Cogent Communications Holdings Inc (CCOI) 2005 Q4 法說會逐字稿

Good morning, ladies and gentlemen.

And welcome to the Cogent’s 2005 yearend earnings conference call.

As a reminder, the conference is being recorded and it will be available for replay at www.cogentco.com.

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

Please go ahead, sir.

Thank you very much, Sylvia.

Good morning to all, and thank you for joining our call.

We’d like to welcome you to our fourth quarter and yearend earnings conference call.

I’m Dave Schaeffer, Cogent’s Chief Executive Officer.

With me this morning is Tad Weed, our Chief Financial Officer.

We will start today’s call by reviewing our operational highlights.

Overall, we are pleased with the results for 2005 and also for the quarter.

And I would personally like to thank the entire Cogent team for their efforts.

I’m also pleased to report that effective as of yesterday Cogent began trading on the NASDAQ national markets under the ticker symbol CCOI.

As we had discussed on a previous call, it was the Company’s intention to migrate it’s listing from the American Stock Exchange to the NASDAQ and that migration is now complete.

As many of you know, we were required to complete our Sarbanes-Oxley internal control audit for 2005 in addition to our usual corporate and statutory audits.

Despite the fact that many companies of similar size were granted extensions by the Securities & Exchange Commission till 2007, because of the timing of our stock offering in June of 2005 we were required to complete our Sarbanes-Oxley work actually in an accelerated, as an accelerated filer in a six-month window.

I am proud to announce that this work is complete, and our auditors will be issuing an unqualified clean Sarbanes-Oxley opinion.

This project required a tremendous amount of work and was accomplished in a greatly reduced time period with our own internal resources.

We are extremely pleased with the results of this, and I need to complement Tad and his Team on the efforts that they have done in ensuring that we have a clean opinion.

Throughout these discussions we will continue to focus on the results of our on-net business.

To remind everyone this is the growth segment of our business.

We are extremely pleased with the margin expansion and the increased operating leverage demonstrated by the growth in our on-net business.

As a reminder, our off-net business is the business that provides services to customers that are located in buildings that are not physically connected to the Cogent network and require a leased connection from a third party telco provider.

We will discuss our operational results in light of these two major segments of our business.

Ted will provide you with additional details on our financial performance for the quarter and the year, and walk you through our expectations for first quarter 2006, as well as for full fiscal year 2006.

Following our remarks today, we will open the bridge for questions and, as always, we also encourage you to contact the Management Team at any point because we are here to try to make sure that we are transparent in our explanation of our operating results.

Now, I’d like to turn things over to Tad to read our Safe Harbor language.

Thank you, Dave.

And good morning, everyone.

This fourth quarter and yearend earnings report and this earnings conference call discuss Cogent’s business outlook and contain forward-looking statements.

The specific forward-looking statements cover Cogent’s expectations for revenue, EBITDA as adjusted, our percentage of on-net revenues, and our operating results and loss per share for the first quarter of 2006 and fiscal year 2006.

These particular 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 any mergers, acquisitions or other business combinations that may be completed after today.

Cogent undertakes no obligation to release publicly any revision to any forward-looking statement today or otherwise update or supplement statements made on this call.

Also, during the call, if we use any non-GAAP financial measures as defined by the SEC and Reg G. You will find these reconciled to the GAAP measurement either in our earnings release or on our web site at www.cogentco.com.

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

Thank you, Tad.

Hopefully, you’ve all had a chance to take a look at our press release that was issued yesterday evening.

As with previous quarters, we have included in this press release a number of historical metrics for previous quarters that will also be added to our web site.

Hopefully, you will find these metrics informative and helpful in understanding the results of our operations.

We have also added some additional metrics in response to suggestions made on previous calls.

These additional metrics include gross margin and deferred compensation expense.

The purpose of adding these additional metrics is to help you better understand the operating performance of our business.

And, as always, if you have additional suggestions on metrics to add or refine, please let us know and we will take those under advisement.

Our 2005 revenues of 135.2 million and our EBITDA as adjusted of 11.5 million were both within the range of guidance provided to you on our last earnings call.

We were extremely pleased with our fourth quarter EBITDA performance of 2.5 million which is at the top end of the range of our guidance.

At 33.2 million our fourth quarter total revenue performance was below our guidance range.

We are pleased with the continued growth of our on-net business.

Our on-net revenues grew sequentially quarter over quarter by 4% and our traffic grew during, carried on our network grew during that same period by 22%, indicating our continued growth and gain in market share relative to our competitors.

However, we did experience a greater than expected decline in our legacy businesses.

These are primarily our non-core and off-net businesses, which declined 1.4 million from the third to the fourth quarter.

This led to our revenue coming in below our guidance that we have previously provided.

Now, in trying to understand overall trends in our traffic and revenue, total service revenue for the fourth quarter of 33.2 million versus the 33.8 for Q3 of 2005 and 28.2 million for Q4 of 2004.

Our total service revenue for 2005 at 135.2 is a substantial increase from the 91.3 million reported for full year 2004.

And the traffic carried on our network for the full year 2005 versus full year 2004 grew by over 170%.

Most independent industry analysts project that the internet’s traffic volume in its entirety is growing at between 80 and 100% per year, indicating our continued gain in market share.

Our on-net revenue and customer connections are important metrics in understanding our growth potential and our business.

Our on-net revenues represent the true driver of growth in our business.

Our on-net revenues grew by 800,000 for the quarter or 4% Q4 over Q3, and by 35.2% of full year 2005 versus full year 2004.

Our on-net revenue increased as a percentage of our revenue from slightly below 60% in Q3 to slightly above 63% for Q4 of 2005.

We are pleased by this trend, and it is a significant factor that has contributed to our expansion in the margin.

Our on-net customer connections grew by 15% from the third quarter to the fourth quarter, again, exceeding the guidance that had previously been in the market.

Our legacy off-net customer connections did decline by approximately 2% Q3 to Q4, primarily due to the continued and slowing churn of customers that were acquired primarily from [Varium].

Our legacy non-core customer connections, these are non-access products, declined by about 130 units or about 9% Q3 to Q4.

As a reminder, we do not actively market these products and expect over time that these revenues will decline to eventually zero, as these customers eventually churn.

Total customer connections came in at just under 10,000, 9,988, as of the end of the year, an increase of approximately 400 or 4% over Q3.

Our average pricing per unit for our on-net customers did decline and there are several factors for that.

To remind everyone we had a dispute with Level 3, another major internet service provider, early in the quarter.

Level 3 had unilaterally elected to disconnect Cogent’s network from its network, causing the most severe outage in the actual history of the internet.

Level 3 quickly restored that connection, and subsequent to that the companies have entered into a long-term settlement free agreement that will ensure the continued flow of traffic.

However, in response to Level 3’s actions Cogent offered a promotion to any customer who was connected to Level 3.

In that promotion those customers could choose to migrate, terminate their services with Level 3, and move to Cogent.

We would give them free connections at their same volume level that they were receiving from Level 3 for one year.

They would then be responsible to pay Cogent for the growth in traffic that they would experience at our standard billing rate.

This resulted in over an approximately 100 customers taking advantage of this promotion.

That represented about 3% I believe of Level 3’s customer base migrating to Cogent, but this did negatively impact our ARPU in that these customers initially recorded no revenue, but we do expect that we will recognize revenue in the future going forward from many of these customers as their traffic volumes increase.

Also, we have substantially increased our sales and marketing efforts.

In this increase in sales and marketing we have focused our net centric sales force on a number of smaller accounts.

While we today serve about 220 carrier neutral collocation facilities where we serve net centric customers, we have historically focused only on the largest customers within those facilities.

We are now focusing on a number of smaller, either access providers who buy aggregated upstream capacity from Cogent or smaller content providers.

This also has resulted in a slightly lower ARPU from our incremental net centric customers that we are adding.

Our corporate customers, their ARPU remains unchanged at $1,000 per month for 100 megabyte connection, our core product.

Despite our revenue results, our EBITDA as adjusted was at the high end of our range at 2.5 million for Q4 of 2005.

This is an increase from the 2.1 million that we experienced in Q3 of 2005.

We achieved this primarily due to the gross margin expansion from additional cost reductions resulting from a smaller number of off-net customers as well as additional SG&A savings costs, primarily in our European operations.

Our first margin expanded to approximately 40% for the fourth quarter of 2005, from slightly over 36% in Q3 of 2005.

For the full year our EBITDA as adjusted was $11.5 million for 2005.

This represents an increase of $25 million in EBITDA from 2004.

As a reminder, EBITDA as adjusted includes in 2005 a onetime gain of $3.4 million in March of 2005 from the sale of a piece of real property, an office building owned by Cogent located in [Leola, France].

Now, I’d like to turn thing back over to Tad so he can go through some additional detail on our Q4 and 2005 results, as well as give you some additional color on our expectations for 2006.

Thanks, Dave.

And, again, good morning, everyone.

And I also want to thank and congratulate our Team on a very significant year for us.

As Dave mentioned, one of our most significant challenges in the second half of 2005 was completing our Sarbanes-Oxley internal control audit.

And, again, this work began immediately after the completion of our June 2005 secondary offering, and involved our subsidiaries and employees in France, Spain, Germany, and Toronto, Canada.

The work is complete and as Dave mentioned, we will be including our unqualified SOX opinion in our 10-K filing to be filed by March 14th, 2006, which is two weeks earlier than was required last year.

This project required a tremendous amount of work, and we’re very pleased with the results.

Regarding the impact of foreign currency, quarter to quarter, the Euro to dollar decline continued to impact European based revenues in the fourth quarter, with an additional 3% decline.

This was an approximate $200,000 comparable revenue impact Q3 to Q4, and as a reminder, Europe is about 20% of our total business.

As many of you may have noticed, we had an increase in depreciation and amortization expense when you look at Q3 versus Q4.

During the fourth quarter we were advised a number of lease option carries that we use in determining the number of years to amortize our capitalized building costs.

These are costs that we incur primarily constructing in the risers and buildings and where we serve our on-net customers, and these costs totaled about $35 million.

We now use fewer option periods in amortizing these costs.

As an example, previously, we would use if we had a lease with an initial five-year period and five-year subsequent renewal options we would include two of those renewal options in the amortization period, resulting in a 15-year amortization period.

We now concluded that we should use one option period so we amortize those costs over 10-years as opposed to 15.

The cumulative impact of this modification to our large appreciation schedules resulted in an approximately $4 million increase to previously expected depreciation expense during the fourth quarter of 2005 as compared to the third quarter.

Regarding loss per share and actual results versus expected results, our loss per basic and diluted common share was $0.47 for the fourth quarter and $1.97 for 2005.

The average analysts’ expectations were $0.37 and $1.93, respectively.

The difference between actual and expected is attributed to the increase in depreciation expense I just previously discussed.

Regarding capital expenditures, they were $5.2 million for the fourth quarter of 2005, just above the top end of our expectations of $5 million for the quarter.

And CapEx for total 2005 was 17.3 million, and that was in line with our expectations.

Regarding cash, debt, and our balance sheet, as of December 31st cash and short-term investments were 31.2 million.

In December 2005 we amended our credit facility.

As mentioned on the previous call, this amendment increased our borrowing capacity from $10 million to $20 million.

However, no amounts were borrowed under the credit facility during the quarter.

Our true debt remains at $10 million, which is our 7.5% [allied riser] notes that are due to be paid in June 2007.

If you look at our balance sheet that debt is shown at a discount and at $6.7 million at the end of ’05.

Our capital lease REU obligations were 92.4 million at the end of December, and 6.7 million of this was current liability.

And, again, as a reminder, these obligations have the remaining weighted average life of approximately 13 years.

Days sales outstanding or DSO for our worldwide accounts receivable did increase to 44 above our target of 40.

We were impacted by the calendar at the end of ’05 and about $2.5 million of customer cash receipts we expected in the last week of December arrived in early January 2006, and that resulted in the increase in DSO which is now back to its normal levels at the end of January and in the month of February.

Regarding operating cash flow, cash flow used in operations was 2.8 million for the fourth quarter.

That was below what we had expected, and that was directly impacted by the timing of the customer cash receipts that I just mentioned.

For the year cash flow used in operations was 9.1 million, and that’s a reduction of over $17 million from the $26.4 million used in operations for 2004.

Now, regarding Q1 2006 and 2006 annual guidance, we’re providing this based upon the current run rates of our business, including our expectations for sales productivity and the increase in our sales and marketing efforts and our revenue and cost performance expectations.

In preparing for this guidance we performed a comprehensive analysis of each of our business drivers, and we also incorporated the expected impact of the adoption of FASB 123(R) which is the requirement to expense option grants beginning in Q1 2006 and the reduction in option periods that I mentioned earlier for amortizing our building costs.

Our 123(R) expense, as a reminder, includes expensing future option grants but also the unamortized balance of the previous option grant.

So, regarding Q1, let me first walk through Q1 ’06, and then through expectations for the year of ’06.

Total revenue was expected to be between 33.5 to 34.5 million.

Regarding the components of our revenue we expect our on-net revenues to increase between 6 and 8%.

We expect our off-net revenues to decline almost 10%.

We expect our non-core revenues to decline approximately 2%.

Regarding gross margin we expect that to be at about 40%.

EBITDA as adjusted is expected to be between $2 to $3 million, as it was included in our press release.

SG&A expenses are expected to be between 30 to 33% of our revenues.

Amortization of deferred compensation which includes the impact of FASB 123 is expected to be between $4 and $5 million.

Again, this is for the quarter.

Depreciation and amortization expense, which includes the impact of reducing the option periods for the amortization of building costs, is expected to be between $14 and $15 million for the quarter.

Our interest expense net of interest income is expected to be consistent with what it was in Q4, which is about $3 million.

This results in EPS expectations of a loss of between $0.40 to $0.50, and that EPS number assumes a flat number of shares which is about 44 million shares.

The impact of FASB 123 included in the numbers above is between $300,000 and $500,000 per quarter.

Now, I’ll speak to the guidance for 2006.

As was in the press release, total revenues is expected to be between $150 to $150 million.

Regarding the components of that revenue, on-net revenue is expected to grow between 40 to 45%, and that is an increase from what we said on the previous call of 25 to 40%.

We expect our on-net revenue to increase to 70 to 75% of our total revenues for 2006.

Regarding off-net revenue, we expect that to decline 25 to 30% for 2006.

We expect our non-core revenues to decline at the same percentage, 25 to 30%.

We expect our gross margin percentage to be in the mid to high 40’s.

We expect EBITDA as adjusted to be between $20 to $22 million.

Regarding SG&A, consistent with the expectations for the first quarter of ’06, we expect that to be 30 to 33% of revenues.

We expect amortization of deferred compensation, again, including FASB 123 impact to be between $12 to $13 million for the year.

We expect depreciation and amortization to be between $62 to $65 million for the year.

Again, including the reduction in option period.

We expect interest expense net of interest income to be approximately $10 to $11 million for the year.

This results in a loss per share expected for 2006 to be between $1.40 and $1.60 per share.

And, again, that EPS, loss per share number assumes the same number of shares as were outstanding at the end of ’05, which is 44 million.

Now, I’ll turn the call back over to Dave.

Thank you very much, Tad.

Hopefully, that was helpful to everyone in giving you the detailed analysis on how we view our business, and the key drivers and trends that will be responsible for our growth this year.

As we discussed previously, as part of the use of proceeds from our secondary offering earlier in 2005, we intended to expand our sales and marketing efforts, as well as expand our building footprint.

Let me give you a quick update on where we’re at on reaching our goal of expanding our network coverage by 100 buildings.

During the quarter we added 14 buildings to our network, bringing our total to 1,040.

This is a key achievement.

We continue to be on plan to hit our 100 buildings add.

We have over 30 buildings that are in the process of being constructed and added to our network at this point in time, and we fully expect to have approximately 1,100 buildings on-net by December 31st, 2006.

Our on-net footprint is comprised of both net centric buildings, as well as corporate buildings.

Our corporate footprint today sits at about 470 million s.f. in North America.

That is out of an installed base of about 1.6 billion s.f. of central business district office space being class A, class B, and class C office space.

That gives us almost 28% of all of the CBD office space in the United States now on-net for Cogent.

I think these are important statistics in helping you understand our addressable market.

To help us focus on that addressable market we continue to ramp our sales force.

We remain on target to hit our goal of being at 130 sales reps, direct quota bearing reps, exclusive of management and sales support, by the end of the year.

We also remain extremely focused on maintaining the high productivity levels of our sales force.

We continue to exceed our expectations in achieving about 5.6 units of productivity per ramp, per month, for the quarter, and I think this is a direct response to the increased sales training programs that we have put in place, as well as our very stringent screening process as we are adding new reps.

We are today extending offers only to about one in eight qualified representatives for our sales force because we remain focused on continuing to have the best sales reps representing our Company going forward.

In the fourth quarter we began with just under 70 sales reps, 67 to be exact, and ended the quarter with approximately 90 reps.

Of these reps at the beginning of the quarter roughly 47 were fulltime equivalents.

At the end of the quarter about 61 were full time equivalents.

We, as of March 1st have 97 direct quota bearing sales reps, with approximately 70 fulltime equivalents.

We believe that these resources will help us continue to grow our on-net business, as well as continue to help us abate the churn in our off-net business.

Our growth in traffic at 22% sequentially quarter over quarter is a direct result of the sales efforts of the team, as well as our revenue growth of 4% sequentially quarter over quarter.

In looking at the competitive landscape, Cogent remains committed to being the low cost provider and this strategy, I believe, is a direct contributor to our ability to gain market share.

Our prices remain constant at $10 per megabyte.

We have seen average market pricing today at about $50 per megabyte, and it is this price differential that has, in part, contributed to the productivity of our sales force.

As Tad presented earlier, we have laid out our goals and our expectations for 2006.

We believe these are realistic, achievable, and are absolutely a result of the value proposition that we give to our customers.

As a reminder, these goals do not contemplate any merger or acquisition activity during the year.

We currently have no discussions that are advanced on any merger or acquisition activity at this point in time.

So, in summary, our on-net revenue, our growth business, continues to increase as a percentage of our revenue, ending the quarter at over 63% of our total revenue.

Our network remains substantially with idle capacity that can continue to accommodate growth as we continue to add customers and, or existing customers continue to utilize our network more extensively.

We have been successful in, hopefully, increasing the liquidity in our securities by moving to the NASDAQ national markets from the AMEX.

We’ve revised our business plan to reflect the realities of our legacy off-net business, and our margins continue to expand as our on-net revenues grow, really demonstrating the operating leverage of our growth business on a going forward basis.

With that, I’d like to now open it up for questions from the floor.

Sylvia, if you can perhaps open the question line.

[CALLER INSTRUCTIOINS.]

And at this time, sir, we show no question registered from the phone line.

Tad, you must have done such a great job here in terms of being complete.

[CALLER INSTRUCTIONS.]

And we show no question registered, sir.

Okay.

Maybe we’ll wait one more minute and see if anybody has anything, and, if not, we’ll be able to adjourn.

[CALLER INSTRUCTIONS.]

At this time, sir, we have no questions registered.

Okay.

Well, we can now adjourn the call.

I’d like to thank everyone for taking the time.

Thank you very much.

Ladies and gentlemen, this concludes the conference call for today.

Thank you for participating, and we ask that you please disconnect your lines.