Cogent Communications Group, Inc. Q4 2008 Earnings Call Transcript

| About: Cogent Communications (CCOI)
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Cogent Communications Group, Inc. (NASDAQ:CCOI) Q4 2008 Earnings Call February 26, 2009 8:30 AM ET


David Schaeffer – Chairman and Chief Executive Officer

Thaddeus Weed – Chief Financial Officer


[Unknown Analyst] - J.P. Morgan

Robert Dezego - Suntrust Robinson Humphrey

[Louie DePalma] - Thomas Weisel Partners

Nick Netchvolodoff - Barclays Capital

Jonathan Schildkraut - Jefferies & Company

[Jason Frazier] - Raymond James


Good morning and welcome to the Cogent Communications Group fourth quarter and full year 2008 earnings conference call.

As a reminder, this conference is being recorded and it will be available for replay at

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

David Schaeffer

Thank you and good morning. Welcome to our fourth quarter 2008 and year end 2008 earnings conference call. I'm Dave Schaeffer, Cogent's Chief Executive Officer. With me on the call this morning is Tad Weed, our Chief Financial Officer.

We are very pleased with the results for the quarter as follows for the full year 2008. Our fourth quarter and full year revenue, EBITDA and EPS were all within the guidance ranges with the exception of fourth quarter revenue, which was $100,000 below our guidance target; however, that takes into account approximately $2.2 million worth of foreign exchange impact.

During the quarter traffic grew on our network by approximately 25%. We are very encouraged by this increase in rate of growth of traffic on our network and are optimistic about our outlook for 2009. During the year we significantly expanded our footprint by adding 109 buildings to our network. We also significantly expanded our sales force. At the end of 2008 there were over 50 additional sales representatives actively in the market selling Cogent services versus the number of reps we had at year end 2007.

We took advantage opportunistically of market conditions and were able to purchase approximately $108 million of face value of the $200 million of our outsourcing convertible notes at an approximate price of $0.45 on the dollar. These note purchases reduced our debt, excluding our capital leases, by over 50% and resulted in approximately a $57.6 million gain for the year.

As we have discussed on previous calls, in June 2008 we extended a pilot program which implemented volume-based discounting as well as term-based discounts to all Cogent NetCentric customers as well as to our existing customers who increased their total contract value with us. During the fourth quarter this program and our business model continued to achieve greater success. In the fourth quarter under this program, nearly 700 of our NetCentric customers representing approximately $25 million in remaining contract value increased their total contract value with Cogent by 140% or $35 million. This increased their remaining contract value to over $60 million. Additionally, the average length of all customer contracts continued to increase by approximately 4.3% quarter-over-quarter, that is, Q3 2008 to Q4 2008. As more and more customers continued to extend their contract terms, this is a great vote of confidence in the quality of our service.

We continued to invest and improve our sales organization. Our rep productivity was 3.8 units per full-time equivalent rep in the fourth quarter, identical to the rep productivity we saw in the third quarter and an improvement from the trends that we had been seeing historically. We have added over 840 NetCentric customer connections in the fourth quarter of 2008 and approximately 3,000 on-net customer connections in full year 2008.

During the quarter, in addition to the note repurchases we continued our stock buyback program. In the fourth quarter we returned approximately $1.2 million to our shareholders by continuing to purchase stock. We purchased approximately 325,000 shares of our common stock. As of today we have approximately $30.8 million authorized remaining under our existing buyback program. Since June of 2007 under our total authorized programs of $150 million of stock buyback, we have repurchased a total of over 6.6 million shares of our common stock for an approximate cost of $119 million. These purchases represent well over 13% of the outstanding common stock that was in place when these programs began.

Throughout this discussion, as in the past, we will continue to focus our results on our on-net business, which represents approximately 82% of our total revenues. We will highlight several operational statistics that we believe demonstrate our increasing market share, expanding scale, and most importantly, the operating leverage of our on-net business model. I will review in greater detail many of these operational highlights and our continued expansion plans. Tad will provide additional details on our financial performance. Tad will also walk through and reaffirm our guidance for 2009. Following these prepared remarks, we will open the floor to questions and answers.

Now I'd like to ask Tad to read our safe harbor language.

Thaddeus Weed

Thank you, Dave, and good morning, everyone.

This fourth quarter 2008 and fiscal 2008 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. The 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 you will find these reconciled to the GAAP measurement in our earnings release and on our website at

Now I'd like to turn the call back over to Dave.

David Schaeffer

Great. Thanks, Tad.

I'd like to give you some highlights from the fourth quarter as well as for the full year. Hopefully you've had a chance to review our earnings press release. As with previous quarters, our press release includes a number of historical metrics. These metrics will be added to our website. Hopefully you will find the consistent presentation of these metrics informative and helpful in understanding the financial results and the trendings of our operations. We believe that we provide our investors many historical and forecasted metrics that will be helpful in understanding our business as well as our historical results.

We have at times, however, been criticized by some for providing too much data. I expect many of you may have noticed the absence of quarterly guidance from our press release. Similar to many other companies that have reduced or completely eliminated all forward guidance, we are aligning our guidance with the practices of many of these other companies. We will be no longer providing quarterly guidance; however, we will continue to provide an update of our annual guidance or forecast. Of course, we will continue to provide historical metrics to the same level and detail that we always have.

Our fourth quarter 2008 revenue was $54.9 million, which was essentially in line with our guidance of $55 million. This increase represents 0.6% increase in our revenues sequentially third quarter 2008 to fourth quarter 2008 and approximately a 9.9% increase in our revenues from Q4 2007. Our 2008 revenue of $215.5 million was above our guidance target of $215 million. This represents a total revenue growth from 2007 of approximately 16.1%.

As we discussed in our third quarter's earnings call, dramatic changes in foreign exchange rates have materially impacted our revenues for the quarter and, in fact, in the fourth quarter reduced our quarterly revenues by approximately $2.2 million. On a constant currency basis, quarter to quarter total revenues would have increased by 4.8% sequentially as opposed to the 0.6% that was actually reported.

Now I'd like to give you a little bit of an overview of pricing and trends within the marketplace. Our pricing for our most widely sold product remains at $1,000 a month for a 100 megabit connection or $10 per megabit. Discounts are available to customers for contract terms. These are available to all customers across all products. Also for our NetCentric customers we have implemented volume-based discounts that are available to those customers who purchased more than a 100 megabit connection and are NetCentric.

Our corporate customers represent approximately 60% of our customer count and 46% of our revenues for the fourth quarter 2008. These percentages remain virtually unchanged from the third quarter of 2008.

One of our competitive advantages is our ability to rapidly install new orders in our on-net footprint. Cogent guarantees an installation of on-net services of 17 business days or less. In the fourth quarter our provisioning team consistently has been able to beat our guarantees, delivering our on-net services for an average of 10 business days, substantially better than the guarantee than we have given our customers.

On churn, our on-net churn, including the impact of the loss of a large customer, Alpha Red, which we mentioned on the third quarter earnings call, however this loss occurred early in the fourth quarter actually, on October 8, our churn was about 2.9% for the quarter. As a reminder, this customer was a reseller and we were able to sign the majority of its customers into direct contracts with Cogent, actually increasing their monthly spend with Cogent. Our off-net churn remained approximately at 2.5% for the fourth quarter on churn.

On-net ARPU continued to decline primarily driven by foreign exchange as well as volume and contract length extensions. ARPU for the third quarter in our on-net customers was approximately $1,143 and for the fourth quarter it had declined to $1,087, a decline of about 4.9%. Our off-net ARPU continued to increase as the average size of off-net customer connections continues to increase. Off-net ARPU increased 1% from $1,001 in the third quarter to $1,012 in the fourth quarter. Substantially all of our European and Canadian revenues are onnet, so variations in foreign exchange do not impact our off-net business but do impact our onnet business.

Now with regard to traffic, traffic increased on our network at an accelerated rate of approximately 25% quarter-over-quarter in the fourth quarter. This growth rate was a significant increase from the 5% traffic growth that we experienced Q2 2008 to Q3 2008. Traffic on our network grew by approximately 30% for full year 2007 over 2008. We continue to see traffic growth in 2009, with monthly traffic growth December 2008 to January 2009 of over 5% sequentially on a monthly basis.

In these cost-conscious times, we believe that Cogent being the low price provider gives us a significant competitive advantage and we are seeing the direct results of our volume-based and contract term-based discounts, resulting in significant acceleration in traffic growth.

Tad will now cover some additional details on our fourth quarter 2008 as well as full year 2008 financial metric. Tad will also reaffirm and provide details of our 2009 guidance.

Thaddeus Weed

Thank you, Dave, and again, good morning to everyone and I'd like to thank and congratulate our entire team on their very hard work during the quarter and also for this year.

Since 2005 Cogent has been subject to the cost and internal control requirements of Sarbanes Oxley Section 404. As many of you know, this annual effort is in addition to fulfilling our usual corporate responsibilities and statutory audit requirements. I'm once again proud to announce that the work is essentially completed and our auditors will be issuing an unqualified or clean SOX opinion for 2008.

SOX certification and compliance, as many of you know, requires a tremendous amount of work. It's especially difficult for a company that is growing very rapidly and geographically expanding at the same time, so we're very pleased with these results, and in particular I'd like to thank the entire finance and IT and IS teams for their efforts in, again, completing this important project.

I will begin with providing some details on the components of revenue, getting into a little more detail than what Dave discussed.

On-net revenue and on-net customer connections. On-net revenue was $44.8 million for the fourth quarter. That was a 1.2% increase from the third quarter and 10.5% from the fourth quarter of '07. On a constant currency basis the increase would have been 5.3% instead of 1.2% on a sequential quarter basis. On-net revenue increased over 20% for the year from $146.6 million to $176 million for 2008.

About 88% of our new sales for the fourth quarter were for our on-net services, similar to the experience we've had for the entire year. On-net customer connection increased by 6.3% for the quarter and 26% for the year, so we ended the year with over 14,000 on-net customer connections. That was an increase of almost 3,000 from the number we had at the end of '07.

Revenues from the off-net business increased 1.8% for the quarter and as expected non-core revenues decreased by 26%. Substantially all of our European and Canadian revenues are on-net revenues, as Dave mentioned, so the variations in foreign exchange have little impact on the off-net revenues and non-core as well. Actually non-core is mostly in Canada, so there was an impact there. Off net revenue increased 7.7% year-over-year and non-core revenues decreased 30% year-over-year.

On EBITDA and gross margin, the operating leverage of our business, in particular our on-net business, continued to result in gross margin, EBITDA and EBITDA margin expansion. Gross margin, EBITDA and EBITDA margins all expanded, both on a quarter-over-quarter and year-over-year basis. Gross margin increased by 80 basis points from the quarter from 55.9% to 56.7%. Gross margin increased by 420 basis points for the year from 52.8% to 57% for 2008. Direct incremental gross margins from on-net revenues continue to be almost 100% and the direct incremental on-net EBITDA margins still approximate 95%.

EBITDA as adjusted was $14.7 million for the quarter. That increased 3.4% from the third. EBITDA as adjusted was $60 million for the year, almost 30% increase from 2007. EBITDA margin expanded by 70 basis points from the third quarter and 300 basis points for the year.

Regarding earnings per share, since we had net income for both the quarter and the year from the gains on our debt purchases, we are reporting both a basic and diluted earnings per share. Basic earnings per share for the fourth quarter was $0.93 and better than our estimated guidance of $0.90 per share. Diluted earnings per share was $0.88 for the quarter.

The $28 million gain on the debt buyback in the fourth quarter impacted the earnings per share by about $1.09 per share, so if you exclude this gain, the loss per basic share would have been about $0.16 for the quarter. For the year, basic EPS was $0.60, at the top end of our range of $0.55 to $0.60. Diluted EPS was $0.59 for the year. The gain for the year on debt of $57.6 million impacted basic EPS by about $1.26 per share, so if you deduct this gain, the loss per share on a basic basis would have been about $0.66 for the year.

Basic weighted average shares decreased from the impact of stock buybacks primarily by about 3.2 million shares. We purchased 4.4 million shares in the year for $59.3 million and the plan for 2009 anticipates and includes an estimated impact of additional stock purchases.

We've touched on foreign currency; I'll get into a little bit more detail. About 30% of our business is outside of the United States.

For the fourth quarter over 21% of our revenues were based in Europe and 7% related to our operations in Canada. As Dave mentioned, the changes in the euro and Canadian dollar to U.S. dollar conversion rates negatively impacted the comparable quarterly revenues by over $2.2 million. The euro to U.S. dollar average was $1.50 in the third quarter and it dropped to $1.32 for the fourth quarter. That's a 12.5% change. The Canadian to U.S. dollar was $0.96 in the third quarter, and that dropped to $0.83 in the fourth quarter, more of a reduction, a reduction of 14%. So these variations in foreign exchange, as you can see, materially impact our U.S. GAAP revenues.

On a sensitivity basis, for each $0.01 decline in the euro to U.S. dollar, that negatively impacts our euro-based quarterly revenues by about $100,000, and each $0.01 decline in the Canadian dollar has about a $40,000 impact on the quarter.

Capital expenditures were $5.2 million for the quarter, down from $9.5 million for the third quarter, and as we've experienced over several years, typically have lower CapEx in the fourth quarter and CapEx can be lumpy due to seasonal factors. CapEx for the year was $33.5 million. When we provided our CapEx guidance we assumed we were adding about another 100 buildings to the network in 2008 and as Dave mentioned we added 109 buildings to the network, so that resulted in the modest increase to our original estimate. We expect for 2009 to add approximately another 100 buildings to the network, so we expect our CapEx rate for '09 to be similar to the rate we experienced for 2008.

On some balance sheet items, at year end our cash and cash equivalents were $71.4 million. In 2008, as we mentioned, we purchased $108 million of the $200 million face value of our convertible notes, spending $48.6 million in cash and resulting in the gain. We have about $92 million of the original $200 million of the notes remaining and, as a reminder, these notes are not due until June 2027.

Our capital leases related to [inaudible] fiber lease obligations were $104.2 million at year end and about $6 million of that is due in the next year, so that is a current liability. These lease obligations are for dark fiber and are being paid over the remaining weighted average life and that's more than a 10-year period.

Days sales outstanding on accounts receivable was 32 days at the end of December and that's significantly better and it has been for awhile of our targeted rate of less than 40 days. So again, I'd like to thank and recognize our worldwide billing and collections team for doing a great job on customer collections.

Operating cash flow. Cash flow from operations was $10.8 million for the fourth quarter. It was $17.8 million for the third quarter. The change was entirely due to the timing of vendor payments, so accounts payable changes. Cash flow from operations for the year increased by 12% from $48.6 million to $54.3 million for 2008.

Guidance for 2009. The guidance that we're providing is based upon current and expected run rates of our business and it also includes the estimated impact of share purchases, increases in our sales and marketing programs, current and anticipated network expansion projects, and the current trends we're experiencing in sales rep productivity, pricing and network traffic. The estimates are also based upon recent foreign exchange rates, so any material changes in those rates will materially impact our forecast, in particular revenue.

For 2009 we are reaffirming the guidance we provided to you on the last earnings call. As a reminder, these are the amounts: Total revenue is expected to be over $250 million. EBITDA as adjusted is expected to grow to between $75 and $80 million.

We have an accounting change to discuss that will impact this in 2009; it was mentioned in our press release. The required accounting change will result in approximately $5.0 million of additional non-cash interest expense for 2009 and that's related to our remaining $92 million of convertible notes. So Cogent and companies that have similar convertible notes will be required to adopt this accounting change on 1/1/09.

The pronouncement is entitled APB 14-1, Accounting for Convertible Debt Instruments That May Be Settled In Cash Upon Conversion. And the pronouncement, what it does is it essentially requires that you bifurcate the convertible feature of our notes and then you separate that. You record that separate amount in the equity section as additional paid in capital, the offsetting side being an increase to debt discount on the liabilities side. So that increase in debt discount must be amortized and it will be amortized to non-interest expense over the period from 1/1/09 until the put date for our notes, which is June 2014, which is earlier than the maturity date of June 2027.

This has no impact at all on cash flows. The adoption of this pronouncement will also require us to retroactively restate 2007 and 2008 operating results, so interest expense that was reported for each of those periods will increase and as a result earnings per share or loss per share will be different.

We expect our 2009 loss per basic share to be between $0.15 and $0.20 per share. That includes the impact of this new pronouncement of about $0.10 per share for 2009. The 2009 estimate assumes about 43 million of weighted average shares outstanding.

Now with that I will turn the call back over to Dave.

David Schaeffer

Thanks, Tad.

I'd like to take a moment and talk about sales force activity and productivity. We began the fourth quarter of 2008 with 223 sales reps and ended the quarter with [244] sales reps. We hired 67 reps in the fourth quarter of 2008, the most reps that we have ever hired in a single quarter in the company's history, outpacing the 62 reps that we hired in third quarter of 2008. Fortysix reps left the company during the quarter, slightly down from the 47 terminations that occurred in the third quarter of 2008, resulting in a slight reduction in the turnover rate of our sales force from 7% down to about 6.5%.

We began the fourth quarter of 2008 with 194 full-time equivalent reps - to remind you, these are reps that have been given a three-month ramp and are now expected to carry a full quota  and we ended the quarter with 219 full-time equivalents. We began full year 2008 in January with 192 reps and 160 full-time equivalents. We expect to continue to add sales reps in 2009 at approximately the same pace that we added them in 2008.

Productivity on a full-time equivalent basis for the fourth quarter of 2008 was 3.8 units of sold business per rep per month, approximately equivalent to that of the third quarter of 2008. As a reminder, these productivity rates are based upon installs, not upon signed contracts.

Now to give you a sense of our scale, we added an additional 25 buildings to our network, bringing our total on-net footprint at year end to 1,326. We expect to add approximately another 100 buildings to our network in 2009, similar to the goal we had in 2008 when we actually added 109 or about 10% ahead of goal.

Now, our scale also continues to grow in terms of metro footprint and intercity fiber. As of year end we had over 12,000 miles of metropolitan fiber in our intra-city networks in over 130 markets. We also had approximately 32,000 miles of inter-city fiber across North America and Europe connecting these markets. We continue to evaluate additional routes in both Europe and North America.

Our network continues to increase its inter-connectivity to other networks with today over 2,600 other networks directly connected to Cogent's network. Approximately 290 of these are settlement free peering partners; the remaining 2,300 plus networks are customers of Cogent. We believe our network has substantial capacity to accommodate additional growth. We are today currently utilizing approximately 22% of capacity in our network.

So in summary, our on-net business, our growth business, continues to grow and traffic continues to grow at an accelerating rate. We believe that our position in the market as the low price provider and the volume and term-based programs that we implemented at mid-year continue to help us gain market share. This program has attracted new customers, had increased contract term, and increased volume commitments from existing customers.

Our business remains completely focused on the Internet and therefore we believe we are isolated from many of the problems that many other telecom service providers have been facing, both due to economic pressures as well as product displacement due to the substitution of Internet products for other more expensive telecommunications services.

We have strengthened our already strong balance sheet, especially when compared to others in our industry selling similar products, and we are continuing to generate free cash. We continue to be extremely encouraged by the trends in our sales force productivity as well as our traffic growth from our customers. Rep productivity has been constant for the past couple of quarters. Traffic growth continued to accelerate at 25%. Our December to January trend of 5% monthly sequential growth continues to give us that encouragement.

Unlike many other negative headlines that we've been being bombarded with on a daily basis, Cogent is not laying off its employees. In fact, we continue to hire and grow our sales force. We are not seeking additional cash as we are continuing to generate cash and therefore do not have to tap the debt markets. Cogent has not had to restructure any debt, but rather has been able to take advantage of the turbulence in the debt markets to create value for its equity holders by repurchasing debt, which we will continue to opportunistically review.

Cogent is not reducing its guidance, but rather reaffirming our 2009 guidance, and Cogent is not suspending its stock buyback program. We are committed to continuing to return value to our equity shareholders.

Now I'd like to turn the floor over to questions. Who has the first question?

Question-and-Answer Session


(Operator Instructions) Your first question comes from [Unknown Analyst] - J.P. Morgan.

Unknown Analyst - J.P. Morgan

A couple of questions for you. One, I just want to talk a little bit about the reiterated guidance. Obviously, we saw an FX impact in the fourth quarter. As we look into 2009 are we seeing kind of a combination of maybe continued expectations of pressure on the FX front offset by the nice traffic growth that you're see there that would give you the comfort to reiterate your numbers?

And then the second question, if I back out the FX impact, it looks as though ARPU is relative flat in the fourth quarter relative to the third quarter. I'm just wonder are we at the point now where maybe we're starting to stabilize despite the press reductions that you implemented last summer and maybe even could see a little bit of an uptick in ARPU going into '09?

David Schaeffer

In terms of FX, obviously we cannot predict the future. But we based our guidance on FX of about $1.30 for the euro. That has the most impact. The Canadian dollar has a little less impact. We're hovering slightly below that, but that slight strengthening of the dollar we don't think is material enough that it will appreciably change our guidance for the year.

And you are correct that our on-net ARPU if you netted out FX would be flat. Now we are seeing several things going on simultaneously on a non-FX basis. One, customers are taking larger connections; however, they also are signing up for both longer term contracts as well as greater volumes, so therefore availing themselves of the price discounts that we put in place.

If you look at since we have implemented the volume-based pricing program in June, our installed base of customers are at about $8 per megabit. The new sales since these volume-based programs have been put in place are at about $6 per megabit. We would expect to see some slight degradation in ARPU if the customers continued to have the same volumes, but because we are encouraged by the volume-based trends that we've seen and the fact that many existing customers have come back and increased both contract term - 4.3% increase in term, but also 140% increase in contract value - they're obviously taking larger connections.

I think we should see some stability in that ARPU. I don't think we'll see any material degradation from this point going forward.


(Operator Instructions) Your next question comes from Robert Dezego - Suntrust Robinson Humphrey.

Robert Dezego - Suntrust Robinson Humphrey

Did you guys give the percentage of corporate revenue as a percentage of the total?

David Schaeffer

Yes, we did, Rob. By customer count it's roughly 60% of our unit number of customers are corporate and as a revenue percentage it is 46% of total revenues. That is virtually unchanged from what it was in the third quarter as a percentage.

Robert Dezego - Suntrust Robinson Humphrey

As we look into '09 I was wondering if you could maybe give us a little bit of your thoughts on where you think that corporate revenue can move relative to the [NetCentric] business and maybe a little bit, if you can give us any kind of color, on what you're expecting in on-net versus offnet for '09 as well.

David Schaeffer

Sure, let's take both of those.

You know, our corporate business appears not to be materially impacted by the economy and I think we're somewhat buffered by the types of buildings we have chosen to connect to our network. That business has grown pretty consistently at between 15% and 20% per annum for the past four years. I would suspect that you should continue to see that rate of growth as we continue to add salespeople.

We today have relatively low penetration in our on-net buildings, having just under eight customers per building out of an addressable market of 51. So by adding sales resources we think that we will continue to see kind of consistent growth in that on-net corporate business.

For the off-net business, which is almost exclusively a corporate business, the growth rates are somewhat slower, probably in the roughly 10% annum range. What we see is not a huge increase in the number of units of sale, but rather a trend where the customers are taking larger connections and, in fact, ARPUs are going up. That business, as well as the on-net corporate business, are almost exclusively North American businesses and are not impacted by FX. So our guidance going forward assumes the growth in both corporate on-net and corporation off-net.

Now to the NetCentric business, the NetCentric business is impacted by multiple factors  by traffic growth, by average price per megabit being sold at a lower price due to volume-based commitments as well as term commitments, and there is material FX impact as well.

We have seen a deceleration in that NetCentric growth rate from the 2006 and 2007 growth rates to where we were in 2008. While we do not anticipate as much FX impact in 2009, we do believe that we will still see some reduction in the average price per megabit because the average price since we have instituted volume-based discounts in June has been about $6 a megabit as opposed to the installed base of $8.

So I think you will see a growth rate in that business probably also in the 15% to 20% range, which gets you to the total projected growth rate for our aggregate business of about 16%, similar to what we accomplished in 2008.

Robert Dezego - Suntrust Robinson Humphrey

Could you talk a little bit about the pricing environment versus your biggest peers, whether it's Level 3 or anyone else you're seeing out there.

David Schaeffer

Sure. So again, to remind you, Rob, in our two different customer bases we have a different competitive environment.

On the corporate side we have not seen any pricing pressure. Typically our competitors are selling an inferior product - a copper-based product - and we're competing against T1s with AT&T and Verizon.

On the NetCentric side, our primary competitors are Level 3 and Global Crossing. We have seen somewhat of a moderation in their rate of price decline. They have not been as aggressive as they were in the third quarter. In fact, in the fourth quarter we did not have a single instance where we had to lower our prices below our targets in order to beat the competition. But we, however, remain absolutely committed to being the low cost provider in the market.

I think as we have seen the cost of capital for these companies rise, they have been more judicious in funding operating losses and reducing prices, so we have seen them be more disciplined and I think that's in part a contributor to the fact that our traffic growth accelerated as much as it did in the fourth quarter.

Robert Dezego - Suntrust Robinson Humphrey

And could you maybe give us an update on where that pricing is from these guys? Historically you've given out a lot of that data on where your prices were versus their prices.

David Schaeffer

Sure. So, again, as I mentioned, our installed base is at about $8 a meg. Our new sales for the second half of the year since we introduced our volume-based pricing initiatives are about $6. If you looked at our competitors, today our competitors installed bases are probably in the upper teens and their average new sale price appears to be between $10 and $12 a meg, substantially  almost double - where we are in the market.


Your next question comes from [Louie DePalma] - Thomas Weisel Partners.

Louie DePalma - Thomas Weisel Partners

Given the re-acceleration in traffic exhibited this quarter, can you talk about the correlation between traffic and NetCentric revenue and any time lag that may exist with customers increasing bandwidth requirements?

David Schaeffer

Sure. So, again, we're very encouraged by this acceleration in traffic growth. Some of that is, I think, the continued migration of video to the Internet, which is becoming more prevalent, driving growth; however, I don't think we've yet seen the full impact of those video-based business models. Secondly, I think we continue to gain market share and that's due to the volume-based pricing that we put in place.

Now as I mentioned earlier, our price per megabit is lower than our installed base, so as people take advantage of these volume-based discounts, they are pulling down our price per megabit and therefore there is not a 1-to-1 correlation between traffic growth and revenue growth.

The second factor, which is quite material in at least the fourth quarter, was the FX impact. Because our NetCentric business is both North America and Europe, while Europe and Canada represent about 30% of our total business, they represent over half of our NetCentric business. And if you have significant strengthening of the dollar, our revenues reported on a dollar basis are substantially lower when the dollar strengthens because we bill in local currency. So that somewhat mitigated the gains we would have had if they were reported on a constant currency basis.

So if you looked at our revenue growth for the quarter, our on-net revenue growth inclusive of FX was 1.2% sequentially quarter-over-quarter, but it would have been 5.3% if you did not have the FX impact. Total revenues grew 0.6% sequentially quarter-over-quarter. They would have grown 4.8% quarter-over-quarter if there was not FX impact.

So it is very difficult with that FX cloud, shall I say, for me to give you any kind of predictive correlation other than what's historically occurred. But just as Scott did, you can kind of net out the FX because of the way we report on a quarterly basis and see kind of at least the historical trends between traffic growth and revenue growth.


Your next question comes from Nick Netchvolodoff - Barclays Capital.

Nick Netchvolodoff - Barclays Capital

I wanted you to talk a little bit about churn. It seems like the on-net churn was up significantly versus the stable at around 2% that you've had for the past couple of years, what that means for the business. And then I guess the off-net was fairly stable. Just to talk about that, especially since I guess that's customer churn, right, not revenue churn, so how does Alpha Red fit into an increase or stability in customer churn?

David Schaeffer

Sure. So I think there are two things in that churn number, Nick.

First of all, Alpha Red took many ports over many locations, so while they were a single customer, remember we report on a customer connection basis. So it was not one customer, but rather many customer connections that churned.

Secondly, as Tad mentioned, we had a significant amount of existing customers - over 700 existing customers - renew with us for a larger commitment and a longer term. Remember we report our churn on a gross basis as well as our sales, so that means if we have an existing customer that ends up canceling its contract to take a longer and larger dollar value contract, we report that cancellation in churn. So a large portion of that uptick in churn was due to these renewals.

When you net out existing customers taking longer contracts, we did not see any degradation in our customer performance or any increase in what people would call kind of true customer loss churn.


Your next question comes from Jonathan Schildkraut - Jefferies & Company.

Jonathan Schildkraut - Jefferies & Company

Dave, could you tell us what percent of traffic came out of your corporate group versus your NetCentric? It's traditionally only a very small piece, but I was wondering if you could give that?

Also, can I get one more significant digit on the percent of revenues coming out of the enterprise group?

David Schaeffer

Sure. I'm going to pass the significant digit question to Tad, but on the traffic number, roughly 96% of our traffic comes from our NetCentric customer base, which is slightly below 40% of the customers and 54% of the revenues. The corporate customers represent only 4% of traffic.

And then for the significant digit question?

Thaddeus Weed

What is the significant digit question?

David Schaeffer

I think he wants it on the corporate versus NetCentric. Is that the question?

Jonathan Schildkraut - Jefferies & Company

For the percent of revenues. You gave us 46%. I'm looking for one more digit.

Thaddeus Weed

Oh, 46.4%, I'm sorry, for the quarter.

Jonathan Schildkraut - Jefferies & Company

Dave, you talked a little bit about what your average price per megabit is at around $8, signing some new contracts and some customers rolling over to $6. What was your average price per megabit for a year ago period?

And I guess where I'm trying to go here, Dave, is that traffic on a year-over-year basis for the complete year of 2008 by our calculations increased I guess around 30%. You may have actually given the number at the beginning of the call, which I missed and I apologize. But if your traffic is growing at a 30% rate and pricing is coming down at around 25%, that would imply that your NetCentric revenues would not grow on a year-over-year basis.

So I'm just trying to get an understanding of what's going on, kind of the price per megabit, so if you could give us a little color where you were a year ago versus that $8 number, it'd be very helpful.

David Schaeffer

Sure. That $8 number was slightly above $9. That number does represent all customers, so we are blending corporate and NetCentric customers together, giving you the average price per megabit sold, because remember corporate customers can also get a discount by taking a longer term contract.

You are correct that we gave the traffic growth number on the call today of approximately 30%. Our NetCentric revenues did in fact grow for the year, albeit slower than they did in 2006 and 2007. They continued to grow on the order of about 15%.

The other variable that comes into that equation, Jonathan, is the amount of traffic that a customer purchases versus what they actually consume or use. And we actually saw a little bit of a decline in the fourth quarter in the percent of burst revenue that we received. So in the third quarter - I mentioned this on the call - it was about 4.5% of total revenues or closer to 9% of NetCentric revenues. In the fourth quarter we actually saw that decline a bit to about 3.3% of revenues. So what that told us is there were customers signing up for commitments that were slightly larger than what they were using because they were less likely to burst over their fixed commit.

We do expect long term to see an increase in that burstability, but in the quarter we actually saw people stretching a little bit more to get the lower price point.

Jonathan Schildkraut - Jefferies & Company

And actually that brings up a really interesting point about I guess what you're charging for capacity versus what actually is being used. I guess taking this from a different angle, in terms of the revenue that you're generating per megabit, let's say, that's actually consumed as opposed to the capacity that you're setting aside for a customer I would imagine would be much higher.

David Schaeffer

Well remember, the product we sell is different than what our competitors sell in that it is a nonoversubscribed and [non-blocked] product. So a common trend in the industry is to sell the same capacity many times. Probably the cable industry is the best example of this, where you can have several hundred homes as broadband subscribers being served by a single head end that may share 20 or 30 megabits, so you will get the full bandwidth if you're the only person on in that instant, but if you compete with other subscribers you obviously get a substantially degraded product.

Our network is non-oversubscribed and non-blocked, which means we reserve all the bandwidth for all customers 24/7 and whether they use it or not, they pay for it.

On the corporate customers the average utilization rate is about 8% of what they purchase. For the NetCentric customers there is a great deal of variability and, quite honestly, we see variability not only between customers but between periods. So a customer may come in, stretch to get a better price point, take more than they need and then over the next month or two grow into it. That number has fluctuated between roughly 60% and 70% utilization as opposed to the roughly 8% utilization on the corporate side.


(Operator Instructions) Your next question comes from [Jason Frazier] - Raymond James.

Jason Frazier - Raymond James

We've heard a little bit recently about cable companies looking to put higher levels of content online. I was wondering what your expectations are for these trends, if you've had any conversations with any of the MSOs on this topic?

David Schaeffer

We today sell to dozens if not hundreds of cable companies globally. I think the cable industry has been struggling with how to best monetize video content as its delivered over broadband as opposed to broadcast cable channels. A number of our cable companies have instituted their own products and offerings; many of them are Cogent customers. But they tend to be somewhat restricted in the amount of capacity they may allow an end user to use that product as compared to their broadcast product because, if in fact their entire libraries migrate over to their broadband offering, they may see a degradation in their subscription base broadcast, cable broadcast services. So they've all been kind of walking that very tight line.

I would say that the majority of video content that has been made available on the Internet has actually come from third parties or directly from studios or channels as opposed to the MSOs themselves in an attempt to possibly disintermediate the MSO.

That, quite honestly, is probably a conversation that's a little bit above my pay grade and probably should reside with the cable operators, but I think the long-term trend will be for more and more video to be available over broadband and then the customer will make a decision on how much they value that broadband video versus what they are willing to pay for broadcast video.


And there are no further questions. Mr. Schaeffer, I'll turn it back over to you for any closing or additional remarks, sir.

David Schaeffer

Well, again, I want to thank you all very much for the time and interest in Cogent. And most importantly, I'd like to thank the men and women of Cogent for delivering a phenomenonal year in 2008 for Cogent; it was a great effort on their part. And we expect as a team to continue the hard work in 2009 to deliver value to our shareholders.

Thank you very much. Take care.


And that concludes today's conference. We do appreciate our participation.

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