Cogent Communications Holdings Inc (CCOI) 2010 Q3 法說會逐字稿

Good day, everyone, and welcome to the Cogent Communications Group, Inc. third-quarter 2010 earnings conference call and webcast. Today's call is being recorded and will be available for replay at www.cogentco.com.

At this time, I'd like to turn the call over to Dave Schaeffer, Chief Executive Officer. Please go ahead, sir.

Thank you and good morning to everyone. Welcome to our third-quarter 2010 earnings conference call. I'm Dave Schaeffer, Cogent's Chief Executive Officer. With me this morning is Tad Weed, our Chief Financial Officer.

We are extremely pleased with our results for the quarter in an improving but still challenging economic environment. Our revenues grew from the second quarter, sequentially, by 3.7%, and on a constant-currency basis, our sequential quarterly revenue growth was 3.5%. Our EBITDA margin expanded sequentially from the second quarter by 110 basis points.

During the quarter, traffic on our network grew sequentially by over 5% from the second quarter of 2010 and over 35% from the same quarter, Q3, of 2009. Since the end of the second quarter of 2010, we have significantly expanded our footprint by adding an additional 36 buildings to our network, and we also added over 1200 metro fiber miles to our network.

During the quarter, our sales rep productivity grew by 2.4% from the prior quarter. Our sales rep productivity increased from 4.2 units of install business per month per rep to 4.3 units of installed business per rep per month. We continue to be optimistic about our outlook for both the remainder of 2010 and for full-year 2011, and we are encouraged by our results and the high level of our order backlog.

These are orders signed but not yet installed in our network. Throughout this discussion, we will highlight several operational statistics that, we believe, indicate our increasing market share, expanding scale, the size of our network and, maybe most importantly, the increased leverage in our business model.

We have assembled a unique set of assets, infrastructure and operations that efficiently generate cash while selling products that demand is continuing to grow rapidly for.

We continue to believe there is a significant barrier to entry for anyone trying to replicate the assets and network that we have assembled here at Cogent, and we are the lowest-cost, most efficient operator in the sector, focused on delivering service to the most revenue-rich locations, which we then bring on-net.

I will review in greater detail certain operational highlights from our continuing operations, as well as our expansion plans. Tad will provide some additional color on our financial performance. Following our remarks, we will open the floor for questions and answers. Now (inaudible) our safe harbor language.

Thank you, Dave, and good morning, everyone. This third quarter 2010 earnings report, and this earnings conference call to discuss Cogent's business outlook may contain forward-looking statements within the meaning of Section 27A and 21E of the Securities Act. Forward-looking statements are based upon our current intent, belief and expectations.

These forward-looking statements and all other statements that 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 can 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 statements made today, or otherwise update or supplement statements made on this call. Also during this call, if we use any non-GAAP financial measures, you will find these reconciled to the GAAP measurements in our earnings release and on our website at cogentco.com.

Now I would like to turn the call back over to Tad.

Thanks, Tad. Now for some highlights of our third-quarter results. Hopefully you've had a chance to review our earnings press release. As within previous quarters, our press release includes a number of historical quarterly metrics. These metrics will be added to our website. Hopefully, you find the consistent presentation of these metrics informative and helpful of understanding the financial results of our business, as well as the trends from our operations.

Our third quarter 2010 revenue was $66.8 million, an increase of 3.7% sequentially from our second quarter 2010 revenues and an increase of 10.9% from our third quarter 2009 revenues. On a constant-currency basis, our third-quarter 2010 revenues sequentially increased 3.5% from the second quarter of 2010, and our increase on a year-over-year basis from Q3 2009 was 13.1%.

Fluctuations in foreign currency materially impact our revenues, in particular, our NetCentric revenues. About 30% of our revenues are derived from our international operations. From Q2 2010 to Q3 2010, foreign exchange rates positively impacted our revenues by approximately $100,000, however, when comparing Q3 2009 to Q3 2010, fluctuations in foreign exchange negatively impacted our revenues by over $1.3 million.

We evaluate our revenues based on product class, that is, on-net, off-net, and non-core, which Tad will cover. We also evaluate our revenues by customer types. Our customer types include two major groups. Our NetCentric customers, who typically buy service from us and carrier-neutral datacenters, and our corporate customers, who purchase service from us in multi-tenant office buildings.

NetCentric customers tend to purchase larger amounts of bandwidth than our corporate customers. Revenue from our corporate customers grew, sequentially, 5.5% from the second quarter of 2010. Our corporate customers represent 57.8% of our total customer connections at the end of the quarter and 50.1% of our Q3 2010 revenues. Our corporate customer connections sequentially grew by 3.3% for the quarter.

Revenue from our NetCentric customers grew by 2% from the second quarter of 2010. our NetCentric customers represent 42.2% of our total customer connections at the end of the quarter, and represent 49.9% of our total revenues.

Our NetCentric customer connections grew sequentially by 2.4% for the quarter. Now, for some overall trends and highlights, and we'll start by talking about pricing and provisioning. Pricing for our most widely-sold corporate customer product is $800 per month for a 100 megabit symmetric connection, or $8 per megabit, typically sold on a two-year contract. We continue to offer discounts related to contract term, as well as volume discounts for our NetCentric customers.

We offer these discounts, and many of our customers, particularly our NetCentric customers, took advantage of these discounts. During the quarter, over 960 NetCentric customers took advantage of these volume and term discounts and entered into longer-term contracts with us. These contracts increased our average contract term again by another 2.3% sequentially for the quarter. These discounted NetCentric customer contracts contributed to a 4.4% reduction on the average price-per-megabit in our install base.

The price-per-megabit declined from $5.17 in the second quarter of 2010 to $4.94 at the end of the third quarter of 2010. The price-per-megabit for new contracts signed in the quarter is $3.65, down from the $4.02 in Q2, in part as a result of some of our promotional pricing, which we discussed on the last earnings call.

Now, for the ARPU. Our on-net ARPU, this is Avenue Revenue Per User, declined by 2.1% in the second quarter, which was a moderation of the rate of decline of 4.2% from the first quarter of 2010 to the second quarter of 2010. Our on-net ARPU was $898 in the second quarter and $879 in the third quarter of 2010.

Our off-net ARPU continued to increase, and an increased by 6.1% sequentially from the second quarter of 2010, as the average size of our typical off-net connection continues to increase, primarily as a result of the availability of the off-net Ethernet services. Our off-net ARPU increased from $1327 in Q2 of 2010 to $1407 in the third quarter of this year. Now, to discuss churn a little bit.

Our on-net and off-net churn increased slightly in the quarter as we entered into a large number of amended moved/adds and changed customer contracts for our on-net customers in the quarter. As a reminder, we consistently report our churn numbers on a gross basis, which includes moves/adds and changes. As a result, a customer who remains with us but enters into an amended contract of greater volume or longer term will be counted in our churn rate.

Our on-net churn rate was 2.6% for the third quarter, as compared to 2.3% on the second quarter. Excluding the increase in moves/adds and changes, our on-net churn was stable, actually, at 2.4%, and our off-net churn rate was 2.9% for the third quarter, as compared to 2.7% in the previous quarter.

Before Tad provides some additional details on the quarter, I would like to address our expectations against our longer-term revenue targets. As a reminder, we had previously announced that we expect our top line revenue growth to be between 10% and 20% annually.

We still remain very comfortable with these ranges. By comparing the first nine months of 2010 to the first nine months of 2009, our revenues grew by 11.9% for those comparable periods. From Q2 to Q3 2010, revenues grew at an annualized rate of 15.7%, and if you adjust that to a constant-currency growth rate, our annualized growth rate, based on the sequential growth, was an annualized rate of 14.8%.

Lastly, as we mentioned in our earnings press release, Cogent is exploring the possibility of raising, in the near future, up to $200 million in a secured-debt financing. We will use these proceeds for general corporate purposes, which may include the opportunistic purchase of our common stock, our convertible notes, or, perhaps, a special dividend.

Tad would like to now cover some additional details concerning our results.

Thank you, Dave, and again, good morning to everyone. I would also like to thank and congratulate the entire Cogent team on their hard work and efforts during this quarter.

I will begin by providing additional details on our revenue by product class. Our on-net revenue was $51.5 million for the third quarter, an increased 2.5% from the second quarter. As with previous quarters, approximately 85% of our new-unit sales for the quarter were for our on-net services.

Our on-net customer connections increased by 676 customer connections, or 3.5% for the quarter, and we ended the quarter with about 19,900 on-net customer connection on our network. Our revenue from our off-net business was $14.5 million for the third quarter, an increase of 8.5% from the second quarter. Our off-net customer connections increased by 58 customer connections, or 1.7% for the quarter, and we ended the quarter with about 3460 off-net customer connections, which are located in about 3350 off-net buildings.

We continue to experience an increase in off-net connection size, to the increase in availability of off-net Ethernet services, as Dave mentioned. Non-core revenues were about $0.8 million for the second and third quarter, and are less than 1% of our revenues, and about 730 customer connections.

Operating leverage of our business continues to result in healthy gross margins and EBITDA margin expansion. EBITDA margin expanded by 110 basis points in the third quarter, due to our increase in revenue, and a reduction of about $400,000 in SG&A expenses on a sequential, quarterly basis.

Our EBITDA margin was 30.4% for the third quarter, as compared to 29.3% of the second quarter of 2010 and, back to the third quarter of 2009, where it was 28.2%. EBITDA as adjusted was $20.3 million for the quarter, an increase of 7.7% from the $18.9 million of EBITDA, as adjusted, for our second quarter, and an increase of 19.6% from the $17 million for the third quarter of 2009.

Our gross profit margin declined by 50 basis points in the quarter from 54.8% to 54.3%. This is primarily due to a continued increase and investment in our expansion activities, and an increase in our lower-margin off-net revenues, with a direct gross margin of about 50%.

Quarterly lumpiness in our EBITDA margins can, and does, occur, and if you look at our 22 quarters of quarterly metrics we have included in each of our press releases, you would see occasional lumpiness in the EBITDA margin expansion. That occurs due to seasonal factors and the timing of our expansion activities, primarily. However, the long-term trend has demonstrated increasing EBITDA margins, and we expect that long-term trend to continue.

Our basic and diluted loss per-share was $0.01 for the third quarter. Previous quarter was a loss of $0.02, and back in the third quarter of 2009, it was a loss of $0.07 per share. Dave touched on foreign currency. Approximately 30% again of our business is located outside of the United States, and for the third quarter, about 22% of our revenues were based in Europe, and about 7% of our revenues were related to our Canadian and Mexican operations.

Continued volatility in the euro and Canadian dollar to US dollar conversion rates, which has a material impact on our comparable quarterly revenues and financial results. At our second quarter earnings call, we estimated that the positive FX-conversion impact of sequential quarterly revenues would be an increase of about $0.2 million. The actual impact on our revenues from the second quarter to third quarter was about $0.1 million, which was close to what we had anticipated.

Regarding the conversion rates. The euro-to-US-dollar average for the second quarter was $1.27, and that increased by $0.02 to $1.29 for the third quarter. If you look back to the third quarter of 2009, that rate was $1.43. Currently, the euro-to-US dollar rate is about $1.40, which is up from the $1.29 for the third quarter. Should that average exchange rate for the fourth quarter of 2010 remain at $1.40, we estimate that the FX conversion impact on sequential, quarterly revenues from the third quarter to the fourth quarter of 2010 will be an increase of about $1.2 million.

For the year, the average euro exchange rate for 2009, the entire year, was $1.39. The exchange rate for the first nine months of 2010 was $1.31. should the average exchange rate again, for the fourth quarter, remain at $1.40, we estimate that the impact of the euro-to-US dollar conversion impact on sequential annual revenues from 2009 to 2010 would be a decrease of approximately $2.2 million.

Capital expenditures-- our capital expenditures were $16.5 million for the third quarter, similar to the $16.7 million we had in the third quarter of 2009, and an increase from the $13.2 million we had in the second quarter of 2010. On a quarterly basis, we came in and have, historically, experienced seasonal variations in our CapEx and construction activities.

Quarterly CapEx is, in part, dependent upon the number of buildings we connect to our network each quarter and the timing and scope of our network expansion activities. Typically, we experience our lowest level of CapEx in the fourth quarter, and we expect that trend to continue in 2010.

We added another 36 buildings to our network in the quarter, which is 8 more buildings than the 28 we added in the second quarter of 2010. We expect to continue our network expansion in 2010 and continue to expect to add approximately another 120 buildings to our network for the year. For 2011, we expect to continue our expansion, but at a more moderate pace than we experienced in 2009 and 2010.

On balance sheet items, as of September 30, 2010, cash and cash-equivalents totaled $47.8 million. Before the quarter, our cash declined by $4.6 million as we continued to invest our operating cash flow in our network and geographic expansion. We have about $92 million of our original $200 million of face value of convertible notes remaining. The notes mature in June 2027, however, may be redeemed by us or (inaudible) by the holders beginning in June 2014. The notes are recorded on our balance sheet at $69.9 million, which is net of their unamortized discount.

Capital lease IRU fiber obligations were $111.3 million at the end of the quarter, and about $7 million of that is a current liability. Our capital lease IRU fiber lease obligations were $109.4 million at the end of the second quarter. The impact of foreign exchange contributed to about a $4 million increase in the IRU fiber obligations in Europe, as the euro-to-US dollar rate at the end of the second quarter was $1.22, but was $1.36 at the end of the third quarter of 2010.

As a reminder, these IRU obligations are for long-term dark fiber leases, and typically have initial terms of 15 to 20 years or longer, with many renewal options.

In October, 2009, we entered into a $20 million revolving credit facility. We have never borrowed under that facility, and we allowed the facility to expire at a scheduled termination date in October of 2010. Again, as Dave mentioned we are exploring the possibility of raising, in the near future, up to $200 million in a secured-debt financing. We would use the proceeds for general corporate purposes, which may include opportunistic purchases of our common stock or convertible notes, or a special dividend.

Base sales outstanding for worldwide accounts receivables were 31 days at September 30, 2010. That metric is, again, significantly better than our target rate of 40 days. Again, I want to personally thank and recognize our worldwide billing and collection team members for continuing to do a fantastic job on customer collections, credit monitoring, and getting all of our customers to pay their bills.

In this economic environment, we will continue to closely monitor our credit standards and our accounts-receivable. Further demonstrating our excellent customer collections performance, bad debt expense was only 1.5% of our revenues for the quarter, which was an improvement from the 1.9% of revenue for the second quarter of 2010.

Again, as Dave mentioned, our average contract term continues to increase, and increase by another 2.3% for the quarter. As our average contract term increases, this impacts our revenue performance under US GAAP.

For example, increases in our average contract term and estimated customer life, results in a longer period over which to recognize our insulation revenues that are billed up-front to many customers when new contracts are installed.

We have experienced an increase in the amortization period used to recognize our insulation revenues, and that has a reduction in the revenues recognized under US GAAP. Cash flow from operations increased by 25% from the second quarter, and was $19 million for the third quarter, as compared to $15.2 million for the second quarter of 2010.

And lastly, on operating income, we continued our progress towards achieving net income and positive earnings per share by increasing our operating income by about 26% from $3 million for the second quarter to $3.7 million for the third quarter of 2010.

With that, I will now turn the call back over to Dave.

Hey, thanks, Tad. A moment on sales force productivity and sales rep activities. We began the third quarter of 2010 with 248 quota-bearing reps and ended the quarter with 242 quota-bearing reps selling our services. We hired 42 sales reps in the quarter, and 48 sales reps left the Company during the quarter.

Our monthly rep turnover for the quarter was 6.5%, as compared to the 5.8% in the second quarter. This rep turnover rates, however, are substantially below our historical rates for the past two years, which have averaged about 8%. We began the third quarter with 236 full-time equivalence sales reps. These are reps that have fully-ramped and have a full-quota responsibility, and ended the quarter with 230.

Our rep productivity of reps in the third quarter were able to produce 4.3 units of installed-- not business, these are customer connections, per month per rep. This performance was an improvement of 2.4% from the 4.2 units of productivity per full-time equivalent rep in the second quarter, and better than our long-term, historical average of 4 units per rep per month.

As a reminder, our rep productivity is based not on contract signings, but rather upon completed and installed customer connections, which then begin billing. To our network scale, we added 36 buildings to the network in the third quarter of 2010, and ended the quarter with 15,039 buildings on-net and over 620 million square feet of multi-tenant office space connected to our network.

Our network now consists of over 15,000 metro fiber miles and 50,700 inner-city route miles of fiber. Our network is one of the most inter-connected networks in the world, where, today, we connect to over 3350 other unique networks. We believe that our network has substantial capacity to be able to accommodate our future growth plans, and we are currently utilizing only 18% of the width capacity in our network.

We continue to evaluate additional fiber routes in Europe, as well as North America. We have taken advantage of certain opportunities that have been presented to us due to volatility in the European markets, particularly in some of the peripheral countries. We may continue to opportunistically entertain certain opportunities to accelerate our European expansion plans.

So, in summary, traffic on our network continues to grow, revenues are growing faster than the growth rates of virtually any of our competitors, and we continue to take market share while offering our customers the lowest price in the industry.

We continue to believe that Cogent's strategy of being a low-cost provider and the value proposition that we offer our customers is truly unmatched. Our pricing strategy has attracted many new customers, improved our rep productivity, increased our average contract length, significantly increased the volume and revenue commitments from our existing customers.

Our business remains completely and entirely focused on the Internet, which is becoming an increasingly important utility for our customers. We continue to evaluate how to optimize our very strong balance sheet for the benefit of our equity holders.

We are putting our operating cash flow to work by continuing to expand our domestic and international footprint, going into additional markets and adding additional buildings within those markets. We remain extremely encouraged by our sales initiatives and the sheer volume of our order backlog, and we remain committed to providing top line revenue growth of 10% to 20% while expanding our EBITDA margin and generating increasing amounts of free cash flow.

With that, that concludes our prepared remarks, and maybe we would like to open the floor up for some questions.

(OPERATOR INSTRUCTIONS). We'll have our first question from David Coleman, RBC Capital Markets.

Thank you. Just a couple of questions. I probably missed it. I was wondering if you could say what the traffic growth was on your networks during the quarter, and then, Tad, you talked about, I guess, building into fewer new buildings in 2011. Just wondering what the CapEx impact would be from doing so, if we should still expect about $50 million of CapEx per year, or if that would come down by a material amount? And then, if there's any kind of SG&A impact from reduced construction activity.

Finally, just as far as the secured debt issue that you're considering, what the preference is at this point, if it would be for share buybacks or new market expansion, etc, and then estimated timing as to when you could pull the trigger on something like this? Thank you.

Sure, Dave. Well, thanks for the questions. I'll take a couple of them and Tad will take a couple. With regard to traffic on our network, traffic sequentially grew at slightly over 5% quarter-over-quarter, and just as a reminder, we have a big exposure to the educational vertical, and during the quarter, two to three months, most schools in the Western world were out. July and August are typically low-traffic months.

We expect to see acceleration in that sequential traffic growth rate in the fourth quarter as we're kind of back to full productivity. On a year-over-year basis, traffic grew at a little over 35%. I'll let Tad take the expansion and SG&A questions, and I'll jump back in at the end on the debt question.

Sure. As I mentioned, we do expect the rate of expansion for 2011 to be less than what we experienced in 2009 and what we expected in current 2010. We have not given direct CapEx guidance, however, what I can indicate is that we do expect it to be less than-- 2011 to be less than 2010.

With respect to SG&A and its impact related to reduced construction activity, that would not have a material impact. There's not a substantial increase in headcount one way or the other related to this internally, so I don't expect that to have a corresponding material impact in 2011 related to reduced construction.

And, Dave, with regard to the balance sheet and potential debt offerings, first of all, all of our expansion activity, to-date and prospectively, at least we believe, will be funded through internally-generated cash. As were evaluating the credit markets and contemplating a potential debt offering, we would really look at that debt offering as a way to optimize the balance sheet and help return cash to shareholders, and that's probably about all we could potentially say at this point.

I understand. Thank you.

We'll go next to James Breen with William Blair & Company.

Thank you very much. Just a couple of questions. One on the margins, are you still seeing some margin improvement, and in reference to the last question, as the building, the CapEx actually drops off in the expansion, where do you think your margin expansion can go next year?

And then, secondly, on the capital spending side for this year, it seemed like CapEx this quarter was a little bit above our estimate. Do you expect there to be a pretty significant drop off in CapEx in the existing fourth quarter? Thanks.

Thanks, Jim. First of all, with margin expansion, if you just look at our year-over-year expansion Q3 2009 to Q3 2010, it was about 220 basis points. That's still a little below what we were doing in kind of the 2006-'07 time frame, but what tends to slow our rate of margin expansion is actually the expansion of the network, because we pick up the operating costs for that larger network in advance of the revenue being recognized.

We believe that we will continue to expand the footprint, again, through internally-generated cash, but we should continue to see margin expansion, I think, similar in 2011 to what we experienced in 2010, maybe even slightly better, but we do expect margins to continue to expand.

And with regard to capital spending, as Tad mentioned, it tends to be a little bit lumpy. We always have experienced our lowest quarter of capital spending in the fourth quarter. It's typically about half of what we do in the third quarter, because many of the markets in which we're doing construction activity have moratoriums that limit the amount of construction activity. We may still have a significant number of buildings come on-net, but the bulk of that construction work and the actual outside plant work would have been done in the third quarter, maybe with final building connection occurring in the fourth quarter.

But we do expect capital spending to be in line with last year for the full year, down in the fourth quarter, and, again, as Tad said earlier, probably down again a little bit next year and, you know, I think that's pretty much it.

Okay, so, just to clarify on the margin side, it's not unreasonable to expect that your consolidated EBITDA margins are up maybe 250 basis points from 2010 to 2011?

I think that might be a little aggressive. I think we clearly were up on a year-over-year basis the 220 that I had indicated. I think if you look at kind of the full-year, it's more like 150 basis points, 200. I think that's probably a little more realistic.

Perfect. Thank you.

We'll go next to Michael Bowen, Guggenheim Securities.

Okay, good morning and thank you for taking my questions. Dave, with regard to the potential debt financing, can you just walk us through kind of what your thought process will be, and how you'll weigh whether to do something like a special dividend versus some of the other options you might have with this.

Then, also, second question, with regard-- I want to make sure I heard this right. I think you said you were going to add about 120 buildings in 2010, but 2011 will be less than this, and if I have my numbers correct there, can you just kind of walk us through what might be driving the decline, and if you can give us an idea of how much of a decline, that would be helpful as well, thank you.

Sure, Michael. First of all, with regard to a potential debt offering. First of all, it is, we believe, opportunistic, and we are considering it. We are not necessarily doing it, but rather, considering it, and then if we are successful in raising capital through a debt offering, if we choose to do so, I think the Board would look at appropriate ways to deploy that capital. As I said, we feel very comfortable that our internal cash flow generation is more than adequate for us to meet our growth objectives, so we do not believe we will need to use that capital for internal growth. We do not, at this point, contemplate any significant M&A.

Whether we buy back bonds, whether we buy back stocks or we issue a dividend will all be based on general market conditions and what the Board feels is appropriate. So, no decisions have been made at this point, and I think it would be a bit premature for us to speculate, since we haven't even decided if we're absolutely going to raise the debt.

To the building addition and expansion, what Tad indicated is, our rate of expansion will actually be more moderate, but I think most of that moderation will come in a reduction in the number of inter-city fiber route miles added and intra-city metro fiber miles added. We anticipate the number of buildings being added to be very similar to 2009 and 2010 rate. If you look at the buildings we add to the network, roughly 70% of the buildings are corporate buildings, and there we have a very defined list that we're going after, and we expect that to continue at about the same pace.

The other 30% of buildings that we add to our network are carrier-neutral datacenters, and we are projecting those centers to be built at about the same pace in 2011 as they were in '09 and '10. Obviously, that is a reactive strategy, and if there are less centers build, we will add less carrier-neutrals to our network, so that number could shrink, or if there are more built, it could be larger.

But I think the number of buildings should be similar next year, the number of route miles of on-haul fiber and metro fiber will probably be at a lower pace of expansion.

Great, and if I could also follow up, with regard to your contract lengths, are you able to give us what the average length of that is, and then one last question, I think you noted that there was a reduction on pricing in the quarter and with the contract terms going up, I think you said 2.2%, how much of that 2.2%, if you can at all, either qualitatively or quantitatively help us understand how much of the pride reductions are driving the increase in contract terms, and do you foresee a period coming up within the next year or two where you can start to slow that reduction on pricing?

This is Tad. I'll take the increase in contract length. What we've seen is, for the installed orders in the current year, the mix from two-year to three-year contracts is substantially increased from the installed base, and to give you some details on that, for example, the two-year contracts in the install base, historically, was less than 10%, and now, virtually, a third of new contracts signed in 2010 are for three-year lengths.

Similarly, for two-year length contracts, again, just less than 10% on two-years in the install base, and almost 15% of the contracts for 2010 are in the two-year bucket. If you go to a monthly rate, about, in the aggregate, 30% of our contracts are month-to-month.

If you look at the 2009 early-install contracts, it's about a third, and then newly-installed contracts, about 20%. So, we're seeing more people signing up for longer terms, obviously, and the primarily-- primarily in the three-year bucket, but some in the two-year, which is resulting in an increase in the length.

It has been about-- close to 3% on a sequential quarterly basis for the past couple of years since we provided these promotional discounts per term.

And to the question of causality, Michael, is it longer-term contracts that are causing the price to go down or is it the fact that the contracts-- that a lower price is making people buy them, or are the contracts going on for longer and therefore pushing the price down, I think it's a little bit of both, qualitatively.

Also, in the quarter, we had run some very aggressive promotions. Some of those have actually continued over into this quarter, so that's why some of our price-per-megabit continues to decline, which does impact our NetCentric customer base, but for our corporate base, ARPUs are actually going up, driven mostly by the migration of TDM services to Ethernet services, and that's why you've seen the off-net ARPUs go up, the revenue growth rate in that off-net business is about 2.5 times the unit growth rate in that business, and then, finally, if you look at our on-net ARPU, the rate of price decline in that ARPU has moderated substantially from the 4.2% in the second quarter to only about 2% this quarter.

So, we feel pretty good about pricing trends, and, at the end of the day, the price-per-megabit is going to fall pretty much perpetually forever, and you should just expect that, but we've demonstrated, over the years, that in a declining price market, we are the price leader, and we have been able to consistently grow our revenues in light of that declining price and expect those trends to continue going forward.

Okay, thank you. Good luck.

(OPERATOR INSTRUCTIONS). We'll go next to Michael Funk, Bank of America Merrill Lynch.

Thank you for taking the question. I just have a couple quick ones. First, a recurring theme this quarter we have heard has seen it be the resurgence, cyclical headwinds, particularly, a number of competitors have called out pressure on usage-based revenue. I was hoping you could comment on that and maybe how that is showing itself in your own business, maybe through churn or customers cutting back on the amount of services they're taking from you.

Second, if you can just remind us what your cash and leverage targets are as we think about the proposed recap that you announced this morning, and then, just finally, I'm sorry if I missed this, but in the past, you've talked about your growth in backlogs during the quarter, and I was hoping you could update us here.

Sure, Michael. First of all, in terms of usage, we actually saw traffic growth on our network, we saw our existing customers' utilization rates increase sequentially for the quarter, but that's kind of to be expected because of the seasonality in Internet traffic growth.

We have seen no significant macro pressures on our business, and you see that in our revenue growth across all segments, on-net, off-net, corporate and NetCentric. Every part of our business grew. We have seen, as we went into a great deal of detail, no material uptick in our churn rate. We did see a number of customers committing to longer-term, higher-value contracts to take advantage of better pricing, but short of that, we feel very encouraged by the growth trends in our business, as well as the backlog.

We continue to have kind of historically high levels of orders that have been signed but not yet installed. We do continue to install our on-net services in what I think is an industry record time of probably, on average, 10 or 11 business days from order validation to install.

I will admit that our off-net installation windows have lengthened. Ethernet circuits take longer for the incumbent providers to provision than traditional low-capacity TDM circuits. So, on average, these off-net Ethernet circuits, from contract signing to installation can be 100 days, where as the TDM circuit may install in 20 to 30 days.

To the cash question, we, today, have adequate cash to run our business and are generating free cash. We have been deploying that cash aggressively to expand the network, and as Tad commented, we expect that rate of footprint expansion to actually moderate next year, and as we're thinking about raising debt, this is purely opportunistic, there is no immediate business driver, and I think, at this point, there is no absolute target for liquidity.

I think the Board is going to evaluate potential uses of cash, either internally generated or raised through financing activities and figure out how to create the most value for our equity holders. I think it's that simple.

I don't think there's a lot more specificity that we can give at this point, because it's hypothetical.

Great. That's very clear. Thank you again.

Thanks, Michael.

We'll go next to David Dixon with FBR Capital Markets.

Good morning, guys.

Hey, Dave.

Jumping around on a few conference calls this morning, but just a couple of quick questions. Really, just wanted to get your comment on some of the dynamics I'm seeing in the market today and the impact, potentially, on revenue growth and EBITDA margins going forward. The checks that we're doing which have just been completed suggest the market is almost giving away CDN services with IP transit. So, I wanted to get your comment about that, being an IP transit provider, how you expect that may impact the business going forward.

And then, separately, Verizon and (inaudible) are entering into these multi-billion dollar initiatives of FiOS-like scale to capture the (inaudible) content going forward. We've seen the first of a multitude of these datacenters being built out in upstate New York, a million square feet of datacenter capacity.

How do you expect these dynamics to impact the business, going forward?

So, first of all, to CDNs, I would say that most CDN providers around the world are Cogent customers today. Because of our low-priced strategy and the high quality of our service, we are generally the provider of choice to CDNs. Remember, what a CDN is doing is marrying multiple components and selling its service, which is basically servers, storage, datacenter space and IP transit, and selling that as a bundled service.

There are real costs in delivering those services. That market is very competitive, and my belief is that some providers may not have economically viable business models. We do monitor the credit quality of our customers and, as Tad mentioned, our DSOs remain low, and our bad debt expense has actually declined, so I think we're very vigilant about making sure that if we're supplying services to less than completely viable business models, we're monitoring our risk.

The nature of the Internet is, end-user consumers expect many services to be given away for free. The underlying infrastructure providers, however, generally do not give away services for free. They may subsidize services to gain market share, and may be selling them for a period of time uneconomically, but I think, long-term, they're there to make money, and they have a clear business model.

The devise of Internet transit has been predicted many times, where people thought that Quantex and datacenters was going to replace the Internet, CDNs were going to replace the Internet, and, in fact, even though both of those trends continue to grow, the Internet continues to grow as well at a very robust rate. In fact, faster than either of those two industries.

So, because transit is a component, is a raw component of the final good or service that a CDN sells, we see no real competition, and in fact, the CDN success helps drive transit success, as the average packet travel on the Internet has not materially changed in 10 years, averaging about 2700 miles, yet CDNs have become much more prolific.

To the question of proprietary datacenters by companies like AT&T and Verizon, to the best of my knowledge, those centers are really focused on their cloud computing initiatives and their enterprise business, and do not really have a material impact on the residential consumer business, which is really where CDN traffic is focused, for the most part.

Okay, and then just a very quick follow-up, I apologize if you answered this question in your prepared remarks, but with the EBITDA growth driven by the-- to the higher CapEx state, to what extent do you think there's an opportunity to change the marketing message, subtly, from the lowest cost to a quality network provider?

Okay, so, first of all, our CapEx is not driving our expansion in EBITDA margin because our CapEx this year will be similar to what it was last year, yet our EBITDA margin expanded 220 basis points. We have always been the highest-quality provider of Internet services. If you measure that service as delivering transport interface routing as well as interconnection, we are the most interconnected network in the world, we have the only non-blocked and non-oversubscribed network.

These differences in quality, however, are fairly subtle, as most other providers also have adequate quality networks, maybe not equal in quality to Cogent, but at least comparable to one another and adequate for many customers' requirements.

So, we have always been a quality provider, and we also believe, for the NetCentric portion of our business, price is the biggest determinant in a customer's buy decision. For our corporate customers, our value proposition is unparalleled, but we do not sell on price, we sell on value and quantity for a similar price.

So, I think it is a maybe more complex marketing message. The quality issues imputed to Cogent have been propagated by our competitors because of their inability to compete with us on a price basis. Cogent remains committed to our strategy, and we do not believe that we either need to change our strategy or modify our capital spending. In fact, as Tad indicated, we expect our capital spending to increase, but our growth rates to remain constant or accelerate, and, finally, our margins to expand.

Well, that's very helpful. Thanks, Dave.

We'll go next to Michael Rollins with Citi.

Hi, good morning. Just wondering, Dave, if you could expand a little bit more. You mentioned, I think, earlier in the call, that the backlog was better heading into the fourth quarter. Could you give us some magnitude as to how that looks and how we should be thinking about that?

And then the second question, just to expand a little bit more, as you look at the SG&A and what you were able to accomplish on the margin side, do you see the need to invest more as you try to continue to ramp revenue growth, or do you think you're at a good level to get more operating leverage out of that? Thanks.

I think I'll let Tad take the SG&A question, and I'll come back to the backlog question.

Sure. Good morning. The variability in SG&A that we'll see will be the bad debt expense that's included in that, so the percentage of bad debt expense to revenues, which, as we mentioned, we did get a benefit of that, sequentially, quarter-over-quarter, of about $300,000 from the reduction in that rate.

I can't say that I'm expecting a further reduction in that. Historically, we've been in the neighborhood of about 2%, or just shy of 2%, historically. Where we will see-- so, you'll see the gross amount increase, I think, as a percentage of revenues, that's generally what we've historically.

Where we'll see increases are kind of in the following areas as we add sales reps to the team. We also do see some seasonality, and it can be relatively material, where we have our audit activities, which tend to be heavily loaded into the first quarter, and also the resetting of tax rates, in particular, in the US, where the FICA, Social Security and Medicare rates reset for the first quarter, so we always see an increase in benefits.

But, with respect to an investment, what I would consider an investment increase in SG&A, that would be tied to the increase in sales reps that we would see.

And we do plan to continue to grow the size of the sales force, but, I think, on a percentage basis, again, that growth rate is going to be more moderate than it has been over the past couple of years as we have rapidly ramped, a few years ago, now we're going the sales force at a more predictable and steady rate.

To the question of backlog, Michael, we have, today, a little over 2000 signed orders that have not yet been installed. That is probably up slightly from where it was in the last couple of quarters, but we saw a material pickup starting at the beginning of the year in the backlog, and it's not because we can't provision it more quickly, it's because this increase in off-net Ethernet has a much longer provisioning cycle, and as that continues, we expect this number to continue to creep up.

But, if we look at our on-net backlog, though it remains robust, it is not growing at a faster-- than kind of the growth rate in the aggregate business. It's growing slightly, but there's no kind of increased aging in that backlog.

The only increased aging exists in the off-net component of our business.

Thanks very much.

We have no further questions in the queue at this time. I will turn the conference back over to Mr. Dave Schaeffer for any additional or closing remarks.

Well, thank you all very much. Hopefully, you were encouraged by our results. We feel very comfortable about the progress of Cogent and our progress going forward. I know it's a busy day and there are a lot of calls going on simultaneously, so thank you all very much for your time, and we'll talk in a couple of months. Take care. Goodbye.

That does conclude today's conference. Remember, a replay of today's conference will be available at wwww.cogentco.com. Thank you and have a great day.