Cogent Communications Holdings Inc (CCOI) 2006 Q2 法說會逐字稿

Good day, and welcome everyone to the Cogent Communications Group second quarter 2006 earnings results conference call. This call is being recorded and will be available for replay at www.Cogentco.com. With us from the company is Chief Executive Officer, Mr. Dave Schaeffer and the Chief Financial Officer, Mr. Tad Weed. At this time I would like to turn the call over to Mr. Schaeffer. Please go ahead, sir.

Thank you all for offer joining us today and good morning. Welcome to our second quarter 2006 earnings conference call. I'm Dave Schaeffer Cogent's Chief Executive Officer. With me this morning on the call is Tad Weed, our Chief Financial Officer. We are extremely pleased with the results of the quarter, and I again would like to take the opportunity to thank the entire Cogent team, in particular our sales team, for their efforts this past quarter that have resulted in the Company achieving all of its objectives. Throughout this discussion we will continue to focus on the results of our On-Net business, which is the growth sector of our Company and our business. As a reminder our On-Net services are provided to customers located in buildings that are physically connected to the Cogent network.

We will also highlight several operational statistics that we believe will demonstrate our expanding scale and tremendous operating leverage in the business. I will start the call today with a review of certain operational highlights. Tad will provide some additional details on our financial performance for the quarter and walk you through the expectations for our third quarter 2006 and our updated expectations for fiscal year 2006. Following our remarks we will open the call up for questions and answers. Now I would like to turn things over to Tad to read our Safe Harbor language.

Thanks, Dave, and good morning to everyone. The second quarter earnings report and earnings conference call to discuss Cogent's business outlook 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 third quarter 2006 and fiscal year 2006. These particular forward-looking statements and all their 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 our supplement statements made on this call. Also during the call if we use any non-GAAP financial measures as defined by the SEC in regulation G, you will find these reconciled to GAAP measurements either in our earnings release or on our website at Cogentco.com. Now I would like to turn the call back over to Dave.

Thank you, Tad. Hopefully you've had a chance to see our earnings press release. As with in previous quarters the press release includes several historical quarterly metrics that will help you understand the performance of the business. These metrics will also be added to our website. Hopefully you find these metrics informative and helpful in understanding the results of our operations. As always, if you have suggestions for additional metrics you would like to see added or additional refinements in these metrics, please let us know either on this call or drop us an email.

Our second quarter 2006 revenue of $36.2 was above the top end of the range of our revenue guidance of $35 to $36 million provided to you on our previous earnings call. EBITDA of $4.5 million was at the top end of the range of our second quarter guidance which was between $3.5 and $4.5 million. Our gross margin percentages continue to improve, gaining over 350 basis points going from 41% to 44.5% from Q1 2006 to Q2 2006. This sequential growth I think demonstrates the operating leverage in our business. We are very pleased with the continued growth in our On-Net business.

Our On-Net revenues grew by 10.8% sequentially Q1 2006 to Q2 2006. Our unit growth of about 14% also demonstrates our continuing growth in our On-Net business. Our continuing diligent investment in our sales and marketing efforts and the network expansions are leading to our gain in market share and driving the increase in our On-Net revenues. The operating leverage of our On-Net business is driving our EBITDA expansion and gross margin expansion. Total service revenues for Q2 2006 were $36.2 million versus $34.4 million for Q1 2006, a 5% increase. Traffic increase on our network grew sequentially approximately 14% Q1 2006 to Q2 2006. We believe that this growth in traffic continues to demonstrate that being a low-cost provider and an industry price leader is helping us continue to gain market share and leverage our On-Net assets. Our On-Net revenues grew by $2.5 million or 10.8% sequentially Q1 2006 to Q2 2006. This growth rate increased from the 8.1% sequential growth rate we experienced in the previous quarter of Q4 2005 to Q1 2006.

Our On-Net revenues continue to increase as a percentage of our total revenues, growing from 66% of our total service revenues in Q1 of 2006 to almost 70% of our revenues in Q2 2006. On-Net revenue or On-Net customer connections grew by 15% quarter-over-quarter, growing from approximately 5300 to nearly 6000 by the end of Q2 2006. As expected, revenue from our legacy Off-Net businesses declined at about 5.8% for the quarter. We experienced total customer connection growth, taking our total customer connections to over 10,600 by the end of Q2 2006. Our pricing policies remain unchanged. We are committed to being an industry price leader, pricing for our most widely sold product 100 Mb for $1000 a month or $10 a megabit remains intact.

Our On-Net customer connection growth of 15% exceeded our revenue growth of 10.8%, primarily due to our focus on smaller service provider and NetCentric customers. Our On-Net ARPU of approximately $1480 for Q2 2006 versus $1525 for Q1 2006 represents a decline of less than 3%. This decline was lower than the rate of decline that we experienced sequentially in the previous reporting period of Q4 2005 to Q1 2006. This change in our net ARPU is attributed partially to a larger sales force being able now to focus on some smaller opportunities and customers who consume less bandwidth. Our Off-Net ARPU was approximately $810 for Q2 of 2006 versus the $795 for Q1 2006, a slight increase of about 1.5%.

This change in Off-Net ARPU is due to two factors; one the fact that the Company has cycled through the majority of its repricing exercise that was necessary for the acquired customer base that we had acquired from Verio in December of 2004, the majority of those customers having one year contracts, having now been totally repriced. And secondly, a trend in the market that even for our Off-Net customers a T1 in many situations is insufficient bandwidth, and we're selling a greater percentage of T3 or higher capacity connection. This has resulted in a slight uptick in that Off-Net ARPU.

EBITDA was $4.5 million for Q2 2006, a 35% sequential quarter-over-quarter growth from the $3.3 million that we experienced in Q1 2006. EBITDA increase largely due to gross margin expansion, which is being derived from the increasing percentage of our business that is coming from our On-Net services. Our incremental On-Net gross margins continue to be nearly 100% with no direct cost of goods sold with incremental EBITDA margins in the On-Net business of approximately 95%. Again demonstrating the operating leverage of our business model and our position as a low-cost leader.

Tad will now cover some additional details related to our Q2 2006 results and some of our expectations for Q3 2006 and finally the remainder of 2006 fiscal year.

Thanks, Dave, and again good morning to everyone, and I would also like to thank our team on their hard work and performance this quarter. On loss per-share our loss per basic and diluted common share was a loss of $0.34 for the quarter compared to $0.38 for the previous quarter, an improvement of $0.04 per share. Our weighted average shares outstanding increased by 1.3 million shares from 43.8 million for the first quarter to 45.1 million for the second quarter. As many of you know on June 7, 2006 we closed a secondary offering of 4.35 million shares. Those shares including the exercise of the green shoe. The offering resulted in net proceeds of $36.5 million and as a result of the weighting of the shares from the 4.35 million shares in the offering that increase weighted average shares for this quarter about $1.1 million. And lowered the loss per share by about $0.01 for the quarter. As of June 30, we have 48.5 million common shares outstanding.

On statement 123(R) which is the requirement to expense stock options which we adopted on January 1, 2006 that increased the Q2 net loss by about $130,000 and that was similar to the amount we recorded in the first quarter. On foreign currency the Euro to dollar impact positively impacted Q1 to [Q 6] comparable revenues by about 300,000, the average euro to dollar being about $1.20 in Q1 and about $1.25 in Q2. And as a reminder approximately 20% of our revenues are based in Europe.

On capital expenditures we added more buildings than plan during the quarter of 23 buildings to the network in the second quarter, which is 10 more than our average of approximately one per week being 13 for Q2. The additional buildings largely attributed to the increasing CapEx which was $7.1 million for the second quarter. We continue to expect to average about $5 million a quarter or $20 for the year. Though largely the increase over the $5 is attributed to the additional buildings added to the network during the quarter. We do experience some seasonality in construction activities. For example the fourth quarter construction is typically less than the third quarter. We do expect to continue to average, however, about one building a week to the network and are committed to the 1100 buildings on the network at year-end. At the end of the second quarter we had 1076 buildings on the network.

On cash, debt and the balance sheet at June 30 our cash and short-term investments were $54.8 million, during the quarter net cash increased by $33.6 million, and that includes the net proceeds of the offering of $36.5 million would have been a use of cash of $2.9 million for the quarter without the proceeds from the offering. We have a $20 million credit facility that was unused during the quarter. Our true debt remains at $10 million. They are 7.5% interest-bearing Allied Riser notes that are due in June 2007 and you may note that is now classified as a current liability because they are due in less than one year.

Capital lease IRU obligations were $89.7 million at June 30, and about $6.2 million of that amount is a current liability. And as a reminder these obligations will be paid out over a weighted average life of about 13 years.

Days sales outstanding on accounts receivable was 46, which is above our target of 40 days, some collections we expected in June arrived in July. However, for July we experienced record cash collection of over $14 million, and our DSO is now below the target of 40. That's $14 million in cash and about a $12.5 million monthly billing run rate currently. On operating cash flow despite the less than expected customer collections for the quarter we are operationally cash flow positive for the quarter and each month in the quarter. Positive cash flow from operations was $4.9 million for Q2. That is a significant $6.5 million improvement from the $1.6 million of cash used in operations in the first quarter; the improvement is attributed to an increase in EBITDA and working capital management on the AP side.

On our 2006 guidance we are reaffirming our 2006 guidance provided to you on our last call and as outlined in our press release. However, largely due to the increase in shares outstanding from the offering we are updating our expected net loss per share to account for those additional shares. Up dating 2006 EPS net loss guidance to be between $1.30 and $1.45 per share, previous guidance was $1.40 to $1.60 per share.

EPS for 2006 now assumes 46.6 million weighted average shares outstanding and weights the 4.35 million additional shares from the June 7, 2006 closing date. That adds about 2.5 million shares to the average for the year.

On Q3 2006 guidance we are providing for the first time, which is based upon the current run rates of our business and our expectations for sales rep productivity and the planned increase in our sales and marketing efforts including hiring additional sales reps and network expansion activities that are planned. We expect total revenues to be between $37.5 and $38.5 million for Q3. The components of that revenue, On-Net revenue growth of approximately 10%, Off-Net revenue decline of approximately 5% and noncore revenue decline of approximately 10% and these are the sequential revenue percentage expectation. Gross margin is expected to expand to be between 45% to 46%. EBITDA for Q3 is expected to grow to be between $5.5 to $6.5 million.

SG&A is expected to be between 30% to 33% of revenues. This amount excludes equity based compensation expense including 123(R) which is classified as SG&A on the face of the 10-Q and those amounts are separately disclosed on the face of the 10-Q in the parenthetical and also easy to see on the table we provide on our press release. That amount that was classified as SG&A expense for the second quarter was $3.3 million. Equity based compensation expense which includes 123(R) is expected to be about $3.5 million for the third quarter. That is total, and depreciation amortization expected to be about $15.5 million for Q3. This results in EPS loss of about $0.30 to $0.35 per share, and that EPS loss assumes 48.5 million weighted average shares outstanding. That increase from Q2 was due to the fact that these shares from the offering outstanding for all of Q3 as opposed to being prorated for Q2.

I will now turn the call back over to Dave.

Thanks, Tad, and again well done for the quarter. We added buildings to our network, 23 buildings in the quarter compared to the 13 buildings that we added in Q1 of 2006. We remained very focused on going after only the most traffic rich targets as we add those buildings to our network, and we try to take advantage of the seasonality advantages of accelerating our construction in Q2 and in Q3, really understanding that in the fourth quarter we will probably have lower capital expenditures due to some city moratoriums that will slow our construction efforts.

We ended the quarter with 1076 buildings. We have 15 buildings that we anticipate coming On-Net over the next quarter, about 22 buildings total in progress at this point in time. And we firmly believe that we will meet our goal of 1100 buildings On-Net by the end of the year. As of August first, we had 116 sales reps. These are actually direct quota bearing reps. We began Q2 with 100 reps and ended the quarter with 103 reps. We remain vigilant about managing out underperforming sales reps and remain very focused on sales force productivity. That productivity was at 5.2 orders per rep per month for the quarter. This was slightly below the previous quarter of 5.6 but still ahead of the Company's plan and goal of 5. That resulted in us managing out some of those underperformers towards the end of the quarter and accelerating our hiring efforts. We do remain absolutely committed and firmly believe that we will achieve our objective of 130 quota bearing reps by the end of the year.

Our full-time equivalent reps added over 5.6 orders per rep per month. We believe that these additional sales resources and the growth in traffic in our network will allow us to continue to achieve our revenue and profitability plans going forward. We continue to expand our footprint and the scale of the network. These expansions included extensions of the long haul network into Milan Italy, Zurich Switzerland, Montreal Canada and Stockholm. We now have over 9600 miles of metropolitan fiber, and we have over 23,000 miles of intercity fiber routes in service. We are directly connected to over 1950 networks around the world, approximately 390 of these networks are settlement free peers and about 1560 of these networks are Cogent customers who are buying upstream connectivity from Cogent.

We continue to believe that we have substantial operating leverage as we have sufficient idle capacity in our network to allow us to continue our growth for the foreseeable future. In summary, traffic growth continues on our network at paces that are better than that of many of our rivals demonstrating that we are gaining market share. We have expanded our shareholder base and strengthened our balance sheet with our recent secondary offering. Our On-Net revenue growth, that is the growth business of the company, continues to increase as a percentage of total revenue and growth is increasing at an increasing rate. These are all very positive trends.

We continue to see gross margin expansion and EBITDA margin expansion demonstrating the operating leverage of our On-Net business. These are all positive signs that demonstrate that the Internet continues to grow and Cogent continues to capture an increasing percentage of that growth. I would now like to open the floor up for questions.

(OPERATOR INSTRUCTIONS) Kevin Moore, KM Moore & Co.

Good morning, Dave. As you talked about the mix going to smaller customers can you give us a sense of what type of customers those are? Are those sort of people who have been around a while or they sort of emerging customers that have been enabled by your lower price points?

You know I think it is a combination of both, Kevin. We as a senior management team get alerts many times during the day, each time a customer is turned up. I have to admit many of our customers who are today household names are people that at the time they were turned up we never heard of. And many of them start with very modest amounts of bandwidth. These are people like YouTube or MySpace that today use tremendous amounts of bandwidth. With a larger sales force what we've been able to do is in the NetCentric portion of our business go after smaller hosting companies, smaller regional distribution networks, some of them have been around quite a while and probably will not experience the meteoric growth. They are small and will remain small.

Others are new business models that are constantly being invented and many of them will fail but many of them will become the next success stories of the next upcoming quarters. And I think our aggressive price point allows companies to come in and try new business models that they could not do at higher price point. So we capture a disproportionate share of new entrants into the market, and I will fully admit many of these entrants will not have kind of the meteoric success but we also will incubate businesses that will become bandwidth leaders.

We also see that some of our larger well-established media companies start with really modest connections and as they move more of their content to the Internet, they start to increase their bandwidth purchases from us. There we obviously don't want to risk these companies going away, but they all are searching for profitable business models. But all of this has resulted in us being able to go after with enough sales resources a lot of these smaller players that previously we just didn't have enough feet on the street to call on.

Thank you.

Michael Bowen, Friedman, Billings, Ramsey.

Good morning, Dave. Good morning, Tad. A couple questions for you. First of all, with regards to the Off-Net ARPU last quarter I think you had also said that there was stabilization from the T3 service and it sounds like this quarter with the Verio customers now completely being repriced, should we now assume that we are still going to see some degradation going forward in the ARPU? And then I have a follow-up.

I think the answer is we believe that there will be some degradation. We quite honestly for the last couple quarters have been a bit surprised that the two countervailing forces have worked against each other but actually bandwidth demand from larger Off-Net customers has more than compensated for whatever price erosion we see in the T1 business. So we are getting a greater mix of new sales being T3. A T1 is a 1.5 Mb connection. A T3 is a 45 Mb connection, and on an Off-Net circuit there's really nothing in between. People either by a couple of T1s or they move right to a T3, and we've experienced an uptick in those T3 sales that have more than offset the price reductions that we've seen in the T1 business. So the average size of these connections has actually increased. I think long-term that trend will continue. We, however, do not have perfect visibility into whether or not that will continue to overwhelm the downward pressure on T1 pricing. So I think for modeling purposes it is probably safe to assume that there should be some ARPU erosion, and we will be thankful if we can surprise to the upside there.

The Company's internal budget and plan does not assume that there will be an increase in Off-Net ARPU. It is just the contrary. It assumes that T1 ARPU pricing will decline at a moderate pace.

I figured that. I just figured since this had ticked up I wanted to make sure our model we show a degradation going forward. So I think we will keep that at this point. And the second and third question would be in the fourth quarter last year, it looked like to me if my data is correct you added about 14 new On-Net buildings. You mentioned that there is a moratorium on construction in some of the cities. Is that something, it almost sounds like now you're going to have fewer buildings brought online this fourth quarter than you did last year. Is this just city specific, or is this something that happens typically every fourth quarter?

It is city specific, Michael, in the sense that for example New York does not allow construction between Thanksgiving and January 15th. Philadelphia and DC have similar moratoriums. Looking at the funnel of desirable buildings to add and also kind of taking advantage of kind of favorable construction conditions, we decided to accelerate our efforts in the second quarter that did result in a larger capital expenditure. But we still feel comfortable that the average pace of one a week is right. We may beat that a little bit this year, but I think every year it really depends on the mix of locations, but it will slow down a little bit in fourth quarter.

And then just lastly as you move into '07 and you move beyond the 1100 buildings and you think about life beyond 130 reps moving to that potential 180, how should we think about you managing the number of sales per rep per month, and how do you -- how will you think about that with regard to your opportunities as we move to higher numbers of buildings with higher numbers of reps?

We remain very disciplined about how we deploy capital. We believe that the Cogent business model is not one network ubiquitously. We need to be very focused on deploying that capital at those locations that have the greatest revenue opportunity. We have a sufficient universe in place of target that we feel very comfortable that in 2007 we will continue to achieve at least one building a week of net additions to the network and still have some additional opportunities in front of us. We don't see any reason though, however, to accelerate that. With regard to the sales force growth we've been very judicious about putting those reps on and maintaining that productivity. As I said, our internal plan anticipates five units of sales per rep per month. We've beaten that plan for the last couple of quarters. We hope to continue to beat that. You can see in the relatively small growth in net number of reps between beginning and of Q2 we've remained committed to taking out underperforming reps. And we are back up to 116 reps as of August first.

We've got a very robust hiring and training funnel in place so we feel very comfortable that we will meet or exceed the 130 that we've set by this year and the 180 by next year, and we think there is enough addressable market out there. But what we're not going to do is higher reps and see any kind of erosion in that productivity below five units per rep per month. And if that means higher turnover, so be it. We are trying to improve our training efforts, and we absolutely believe that there is sufficient addressable market and our price points still are far below that of our competitors, as virtually all of our competitors have publicly announced that they have ceased price reductions and some have actually said they are raising prices. We won't tolerate the excuses from the sales force that they are not hitting their quota because of price differentials. So we think there's plenty of headroom here.

Nice quarter. Thanks, guys.

Nick Netchvolodoff, Lehman Brothers.

Quick question about you mentioned the funnel of desirable buildings. Can you talk about what the mix of buildings is going to be to the end of the year and which markets you're moving into and kind of -- I guess the demographics of those buildings or whatever word you want to use to describe how the new buildings compare with your existing base.

If you look at the buildings in our funnel, roughly 75 to 80% of the buildings are corporate end-user buildings, about 25 to 20% of the funnel are data centers, carrier neutral data centers. Examples would be Equanex has recently gone through an expansion program buying some additional data centers that were previously data centers but had been dark for a number of years. As they are adding those centers to their network, we are then adding our connectivity to those centers. And we are seeing that trend in California. We're seeing that trend in Europe. We are seeing it in the central part of the country particularly in Texas, we are seeing some centers that had been dark for several years being relit and customers committed to those facilities. We then bring our network in to serve those customers.

On the corporate building side we ended the quarter with a little over 465 million square feet out of an installed base in North America of about 6.2 billion square feet. We're about 7.5% of the total office-space market in North America. As we add corporate buildings we tend to focus on buildings that are probably equal or slightly larger than our average today which is about 570,000 square feet, so many of the buildings we are adding are north of one million square feet. There are a few in New York. We recently added a group of buildings in Chicago, north of the river like the IBM building, the AT&T, its just called that, actually AT&T is not even in the building, and the NBC Tower are examples in Chicago of some very large million square foot plus trophies that we've added. I think in the funnel yesterday I just saw 277 Park in New York which is 1.6 million building coming on. So they tend to be these very high-profile large buildings, and we've also sees some buildings that had previously been passed by Cogent because they were single tenant or they had only a few opportunities, that major tenant has left the building and now it is becoming more of a multitenant opportunity and therefore fitting our model better.

And how does the cost -- you've said in the past it is about $120,000 to add a building. How does the corporate cost to add a building compare to the data center cost and are those coming down or is it just sort of stable?

It's relatively stable. If anything I would say it probably goes up almost with inflation because most of the effort is construction related. It is not equipment where there is deflationary pressures, but rather it is back hoe work or inside plant work. There's a great deal of variability depending on what market its in and the union requirements within that market. Cities like New York and Chicago tend to be more expensive than say a Houston or a Miami. Europe, the Spanish and Italian markets are a little less expensive to work in than the German or French markets. So there is a great deal of variability, but that 120,000 is a good number, and in terms of the corporate versus NetCentric type buildings or data center buildings, the corporate buildings require more expenditure on inside plant work, meaning riser work and generally are closer to the ring. Some of the carrier neutral facilities that we are adding tend to be further from the ring and require more outside plant work. So the average remains about the same, and the mix of buildings as well as that 120 should remain constant through the end of '07.

Thanks, guys. Good on the background.

Juergen (indiscernible), Wachovia Securities.

Thank you very much. How are you guys this morning? Just maybe you can comment on your traffic a little bit. I know when one of your competitors last week reported flat quarter-over-quarter traffic. I know they blamed one time a customer migrating away from their network, but they are also blaming on seasonality and maybe you can just comment on that, whether you saw that (indiscernible) impact as well in your traffic this quarter. Thanks.

As we stated, our traffic grew sequentially quarter-over-quarter at 14%. That again represents a very healthy growth rate when compared to the Internet in its entirety and some of our competitors. There is some seasonality to new sales. Typically you see in December and in August a lower sales productivity than in other months due to people's vacation and holiday schedule that is particularly true in Europe, probably a little bit more than North America where business is a little more even. But in terms of traffic usage we actually have a fairly large exposure to the university community serving over 450 university clients. And if anything we would see more of an impact in third quarter then you would see in second quarter and that people were in school most of the time. So I don't buy flat growth and blaming it on seasonality. We've got now I guess 21 or 22 successive quarters of reporting and have shown traffic growth each and every one of those quarters with no great seasonal variation.

Moving on to your On-Net growth on a year-to-date basis the revenue has been growing about 29%. Now you're guiding towards [40], 45% for the year which implies about 52% growth in the second half of the year. That seems to be quite an increase that I'm assuming that maybe I think you guys would be okay with your guidance.

We are absolutely fine with our guidance. We are adding additional people, and that results in additional On-Net growth. Also if you look at it Q4 '05 to Q1 we did about 8.1% growth off of a larger base Q2, Q1 to Q2 '06 we did almost 11%, 10.8, and the great news is compounding really does matter, and we feel very comfortable again with that 40 to 45% year-over-year growth number that we laid out. And to get there we probably wouldn't even need to see any acceleration; yet in fact we have seen acceleration from previous quarters to this quarter.

And if I do, I suggest some calculation, it looks like you guys are doing about 700 to $720,000 on monthly sales, and I'm assuming that I guess in the coming months that is an increase significantly to get to that guidance of yours.

Juergen, I think the metrics to use are the addition of the sales reps and using a full-time equivalent calculation of a new rep count as zero the first month and then fully up to speed in the fourth month. We expect at least five sales per month with an 80%, 20% mix On-Net and Off-Net with a slight decline is the plan quarter-over-quarter in ARPU and to have us at 130 sales reps by the end of December. And as we said we are at 116 now. So with those metrics, that is largely what is driving the revenue growth.

And one last question, in the last quarter you guys get sequential growth expectations for the second quarter. I do not recall you guys giving the same kind of guidance for the third quarter on the segment basis.

I believe it is actually inferred in our press release, if you take a look at that. We absolutely do believe that we will continue to see a greater percentage of our revenue being derived from our On-Net business. We see that On-Net business sequentially growing better than 10% quarter-over-quarter with the sequential decline in the Off-Net business and the noncore businesses of probably about 10% in the noncore and about 5% in the Off-Net businesses.

Juergen, my cheat sheet here for the second quarter guidance was On-Net growth of 10%, Off-Net decline of 10, and noncore decline of 10 and the range of 35 to 36. I think we exceeded the On-Net of 10 at 10.8 and then did slightly better on the declines as well and then we are outside the top of the range at 36.2.

Okay one final question, I promise. I look at your cash flow statement it looks like you guys have a favorable list on currency exchange this year versus last year you had a variable change. Do you build this into your EBITDA guidance the impact of currency exchange?

We definitely do, and again, our percentage of revenues that are in Europe are approximately 20%, that has remained relatively constant. Before we provided updated guidance for '03 and reaffirmed '06 we update our plan with the current trends and see where we expect to be. The original target for U.S. dollar to Euro was about $1.20 and as we indicated it was about $1.25 for the second quarter.

All right. Thank you. I appreciate that help.

James Breen, Thomas Weisel.

Good morning, guys. Just a couple quick questions. One, you've talked a lot about kind of plans in terms of going into buildings. I was wondering if you can talk about the economics of the buildings and kind of free cash flow breakeven standpoint on average. When you enter a building how long it takes to build out and then once you actually start selling to the building how long it takes to be at free cash flow positive. And secondly just wondering if you had any thoughts on the XO announcement about relaying some fiber. Thanks.

Let's start with the building economics and timeline. From the point in time that we identify a building that we wish to go into and we actually light it, on average it takes close to a year. The reason is there needs to be a license agreement entered into with the building owner. There needs to be a construction plan put together. There is permitting issues that in many cases require governmental review, and there is a great deal of variance. There are some places where you can move very quickly; others can stretch out, and it is very geographically specific. In terms of those economics, the average buildings about $120,000. That money is spent over that period of time from initiation to actual construction. But really the bulk of the money is spent once we actually get the green light from the city to go forward and do that outside plant and in many cases we actually have to get permits for inside plant work as well. Some cities don't but most do require that.

In looking at the buildings, we have kind of two different dynamics. On the carrier neutral facilities we today have an embedded base of about 14 to 15 customers per facility. Those customers, if you look at our On-Net ARPU of about $1500 roughly get us to cash flow breakeven pretty quickly, and it is probably about a 12 to 18 month ramp until we get to that breakeven point. On the corporate buildings it tends to be a little bit longer; the sales cycle takes a little longer. Our penetration rates are a little lower. The stickiness, however, of those customers more than compensates for that. The customers tend to churn less in the corporate buildings, and there is a greater I think overall potential opportunity. So there we are probably at the 18 to 24 month type breakeven, so we kind of try to think about buildings as we add them and roughly about 18 months to try to get to incremental cash flow breakeven. And that is not really allocating anything to the backbone simply because we have so much idle capacity.

To your second question about XO, they are actually lighting fibers that they had purchased under an IRU and are competing in a market segment that is different than one that we compete in. Cogent does not sell point to point transport. We don't sell wavelengths, we don't sell SONET or SDH services. What they lighting and selling is high-cap point to point services in direct competition with companies like Global Crossing, Broadwing and Level 3. We use all of our bandwidth for Internet connectivity. We are an all IP company operating at layer 3, meaning we don't sell just the bandwidth. We sell the bandwidth coupled with the router, coupled with the piering, coupled with the interface to the customer, it is a complete bundle solution where what they are selling is basically point to point connectivity. Our belief is that that market is today and has been for some time, over capacity supplied and XO's entry into that market just further exacerbates the problem because there are too many providers and more importantly not enough potential customers.

If you look at the addressable market there is a very limited universe of people that want point to point high-caliber services whereas the universe of organizations that need Internet connectivity is much larger. And for that reason Cogent has always focused on Internet connectivity as the way to maximize the value of its bandwidth.

Thank you very much.

At this time I would like to turn the conference back over to Mr. Schaeffer and Mr. Weed for any closing remarks.

Again, we thank everyone for their attention and time. We are available for follow on questions. We will be speaking at the RBC conference I think tomorrow. Obviously happy to answer additional questions, take input on our press release, and finally I would like to just thank the entire team for growing the business and delivering some great results.

Thanks to everyone for being on the call today and your interest in the Company and your support.

Take care.

That does conclude today's conference. You may disconnect at this time.