, we will open it up for questions and answers. Now, I would like to turn it over to Tad to read our Safe Harbor language.

Tad Weed

Thank you, Dave, and good morning everyone. This third quarter 2007 earnings report and this earnings conference call discuss Cogent's business outlook and contain forward-looking statements within the meaning of Section 27-A and Section 21-E of the Securities Act. Forward-looking statements are based upon our current intent, belief and expectations. These forward-looking statements and all other statements that maybe made on this call that are not historical fact 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 SEC and Regulation G, you'll find these reconciled to the GAAP measurement in our earnings release and on our website at

I would like to turn the call back over to Dave.

Dave Schaeffer

Hey thanks, Tad. Hopefully, you've had a chance to review our earnings press release. As within previous quarters, this press release includes a number of historical quarterly metrics. These metrics are also added to our website. Hopefully you'll find these metrics helpful and informative in understanding our financial results and trends within our operations. As always, if you have any suggestions on how we can either refine or add to these metrics, please let us know.

Our third quarter 2007 revenue of $47 million was at the midpoint of our guidance of between $46.5 million and $47.5 million. EBITDA as adjusted of $11.7 million was also within the range of our guidance, which has been between $11.5 million and $12.5 million.

Our loss per share at $0.12 was better than our range of guidance of $0.18 to $0.23 per share. We continue to be pleased with the growth trends in our On-Net business.

We are continuing to increase our investments in our sales, marketing, and network activities to increase the number on-net customer connections, and ultimately the on-net revenues from those connections.

Our on-net revenues grew at 6.7% sequentially quarter-over-quarter from Q2 2007 to Q3 2007. This growth rate was greater than the increase of 6.5% we experienced from Q1 2007 to Q2 2007, but were slightly below our on-net target growth rate of 7% to 9%.

Net additions of customer connections increased 7.4% sequentially quarter-over-quarter from Q2 2007 to Q3 2007. Our on-net revenue per subscriber or ARPU decelerated its rate of reductions to 3.5% from Q2, 2007 to Q3 2007 from the historically decline rate of 5.1% in Q1 2007 to Q2 2007.

During the quarter, we saw larger accounts leading to a deceleration in the rate of ARPU decline. During the quarter, we again extended our average contract length. I think this represents a significant vote of confidence encouraged by its customers.

Our average contracts length increased in the quarter by approximately 5%, and as these customers take longer term contract, we are insuring a more stable and long-term revenue growth trend.

Overall revenues for the quarter grew to $47 million. This represents a 4.1% sequential quarter-over-quarter increase from the $45.1 million of revenue in Q2, and a 23.8% year-over-year increase from Q3 2006 when revenues were $38 million.

Traffic on our network grew approximately 2% sequentially quarter-over-quarter, and approximately 66% year-over-year Q3 2006 to Q3 2007. Our on-net revenue and customer connections continue to increase. On-net revenues increased by $2.4 million sequentially quarter-over-quarter or 6.7%. On-net revenues increased by $10.2 million year-over-year or 37.1% on an annual basis Q3, 2006 to Q3, 2007.

On-net revenue continues to increased as a percentage of our revenues, growing from 78.2% of service revenues in Q2 to over 80% of our Q3 revenues. Over 90% of our new sales in Q3 were on-net services. This is a greater percentage of sales than we have historically been experiencing as a percentage of our on-net revenue growth, again demonstrating the acceleration and growth in that business.

Our on-net customer connections increased by 7.4% for the quarter from a little over 9700 customers to over 10,500 on-net customer connections by the end of Q3, 2007.

Revenues from our Off-Net business declined at approximately 2.3% for the quarter, and non-core revenues, these are revenues for services which we no longer sell declined sequentially at approximately 16.5%.

Pricing trends in the industry remain intact. Cogent's pricing policy remains unchanged, and we are committed to being the industry price leader. Our pricing of our most widely sold product that is a $1,000 a month, 100 megabit connection on a month-to-month contract or $10 per megabit remains unchanged since the company's inception. We do continue to offer discounts for longer-term contracts, as we've mentioned on previous calls, and we have had an increase in the number of customers availing themselves of these contract discounts and saw our average contract term extend as I had mentioned earlier by approximately 5% within the quarter.

We also guarantee customers that any on-net service will be provisioned in 17 business days or less. In 2007, we delivered on this guarantee with an average on-net provisioning cycle of less than 12 days. On-net ARPU was approximately $1,238 in Q3, 2007 as apposed to $1,283 in Q2, a decline of approximately 3.5%. This decline was lower than the rate of decline that we experienced on a sequential basis in Q1, when that decline was about 5.1%.

Off-net ARPU actually increased from $807 in Q2 to approximately $841 in Q3, and this was a result of selling larger off-net connections and increase in both Q3 connections, as well as off-net Ethernet services, where we purchase the local loop from generally an incumbent telephone operator.

EBITDA was approximately $11.7 million for Q3 2007. This represents an approximately 6.3% increase from the $11.1 million that we experienced in Q2 of '07. Our EBITDA and EBITDA margins continue to expand and increase due to the gross margin expansion of our business. Our EBITDA margins expanded 50 basis points from 24.5% in Q2 to 25% in Q3.

Our gross margins decreased marginally from 52.5% in Q2 to 51.6% in Q3. Gross margin decline was primarily due to the increased fixed costs of operating our networks and the additional costs that were assumed by acquiring six data centers at the end of last quarter. As we had mentioned, these data centers were predominantly empty and we picked up the cost of these centers as we begin to populate them with our customers.

Our direct incremental on-net gross margin continues to be nearly 100% and our direct incremental on-net EBITDA margin remains at about 95%.

We continue to expand our network. We expect to meet or exceed our goal of adding 100 buildings to our network in 2007. In the third quarter, we added 30 buildings to the network and have added 82 buildings to the network year-to-date in the nine months ending September 30,'07. We expect to add additional buildings and meet or exceed that goal.

During the third quarter, we also fully integrated the six new data centers that we acquired at the end of the pervious quarter and confirm those data centers to Cogent's standard configurations and operating procedures.

Since the last call, we've also extended our network by securing additional fiber in new markets and countries. We continue heading in Europe further east, extending our network significantly into Bucharest, Romania, into Helsinki in the North, Manchester in Britain and more on Glasgow in Scotland, and here domestically adding new cities to the network such as Stanford, Connecticut and Providence, Rhode Island.

We continue to evaluate additional expansion opportunities being very judicious about deploying that capital and focusing only on the highest traffic growth locations. Tad, would like to now cover some additional details on our Q3 operating results. Tad will also provide additional expectations for Q4 of 2007, reaffirming and tightening our full year expectations, and also providing our additional guidance for calendar and fiscal year 2008.

I'd now like to turn it over to Tad.

Tad Weed

Thanks Dave, and again good morning to everyone. And I would like to also firstly thank and congratulate our team on there very hard work and performance this quarter.

On loss per share, our loss per basic and diluted common share, as Dave mentioned, was $0.12 for the third quarter. We did have from non-recurring, below the line, non-operating gains, primarily related to a $2.1 million lease settlement that was acquired in our Verio acquisition back in 2004. And these gains reduced out net loss by $2.6 million in total during the quarter, and as a result reduced the loss per share by about $0.05.

So without these gains our basic and diluted common share loss for the quarter would have been $0.17. That recurring loss of $0.17 was a penny better than our range of guidance issued to you of $0.18 to $0.23 per share. Non-cash equity based comp expense, including the impact of 123-R, increased our Q3, 2007 loss by about $3.1 million or about $0.07 per share.

Regarding foreign currency the Euro to dollar conversion rate positively impacted our Q2 to Q3 comparable revenues by about 200,000. The average Euro rate for Q2 was a $1.35 and a $1.37 for Q3. And I'm sure as many of you know that Euro rate has significantly increased during this quarter.

As a reminder, about 22% of our revenues are based in Europe and about 8% of our revenue are in Canada. On capital expenditures, as we may have mentioned on prior calls, we're accelerating our rate of adding buildings to our network which is impacting CapEx. CapEx was $9 million for the third quarter slightly less than a $9.5 million for the second quarter. We added the same number of buildings during Q2 and Q3, that being 30 per quarter.

We’ve added a total of 82 buildings for the network in the nine months ended September 30, so well on our way to our goal of 100. On our balance sheet, as of December 30, our cash and cash equivalents totaled $180.2 million that is all invested in money market funds.

Our second $50 million approved stock buyback, the Broad approved in August 2007. As Dave mentioned we purchased 194,000 shares for $4.4 million, so an average price of 22.85 per share.

Capital lease, IRU obligations were $90.9 million at December 30; and $7.3 million of that amount is a current liability, and these lease obligations are being paid over our remaining weighted average life of approximately 12 years.

Day sales outstanding on account receivable was 40 days till September 30, which is our bogey rate. This compared to 32 days at June 30, which was well ahead of our bogey rate. We were impacted by the calendar, where the last two days of the month fell on a weekend, so some September cash fell in to October and we are well back into below 40 today.

Operating cash flow increased by $1 million from the prior quarter, primarily from the increase in EBITDA, positive cash flow from operations with $11.3 million for the third quarter compared to $10.3 million for the second quarter.

I'm now going to provide guidance for three periods for the fourth quarter, update 2007 based upon that fourth quarter guidance, and provide initial guidance for 2008, and these based upon the current and expected run rates of our business, planned increase in sales and marketing programs, in anticipated network expansion projects.

The guidance covers each line item on our P&L down to the net loss level, so hopefully you'll find this very helpful in modeling. Updates to our 2007 guidance are mostly narrowing our previous ranges and our projected 2007 revenue EBITDA and loss per share are all expected to be within better than our standing 2007 guidance.

Here we go on the fourth quarter. We expect the fourth quarter total revenue to be between $49 million and $50 million. The components of that revenue, we expect on-net revenue to increase quarter-over-quarter by 7% to 8%. We expect off-net revenue to be flat or to increase approximately 5%, so off-net would be flat to an increase approximately 5%, and non-core revenues to decline quarter-over-quarter by approximately 15% to 20%.

We expect our gross margin percentage to increase and to expand by approximately 200 basis points to about 54% for the quarter. We expect EBITDA as adjusted to grow to between $13 million and $14 million. That will put our EBITDA margin standing by another 200 basis points to about 27%.

We expect SG&A excluding the non-cash equity-based comp expense, that’s classified as SG&A in the 10-Q format to be 28% to 29% of our fourth quarter revenues. We expect that non-cash equity based comp expenses in total to be between $3.5 million and $4 million for the quarter.

We expect depreciation and amortization to be between $17.5 million and $18.5 million, and we expect net interest expense, so interest expense net of interest income to be between $1 million and $1.5 million of an expense.

These results are expected to result in a loss per share of between $0.17 and $0.22 from the quarter. Net loss per share assumes $47 million weighted average outstanding.

As a reminder, if we purchased additional shares that will lower the share outstanding and helps the impact of raising our loss per share.

The 2007 guidance that I am refining and updating is as follows. Our total revenue now is expectant to be between $184.5 million and $185.5 million for the year and that will result in the following growth rates for the components of revenue. On-net revenue to grow between 38% and 40% and I think our guidance there was 35% to 40%, off-net revenues to decline by between 5% and 10%, non-core revenues to decline by between 25% and 30%.

We expect our full year 2007 gross margin to be approximately 52.5%. We expect EBITDA for 2007 to be between $46 million and $47 million and we expect SG&A to be between 28% and 29% of our revenues, again, excluding comp expense, classified that way in the 10-Q, and non-cash equity-based comp expense to be between $10.5 million and $11.5 million for the year. Depreciation and amortization to be between $66.5 million to $67.5 million and net interest expense to being expensed of approximately $4 million to $5 million.

These results are expected to result in a loss per share for the year between $0.65 and $0.75 Net loss per share assumes a weighted average share outstanding of 47.7 million, again, if we buy the additional shares between now and the end of the year that will reduce the shares and could increase for loss per share. And total CapEx is still expected to be under $30 million for 2007.

Now, our initial guidance for 2008. Total revenues expected to be between $225 million and $235 million. If you take the midpoint of '07 and '08 this is an increase of about 25% from '07 to '08 in total revenue. And the following growth rates for the components of revenue, on-net revenue to grow between 30% and 33%, off-net revenue be flat to an increase of 5%, and non-core revenues to decline by between 35% and 40%.

We expect our 2008 gross margin to increase to approximately 60% for the full year. We expect EBITDA, as adjusted, to grow to between $75 million and $80 million, at the midpoints of the ranges, this is an approximately 67% increase in EBITDA from '07 to '08.

We anticipate our 2008 EBITDA margin to expand to approximately 34% for the year. We expect SG&A to be between 26% and 27% of total revenues for the year, again, excluding equity-based comp. And we expect that equity-based comp to be between $14.5 million and $15.5 million.

We expect deprecation and amortization to be between $62 million and $63, and we expect net interest expense to be approximately $11 million to $12 million. And those of you that have seen our press release, our 2008 interest expense guidance includes about $9 million of additional non-cash interest expense that we expect to have to record under our proposed accounting standard that Cogent and companies with similar convertible notes are expected to have to adopt on January 1, 2008.

And the pronouncement entitled APB 14-a, called Accounting for Convertible Debt Instruments that maybe settled in cash upon conversion and the pronouncement essentially requires that convertible feature of our notes be bifurcated from the notes and separately valued. It looks like that values about $80 million. So, that will result in an increase in the debt discount and a corresponding increase to the additional paid-in capital, so a balance sheet entry, if you will. Due to that increase in the debt discount, which needs to be amortized, there'll be additional non-cash interest expense from amortizing that through June of 2014, which is the earliest put date. There is obviously no change here in cash flow, so the pronouncement is currently proposed.

We will also require that we, and although is impacted by this, restate that 2007 results as well and show additional interest expense from the amortization of the discount. That amount for us is about $5 million, and the notes, as a remainder, were issued in June, 2007. So, that's the additional interest expense from June, '07 through the end of the year.

We are including this, because and consulting with our auditors. The approval of this pronouncement appears imminent. So, we thought it was appropriate to include this in our 2008 guidance. I apologize for that long explanation, but that's a very material item that should be approved.

We expect our 2008 loss per share to be between $0.15 and $0.30 per share. As Dave mentioned, we anticipate achieving another corporate milestone in 2008. We expect to have positive net income by the fourth quarter of 2008. We do have significant NOLs that will offset this book net income.

Our EPS estimate assumes 47 million weighted average shares outstanding for the year and any buybacks would reduce those shares. And we expect our 2008 CapEx to be similar to our 2007 range and adding another 100 buildings and there would be approximately $30 million.

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

Dave Schaeffer

Hey, thanks Tad. As we mentioned earlier, we expect to continue to expand our footprint. We did add 30 buildings to our network in the most recent quarter, as well as the intercity route extensions that we discussed.

We've added 82 buildings during the first nine months of 2007 and are on pace to exceed our goal of adding a 100 buildings in 2007, and we anticipate adding another 100 buildings to our network in 2008. As of September 30, 2007, we had 1,189 buildings directly connected to the network, representing over 520 million square feet of rentable office space, out of an addressable inventory in North America of about 6.2 billion square feet. We also have approximately 25 buildings that are under construction and in the process of being connected to our network as we speak.

In terms of our sales force, as of today, we have 179 quota-bearing reps selling our services in North America and Europe. These 179 reps equate to 152 full-time equivalents based under our ramping protocol. And just to remind people on this call, basically when a rep is hired, in the first month they have no quota, one-thirds, two-thirds and then full quota responsibility of a sequentially monthly basis.

We began Q3, 2007 with a 143 representatives and ended the quarter with a 166. For a record, net quarter adds of 23 sales reps. We began Q3, 2007 with a 122 full-time equivalents and ended the quarter with a 134 full-time equivalent reps, representing an increase of 12 full-time equivalents over the quarter.

Our sales reps continue to maintain their productivity. While productivity per FTs for the quarter was below our target of [four], we also has been focusing our reps on some larger and more lucrative opportunities and also building upon all to ensure their continued success. We continue to be very disciplined about monitoring the productivity of our reps and removing those reps who do not meet our productivity requirements.

We continue to be quite comfortable with our 2007 and 2008 revenue plan. Our business remains entirely focused on the Internet and therefore a beneficiary of the huge trends in our economy that are migrating traffic to the Internet from other forms of communication and also proliferating the amount of information that is available. Due to the successful recruiting, we expect now to increase the number of sales reps quarter, quota-bearing reps that we have, by the end of the year to a 190, from our previously announced goal of 180.

We see significant opportunities to add these reps and still have ample addressable market. We also expect to continue to add sales reps in 2008 to address both our existing footprint and our expanding footprint. As announced on the previous call, we expect to increase number of reps by 50 in 2008. As a result, this will take our sales rep count from the previously announced 230 reps at end of '08 to now 240 reps. We continue to be very judicious about hiring only the best candidates who apply for jobs at Cogent, and then can train and sent these people to keep them productive. But to manage out those individuals that don’t' need our strict requirements for productivity.

We continue to expand our footprint, we now have over 10,000 miles of metro fiber, 249 operational rings, and over 100 markets.

We have over 26,000 miles for terrestrial and inner-city fiber. We are today the most inter-connected network in the world, today directly connected to over 2270 other networks.

Over 350 of these networks are settlement-free peering partners, and over 1920 networks that connect to our Cogent customers who pay us for connectivity. We believe our network has substantial capacity to accommodate our future growth plans.

We are currently utilizing a little bit less than 22% of the lit capacity in our network. So, in summary, our on-net revenues or growth business continues to grow as an increasing percentage of our total revenue, and traffic continues to increase on our network.

We are surpassing our provisioning goals of 17 days for on-net services, allowing customers to experience 12 days from order placement to actually receiving Cogent services in any of our on-net footprint.

We are well on track to exceed our footprint expansion plans and our rate of adding buildings to the network. We continue to have a strong balance sheet, with less than $20 million in true net debt. We continue to be focused on statistically expanding our network into the higher traffic locations, both domestically in existing markets and new market, as well as internationally.

We will continue to invest in our sale force, and continue to remain focused in our marketing effort. And then finally, and maybe most importantly of all to our shareholders, under our 2008 plan, we expect to generate and access of $1 per share of free cash flow for the benefit of our equity shareholders. And we will continue to look to return that value to our shareholder.

Now I'd like to open the floor to question.

Question-and-Answer Session


Thank you. (Operator Instructions). Now we'll go first to Tom Watts with Cowen and Company.

Tom Watts - Cowen and Company

Hi, Dave, how are you?

Dave Schaeffer

Hey, good, Tom.

Tom Watts - Cowen and Company

Congratulations on the quarter. A couple of things, one can you just give a little bit more color, you'd hoped for the 7% to 9% on that revenue growth in the quarter, and why didn't we quite get there, even though things are going well.

And then second; so you're having a phenomenal expansion on your sales force, are you seeing different products being sold or how was it changing - changing what's coming in the door, and particularly you mentioned your productivity was lower this quarter. And then, is that going to rebound and how will that change product mix?

Dave Schaeffer

Sure. First of all let's start with the sequential on-net revenue growth. You are correct, while we were hoping for a little better sequential growth we did see acceleration from the previous quarter.

I think probably, the biggest contributor to our revenue growth not hitting our target of 7% to 9% was the fact that sequential traffic growth was only a couple of percent for the quarter. So, we were getting lift of uplift from existing customers buying bigger connections, but we were continuing with a great deal of success signing brand new customers and new logos.

And, I think, this is a result of some of the seasonality associated with internet traffic growth, particularly as it becomes more of a kind of content delivering and entertainment media, there tends to be a little bit more seasonality with slower growth in summer month.

Also, as a backdrop, several of our competitors have recently released results in which they've experienced sequential quarter-over-quarter declined in their internet businesses, where we are experiencing 6.7% sequential growth.

And as Tad indicated in our guidance for next quarter, as we see traffic increase just in the month of October at a sequential rate of about 5% month-over-month, we are quite comfortable with the 7% to 8% on-net revenue growth number that we are forecasting for fourth quarter, and the full year growth number in on-net revenue of 30% to 33% for 2008, also is a direct result of these long-term trends that we are seeing.

To your second point about sale force product mix, we continue to hire a sales force at an unprecedented rate, at least for Cogent, and make sure that we continue to manage out those individuals that are less productive. Our product suite remains very focused, but we felt no other products other that Internet Connectivity and the co-location space associated with that Internet Connectivity.

So we are a direct beneficiary of the growth in Internet Traffic, in the migration of traffic from other types of networks to the Internet. What we do not sell, however, are value-added services in competition with our customers. So the sales force product mix what that they have in their bag remains constant.

What we have instructed sales people to do is spend time building those funnels, getting out there, and talking to enough customers so they can selectively pick under the larger accounts to be working on, and close. That did have some impact on productivity.

We have seen productivity down last quarter in Q2. It was actually the highest in the company since [5.8], but that was coming off a quarter where in Q1 it was 4.5%. So we've used the four units per rep as somewhat indicative of this kind of fluctuation on a quarterly basis. It also is a direct result of these reps continuing the focus on building their funnels.

Tom Watts - Cowen and Company

And perhaps I should have been more accurate. I think last quarter you'd said that a lot of the newer reps were selling smaller contract because those were easier. It sounded like you tried to refocus on this quarter, have you seen progress on that front, and then should we expect that going forward?

Dave Schaeffer

Yeah, we did. We sit down with the sales force on a weekly basis and monitor their productivity. We look at their funnels and also try to give them counsel to make sure that they meet their total requirements and remain employed at Cogent.

And, in doing that, we really emphasize that people needed to work on building bigger funnels and having the luxury of being able to work on bigger accounts.

And we actually saw that in the deceleration of the rate of ARPU decline, coupled with the fact that contract lengths for the quarter across the entire base increased by 5% resulting in lower ARPU because of the discounts.

So, we absolutely are seeing a pickup in larger sales, and we expect to see that even accelerate more in the upcoming quarter particularly as some existing customers will come back and increase their traffic purchases as their traffic requirements increase.

Tom Watts - Cowen and Company

Okay. Thanks very much.

Dave Schaeffer



We'll go next to Jonathan Schildkraut with Jeffries & Co.

Jonathan Schildkraut - Jeffries & Co

Thank you for taking the questions. Just two questions, first if you could tell us what some of the cost associated with the launch in the new data centers, the six new data centers was, just to get a sense of what the incremental margin might have looked like without that? And secondly, what percent of your customer base is now under long-term contract?

Dave Schaeffer

Sure. So, let me start with the data centers. Adding six new data centers to our footprint that were virtually vacant and we did acquisitions at the end of second quarter in late June. So, we've picked up all the expense associated with those centers. The direct cost of carrying those centers was approximately $200,000 a month or about $600,000 for the quarter. We also picked up probably another $300,000 in increased operating cost of the existing centers due to increases in power cost and rental cost within those centers.

We also experienced a slight up tick in capital spending as a result of bringing those centers up to Cogent’s standards. Now, while these were completely build-out centers, they had been virtually vacant at the point of acquisition and did not have, say, the same security and environmental monitoring systems that our other 28 centers have. We did complete the integration and the standardization of those facilities.

But probably most importantly, we are beginning to sell customers into those facilities and beginning to increase the occupancy. The worker cost or entire footprint, we are still running above 40% occupancy within our data centers. And also rack and power as a percentage of revenues did increase for the quarter from about 3.4% of revenues to a total of about 3.8%. So, we are starting to see some of the up tick from the growth that we are getting in the data centers.

Let me let Tad then take the margin question on the contract line.

Tad Weed

So, if you look at 2007 installed orders through the end of the second quarter, the weighted average was about 10.7 months and that increased to about 11.3 months on the third quarter. Another way of looking at that is contracts that are one year or greater, so, we do have some three-year contracts and longer, were about 75% through the second quarter. And then that increased to 80% of contracts in the third quarter. So, again, the trend is more of longer-term contracts.

Jonathan Schildkraut - Jeffries & Co.

Thank you.


We'll go next to Jonathan Atkin with RBC Capital Markets.

Jonathan Atkin - RBC Capital Markets

Yeah. I was wondering if you could refresh us on the mix between corporate and NetCentric revenues or the portion of corporate versus NetCentric among your incremental revenues? And then, the new buildings that you adding, are they predominantly data centers or office buildings?

Dave Schaeffer

Hello, John. First of all in Q2, our mix was roughly 56% NetCentric revenue and 44% corporate. That mix actually changed in the third quarter, where we were about almost 57.6% NetCentric and just about 42.3% corporate in our revenues. Now in terms of new buildings, here in North America, the majority of the buildings we are adding are corporate. In Europe, virtually all of the buildings that we are adding are NetCentric or data centers. That mix remains for incremental buildings at about 75% -- of the incremental buildings are corporate, about 25% of the incremental buildings are data centers with the Europe kind of leading a way there.

Jonathan Atkin - RBC Capital Markets

And then, Tad mentioned 22% Europe, 8% Canada and maybe, if we fast forward one year, is the mix of domestic versus international likely to be similar as we exit next year?

Tad Weed

Yes. We don't anticipate a difference in the mix and the growth rates are relatively similar across the regions. So, don't expect that 22% and 8% to vary significantly.

Jonathan Atkin - RBC Capital Markets

And then, when you connect to a data center, how many other bandwidth providers are also connecting?

Dave Schaeffer

Fairly greatly, but data centers by their nature, have multiple providers. I would say that on the typical data center that we connect to, there are seven or eight other unique networks connected to that facility. Whereas, when we connect to a corporate building, there is generally only one or two other networks typically connected to that corporate build.

Jonathan Atkin - RBC Capital Markets

Thanks very much.


We'll go next to James Breen with Thomas Weisel.

James Breen - Thomas Weisel

Thanks. Given what your guidance is for revenue for next year, can you talk about the trends in the off-net side and the non-core revenue businesses, to give us a better picture of the growth in on-net business? Thanks.

Dave Schaeffer

Yeah. Hey, sure, Jim. It's Dave. As we pointed out, we expect our on-net revenue growth to be between 30% and 33% of revenues or sequentially that business to grow. We also indicated that for the first time, incremental sales are approx 90% being on-net, whereas our kind of historical run rate was only about 80% of new sales being on-net, where 20% were off-net, and that were more like 90/10. We do expect to see a continued deceleration in the rate of decline in the off-net business that will be helped by the availability of higher capacity in the local groups from the incumbent operators and the increased availability of Ethernet services.

I think with these strengths, we expect to see relatively flat. So I think Tad said, flat to down 5% are off-net revenue growth. We do expect to see the non-core continue to dissipate quickly. Remember, included in non-core is our managed modem service business, really the provisioning of wholesale dial-up services to companies like EarthLink and United Online, which are continuing to see continued defections from dial-up to broadband.

And then finally, or the most important part of our business that's being on-net, we will see growth from both new logos buying from Cogent as well as existing customers particularly NetCentric customers taking more capacity. I think all of these factors together give us a great deal of comfort and seeing our total top line revenue growth from about $185 million this year to about $230 million at the mid points of our guidance for next year.

James Breen - Thomas Weisel

Great and just one follow up on traffic. You said that the same store sale sort of over the customer growth slowed a little bit this quarter. Was that broken evenly between the NetCentric versus your corporate customers?

Dave Schaeffer

Actually, the corporate customers continue to grow at a pretty fast pace, but they account for only about 4% of our traffic. 96% of the traffic on Cogent's network comes from that 57% of our revenue that is coming from the NetCentric customers. Those customers typically buy on a per-megabit and their additional spend comes from consuming more megabits. Whereas corporate customers, even though they may grow, don't generate more revenue for Cogent, simply because we sell on increments that are typically larger than they can consume. So, traffic road disproportionally impacts the NetCentric part of our business in terms of revenue growth.

James Breen - Thomas Weisel

Great, thank you.


We will go next to Tim Horan with CIBC World Markets.

Tim Horan - CIBC World Markets

Good morning, guys. Thanks a lot. Good quarter.

Tad Weed

Hey, thanks Tim.

Tim Horan - CIBC World Markets

Dave, the stock looks like it’s weak this morning and when you look at your guidance, it looks like you are looking to more like 8% sequential growth going forward. And that from a surface seems aggressive particularly where the stock is. Why wouldn't you guide them more like 6% to 7% like you are seeing now and when the upside comes, that's fine? And the net gain, can you maybe talk about what you are expecting the ARPUs the next year? You might have touched on it, but how does that kind of revenue break down on the on-net front? And then I just have one follow up. Thanks.

Dave Schaeffer

Yeah. Sure. Let me start with the growth. So, we did see an acceleration in our sequential quarter-over-quarter growth to 6.7%. If you compounded that out, that would put us in the high 20s, probably 28% - 29%.

We do see acceleration in that sequential growth to the kind of 7% to 8% this quarter, and if you look at kind of the long-term trends, we have averaged 9% to 10% sequential on-net revenue growth over the past couple of years.

We continue to believe that the selling environment and our competitive advantage, is as strong now, as it's ever been. So we feel very comfortable that we will eventually return to that 9% to 10% long-term trend.

We did dive to 30% to 33% in a sense conservancy, in the sense of giving us some ramp to do that. You will see some fluctuations quarter-over-quarter particularly as traffic growth fluctuates quarter-over-quarter.

And we continue to increase as a percentage of the worlds' internet traffic. So it will become much more of a proxy for the entire internet, and therefore, our ability to kind of outperform the internet tends to compress.

We do believe, however, that there are a number of significant social and business trends that are going to continue to drive traffic growth at the same historic rate that it has experienced for the past 15 years - 18 years.

And from that, we feel very comfortable with the revenue guidance, and again, we feel that the 7% to 8% that we guided to in Q4 is extremely achievable base, particularly on early results that we've seen from October traffic growth.

Tim Horan - CIBC World Markets

Thanks for that. On a longer term on note, one of your main benefits versus your peers is you've not had to kind of, re-price your base. What we're hearing from data center prices that you can buy service in the $20 megabit range kind of declining 25% a year.

I know in the corporate environment the office building environment that's more like $40 a megabit. But if you extrapolate those trends out at some point in the next three years, you're probably going to have to start re-pricing your base, and that could, at that point, try to impact the revenues. I know it's a ways out, but can you talk about your plans how and what you're going do when that comes to fruition? Thanks

Dave Schaeffer

Sure, Tim. I'll take that and I'll let Tad touch on your ARPU questions which we owe to get an answer on. If you look at our effective price from megabit with today 80% of our contracts being one year or longer in length, our effective price per megabit today is about $9 per megabit based on the pricing discounts that we gave for contract term.

Remember $10 a meg is month-to-month, $9 a megabit is for one year contract, and $8 a megabit is for two year or longer contract. Also are the pricing rent you referred in the 20’s in some data centers, is buy a few more aggressive careers that are probably loosing money and are also only offering those prices to extremely large customers.

We have a very different model in which we offer flat pricing not based on volume commitments but rather on contract term. Because our belief, is that there is a huge advantage to Cogent in having a lot of new business models choose Cogent, where a few of those models will become a very successful and others may not. So we think in the long-term our pricing strategy is the right one.

In terms of eventually re-pricing our base, again, we have a policy that says any customer can present us an invoice from a competitor, and they can either take the standard approach in price, or under cut it by 50%.

Now I will admit we do see a slight increase in that take rate on that program last quarter, and as I mentioned in Q1, I think we had a grand total of one instance, where we had to do that. I think we actually had two instances in this most recent quarter. So it's still relatively insignificant.

But if you really put your crystal ball in front of you and look far and [wide] in to the future, the internet is very deflationary, prices will fall. We are uniquely positioned to be the price leader. Remember, we are utilizing less than 22% of our lit capacity.

And while we do not anticipate any material impact from re-pricing our adjusting base for the foreseeable future, eventually the market average price will get to Cogents' price, but there will be a whole lot less players in the market and that’s probably a good, safe way to test ARPU response

Tad Weed

The overall trend on our ARPU basically, what we experienced this quarter versus last quarter was de-continuing through the fourth quarter and in to '08. So that being an increase in the off-net ARPU and a decline in the on-net ARPU, however the decline expected to occur at a slower rate.

We don't and having in the past given the exact rate, because we can essentially hit the revenue target with a different mix of units, but I do think the overall impacts in the trends will continue with off-net ARPU increasing and on-net decreasing, but at a slower rate.

Tim Horan - CIBC World Markets

Thanks a lot guys.


We'll go next to Tom Seitz with Lehman Brothers.

Tom Seitz - Lehman Brothers

Thanks for taking the question. Couple of, I guess, follow-ups. If you've got 80% of your customers on long-term contracts today, can you tell us what's baked into the guidance from next year for your expectation for the percentage of customers on long-term contracts next year?

And then second question, you've talked about how the European opportunities is mainly a data center NetCentric customer opportunity, which I think implies a higher ARPU customer. And I was wondering if you could tell us of the sales force additions that you are adding, what number or what's the growth like in the European sale force versus the US sales force? Thanks.

Dave Schaeffer

Okay, hey, great Tom. Thanks for the question. First of all, we do anticipate continued lengthening of contracts. We were actually a bit surprised in Q2 at the rate of acceleration and customers taking us up on our discount offer and longer term contracts. We continue to see that trend continuing.

Our modeling methodology as we prepare guidance is that Tad, and his team, basically pick all of the trend lines from key drivers in our business from the previous six months. We look at any out wires that are not particularly within the range, and then we take kind of the average of that range, and project it going forward.

With that, we would expect that the percentage of customers taking advantage of the discount therefore, on longer term contracts than month-to-month will probably, by the end of next year get close to 90% of our base as opposed to the 80% today. So, we'll expect to see that continue.

Now, to your European question, while we would love to have a corporate business in Europe, the building footprint just doesn’t fit our demographic requirements. There are few buildings in Europe of the scale of buildings here in the U.S, and secondly, those very large buildings tend to be more single tenant than multi- tenanted.

So, we do have a few buildings in Europe. We are actually in the process of adding a few building in the Canary Wharf region in London to our network. So there are some corporate opportunities, but it is true that most of the opportunity in Europe is selling to either content companies or in many cases PTGs within Europe, and we continue to do quite well in the market space.

That does generally, mean higher ARPUs, meaning that they generally are paying more than a corporate customer per connection. However, some of these countries have relatively small installed broadband basis. There is an opportunity for significant growth in their broadband penetration rates, whereas in Western Europe and the U.S. that’s much more of a matured market.

So I think, we'll some smaller ARPUs there, and we'll have some acceleration in growth that comes from someone who buys a smaller connection in the market that has only 10% or 15% broadband penetration, maybe growing to the 60% to 70% that we are seeing in the western world. And then the final impact on non-US ARPU is, quite honestly, the FX impact. And as Tad said, we obviously are expecting to see some pick up this quarter at an accelerated rate then we've seen in the past. But, at the end of the day, we are not currency traders, we are running an Internet company and we are trying to best of our ability not to create cross border arbitrage opportunities with our products.

Tom Seitz - Lehman Brothers

Great. Thank you very much.

Dave Schaeffer

Thanks Tom.


We'll go next to Jurgan Usman with Wachovia Securities.

Jurgan Usman - Wachovia Securities

Hi, thank you very much, at the end of the line here, couple of questions. First of all, on the revenue churn. Can you maybe give that out?

Dave Schaeffer

Sure. Essentially, on-net has held steady at 2% for quite some period of time. So, it was 2% for the quarter, basically, identical to what it was for the first half and for the prior two quarters of 2007. We did see that off-net ARPU or churn, rather, did declined. And giving the exact numbers here it was 6% for the second quarter and 3.5% for the third quarter. So, the churn for off-net did decline and for on-net essentially dead-on at 2%.

Jurgan Usman - Wachovia Securities

All right, and then next one, can you give me an update on your largest customer and how they did, I guess, in the quarter regarding bandwidth commitment?

Dave Schaeffer

Sure. Our largest customer represents about 2.7% of revenue. That particular customer did increase their commitments in the quarter, Jurgan, primarily by expanding their footprint into Europe. So, they have taken multiple connections throughout Europe, as well as North America. We did see, quite honestly, their North American traffic growth slow, while still positive, not growing at the same rate, kind of indicating maybe a bit of a maturity in their business model. But, we have a very diverse customer base with a number of different business models and overall we are seeing a good pick up across all of our customers, represented by the fact that our monthly traffic growth in October was about 5% sequentially just month-after-month.

Jurgan Usman - Wachovia Securities

All right, and then next one is on your productivity seems to be fluctuating a lot, more volatile, I guess, in the past couple of quarters or so, which, I guess, is kind of counterintuitive given that you have larger number of sales people. Has there been an increase in terms of sales force churn or is this just because of they are still building their funnels, or what's going on there?

Dave Schaeffer

Sure. Big part of it is funnel building here again. Sale force churn has been relatively constant. What has happened, though, is the average tenure of the sales force continues to decrease. As we indicated, we had record hiring in the most recent quarter. In Q3 we added more reps than we had ever added in a given quarter. So, that kind of brings down the average tenure of those sales reps with less tenured people they tend to have less material funnels and therefore are more subject to these volatilities. And again, we feel very comfortable that the long-term trend remains intact and you are just going to get volatility quarter-over-quarter based on lumpiness of specific customer contracts and timing. But, the long-term trend for these reps to remain productive at about five units per rep, per month.

Jurgan Usman - Wachovia Securities

And then last one, I promise. Are you…

Dave Schaeffer

That's okay.

Jurgan Usman - Wachovia Securities

Yeah. On that revenue growth guidance for 2008, can I imply about 7% sequential growth, obviously lower than your current guidance of 7% to 9%, 7% to 8% in the fourth quarter? Now you did say in the past that, I guess, longer-term you expect on-net to grow 9% to 10% sequentially. I mean, if this something that you probably see somewhere longer in the future, maybe 2009 or so. Or, I was just wondering there seems to be a little bit of disconnect with what you said and what the guidance imply. Thanks.

Dave Schaeffer

Sure, Jurgan. As I said, I think the long-term drivers of our growth remain intact. We do believe that with adequate number of sales people and that's why we would increase the number of sales people that we plan to add, we can continue to achieve that type of growth.

As we look at, coming up with projections for the next quarter and the next year, I am going to again revert to the methodology we used. And what we do is take actual results form the previous six months and straight-line down, because we experience lower growth sequentially in Q2 and Q3.

In our long-term historical run rate we're projecting that out in to Q4 and into next year. But, we do believe that the underlying drivers of growth are as strong as ever and we do believe that we will be able to return to that 7% to 9% or ultimately 9% to 10% growth rate in the long-term, and maybe even in 2008.

We just try to be as conservative as responsible. And hopefully, investors get comfort in the fact that we gave our guidance in November of 2006, and are literally at the midpoints of those guidance numbers a year later in an industry that is growing rapidly. So, I think our methodology of forecasting has hopefully earned us a little bit of creditability.

Jurgan Usman - Wachovia Securities

Alright, finally last on CapEx, 2008 seems to be, I guess, flat versus 2007 about $30 million give or take?

Dave Schaeffer

That’s correct, Jurgan. This year CapEx went up just marginally because of the data centers that we didn't anticipate when we put that guidance out and having to bring them up to standards. We do expect to continue to expand the network and report on a series of new markets and obviously new buildings. We intend to exceed the goals that we have. We absolutely anticipate CapEx to be flat and in that kind of $30 million range or slightly under, next year as well as this year.

Jurgan Usman - Wachovia Securities

All right, thank you very much.

Dave Schaeffer



We'll go next to Scott Goldman with Bear Stearns.

Scott Goldman - Bear Stearns

Hi, good morning guys.

Dave Schaeffer

Hi, Scott.

Scott Goldman - Bear Stearns

Just wanted to go back on the gross margins; I guess, back in the second quarter you added the data centers late in the quarter. You talked about being able to grow gross margin the 100 basis points in the third, obviously that did not materialize and there had been a decline.

So, just wondering what may have changed from those original expectations that resulted in that decline? Is that also what brought incremental margins appear to be below your historic run rate in this quarter as well? It's the same factor that impacted gross margins at work there.

Secondly, you talked about seasonality of traffic, just wondering if you can make any comment as far as what you may have seen kind of late in the quarter, September or what you saw already in October as far as traffic growth.

Dave Schaeffer

Sure. First of all, with regard to the new data centers, they did have a direct cost on network operations, as I reflected earlier, of about $600,000. As we took over centers that were baked in, were virtually baked in. Just a few costs connects them down with virtually no revenue and then had to both bring them up to standards and to begin to populate them.

We did indicate that our gross margins for Q4 should expand 200 basis points. As I have shared with investors over the years, there is typically some volatility in any given quarter due to lumpiness of payments, various service contracts and so for. But, that 100 basis point margin expansion on a sequential basis, both gross and EBITDA trend remains intact.

If you look at our margins for next year, we are actually forecasting better than a 100 basis points sequentially of gross margin and EBITDA margin expansion for the year. So, we are looking at full year 2008 gross margins of about 60%, up from the roughly 54.5% this year and EBITDA margins continuing to expand from the roughly 27.5% that we are going to do this year, up to the roughly 34% that we're forecasting for next year.

We do see continuing operating leverage as the on-net portion of our business continues to increase, as we increase the utilization of our existing footprint more effectively. So, while we did see some gross margins degradation in the quarter as a result of picking up these empty data centers, we see that as a one-time anomaly, not as any kind of long-term trends and feel very comfortable that the guidance we've given.

In terms of seasonality of traffic, as I'd mentioned earlier we saw significant pick up in the month of October where the traffic on a month-over-month basis picked up at about 5%. That we compound to better than the 75% annual rate. We also saw a significant pick up in September over August. Basically, July and August were relatively flat months, as we have seen previous summers.

Although, we think that the proliferation of media migrating to the internet will be the continuing driver of growth, maybe a little bit more pessimistic than others in industry. We don't see an acceleration but we do see kind of a consistent rate of traffic growth.

Tad Weed

[Since the package is out], I will add one thing to the gross margin comment. In our cost of good sold we did have some cost associated with our expansion. And our expansion, frankly, is kind of ahead of our schedule. So, we did incur some cost of good sold expenses kind of ahead of plan, which contributed to the margin decline in Q2 to Q3.

Scott Goldman - Bear Stearns

Okay, great. One follow-up and one other additional question, I guess, as going with standard, Jurgan's number of questions that should be okay. Anyway Tad, you can quantify those costs that you are just referring to and then, just quickly on customer adds, on-net, ramping sales force.

We've talked a bit about the productivity on the call already, churn relatively flat. Is there anything about the sales cycle of trying to sell to the higher bandwidth that would maybe have brought that on-net customer add number below, maybe were I was expecting relative to past quarters?

Tad Weed

On the quantification, I'd put it in the total cost of goods sold, dollar amount in the $700,000 to $800,000 range. As Dave, mentioned the way we build our forecast just looking at the recurrent run rates and anything there that is recurring as opposed to non-recurring is baked into the plan for the fourth quarter and for 2008. On the sales cycle, I would say there is nothing in particular there to point out, at least from my end, but Dave might have something.

Dave Schaeffer

Yeah, I think on the sales cycle, there really is no difference in selling to someone if they are large customer or small customer. They basically are going to buy when they need the service and when they are out of contracts with their existing provider. Where the variation comes from is, really having a bigger funnel.

So, if a ramp has more things that are becoming actionable in a given month, they are able to pick and choose and go after the bigger deals. And we are really trying to train and in essence, the sales force continues to build that funnel. The limiting factor in Cogent’s growth for the foreseeable future is actually, still sales people and not contacting enough of the opportunities on our footprint. But, again, within the footprint, we want to go after the better opportunities first, and that's probably the bigger factor.

Scott Goldman - Bear Stearns

Great. Thanks for taking the time, guys.

Dave Schaeffer



We go next to Andrew Bill with [RDD Research]

Andrew Bill - RSA Research

Hi, it is Andrew Bill from [RSA] Research. Can I just go back to the sales force churn question, first of all, and just ask you how many gross sales force additions did you make to get to your 23 net? Secondly, in terms of the 100 buildings that you are planning to add in '08 is there any measure you could give on the revenue potential per of building of those, rather to your existing buildings. I mean, just presumably, they are getting slightly smaller in terms of average size.

And then thirdly, I don't know is there anyway you can think about breaking down the revenue growth in a slightly different way to talk about, how much of it comes from increasing share within building. How that comes from adding new buildings and how is just from the underlying demand, which I think you probably said was 2% sequentially. But, any thoughts you have on those areas, appreciated. Thanks

Tad Weed

I’ll take the first question. I can kind of give you the role forward, if you will, of sales reps. That we started the third quarter with 143 representative, added 53 and turn 30, so…

Dave Schaeffer

So, in terms of the building demographics, actually, the corporate buildings that we are adding today are actually slightly larger than our existing average. So, that number continues to increase towards nearly at 580,000 square feet up from roughly to 570,000.

We are very judicious about adding those buildings. It's in those buildings we have increased our penetration work. Today, across the entire footprint we have about simply the customers or corporate building out of an addressable market of about 50, which are those buildings.

For those corporate customers is almost a certainty that they are not going to buy a second connection in the same building or increase their connection. Now that portion of our revenue stream is about 23% of revenue. So roughly 43% being corporate, 23% of that 43% is the net corporate customers.

Now for the NetCentric customers, a little bit different demographic; within the data centers we have just under 15 unique customers per center across the entire footprint. That represents about a 7.5% unit penetration, but still about an 18% penetration by bandwidth consumed within those facilities.

In any given month, roughly 70% of our sales come from brand new logos, someone who never bought connection from Cogent before. Roughly 30% sales come from existing customers. So then if you look at the split between NetCentric and corporate, that kind of 70:30 ratio applies almost equally to two basis.

So with 40% of NetCentric incremental revenues coming from existing customers, there is a high correlation between traffic growth and revenue growth for that 30% of the 57%. So hopefully that was enough detail to answer your question.

Andrew Bill - RSA Research

That's great. Thank you.


We'll go next to Andrew Tuttle with [Crowe Point Partners].

Andrew Tuttle - Crowe Point Partners

Can you hear me?

Dave Schaeffer

Yeah, sure.

Andrew Tuttle - Crowe Point Partners

Okay, thanks. Forgive me if you've answered these questions before, but could you give the traffic growth stats sequentially and year-over-year?

Dave Schaeffer

Yes. Year-over-year traffic grew by a little over 66% from Q3, 2006 to Q3, 2007.

Andrew Tuttle - Crowe Point Partners

Okay. I've also noticed that in about the last 18 months or so, the average revenue per on-net connection is probably down 18% or 19%. Is that decline going to abate do you think going forward or where does that go?

Dave Schaeffer

Yeah. I didn't touch on that. We see that ARPU continues to decline at least for the next year, eventually, at some point, it will actually start back up. But the decline is driven by kind of two key factors. The first is on the NetCentric portion of our business which is 57% of revenues. That portion of our business is selling to smaller and smaller customers within those data centers. So their average buy is less not that they are paying less per megabit, but they are just buying less megabit.

On the corporate side, we see ARPUs virtually flat. And then, the second factor is this increasing contract length. So in the quarter we saw the entire base of average contract duration extend about 5%. So we saw it going up probably 10.7 months to 11.3 months that has the impact of reducing our price per megabit because we do offer discounts.

So our effective price per megabit today is just around $9 a megabit. That is down from probably, maybe $9.40 or $9.50 a year ago on a weighted average basis of customers' contract length. So ultimately, what will happen is, we'll get to a saturation point of people that take longer term contracts, I think 90% probably close to that, where we think we'll be by the end of next year.

And then secondly, we will see that even the smaller NetCentric customers' buys are as big as our ARPU, and at that point it will see ARPU for on-net business begin to actually increase.

Andrew Tuttle - Crowe Point Partners

Okay. And if you get to 90% of your customers on long term contract by the end of next year like you're targeting, I imagine that churns going to have to tick up a little bit at least after that point, if you kind of map it out on your contracted customer basis.

Dave Schaeffer

Well, not really, because remember, churn is measured when a customers goes away. As we had mentioned on the previous call, approximately 94% of our contract have auto-renewed provisions on them. So even for those customers that take a one year contract, at the end of that one year, they automatically renew for one year unless they proactively cancel.

Now, we do not count that renewal in our new sales numbers. But, I think as the percentage of business that goes under longer-term contract increases, that should actually have a beneficial impact on churn, and we've seen no increase in churn, if anything, we are seeing a slight decrease in the rate of which revenue is churned.

Andrew Tuttle - Crowe Point Partners

All right, great. Thanks, guys.


It appears we have no further questions at this time. I would like to turn the call back over to our speakers for any additional or closing remarks.

Dave Schaeffer

Well, again, thank you all very much for your support for listening to today’s call. The management team will be available, if you have any follow-up questions. I personally, again, would like to thank the entire Cogent team for the efforts of growing our revenues, of installing those revenues, and in timely manner and generating the incremental cash flow that's allowing us to buy back shares in the market. So with that, I would like to thank everyone, and we'll talk next quarter. Take care, bye- bye.


And thus conclude today’s call. We do appreciate your participation. You may disconnect at this time.

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Source: Cogent Communications Group Q3 2007 Earnings Call Transcript
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