Cogent Communications Holdings Inc (CCOI) 2005 Q3 法說會逐字稿

Good morning and welcome to the Cogent Communications Group earnings conference call for the third quarter of 2005. As a reminder, this conference call is being recorded and it will be available for replay at www.Cogeco.com. (OPERATOR INSTRUCTIONS).

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

Thank you very much, Jennifer, and thank you all for joining us on the call. Good morning. Welcome to Cogent Communications third quarter 2005 earnings conference call. I am Dave Schaeffer, Cogent Communications CEO. With me this morning on today's call is Tad Weed, our Chief Financial Officer.

We would like to start today's call with a review of our operational highlights. We are extremely pleased with our results and I'd like to personally thank the entire Cogent team for their efforts in achieving these results. Throughout this discussion, we will be focusing on our On-Net business which is really the growth driver of Cogent.

As a reminder our On-Net services are provided by two customers located in buildings that are physically connected to our network -- the most literal definition of on-net. Tad will later provide a more detailed overview of our financial performance for the quarter and then we will open the floor for discussions on -- in Q&A.

Now I would like to turn it over to Tad so he can read the Safe Harbor language.

Thanks, Dave, and good morning, everyone. The Safe Harbor language -- this third quarter earnings report and the earnings conference call is to discuss Cogent's business outlook and contains forward-looking statements. The specific forward-looking statements cover Cogent's expectations for revenue and EBITDA as adjusted for the fourth quarter of 2005, fiscal year 2005 and fiscal year 2006.

These particular forward-looking statements and all other statements that may be made on this call but 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 any mergers, acquisitions, or other business combinations that may be completed after today.

Cogent undertakes no obligation to release publicly any revisions to any forward-looking statement made today or otherwise update or supplement statements made on this call. Also during this call if we use any non GAAP financial measures as defined by the SEC and Reg. G, you'll find these reconciled to the GAAP measurement on our web site at Cogeco.com.

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

Thanks, Tad, and again, thank you everyone.

We would like to start with the highlights of our third quarter results. Hopefully, you have had a chance to review our press release. As with our release in previous quarters, we have tried to include several historic metrics in that release that will be helpful in you analyzing our performance for the quarter.

This material will also be available on our web site. Hopefully, you will find these metrics informative and helpful in understanding the operational results of the business. If you have any suggestions, please let us know in the question-and-answer period and we may be able to include additional metrics in future calls.

We are extremely pleased with our results for the third quarter, both in terms of our revenue and EBITDA as adjusted, which were well within the guidance that were provided to you on our second quarter earnings call. We are extremely pleased in the fact that the Company has, for the first time in its history, become cash flow positive from operations. This we view as a major milestone for the Company and its continued progress towards profitability.

Now in trying to understand the overall trends and the highlights in our business and the differences between the second quarter and the third quarter, our total service revenue for the quarter was $33.8 million, well within the guidance that we had laid out of $33 to $34 million. Our EBITDA as adjusted was $2.1 million for the third quarter of 2005, again well within the range that we had outlined in our previous guidance of $1.5 to $2.5 million.

Cash flow from operations was $1.8 million for the third quarter. This was significantly ahead of the guidance that we had laid out at 1.1 million and, again, is the first time in Cogent's history that we have been able to achieve cash flow -- positive cash flow from operations. Our capital expenditures were well in line with what we had indicated in our previous guidance of $3 to $5 million for the quarter, coming in at $4 million square in the middle of that range.

In addition, I would like to take a moment and comment on traffic growth that we have experienced for the quarter. Our traffic grew Q2 to Q3 sequentially at greater than 30%. We are seeing this increase in traffic growth, both from existing customers and from the addition of new customers to our network. We believe that this traffic growth statistic demonstrates the fact that we are continuing to gain market share and are capturing business from our competitors due to the compelling nature of our value proposition.

We remain committed to being the price leader in dedicated Internet access.

Now to take a moment and focus on the growth portion of our business, our On-Net business. In this business our On-Net revenue grew sequentially Q2 to Q3 by $1.2 million, or approximately 7% sequential quarter-over-quarter growth. The percentage of our aggregate revenue that was derived from our On-Net business increased sequentially from 56% in Q2 to approximately 60% in Q3. The number of On-Net customer connections grew by nearly 13% sequentially Q2 to Q3, taking us to over 4000 On-Net customer connections.

Customer connections grew at a faster rate than did our revenue growth for On-Net, implying that we had a reduction in ARPU -- Average Revenue Per User. This reduction however was not due to any price pressures but rather due to the mix of customers that we added within the quarter. 77% of our On-Net customer sales in the quarter came from our corporate customers.

To remind you, our Cogent sales to two primary market segments with its On-Net products. We sell to corporate customers that are located in large multitenant office buildings, typically located in the central business districts of major cities, and then we sell to service providers, broadly defined who meet our networking carrier-neutral colocation facilities.

77% of our sales of On-Net products for the quarter went to the corporate customers. Corporate customers typically buy the Company's core product, which is the 100 Mbps dedicated Internet access service for $1000 a month. Our service provider customers typically buy much larger connections, typically gigabit connections, and the fact that we sell the majority of our new incremental sales to our corporate customers is reflected in the reduction and average revenue per customer.

It is important to note, however, that the quality of our corporate customers is our highest quality customer base. These customers typically have the longest life with the Company; and we feel that this shift in our product mix and customer base is a very positive for the Company.

With that I'd like to turn things over to Tad so he can walk you through a little bit more of the details on the financial results; and then I will be rejoining you shortly.

Thanks, Dave, and again, good morning everyone. I'd like to thank our team on the results for the quarter.

Regarding revenue, as Dave mentioned, total revenue for Q3 was 33.8 million, essentially unchanged from total revenue for Q2 of also 33.8 million. Total revenue increased over 55% compared to total revenue of 21.7 million for the comparable quarter in 2004.

Regarding foreign currency and the impact on our revenues for the quarter, the euro to eurosdollar decline continues to impact our euro-fee and -based revenue and the average rate of decline for the quarter was 3%.

As a reminder, our euro-based revenues are about 20% of our business. This impact was much less than the impacts for Q2 and the average rate was in line with our planned rate but the decline did negatively impact the comparable quarter to quarter revenue results by about $200,000.

We did have a couple of non-recurring items that occurred during the quarter. Two of them related to our European operations. One was a charge and one was a gain. We revised our sublease assumptions related to our former Paris office lease and that resulted in a restructuring charge of 1.3 million during the quarter. We determined there was no opportunity to further sublease this space and reduce the future estimated sublease income to zero. So as of now, this liability is fully reserved.

Second we negotiated an amendment to our IRU (ph) Capital lease in Spain that reduced our mostly payments and extended the lease term. This transaction resulted in a gain of 844,000 as the amendment reduced the net present value of the capital lease to liability. Neither of these items are reflected in EBITDA as adjusted.

Regarding the mix of revenue for the third quarter, On-Net revenue increased 6.6% from 18.9 million in Q2 2005 to 22 -- 20.2 million in Q3 and On-Net revenue increased 41.3% from 14.3 million for the comparable quarter of 2004.

Off-Net revenue decreased 9.9% from 11.7 million for Q2 2005 to 10.6 million for this quarter. Off-Net revenue increased 106.6% from the comparable quarter in 2004. And that reflects the impact of our Vario (ph) acquisition which occurred in December 2004 which consisted of Off-Net revenue.

Lastly non-core revenues for the quarter decreased 3.6% from 3.2 million in Q2 to 3 million for Q3 2005.

Regarding Off-Net churn, as in Q2 we continued to experience Off-Net revenue churn due to the repricing of existing contracts and unit churn in our off-net business. And again this was primarily related to our Vario Off-Net acquired revenues.

As a reminder, in December 2004 we acquired approximately 3700 Off-Net customer connections which generated approximately 2.5 million of monthly Off-Net revenue in December 2004. And also, we purchased these contracts from Vario for $1.00.

Of the remaining 3000 acquired customer connections at the end of last quarter, we lost approximately 300 customer connections during this quarter. Of the contracts that we retained and repriced, they repriced at a 23 discount -- 23% discount in the third quarter. That is less than 30% discount that we had in the second quarter.

Regarding EBITDA as adjusted, as Dave mentioned it was 2.1 million for Q3 2005; and for the previous quarter it was 2.3 million. This decline from the prior quarter was largely attributed to increased cost associated with ramping our sales force and increased maintenance costs.

Customer connection. Customer connections were 9,609 at September 30, 2005, a net increase of 141 connections from 9,468 at the end of Q2. On-Net customer connections increased in net 477 or 13.3% from Q2 (ph) . And Off-Net customer connections defined a net 194 or 4.5% from Q2, again, primarily due to Vario churn.

Lastly, non-core customer connections decline at 142 were about 8% from Q2. Regarding ARPU, our Average Revenue Per Unit, the ARPU for our On-Net business declined 4.8% from Q2 to 1,760. As Dave mentioned this was primarily due to a change in mix between quarters for the new business during Q3. Also to a much lesser extent the euro decline impacts this ARPU as well.

The ARPU for our Off-Net business declined 6% to 840. This rate of decline was consistent with the rate we experienced last quarter to quarter and reflects the impact, again, of repricing of the Vario contract.

Regarding capital expenditures, 4 million for the quarter, this was at the midpoint of our expected range between 3 and 5 per quarter.

Regarding cash in the balance sheet. As of September 30, cash and short-term investments were 40.3 million. 4 million of this cash is restricted under our credit facility. That restriction is being eliminated with an amendment that we are currently negotiating and I will detail in a moment.

Our true debt $10 million. Those are the 7.5% Allied Riser (ph) notes that are due in June 2007. We do have capital lease obligations related to our long-term IRUs and they total 93.2 million at September 30, and 6.5 million of this amount is a current liability.

Our day sales outstanding for accounts receivable worldwide was better than our target of 40 days at 39 days; and this achievement helped to contribute to our positive cash flow from operations for the quarter.

Regarding the credit facility amendment, as a reminder, we have a $10 million credit facility. No amount was borrowed during the quarter and the full amount is presently available. We are amending the credit facility that will increase the borrowing capacity from 10 million to 20 million. That amendment will eliminate the 4 million restricted cash covenant and substitute typical financial covenants for a facility of that size.

Regarding operating cash flow, we are proud to report positive cash flow from operations of 1.8 million for Q3. There was a negative 1.5 million for Q2 2005. Again, this represents a significant milestone for us as we make progress towards becoming truly cash flow positive. And we define that as more money at the end of the month in the bank than at the beginning of the month.

Q4 2005 and 2005 guidance, we are providing Q4 guidance based on the current run rates of our business and our expectations. Q4 2005 revenue is expected to be between 34 and 35 million; and Q4 2005 EBITDA as adjusted is expected to be between 1.5 to 2.5 million. We are also reaffirming our fiscal 2005 guidance.

In a moment, Dave will present some targets regarding our expectations for 2006.

Finally, we mentioned on the last call we had a NASDAQ application to move from the AMEX due to the volatility in our share price and the $5.00 per share minimum listing requirement for NASDAQ. We rescinded that application at this time.

Now I will turn the call back over to Dave.

As we presented in our secondary offering to investors, we intended to use the use of proceeds from that offering for three primary purposes. One being to increase our sales and marketing efforts; two, to be expanding our network footprint and adding some additional On-Net buildings to that footprint; and, third, to repay debt.

As we previously reported, we have in fact repaid those outstanding debt amounts. Now I'd like to comment on the expansion of our network.

During the quarter, we added 17 buildings to the network. The majority of these buildings were in Europe, bringing our quarter end total to 1,026 On-Net buildings. We currently have approximately 10 buildings in progress for implementation to the network expected to be completed this quarter.

We are actively ramping our sales force. We are very pleased to report that the productivity per rep within the Company was the best in the Company's history. We continue to see rep productivity of greater than five unit sales for rep per month, which is an extreme accomplishment for the sales force.

We began the third quarter with 54 sales reps in place. We ended the quarter with 67 reps in place, of which approximately 60 were full-time equivalents. We continue a program of forced attrition of underachievers in our sales force. We currently plan to add 20 additional net sales representatives in the fourth quarter as we continue to drive increased revenue growth within the Company and focus those reps on our On-Net services. We believe these additional resources will allow us to achieve the revenue growth plans that we have laid out.

Now I would like to take moment and maybe give a little bit of a tutorial about depeering. It is probably a topic that many of you were deeply concerned about earlier this quarter, as we experienced a major dispute with one of our peers, Level Three.

Level Three unilaterally elected to disconnect its connectivity to Cogent, creating disruption both to Level Three's customers as well as customers of Cogent, not to mention a disruption to the entire Internet. We are pleased to announce that we have reached a new agreement -- long-term agreement -- with Level Three that remains a settlement-free agreement. And this is a result of Level Three prior to that agreement being executed, initially re-establishing connectivity with our network.

I think what was demonstrated in this action was the significance of the amount of traffic that was carried by Cogent's backbone. And more importantly the amount of traffic that was unique to Cogent. Independent studies by the North American Network Operators Group indicated that over 4.3% of the entire Internet disappeared when this depeering occurred. Probably close to 15 to 20% of the Internet's traffic was impacted in some way; but 4.3% actually disappeared.

The reestablishment of this connectivity and the continued expansion of our settlement preconnectivity allows our customers as well as customers of our competitors to continue to derive the benefits of the Internet which is a network of networks.

We believe that these actions by other companies are a direct result of the competitive landscape, as companies are under significant financial pressure. Cogent remains committed to the model of being the lowest cost provider in the market. Our price points are clear and concise to our customers at $10 a megabit. We are still seeing average pricing in the market of between $50 and $60 of megabit from our competitors. We are seeing some price erosion in our competitors.

But I think the fact that our traffic growth occurred sequentially quarter-over-quarter at an accelerating rate of over 30%, implying about 175% annual growth rate in traffic compared to industry studies where the Internet is growing at between 80 and 100% indicates that Cogent continues to gain market share.

I would now like to lay out some of the roadmap for the Company going forward in 2006 and give you some of the high-level metrics that we are working to achieve. As we progress through the year, we will tighten this guidance up and give more concise guidance on a rolling quarterly basis. We do however believe that the metrics we are laying out are achievable, and indicate a roadmap to where management and the Company are headed. We see overall revenue growth -- this is On-Net and Off-Net, our entire business -- without any impact of acquisitions being between 15 and 20% in 2006. We see our On-Net revenue growth for 2006 being somewhere between 25 and 40%. And, finally, we see our EBITDA growth approximately doubling in 2006 over our 2005 performance.

In summary, I'd like to give you a set of highlights on where we stand and how we can achieve these goals going forward. Our network remains less than 4% utilized. We have ample capacity and Cogent remains focused as a company on the twin goals of really increasing profitability and gaining market share.

We are pleased with the percentage increase in the revenue that is derived from our On-Net business going up from 56% of our aggregate revenue in Q2 to 60% in Q3. We also remain encouraged by the productivity of the reps on a per rep basis of over five orders per rep. We are pleased that out peering dispute with Level Three has been resolved and that many of our other peers are actively increasing their connectivity to the Cogent network, again demonstrating our, I think, importance to the Internet in its entirety.

Then finally I really want to compliment our entire team on the effort in helping the Company meet its milestone of becoming cash flow positive from operations. We view this as a significant step towards becoming truly cash flow positive, as Tad indicated in our most literal definition of the term, and also then becoming earnings per share positive as we continue to increase profitability.

The Company will be hosting an Analysts' Day on Monday here at the Company inviting any analysts to attend -- either buy side, sell side or industry research analysts -- to help get a more in-depth understanding of our business, allow us to answer further questions and need a broad cross-section of the management team. So we encourage those of you who can attend, to please come to that meeting.

And then, in addition, the Company will be presenting next week at the Lehman Brothers Small Cap Conference in California. Hopefully, again, allowing investors another opportunity to analyze the Company's performance and question management on our plans going forward.

With that, I would like to open up the floor for questions and turn it back over to Jennifer to moderate.

+++ q-and-a.

(OPERATOR INSTRUCTIONS) Michael Bowen. Friedman, Billings, Ramsey.

Couple of questions here. First of all just a point of clarification on your '06 guidance. You said EBITDA growth doubling -- I know this is a nit but do you mean the rate of growth doubling or the absolute amount doubling?

The second question I have is with Vario. I think you implied -- I guess there are about 2700 customers -- I think I'm reading that right -- left at this point. You said they were repriced at 23% of a discount which of course is an improvement from last quarter. But how many of these customers are left to be repriced? I think last I talked to you you said about 25, 30% of those are left to be repriced.

And the final question is can you maybe give us a little more color on how you were able to bring the dispute of Level Three to conclusion? How you were able to get them to acquiesce as far as your not having to pay them for settlement, either peering or agreement?

Let me try to clarify all three of these points and again I apologize for my inarticulate use of the English language perhaps.

What we mean in terms of EBITDA is actually not a doubling of the growth rate, although I think that will occur also but the absolute number doubling. So if we look at our guidance for 2005 being between $10 and $12 we are looking for a number double that for '06.

Just to clarify, again, that 10 to 12 includes the 3.5 million for the distribution of assets in the first quarter. Correct?

That is correct, Michael. To your second question which is the Vario repricing. When we acquired the 3700 customer connections from Vario in December, the majority of these customers were under a one-year term contract. There was no particular seasonality to this contracts so about 112 came out of contract each month.

We have completed the vast majority of that repricing exercise. There were some customers still under contract in October and November that will impact this quarter. There will only be two of the three months and will probably represent about 5 or 6% of that customer base.

Because there were some customers at the beginning that were month-to-month and then, the remaining portion of that customer base was pretty much ratably spread over the 12 months and we have done that repricing. Most of the catch-up effort occurred in the second quarter and, therefore, a smaller number here in the third quarter, and a very small amount of that to occur we believe in the fourth quarter.

As Tad mentioned, the discount that we had to apply was less severe in the third quarter than what we did in the second quarter where the average discount to retain those customers was about a 30% discount in the third quarter, the average discount applied was the 23%. And the unit number of churn taking down that acquired customer base by about 10% in the quarter was in line with what we anticipated and we see no great acceleration in unit churn of those customers.

So the vast majority of the impact of the Vario transaction -- again, remind you this was a customer base that we paid only $1.00 for -- is behind us at this point in time.

Real quickly, the 23% discount versus the 28 or 30% discount to some of the other customers. Was that because these customers were already a little bit lower than the other customers that you had to reduce by 30%? Or could the prior customers that you reduced by -- could be customers now at 23% discount come back and want another 7% discount on top of it because you gave 30% to the others?

The variants -- I don't have a great answer for it. We have a team of four individuals who concentrate on retention of customers as their contracts roll out. They look at each customer contract and are actually incented to basically sign those customers up as close to their current price as possible. They get a higher bonus if they are able to do that. They were just more successful in getting down to that 23%. I think it probably has to do with just the geographic location of those customers that happen to come off of contract in the quarter and what the competitive pressures are.

For the customers that are located in major cities, it is pretty difficult, competitive environment where there are a lot of options. For those that are probably in a suburban or semirural locations there are generally less competitive alternatives and therefore less of a need to discount as aggressively.

But beyond that I do not have any great clarity to that differential between 23% and 30%.

To your last point and I'm going to have to temper what I say, based on the fact that as part of our Level Three settlement, both parties entered into a confidentiality and nondisclosure agreement. So I can't comment about what occurred in the negotiations. What I can talk about are things that are in the public domain and are not really subject to these confidentialities.

The first point being the percentage of the Internet that was isolated. While it was 4.3% of the Internet in its entirety. the way that study was that is a number of engineers took a variety of views of a routing table and just saw which routes disappeared when Level Three took this action. In that same engineering analysis, they looked at the number of single homed customers behind each of the two companies which were about equal.

However my expectation is that Level Three has a much larger percentage of its business derived from its managed modem business. That is a business in which those customers are entirely single owned and there are three or four very major companies that account for the majority of that market. I believe that those companies and their respective customer bases probably put an awful lot of pressure on Level Three that allowed them to turn up the temporary connection and then allowed us to sit down in good faith and negotiate an agreement that is equitable to both sides and retains the fundamental tenet of being settlement free.

Maybe if I can follow up very quickly. Can you give us any indication how many Level Three customers you have been able to bring over to Cogent?

As I think what you are referring to, Michael, is as part of the dispute and our response to it, we offered a promotion to any customer who was a Level Three single home customer to switch to the Cogent network and receive one year of free traffic at about -- at the same level of service that they received from Level Three allowing Cogent to bill them for the increase in traffic that they would experience.

We have signed up about 50 of those customer connections at this point in time.

Blake Bath from Lehman Brothers.

We have a couple of questions here. I guess we will take them one by one. The first is, with the Off-Net business decreasing and On-Net increasing why isn't there a positive impact to gross margin and EBITDA margin?

As we mentioned, we did incur some additional maintenance costs during the quarter which we didn't have in the second quarter. But we do expect margin expansion in the fourth quarter.

I guess my second question is on ARPU. We calculate that the On-Net ARPU declined 5% sequentially. A, is that right? And B, how much of that would you attribute to the new customers coming on in the next shift towards corporates versus how much was "repricing" the bases. 5% sequentially seems like a lot.

I'll take that one. We saw in terms of repricing, no real need to reprice. There was almost no impact on that. You are correct in the 5% sequential calculation. That is almost entirely attributable to the shift in the customer base with a much larger percentage of the customer connections coming from the corporate connection. So about 80% of our connections sales of On-Net customers was 477 customers corporate. The corporate customer ARPU is almost 1/10 that of the net-centric ARPU and it was that shift that had the 5% sequential impact. (MULTIPLE SPEAKERS) Excuse me?

So that is something that we should expect to continue then, is an ongoing shift to the corporates from the net-centric folks and I mean is this 5% sequential decline in ARPU likely to continue?

I will be honest. The shift in mix took us a little bit by surprise. The sales force remained focused on the same customer base but they just had a great deal more success with the corporate customers over the quarter.

I would expect that you would see some continued pressure if the trend continues but the sales force focus remains virtually unchanged. I will say, also, that the remaining net-centric targets that are not customers tend to be smaller than our existing customers and that's reflected in whether you look at the total amount of traffic we carry as a percentage of the Internet versus the number of customers that we have. With slightly less than 10,000 customers it is kind of -- you scratch your head and say, "How does that equate to 4% of the Internet?" And it's because we focus on such a very large group of customers, the very large customers.

I would also say that there was a small impact but not significant due to the euro-dollar change. As Tad indicated it was about a $200,000 hit for us in topline this quarter versus a much larger hit last quarter.

The employment change -- those folks you brought on this quarter. How many of those were salespeople and just to verify, you said you are going to add 20 more in the fourth quarter, all being sales-related?

The second question, that is correct. All of our additional hires that are planned in the fourth quarter are sales actually direct quota bearing. Part of what occurred, you had asked the question about why did we not have the EBITDA expansion. And part of it is hiring these salespeople and then getting them ramped up so we anticipated some of that cost impact on EBITDA.

And we ended up increasing the total number of employees in the Company in the third quarter by 22. So it will be about 20 we expect in the fourth quarter, all those being salespeople. And we typically allow a three-month ramp until a salesperson becomes fully productive so you will see that additional headcount.

There has also been some expenditure in the quarter on additional resources for Sarbanes-Oxley compliance. The Company had previously not been an accelerated filer and once we completed our secondary offering we effectively had a half year to comply as opposed to a full year with Sarbanes-Oxley. And we did add a couple of people in the third quarter to help us with that work. We are not going to be adding any additional people in the fourth quarter.

Then I would like to probably expand on Tad's comment a little bit, about cost of goods sold. Tad had indicated the increase maintenance costs, what we want then with that too is power and we did see a pretty significant increase in our data centers.

We operate today about 300,000 square feet of data centers space. And we actually have power charges at over 1400 locations across the network. These can either be regenerator sites, data centers or within buildings that have power pass-throughs. We don't expect -- it wasn't a material number but we did experience some increase in power costs for the quarter.

My last question is the change in working capital in the quarter. I apologize if I missed it but what was that?

Part due to the better quality of accounts, more corporate sales and net-centric sales and the reduction in day sales. The AR collection was frankly better than planned. That helped attribute to beating the 1.1 which we planned versus the 1.8.

Are you looking for the actual amount?

I was looking at the release like a $3 million change in working capital.

It has to do with better collections on AR and management of AP as well. Both sides of the equation.

Vik Grover from Thomas Weisel Partners.

This is Colby. Question for you -- just, sorry to keep on talking about this, but the guidance for 2006 seems pretty good and I just want to confirm that if it is about 20 to 24 million on an absolute basis for EBITDA and your guidance for the fourth quarter is flat, help us try and understand how we get to that? Where is this really going to be coming from to get us from where we are today and I guess where we're going to be in the fourth quarter through where you expect to be by the end of '06?

I will take it and then maybe Tad will follow on it, as well. First of all we are really starting to begin to see the benefit of ramping the salesforce but we are also bearing the cost of that as we carry salespeople on their ramp, towards full-time quota of equivalency.

So we expect to see the majority of this impact in terms of increased aggregate topline revenue and sales in the first quarter of next year, because we are bearing still a lot of the cost by adding just 20 people this quarter and 20 people last quarter. Those people take about three months to become fully productive.

Secondly, we do continue -- we do expect to see a continued shift in our revenue mix. The sequential change from 56% to nearly 60% of our revenue being derived from On-Net will have a material impact on our EBITDA because our cost basis in our Off-Net products is relatively high and our On-Net products have virtually no marginal costs associated with them.

We have also got in the fourth quarter -- your question is good -- we've got the cost related to Sarbanes-Oxley and our annual audit as well, which I hate to report, are not insignificant. That will impact the Q4 EBITDA versus Q3 EBITDA. We don't expect to have those costs in the first quarter of '06, which will help in the ramp from Q4 '05 to Q1 '06.

Regarding the On-Net net adds per customer of 4.77 which you have talked about, according to our model that seems like the highest number for quite some time. Did you experience anything in the quarter which really led to that? Was it because of Level Three and maybe those 50 customers which you implied earlier? Or was there something else there that you think is going to be a catalyst going forward as well?

Level Three occurred on October 4th, so the impact of that and I think the heightened brand awareness of Cogent should be something that we experience in fourth quarter. There was no impact in the third quarter.

I think what we saw -- I think three factors that attributed to that. One, more salespeople. Even though they were on a ramp, there were more of them. Secondly I think we are seeing the benefit of our formalized training program that we put in place for the salesforce that has resulted in the salesforce increasing the productivity per sales rep to the highest level in the Company's history. Then, third, we did add additional On-Net buildings and as our addressable universe continues to expand, I think we can expect to see good numbers and increasing numbers of On-Net add.

So you don't think the 477 was more of an anomaly. You think that this is actually -- could be a normalized number?

Yes we feel very comfortable. We actually would expect to see continued growth from this point going forward in terms of unit number of add.

My last question -- more just trying to understand how do business works. The 30% quarter-over-quarter traffic growth that you referred to. How did that translate into revenues? I mean how do you actually take advantage of that and later on, see that reflected in your income tax statement?

Right. How do we monetize the fact that we carry more and don't necessarily collect more. I think there are two components to that. The first component -- what is important to understand is, the vast majority of Cogent's customers well in excess of 90% of our dedicated Internet access customers buy their service on a fixed connect basis, meaning, they buy a connection whether it be a 100 Mb, 500 Mb or a gigabit, they pay a flat fee. And they can either use all of that or none of that.

So what we see is people increasing the percentage of utilization of what they pay for. So there it is a lag effect because people typically buy more than they actually use so they have cushion and then will grow as they start to bump up against that cushion. So we have seen that repeatedly with customers that go from 100 Mg to 200 Mg to gigabits or even multiple gigabits. So we will see growth lagging as people fill up their there fixed commit.

The second way in which it helps Cogent monetize that is, as people utilize their ethernet-based connections and they experience traffic growth, the alternate TDM kind of telco based interface is being T1s and T3s, no longer become practical alternatives. They've become hooked on the high bandwidth and what our services can deliver to them.

It is also important to remember that this growth comes from two very distinct sources. Part of it comes from our existing customers which I have just described how we can monetized that. The second way in which that growth does come and is directly reflected in our On-Net revenue growth, which was significant at nearly 7% sequentially quarter-over-quarter, is winning customers. I.e., getting people that were not Cogent customers at the beginning of the quarter and making them Cogent customers at the end of the quarter or during the quarter.

Both of those factors -- growth from existing customers which was the first point I made and, secondly, winning new customers -- account for the aggregate 30% growth but if you look at independent third party studies of the Internet, most industry analysts project that aggregate traffic is growing somewhere between 80 and 100% per year. We are growing at two to three times that base.

David Hanover from Curtman (ph) Hanover.

I got cut off from the call a couple minutes ago. You said I believe that you thought EBITDA margins would go up this quarter versus last quarter. Is that correct?

The target for EBITDA this quarter is between 1.5 and 2.5 million on 34 to 35 million of revenue.

I thought I heard you say something about EBITDA margins going up. I guess I must have misinterpreted that then.

That was probably with respect to the 2006 guidance that Dave laid out.

, 2006, okay. That's fine.

That's correct, as we indicated that we expect aggregate EBITDA to double from the 2005 numbers to 2006.

Do you have any guidance as to when you think you'll get to free cash flow neutral or positive?

We have not issued that guidance at this point. But we do plan that towards the end of '06. That is certainly in the running.

That we will be able to be true free cash flow as opposed to the more limited definition of cash flow positive from operations.

The other question -- again this is when I got cut off you were talking about Starbase Sarbanes-Oxley and the expenses related to that and I guess that is going to hit in Q4, you said? Did you give an amount that that would be?

It will be in the neighborhood of $500,000 to $1 million. That is audit and stocks combined.

That's versus in Q3 with zero or what is the comparable number?

Essentially zero. (MULTIPLE SPEAKERS).

There are no further questions at this time. Please continue.

Again, I'd like to thank everyone for taking the time to follow the Company, to look at our results and ask thoughtful questions. I would like to reiterate that we are extremely pleased with the performance of our core business and the growth that we are experiencing and look forward to answering further questions either at our Analysts' Day on Monday or at the Lehman Brothers Small Cap Conference. Again thank you very much, everyone.

Ladies and gentlemen, this concludes the conference call for today. Thank you for your participation. Please disconnect your lines.