Cogent Communications Holdings Inc (CCOI) 2010 Q4 法說會逐字稿

Good day everyone, and welcome to the Cogent Communications Group fourth quarter and full year 2010 earnings conference call and webcast. Today's call is being recorded. This conference will be available for replay at www.cogentco.com. At this time, I would like to turn the call over to Dave Schaeffer, Chief Executive Officer. Please go ahead, sir.

Good morning, and thank you. Welcome to our fourth quarter 2010 earnings conference call. I am Dave Schaeffer, Cogent's Chief Executive Officer. And with me on this morning's called is Tad Weed, Cogent's Chief Financial Officer. We are extremely pleased with our results for the quarter and for the year, in an improving economic environment. Our revenue grew from the third quarter of 2010 by 4%, and on a constant currency basis grew sequentially by 2.7%. For the year, our revenue grew by 11.7% and on a constant currency basis for the full year our revenues grew by 12.2% year-over-year.

Our EBITDA margin for the quarter expanded sequentially by 210 basis points from the third quarter of 2010, and expanded 470 basis points from the fourth quarter of 2009. Our EBITDA margin expanded by 250 basis points for the full year 2010 over full year 2009. During the quarter, traffic on our network grew sequentially third quarter 2010 to fourth quarter 2010 by 13%, and was up 24% from the fourth quarter of 2009. For the full year 2010 over full year 2009, traffic grew on our network by 41%. Since the end of the third quarter of 2010, we have expanded our network footprint by adding 40 buildings, 450 metro fiber miles to our network. For the year, we significantly expanded our footprint by adding a total of 128 buildings to our network, over 2,300 metro fiber miles, and over 10,800 inner city fiber route miles to our network. This represents an approximately 20% increase in the scope and breadth of our network.

During the quarter, our sales rep productivity grew sequentially by 9.3% from the prior quarter. Our sales rep productivity increased from 4.3 units per rep per month of installed business in the third quarter to 4.7 orders installed per rep per month for the fourth quarter. We funded 100% of our expansion activities in 2010 with internally generated cash. We generated positive cash for the fourth quarter of $8.4 million inclusive of all investing and financing activities. We were also true free cash flow positive for the full year inclusive of all expansion spending, including capital and prepaid capital lease activities.

Finally, in January of 2011, we opportunistically took advantage of what we believe to be a relatively low interest rate environment and strengthened our balance sheet by closing on a $175 million offering of senior secured notes. We intend to use a portion of the proceeds from this offering to buy back stock, and we may use the other portions for additional stock purchases and/or dividends or other general corporate purposes. As mentioned in our press release, our Board has approved an initial buy back program of $50 million. We are optimistic about our outlook for 2011, encouraged by the results and recent trends, including the level of our order backlog, that is orders signed by not yet installed.

Throughout the discussion, we will highlight several operational statistics that we believe demonstrate our increasing market share, expanding network scale and scope, expanding customer base, and most importantly, the operating leverage of our business model. We have assembled a unique set of assets and infrastructure and operations that allow us to generate cash, while selling a product at lower prices than our competitors with better margins whose demand is rapidly growing. We believe there is a significant barrier to entry for any attempt to replicate the assets that we have assembled here at Cogent, and we are the lowest cost, most efficient operator in our sector, and target our activities on the most traffic-rich and revenue-rich opportunities that we bring On Net.

I will review in greater detail certain operational highlights and continued expansion plans. Tad will provide some additional details on our financial performance. Following our prepared remarks, we will open the floor for questions and answers. Now I would like to turn things over to Tad so he can read the Safe Harbor language.

Thank you Dave, and good morning everyone. This fourth quarter 2010 and full year 2010 earnings report and this earnings conference call will discuss Cogent's business outlook and 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 could cause actual results to differ.

You should also be aware that Cogent's expectations do not reflect the potential impact of mergers, acquisitions, other business combinations, or financing transactions that may be completed after today. Cogent undertakes no obligation to release publicly any revision to any forward-looking statement made today, or otherwise update or supplement statements made on this call. Also during this call if we use any non-GAAP financial measures, you will find these reconciled to the GAAP measurement in our earnings release, and on our website at www.cogentco.com.

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

Thanks, Tad. Now for some highlights from our fourth quarter results. Hopefully you have had a chance to review our earnings press release. As with previous quarters, our press release includes a number of historical quarterly metrics. These metrics will also be added to our website. Hopefully you will find a consistent presentation of these metrics informative and helpful in understanding our financial results and the trends from our operations. Fluctuations of foreign currency do materially impact our revenue, in particular that revenue reported from our Net Centric customers. Approximately 30% of our revenues are derived from our international operations outside of the US

Our fourth quarter revenue 2010 was $69.5 million, an increase of 4% from the third quarter revenue of 2010, and an increase of 11.1% from fourth quarter 2009. Our 2010 revenue for full year was $263.4 million, an increase of 11.7% from our full year 2009 revenues. On a constant currency basis, our revenues for the fourth quarter increased sequentially 2.7% and increased from Q4 2009 by 12.9%. On a constant currency basis, our full-year revenues for 2010 increased 12.2% from the full year 2009.

We evaluate our revenues based on product class, that is on net services, off net services, and noncore revenues. Tad will cover these in greater details. We also evaluate our revenues by the type of customer purchasing our services. Our customer types include two major groups, net-centric customers and corporate customers. Net-centric customers buy large amounts of bandwidth from us typically in carrier neutral data centers. These network operators can either be access companies or content based or application based businesses. Corporate customers buy bandwidth from us in large multi-tenant office buildings located in the central business districts of major cities.

Revenues and customer connections from both our corporate customers and net-centric customers grew sequentially in the quarters. Revenues from our corporate customers grew 4.8% sequentially from the third quarter, and grew 16.5% for the full year. Our corporate customers represent 57% of our total customer connections at year end, and represent approximately 50% of our revenues in Q4 2010, and also for full-year 2010. Our corporate customer connections grew by 3.1% sequentially in the quarter from third quarter, and by 15.2% for the full year 2010 over 2009.

Revenues from our net-centric customers increased 3.2% sequentially in the quarter, and grew by 7.4% for the full year. Our net-centric customers represent 43% of our total customer connections at quarter end, and 50% of our revenues for both the fourth quarter 2010 and full-year 2010. Our net-centric customer connections grew sequentially in the fourth quarter over the third quarter by 5.4% and for full year grew by 20.3%.

Now for some trends in terms of pricing and provisioning. Our most widely sold corporate product remains a 100-megabit per second non oversubscribed nonblocked dedicated Internet access connection. Our most widely sold net-centric customer is actually now a 10-gigabit connection. We continue to offer discounts related to contract term to all of our corporate customers and net-centric customers. We also offer volume commitment discounts to our net-centric customers.

During the quarter, 990 of our net-centric customers took advantage of these volume and term discounts and entered into longer term contracts, increasing their total revenue commitment to Cogent by approximately $30 million in the quarter. Customers also continued to express confidence in Cogent by entering into longer term contracts. These are both corporate and net-centric customers. Our average contract term increased in the quarter sequentially by another 2.6%, almost one out of every three customer contracts entered into in 2010 was a three-year term contract.

As a reference point, two years ago when we were offering three-year contracts, these only represented about one in ten customer contracts. The price per megabit for our net-centric customers is an important metric. The price per megabit for our installed base and new customers continue to decline. Our average price per megabit for the installed base would decline by 6.3% for the quarter. The average price per megabit for the installed base in third quarter 2010 was $4.94, and in fourth quarter 2010 was $4.63.

The price per megabit for new contracts entered in the quarter, fourth quarter, was $2.59, down from the $3.65 for the average new contract entered in third quarter. And this was due to the promotional pricing that we discussed on our last earnings call that was in place for the entire fourth quarter. However, our on net ARPU only declined by 0.2% sequentially from the third quarter. This was a significant moderation in the rate of decline from 2.1% in the second quarter of 2010 to the third quarter of 2010.

Our On Net ARPU was $879 per connection in the third quarter of 2010, and $877 in the fourth quarter of 2010. Our Off Net ARPU continued to increase, and increase by 2.3% from the third quarter as the average size of our Off Net connection continues to increase, primarily due to the availability of Ethernet services. However, the rate of ARPU increase moderated from the 6.1% sequential increase that we saw second quarter to third quarter. Our Off Net ARPU increased from $1,407 per connection in the third quarter to $1,440 per connection in the fourth quarter 2010.

Now to discuss a little bit about churn. Our gross churn rate was relatively flat for the quarter, and our Off Net churn rate increased slightly over the quarter, as we entered into more amended, or moves adds and change contracts in the fourth quarter. As a reminder, we consistently report our churn numbers on a gross basis. As a result, customers who remain with us, but enter into an amended contract with Cogent, increasing their term or volume commitment, is counted in our gross churn numbers. Our On Net gross churn was 2.7% in the fourth quarter as compared to 2.6% in the third quarter. Excluding increases that occurred because of moves, adds, and changes, our net churn rate was 1.4% for the quarter, our Off Net gross churn rate was 3.3% for the fourth quarter, as compared to 2.9% in the third quarter. Excluding the moves, adds, and changes for our Off Net customers the net churn rate was 2.2%.

Before Tad provides some additional details on the quarter, I would like to address our results and expectations against our longer term revenue and EBITDA targets. As a reminder, we have previously announced the expected increase in our top line revenues of between 10% and 20%. For the year 2010, our revenues grew by 11.7%,and when converted to a constant currency basis, that growth was 12.2%. As we have expected, our annual EBITDA margins continue to expand, and in 2010 over 2009, that EBITDA margin expansion was 250 basis points for the full year. As I mentioned on our last earnings call, we expect our EBITDA margin for 2011 over 2010 to increase somewhere between 150 and 200 basis points for the full year. We remain comfortable with our revenue and EBITDA margin targets.

Tad will now cover some additional details around our results.

Thanks, Dave. And again, good morning to everyone. And I would also like to thank and congratulate the entire Cogent team, on their hard work and efforts not only for the quarter but also for the full year of 2010. I will begin by providing additional details on our revenue by product class, which is On Net and Off Net. Our On Net revenue was $53.6 million for the fourth quarter, which was an increase of 4.1% from the third quarter. And our On Net revenue was $205 million for the year, which was an increase of 8.8% from 2009. On a constant currency basis, the increase was 9.3% for 2010 over 2009.

Similar to prior quarters, about 85% of our new sales, and that is both revenue and units, were for our On Net services. Our On Net customer connections increased by 1,003 customer connections or by 5% for the quarter, and our On Net customer connections increased by 3,684 customer connections, or 21.4% for the year. And we ended the year with about 20,900 On Net customer connections on our network.

On our Off Net business, our revenue from our Off Net business was $15.1 million for the quarter, and that was an increase of 4.1% from the third quarter. Our Off Net revenue was $55.3 million for the year, which was an increase of 27.6% from 2009. Our Off Net customer connections increased by 60 customer connections, or 1.7% for the quarter, and by 290 customer connections, which is 9% for the year. And we ended the year serving about 3,500 Off Net customer connections, and about 3,400 Off Net buildings. We continue to experience an increase in Off Net connection size as Dave mentioned due to the increase in availability of Off Net ethernet services. Lastly, noncore revenues were about 800,000 for the third quarter and fourth quarter and they are about 1% of our revenues, and about 650 of our customer connections at the end of the year.

EBITDA and gross margin. The operating leverage of our business continued to result in healthy gross and EBITDA margins, and in particular we experienced gross margin expansion of 120 basis points for the quarter sequentially, and significant EBITDA margin expansion of 210 basis points in the fourth quarter sequentially, and 250 basis points of EBITDA margin expansion for the year. Our EBITDA margin was 32.5% for the fourth quarter, and 30.1% for the year. Our EBITDA margin of 32.5% for the fourth quarter was the highest EBITDA margin percentage in Cogent's history. EBITDA as adjusted was $22.6 million for the quarter, which was an increase of 11% from the third quarter of 2009. EBITDA adjusted for the year was $79.2 million, which was an increase of 22% from $64.9 million for 2009.

As I mentioned, our gross profit margin increased, a net increase by 120 basis points from the quarter from 54.3% to 55.5% for the fourth quarter. This expansion of our gross margin percentage reversed the trend of quarterly declines as our investment in expansion and increase in sales productivity produced an acceleration of the increase in our On Net revenues. As a reminder our On Net revenues carry a 100% direct incremental gross margin. For the year, our gross profit margin decreased by 150 basis points to 55%. This is primarily due to the impact of our expansion costs, and increase in Off Net revenues which carry a 50% incremental gross margin.

Quarterly lumpiness in our EBITDA and gross margins can and does occur. If you examine our 23 quarters of quarterly metrics that have been included in our press releases since the second quarter of 2005, you will notice lumpiness in quarterly margin expansion. This lumpiness can occur due to seasonal factors, such as the resetting of payroll taxes in the first quarter particularly in the US, and the timing of our audit and tax services which increase in our first quarter, due to the finishing of our audit and filing of our 10-K and our expansion activities. However, our long term trend has demonstrated increasing EBITDA margins, and we expect that long term trend to continue.

Earnings per share, our basic and diluted income per share was $0.06 for the fourth quarter, and our loss per share was $0.01 for the prior quarter of 2010. Basic and diluted income per share was $0.01 for 2010, and our loss per share was $0.39 for 2009. Now there were some tax benefits included in these numbers, including in the net income per share for the fourth quarter and the year of 2010 was a tax benefit of $1.5 million related to reversal of a deferred income tax asset valuation allowance related to our Canadian operations. This amount represented $0.03 per share for both the quarter and the year.

Similarly, in the fourth quarter of 2009, we had a similar income tax benefit also of $1.5 million. That was also $0.03 per share for the fourth quarter 2009, and for the full year of 2009. So if you exclude the tax benefit from our income per share, it would have been $0.03 for the fourth quarter as opposed to the $0.06, and our loss per share would have been $0.02 for the full year instead of income per share of $0.01 for the year. If you do the same thing in 2009, our loss per share would have been $0.42 instead of $0.39.

Interest expense on our notes that we issued in January will impact our 2011 earnings per share, and that is at our current share rate, that is about $0.33 per year. Foreign currency. As Dave mentioned about 30% of our business is located outside of the United States. For the fourth quarter in the year, approximately 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, Canadian dollar, and Mexican peso to the US dollar conversion rates can materially impact our comparable quarterly and annual revenues and financial results.

At our third quarter earnings call we estimated a positive FX conversion impact of sequential quarterly revenues at an increase of about $1.2 million. And the actual increase from the third quarter to the fourth quarter was less than that. It was $0.9 million. That is because our estimated rate for the fourth quarter was $1.40, and the actual rate came in once the quarter was over at $1.36. That is the euro to US dollar exchange rate. The average euro to US dollar exchange rate so far in the first quarter is about $1.35, although it is currently trading at about $1.37. But the average is $1.35. That is a decrease in the $1.36 for the fourth quarter. And should that average exchange rate remain at $1.35, we would have an impact from the fourth quarter 2010 to first quarter 2011, would be a slight decrease on revenues of about $100,000. The average rate for full year of 2010 for the euro to US dollar exchange rate was $1.32. If that rate remains intact for 2011 at $1.35, the current average, the impact from 2010 to 2011 revenues would be an increase of about $0.6 million, and increase in sequential revenues.

Capital expenditures. On a quarterly basis we can and have extorially experienced seasonal variations in our CapEx and our construction activities. Our quarterly CapEx are 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 our fourth quarter. And again, that occurred this year. Our CapEx again seasonally declined in the fourth quarter, and declined by 29% in the fourth quarter, and was $11.7 million for the fourth quarter versus the $16.5 million we had in the third quarter 2010. For the year, CapEx was $52.8 million versus $49.5 million for last year. That was a decrease of 6.6%, and that was an increase of 6.6% but on a network expansion of 20%.

Despite the holiday season and certain construction moratoriums, we added another 40 buildings to our network in the fourth quarter, and that was four more buildings than the 36 we connected in the third quarter. Our capital lease payments, including prepaid capital leases also declined to $2 million for the fourth quarter from $8.6 million for the third quarter of 2010. We expect to continue our network expansion in 2011, but that is slightly more moderate taste than we experienced in 2009 and 2010. We expect to add approximately another 120 buildings to our network in 2011.

On some balance sheet items, at year-end our cash and cash equivalents total $56.3 million. And for the quarter, we were cash, true cash flow positive and cash increased by $8.4 million as we generated $22 million of operating cash flow that was only partly offset by $11.7 million of CapEx and $2 million of IRU capital lease payments. For the year, we were also net cash flow positive of $0.3 million as our $71.5 million of operating cash flow was not entirely offset by $52.8 million of CapEx, and $19.1 million of IRU capital lease payments for the year.

We have about $92 million of our original $200 million face value of our convertible notes still outstanding. Those notes mature in June of 2027, but they may be redeemed by us or put by the holders beginning in June of 2014. The notes are reported on our balance sheet at $71.2 million, which is net of the unamortized discount on the notes. Capital lease, IRU obligations were $111.7 million at year-end, and about $6 million of that is a current liability. At the end of the third quarter, the total was $111.3 million.

We assumed $27.8 million of present value of capital lease IRU obligations in 2009. And for 2010, that number declined to $23.3 million. As a reminder, these capital lease IRU obligations are for long-term dark fiber leases, and typically have initial terms of 15 to 20 years and in some instances longer than that, and they often have multiple renewal options, typically have multiple renewal options.

Day Sales Outstanding for our worldwide Accounts Receivable was outstanding at 29 days at year-end. And that metric is again, significantly better than our targeted rate of 40 days, and was an improvement from the 31 days at the end of the third quarter. I have said this for years and I am proud to thank or recognize our billing and collections team for continuing to do a great job on customer collections and credit monitoring, despite our increase in revenues and customer connections. Further demonstrating our excellent customer collections performance bad debt expense was only 1.4% of revenues for the quarter, and that was an improvement from 1.5% from the third quarter. Bad debt expense was 1.6% of revenues for the year, which was a significant improvement from the 2.1% we experienced the last year.

As Dave mentioned, our average contract term continued to increase, and increased by another 2.6% for the quarter. Increases in our average contract term can and has impacted our revenue recognized 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 nonrecurring or installation revenues. We have experienced an increase in the amortization period used to recognize our installation revenues in the past, andthat reduced our revenues that are recognized under US GAAP.

Operating cash flow, we experienced material increases in cash flow from operations for the quarter and the year. Cash flow from operations increased by 16% from the third quarter, was $22 million for the fourth quarter compared to $19 million for the third quarter. Cash flow from operations increased by 26% for the year, and was $71.5 million for the year compared to $56.9 million for 2009.

Finally in January 2011, Dave mentioned we closed the $175 million senior secured notes offering. The notes were sold at par, and they bear interest at 8.375% per annum. Interest is paid semi annually in February and August, and the first interest payment will be in August 2011. We plan on using the proceeds for purchases of our common stock, convertible notes, a special dividend or for general corporate purposes, including an expansion of our sales force. We received approximately $170.5 million ofproceeds after the $4.5 million of offering costs. We will incur approximately $15 million of additional annual interest expense while the notes are outstanding. That is $0.33 per share for 2011 at current share count, or about $0.08 a quarter.

I will now turn the call back over to Dave.

Hey, thanks Tad. I would like to take a moment and speak a little bit about sales rep activity and productivity. We began the fourth quarter of 2010 with 242 sales reps, and ended the quarter with 252 reps selling our services. We began 2010 with 267 reps. We hired 51 reps in the fourth quarter, and 41 sales reps left the Company during the quarter. Our monthly rep turnover improved significantly, and was 5.5% in the fourth quarter as compared to 6.5% in the third quarter.

Our sales rep churn fell for the full year 2010 to 5.4%, a substantial improvement over the sales force turnover rate of 7.8% monthly that we experienced in 2009. We began and ended the fourth quarter with 230 full-time equivalent reps selling our services. We began the year with 235 full-time equivalent sales reps. Productivity on a full-time equivalent basis, the fourth quarter rep productivity monthly was 4.7 units of installed business per rep per month. This performance was a 9.3% improvement sequentially from the 4.3 units per rep per month we experienced in the third quarter of 2010, and substantially better than our long-term average, which has averaged about four units of installed business per rep per month since the Company's going public. As a reminder, our rep productivity rates are not based on contract signings, but are based on actual customer installations and the beginning of billing of service.

In the quarter, we also substantially expanded our network scale. We added 40 buildings to the network in fourth quarter 2010, and we ended the year with 1,579 buildings attached to our network. These are both corporate multi-tenant buildings and carrier neutral data centers. The size and scope of our network continues to grow. Our network consists of over 15,500 metro fiber miles, and over 51,200 inner city route miles of fiber. The Cogent network is one of the most inner connected networks in the world where today over 3,500 other networks directly connect to Cogent. We are utilizing about 18% of the lit capacity in our network as of the end of the year.

We believe our network has substantial capacity to accommodate our future growth plans. We continue to evaluate additional fiber routes both in Europe and North America, and we have taken advantage of certain opportunities presented to us in the volatility in the European market, and have purchased fiber into Greece and began our expansion into the Greek market. We continue to opportunistically take advantage of other opportunities and accelerate our expansion plans. Traffic continues to grow on our network, and our revenues are growing faster than those of most of our competitors demonstrating our ability to gain market share.

We believe that Cogent is the low-cost provider, and that our value proposition to our respective addressable markets is unparalleled in our industry. Our pricing strategy has attracted many new customers, improved our rep productivity, increased our average contract duration, and significantly increased the volume and revenue commitments from existing customers. Our business remains completely focused on the Internet, and provides us the ability to participate in the fastest growing market, yet provide a necessary utility to our customers. We are evaluating how to optimize our strong balance sheet, and use the proceeds of our recent senior secured offering of debt to the benefit of our shareholders.

Our Board has authorized an initial stock buy back program of $50 million. Similar to the initial authorizations in our previous buy back programs. We are putting our operational cash flow to work by continuing to expand our domestic and international footprint, as well as the number of buildings we serve and markets we serve. We are very encouraged by the results of our sales initiative and the size of our order backlog. We are committed to providing top line revenue growth of between 10% and 20%, and expanding our EBITDA margins and generating increasing free cash flow for the benefit of our equity holders.

That concludes our prepared remarks. And with that, we would like to turn the floor over for questions.

Thank you. (Operator Instructions). Your first question comes from Dave Coleman with RBC Capital Markets.

Thank you. Just a couple of questions. I was wondering if you could talk about the stabilization on the On Net revenues per customer. If that is just a higher mix of net-centric over customers leading to that stabilization?And then the per meg price for a new customer dropped a lot more than we were anticipating. And with overall traffic growth on your network slowing to about 24% year-over-year, does this more net-centric customers taking advantage of longer term contracts and volume discounts in light of overall traffic decreasing, make it more difficult to grow the top line at the same rate that you have been?Thank you.

Sure, Dave. So first of all, with regard to ARPU stabilization, you are correct that it is an increase in the average connection size of our net-centric customers, and the relative mix of corporate and net-centric customers that has resulted in a relative stabilization of our On Net ARPUs. With regard to the price per megabit, as we had mentioned on the previous call, we were running some aggressive promotions that actually had some pricing as low as $1 per megabit on certain types of interfaces that had technical constraints. That $1 per megabit promotional offer pulled down the average substantially, and that offer was in place only for a very small portion of the third quarter, but for the entire fourth quarter. We expect that rate of decline to moderate somewhat, but the decline per megabit will continue on I think forever as traffic volumes grow.

Now with respect to volume growth, our traffic growth sequentially for the quarter was up 13%, fourth quarter versus fourth quarter was up 24%. But as we mentioned, full year 2010 versus full year 2009 was actually up 41%. We have seen our net-centric business grow at rates that are comparable to that of our On Net corporate business, and we anticipate that in our 10% to 20% top line revenue growth, approximately half of that revenue growth will come from our net-centric business, about half from our corporate business. We do expect in our Off Net business to continue to see a slightly faster growth rate, due to the continued price per connection increasing, due to the fact that we are selling a much greater percentage of ethernet over TDM services.

We believe that the total addressable market for our net-centric opportunity, that is in the 490 carrier neutral data centers that we are connected to, is about a $1.5 billion market for the purchase of Internet transit. Today we have only between 9% and 10% of that market by dollars spent. We obviously have a much larger share of the market by bits consumed, because of our pricing differential compared to that of our competitors. But we absolutely believe that we can continue to grow our revenues in that 10% to 20% range for our net-centric business, even though volume growth may moderate, and price declines will continue, we will gain market share.

That is very helpful. And just two quick questions. The expected FX impact in the first quarter, if I am thinking about it correctly, it was about a $900,000 positive benefit in the fourth quarter. It should be about a $100,000 benefit in the first quarter assuming FX rates stay constant?

That is correct.

I am not sure if you disclosed the number of full-time equivalent sales reps added during the quarter?

We did. Actually, we started and ended the quarter with the same number. While we added 51 reps in the quarter and 41 reps have left the Company, in aggregate on a FTE basis, we were at 235 both at the beginning and end of the quarter.

Your next question comes from Colby Synesael with Cowen.

I have two questions one, I just wanted to talk about the margins you pointed out the reason we saw margins go up for the first time in five quarters was based on rep productivity. Is that a trend you think is sustainable? Obviously with about I think you said 4.7 in terms of installs per rep per month versus the average at 4. It seems like that is a difficult number to sustain going forward. So I was wondering if you could talk about that?

And the other question I had to do had to do with Off Net. I was curious what percentage of your Off Net connections are now ethernet, and what do you think the potential is for that to go to, so what percentage do you think we will eventually get to?Just trying to get an understanding of how far along we are in terms of the opportunity to see ARPU going up because of that? Thanks.

So with regard to margin Colby, obviously our sales and SG&A costs declined because of the rep productivity increase, and the same number of reps in the quarter and a larger revenue base. In terms of gross margin, it is really two things. One, the fact that total revenues continue to grow. And actually, the biggest contributor to the gross margin improvement was actually the fact that our expansion rate moderated in the third quarter and fourth quarter, we added less route miles to the network.

So as Tad mentioned, we expanded the overall network by about 20%, the long haul network increased by over 10,000 miles in 2010. But the majority of that increase occurred in the first three quarters of the year, and we only increased it by a few hundred miles in the final fourth quarter. When we add to the footprint, we pick up all of the operating costs in advance of the revenue. That tends to dilute the rate of margin expansion that occurs because of the relative contribution margins.

On net contribution margins are 100% gross margin contribution, $0.95 of EBITDA. Our Off Net revenues have grown at a faster rate than On Net and they only represent a 50% contribution margin for gross margin, so they are somewhat diluted to the 56% margins that we have today. We do expect, however, that margin expansion should continue at a moderate rate. In terms of rep productivity, we --

I was going to say so you are basically saying that if you don't add any more network route miles to your footprint going forward, gross margins should theoretically go up, despite the fact that your Off Net is growing at a faster pace than On Net and that is a lower margin business?

That is correct. 85% of our sales are On Net and about 15% are Off Net. So while the Off Net margin contribution is lower, it is overwhelmed by the contribution margin of the On Net. And you are correct that if we slow down the rate of network expansion, even with the relative mix of On Net to Off Net, we would expect gross margins to increase.

And you have noted I think in your prepared remarks you are expecting to slow down the expansion of the footprint in 2011 from 2010, correct?

That is correct. We do not anticipate adding another 20% to our long haul footprint, and while we expect our building additions to be relatively comparable and probably our metro additions, we think that today Cogent is serving 29 countries as I mentioned on the call, Greece will be our 30th country. We are targeting some additional markets in existing countries, and new markets or new countries, but we think that rate of addition will be lower, as many of those markets do not represent a large enough addressable market to justify the capital expenditures.

That should also then reduce your CapEx in 2011 relative to 2010?

Yes. We anticipate that our capital expenditures, that being CapEx and prepaid capital leases, will decline in 2011 from the combined number in 2010, and we would actually expect each of those components independently to decline. To your rep productivity question, 4.7 is obviously better than our long term average. We anticipate that a lot of the training and management of changes that we have made over the past couple of years are paying dividends, and we hope that 4.0 average continues to trend up. And we are encouraged by the rep productivity that we are beginning to see in the first quarter.

And then finally, on your ethernet question, today well over 90% of the incremental Off Net sales are ethernet, not TDM services. However, for that approximately 3,500 Off Net connections we have, the vast majority over 75% of those connections are still TDM services. So two things are true. One, our new sales going forward for brand-new customers who buy On Net from us and then buy ancillary Off Net locations, we expect to continue to see predominantly those customers choosing the more expensive ethernet based services with greater throughput, and we continue to go back to the installed base of TDM customers and offer them the ethernet options where available. And for those two reasons, we expect ethernet to continue to increase as a percentage of Off Net opportunities. I will be honest,I don't know where it plateaus.

But clearly, a large opportunity is still in front of you. It is not necessarily behind you yet?

Oh, absolutely. A huge opportunity.

Great. Thank you.

Your next question comes from Frank Louthan with Raymond James.

Great. Thank you. Can you give us an idea of what your expectations are for traffic growth over the next 12 months? And obviously the back half of the year was pretty strong. I assume that the political advertising and political issues and Netflix have some impact. But any thoughts on where we can expect traffic growth in the next 12 months?

Yes, Frank. Thanks for the question. Traffic growth typically grows at a more rapid rate in colder months as the Internet is predominantly a northern hemisphere phenomena, and people are inside using the Internet more. Today over 95% of growth in traffic is coming from video, and over 75% of the traffic on the global Internet is video. I think we are seeing an acceleration in the rate at which video is being distributed over the Internet. There are a number of subscription based and pay per view services that have been initiated. All of these should be helpful to traffic growth.

And based on those trends, I would anticipate that the 41% year-over-year growth rate we saw in 2009 to 2010 will actually be greater in 2010 to 2011 than it was in 2009 to 2010, Which it was significantly below the long term trend line. So I think we are seeing a reacceleration of traffic growth on the global Internet, and Cogent disproportionately benefits from that because of our pricing model for net-centric customers. Those that use the most bandwidth are the most price sensitive, and most likely to come to Cogent. So I think this should result in our ability to achieve kind of equal rates of revenue growth in both our net-centric and corporate businesses. And again, growing that revenue base at the kind of 10% to 20% top line rate.

Okay. Great. And can you give us an outlook for network construction, particularly what are your thoughts on building adds, and the long haul network expenses that you are going to, upgrades and route extensions that you are going to have to make for the year?

Yes. We anticipate continuing to grow the network as we said we will add about 120 buildings. That is actually was our target last year, and we did a bit little better than that. Most of those buildings are in existing markets. Those buildings are both multi-tenant office buildings, which allow us to connect to corporate customers and carrier neutral data centers. On the corporate buildings, we have a pretty clear target list of a couple hundred buildings we continue to focus on over the next couple of years. On the data centers, it is really somewhat reactive as new centers get built or commissioned. We will continue to add those to the network.

And then in terms of new metro miles and new long haul, in existing cities our networks are fairly mature, and we don't believe we will be adding a lot more metro miles, maybe in a few limited situations. But we will continue to grow the 160-plus markets to a larger number. Today as I said, we are in 29 countries. Greece will be our 30th, and there are about a half a dozen other countries we are evaluating such as Russia, Turkey, Serbia and Croatia, that today we do not have network into, Lithuania, Lathia, Macedonia, are all potential expansion opportunities for us. But we tend to be very disciplined about what we will pay for that fiber, and we can't exactly predict when and if we will get all of those markets. But we do believe that our rate of footprint expansion will be slower in 2011, and that will be in part, a contributor to our ability to improve our gross margins, as well as our EBITDA margins.

Okay. Great. Thank you.

Thanks, Frank.

Your next question comes from Jennifer Fritzsche with Wells Fargo

Thanks Dave. Just a question on SG&A. SG&A was lower in absolute dollars, well down sequentially I believe, and I was just wondering the drivers of that?And if you think that is a sustainable trend looking into 2011?

I am going to let Tad take the credit on that.

Okay. Thanks Dave.

Yes, Jennifer SG&A did decline really two main drivers there, as we mentioned on the call we had an improvement in our bad debt expense as a percentage of revenue, that directly impacts the level of SG&A costs and that was an improvement both quarter and also year-over-year. And also an improvement in rep productivity which lowers the relative SG&A costs as we have fewer reps selling more product. So that lowers our cost of revenue acquisition and also improves the SG&A line.

Great. And then just, I guess with that in mind, it sounded like you were guiding to margin expansion of 150 to 200 basis points versus 2010 levels of 30.1% but yet you did 32.5% in the fourth quarter. I know margins tend to be lumpy, but that seems somewhat conservative to me?

We have tried to be conservative in our outlook, you have got a couple things that happen in the first quarter that I mentioned on the call. So we do have some seasonal SG&A costs, outside of expansion, which is cost of goods sold in the first quarter, we have got the resetting of payroll tax rates in the US, which is not immaterial as everyone has to reload on their FICA. We have got the costs of our annual audit and filing of our Annual Report and Proxy, also in the first quarter. And not as material, but we also have our annual sales meeting in the first quarter. So in the neighborhood of about $1 million historically of increase in SG&A relative from Q4 to Q1 related to those items, which impacts the expansion and EBITDA on a quarterly basis, and then you need to factor that into what we do year-over-year.

But I would echo Tad's comment, Jennifer, that we try to be very conservative in our year-over-year outlook for margin expansion.

Okay. Thanks very much.

(Operator Instructions). Your next question is from Michael Funk with Bank of America Merrill Lynch.

Great. Thanks for taking the question. One more question one more time on the margin. Just to get clarification. Your top line growth expectations for 2011, your comments on contribution margin and the percent of the growth coming from On Net, do all seem to imply significantly greater margin expansion in 2011 than you are guiding to. Tad, I heard you call out payroll and cost of audit, and some of the potential sequential increases, but anything else to think about? Any other moving pieces in 2011 that will push us closer to your guidance rather than a higher number?

Well, I really don't think there is anything else. Again, we tried to be somewhat conservative. To the question Colby asked about ethernet opportunities, that again is somewhat lumpy. While we make that available to all customers, some take it and some don't, because it is more expensive. Obviously, if we see a big uptick in Off Net growth rates, that would be somewhat dilutive to the rate of margin expansion. But there are really no extraordinary events or costs or things that we are anticipating this year. And obviously we would like to do as good as possible, in terms of margin expansion and what we tried to be is just very, I would say conservative in what we are projecting.

Okay. And one just quick follow-up then here as well. You highlighted video traffic as an opportunity for top line growth. Any thoughts or comments maybe on how you were different or similar to Level 3 in their appearing dispute with Comcast, why you may not or may be subject to similar totals or traffic charges?

Yes. I think the big difference is Level 3, while operating a global network, also operates a CDN business. That is, they are providing the servers, the space and hosting and generating the actual traffic. And I think access network operators view hosters and CDNs differently than global Internet backbone operators. We are different than Level 3 in that we pay no party for interconnection. We today have more networks connected to us. We have over 3,500 networks. About 100 of those are settlement free peers. About 3,400 of them actually pay us, some of those are access networks. Some of those are content-based networks that connect to us. But we ourselves are not a CDN.

I do believe that originators of video traffic are evaluating the cost of having a third party outsource and manage that hosting or doing it themselves. We have a large number of companies today that generate video that previously had used CDNs, and had decided to effectively buy their own servers and house them either in our data centers or carrier neutral data centers, therefore, constructing their own CDN, and then purchasing transit services from Cogent. We remain, I think, a vital peering partner for all of the major access network operators, and I think globally we have great relationships, we have seen occasionally some of the incumbent Europeans be a little slow to upgrade, due to some of their capital constraints, or at least that is what they have told us. But other than that, we have had great connectivity and do not view ourselves susceptible to the same types of pressures that others that operate a CDN are experiencing from the access network operators.

Great. Thank you for taking the questions.

Thanks, Michael.

And we have no further questions in the queue at this time. I would like to turn this back over to the speakers for any additional or closing comments.

Well, again, I would like to thank everyone for joining us today. Thank the entire Cogent team for a great year in 2010, and we look forward to our continued success as the trends that occurred in the fourth quarter continuing throughout the year in 2011. We feel extremely comfortable with the outlooks that we have shared with investors, and our goal is to continue to return value and create value for our equity holders, and meet our obligations of all of our stake holders. Thank you all very much.

And again, that does conclude today's conference. We thank you for your participation.