Cogent Communications Holdings Inc (CCOI) 2011 Q1 法說會逐字稿

Good day, everyone, and welcome to the Cogent Communications Group, Inc. First Quarter 2011 Earnings Conference Call and Webcast. Today's call is being recorded. This call is available for replay at www.cogentco.com.

At this time, I would like the conference over to Mr. Dave Schaeffer, Chief Executive Officer. Please go ahead, sir.

Thank you, and good morning to everyone. Welcome to our first quarter 2011 earnings conference call. I'm Dave Schaeffer, Cogent's CEO, and with me on today's call is Tad Weed, our Chief Financial Officer. We are extremely pleased with the results for the quarter and an improving economic environment.

We experienced significant sequential revenue growth, gross margin expansion, EBITDA margin expansion, improved churn rates, traffic growth, all in the quarter. We significantly strengthened our balance sheet by closing our $175 million senior debt offering in January.

Our revenues grew for the fourth quarter by 5.8% sequentially, and grew year-over-year by 17% from the first quarter of 2010. Foreign exchange did not have any material impact on our revenue growth rates. Our constant currency basis for sequential revenue growth was 5.5%. ARPU for both our on-net and off-net customers increased in the quarter. The average price per megabit of new sales in the quarter also increased.

However, the long-term trend remains that price per megabit will fall as volumes continues to increase. Our gross margin continued its expansion that it experienced last quarter, and expanded by an additional 150 basis points sequentially. Our EBITDA margin expanded by an additional 50 basis points sequentially from the first quarter to 33%, and expanded by 510 basis points from the comparable first quarter of 2010.

Our EBITDA increased sequentially by 7.4% from the fourth quarter and by 38.5% from the comparable quarter Q1 of 2010 to $24.2 million, due to our revenue growth and the significant operating leverage on our business. During the quarter, traffic grew on our network sequentially by 18% and over 39% from the first quarter of 2010.

Since the end of the fourth quarter, we have continued to expand our footprint by adding an additional 30 buildings. We added 390 metro fiber miles to our network and over 2100 inter-city fiber route miles to our network.

During the quarter, our sales were up. Productivity was 4.4 units of installed business per full-time equivalent rep per month. This, again, is above our historical average of 4.1 units per rep per month.

Throughout this discussion, we will highlight several operational statistics that, we believe, demonstrates our increasing market share, expanding scale, expanding size of our network and, most importantly, the operating leverage of our business model.

We have assembled a unique set of assets and infrastructure. The operations generally operate efficiently to generate cash while selling a product at lower price points than our competitors, with better margin, and a product whose demand continues to grow.

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

We are optimistic about our outlook for the remainder of 2011, and encouraged by our recent results, recent trends, the level of our order backlog, that is order side but not yet installed on our network.

I will review in greater detail certain operational highlights and continued expansion plans. Tad will provide some additional color on our financial performance, and then, following our prepared remarks, we will open the floor for questions and answers.

Now, I would like to turn things over to Tad to read our safe harbor language.

Thank you, Dave, and good morning, everyone. This first quarter 2011 earnings report and this earnings conference call will discuss Cogent's business outlook and contain forward-looking statements within the meaning of Sections 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 always 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 measurement and our earnings release and on our website at cogentco.com.

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

Hey, thanks, Tad. Now for some highlights from the first quarter's results. Hopefully, you've had a chance to review our earnings press release from this morning. As with previous quarters, our press release includes a number of historical quarterly metrics.

These metrics will be added to our website, and hopefully you find the consistent presentation of these metrics informative and helpful in understanding our financial results and the trends from our operations.

Our first quarter 2011 revenue was $73.5 million, an increase from $5.8 from the fourth quarter of revenues, and an increase of 17% from Q1 2010 revenues. As a reminder, we evaluate the components of revenues based on product class. That is, on-net, off-net, and non-core, which Tad will cover in greater detail.

We also evaluate our revenue by type of customer. Our customer types include two primary groups, our net-centric customers, and our corporate customers. Net-centric customers buy large amounts of bandwidth from us in carrier-neutral datacenters. Our corporate customers buy bandwidth from us in large, multi-tenant office buildings.

Revenues and customer connections for both our corporate and net-centric customers grew in the quarter. Revenues from our corporate customers grew 3% from the fourth quarter of 2010. Corporate customers represent 56% of our total customer connections at the end of the quarter, and represent approximately 49% of our revenues in Q1 2011. Revenues from our net-centric customers increased by 8.5% from the fourth quarter of 2010. Our net-centric customers represent 44% of our total customer connections at the end of the quarter, and represent 51% of our Q1 2011 revenues.

Now for some views on pricing and overall trends. Our most widely sold corporate product remains a 100 megabit per second connection. Our most widely sold net-centric product is a 10 gigabit connection. We continue to offer discounts related to contract term for all of our corporate and net-centric customers. We also offer volume commitment discounts for our net-centric customers.

During the quarter, over 920 of our net-centric customers took advantage of our volume and term discounts to enter into longer-term contracts with Cogent, increasing their revenue commitment to us by approximately $10 million.

All customers continued to express their confidence in Cogent, entering into longer-term contracts with us. Our average contract term increased by another 1.5% in the quarter. More than 1 out of every 3 customer contracts entered into in the first quarter was either for a 2 or 3-year term. As a reference point, 2 years ago, these multi-year contracts represented less than 1 in 10 customers.

The price per megabit for our installed base continues to decline. However, the price per megabit for new contracts sold in the quarter increased over the previous quarter. Our average price per megabit of the installed base decreased by 11.4% in the quarter. The price per megabit for the installed base declined from $4.63 per megabit in the fourth quarter of 2010 to $4.10 per megabit in Q1 2011.

The price per megabit for new contracts entered into in the quarter increased to $3.14 from $2.59 in the fourth quarter of 2010, representing a 21.2% increase in the price per new megabit sold. As we mentioned on our last earnings call, we offer certain promotional pricings to net-centric customers in the fourth quarter which did materially impact the price per megabit of contracts in that quarter.

As I mentioned earlier, our on-net ARPU increased by 0.9% in the quarter. Our on-net ARPU was $877 in the fourth quarter, and increased to $885 in the first quarter. Our off-net ARPU continued to increase, and increased by another 3.1% from the fourth quarter of 2010, as the average size of our off-net connection continues to increase, due to the prevalence of Ethernet. Our off-net ARPU increased from $1440 in the fourth quarter to $1484 in the first quarter of 2011.

Before Tad provides some additional details on the quarter, I would like to address our results and expectations against our long-term revenue and EBITDA targets. As a reminder, we have previously announced expected topline revenue growth of between 10% and 20%. For the first quarter of 2011, our revenues grew by 5.8% sequentially and 17% year-over-year.

As I indicated on the last earnings call, we also expect our EBITDA margins to expand by 150 to 200 basis points for 2011 over full-year 2010. Our EBITDA margin for the quarter grew by 50 basis points sequentially, and grew by 510 basis points from the first quarter of 2010.

We remain comfortable with our revenue target range, but, however, we now expect and anticipate exceeding our EBITDA margin expansion target that we laid out previously.

Tad will now cover some additional details concerning our results.

Thank you, Dave, and again, good morning to everyone. I'd also like to thank and congratulate the entire Cogent team on their hard work and efforts for the first quarter of 2011.

I will begin by providing additional details on our revenue by product class, which is on-net, off-net and non-core. Our on-net revenue was $56.8 million for the first quarter, which represented a 5.9% increase from the fourth quarter of 2010. Similar to prior quarters, about 85% of our new sales in the quarter were for our on-net services. On-net customer connections increased by 1006 customer connections, or 4.8% for the quarter, and we ended the quarter with about 21,900 on-net customer connections on our network.

Our revenue from our off-net business was $16 million for the quarter, which represented a 5.6% increase from the fourth quarter of 2010. Off-net customer connections increased by 116 customer connections, or 3.3% for the quarter, and we ended the quarter serving about 3640 off-net customer connections and about 3500 off-net buildings.

We continue to experience an increase in the size of our off-net connections, due to the increase in the availability of off-net Ethernet services. Our non-core revenues represent about 1% of our revenues, and about 620 customer connections.

On churn rate, as Dave mentioned, we saw an improvement during the quarter. On-net and off-net gross churn rates both improved. As a reminder, we have consistently reported our churn numbers on a gross basis. As a result, a customer who remains with us but enters into an amended Cogent contract is counted in churn and included in our gross churn rates.

Our on-net gross churn rate improved to 2.4% for the first quarter as compared to 2.7% for the prior quarter. If you exclude the increase in these move/add/change contracts, our on-net churn rate was 1.1%, which also was an improvement from the 1.4% for the fourth quarter. Our off-net gross churn rate improved to 2.4% for the first quarter, and it was 3.3% in the fourth quarter of 2010.

If you exclude the increase in off-net move/add/change contracts, our off-net churn rate was 1.4%, which also was a significant improvement from the 2.2% churn rate for the fourth quarter.

The operating leverage of our business continued to result in the healthy gross and EBITDA margins, and we experienced sequential gross margin expansion and EBITDA margin expansion. Our EBITDA margin was 33% for the quarter. This 33% EBITDA margin percentage represents the highest EBITDA margin percentage in Cogent's history, beating the record we established last quarter.

EBITDA as adjusted was $24.2 million for the quarter, which was a 7.4% increase from the $22.6 million for the fourth quarter, and an increase of 38.5% from the $17.5 million for the comparable quarter in the first quarter of 2010.

Gross profit margin increased by 150 basis points for the quarter to 56.9%, and this expansion of our gross margin percentage for the last two quarters has reversed the previous trend of quarterly declines we experienced through the third quarter of 2010 from the increase in our expansion activities.

Our investment in expansion has produced an acceleration of the increase in our on-net revenues. Our on-net revenues carry a 100% direct incremental direct gross profit margin, and our off-net revenues carry a 50% incremental direct gross profit margin.

Occasional lumpiness in our EBITDA and gross margins can and does occur on a quarterly basis if you examine our 24 quarters of quarterly metrics included in each of our press releases, you will notice lumpiness in our quarterly margin expansion.

This lumpiness can occur due to seasonal factors such as the resetting of payroll taxes and cost-of-living increases incurring in the first quarter, the timing of our audit and tax services, and the timing and scope of our expansion activities.

We did experience EBITDA expansion in the first quarter despite the seasonal SG&A increases that occur typically in our first quarter from the operating leverage of our business. 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 for the fourth quarter was $0.06. Our loss per share for the first quarter was $0.01. As a remind, net income per share of the fourth quarter, we had a tax benefit of $1.5 million related to the reversal of a deferred income tax valuation allowance.

That amount represented $0.03 per share for the fourth quarter. For the first quarter, we had an increase in interest expense related to our notes of approximately $2.8 million, or $0.06 per share, and the notes were issued on January 26th, 2011.

Foreign currency impact. Consistent with prior quarters, about 30% of our revenues are derived internationally. For the first quarter, and consistent with prior quarters, 22% of our revenues were based in Europe, and about 7% of our revenues were related to our Canadian and Mexican operations.

Fluctuation in foreign exchange rates can materially impact our revenues and, in particular, our net-centric revenues. However, from the first quarter of 2010 to the first quarter of 2011, and from the fourth quarter of 2010 to the first quarter of 2011, there was only a minor foreign exchange impact on revenues.

At our fourth quarter earnings call, we estimated that the positive FX conversion impact of sequential quarterly revenues would be a decrease of about $100,000, and the actual foreign exchange impact was an increase of $200,000.

Our first-quarter 2011 revenue increase of 5.8% was 5.5% on a constant-currency basis. Our first-quarter 2011 revenue increase of 17% from a first-quarter 2010 revenues was 16.9% on a constant-currency basis, so, again, only a minor impact.

The average euro-to-US dollar exchange rate so far for the second quarter of 2011, is approximately $1.45, which is a material increase from the average exchange rate of $1.37 for the first quarter.

Should that average exchange rate remain at $1.45, we estimate that the foreign exchange conversion impact on sequential quarterly revenues from the first quarter to the second quarter of 2011 will be an increase in revenues of approximately $900,000.

Capital expenditures-- on a quarterly basis, we can and have historically 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. Our CapEx totaled $12.8 million for the first quarter versus $11.7 million for the fourth quarter of 2010. We added another 30 buildings to our network in the quarter and have added 134 buildings to our network since the end of the first quarter of 2010.

We expect to continue our network expansion in 2011, but at a slightly more moderate pace than we experienced in 2009 and 2010. We expect to add approximately another 120 buildings to our network in 2011, and we are at pace to achieve that goal.

Our capital lease payments, including prepaid capital leases, were $3 million in the first quarter as compared to $2 million for the fourth quarter of 2010.

Balance sheet items. At the end of the quarter, our cash and cash equivalents totaled $225.3 million. For the quarter, our net cash increased by $169.1 million, and in January, we received $170.5 million of net proceeds from the issuance of our senior secured notes.

Our operating cash flow was $13.5 million for the quarter, and declined from the fourth quarter primarily due to the timing of certain vendor payments, including pre-payments for services that are billed on-- for an annual period, but billed typically in the first quarter.

Our operating cash flow was offset by $12.8 million of CapEx and $3.0 million of IRU capital lease payments. If you exclude the proceeds from our senior secured notes, cash-- net cash decreased by $1.4 million for the quarter.

We have about $92 million of our original $200 million face value of our convertible notes remaining outstanding. Those notes mature in 2027 and may be redeemed by us or put by the holders beginning in June of 2014. The notes are reported on our balance sheet net of their own amortized discount at $72.5 million.

Our capital lease IRU fiber lease obligations totaled $129.2 million at the end of the quarter, and about $8 million of that is a current liability. Our capital lease IRU fiber lease obligations were $111.7 million at the end of the year. During the quarter, we assumed $16.8 million of present value of capital lease IRU obligations, and as a reminder, these IRU lease obligations are for long-term (inaudible) fiber leases, that typically have initial terms of 15 to 20 years or longer, and typically include multiple renewal launches.

Our day sales outstanding on accounts receivable was 28 days at the end of the quarter, which was an improvement from the 29 days at the end of the year, and again, I want to personally thank and recognize our worldwide billing and collections team members who are continuing to do just a fantastic job on customer collections and credit monitoring.

Further demonstrating excellent customer collections, bad debt expense was 0.9% of our revenues for the quarter, which was an improvement from the 1.4% for the fourth quarter and 1.7% for the first quarter of 2010.

As Dave mentioned, our average contract term continued to increase, and increased by another 1.5%. When we experience these increases in our average contract term, that impacts our revenue recognized under US GAAP. For example, increases in our average contract term and estimated customer life result in a longer period over which to recognize our billed installation revenues.

We have experienced an increase in the amortization period used to recognize our installation revenues, and that causes a reduction in our revenues recognized under US GAAP. Finally, regarding our notes, on January 26th, as we've said, we sold $175 million of senior secured notes, and the notes were sold at par and carry interest at 8.375%. Interest is paid semi-annually in February and August and the first payment will be in August 2011.

We plan on using the proceeds for purchases of our common-stock convertible notes, special dividend or for general corporate purposes. We received approximately $170.5 million of proceeds after deducting the $4.5 million of offering costs.

We will incur approximately $15 million of additional interest expense on an annual basis while the notes are outstanding, and during the first quarter, we incurred $2.8 million of interest expense related to these notes.

I will now turn the call back over to Dave.

Hey, again, thanks, Tad. I would like to take a moment and comment on some of the trends in our sales force. We began the first quarter with 252 quota-bearing reps, and ended the quarter with 243 reps selling our services.

We hired 39 reps during the quarter and 48 reps left the Company during the quarter. Our rep churned increased slightly to-- from the first quarter from 5.5% in the fourth quarter of last year to 6.5% in the first quarter, still below our long-term historical turnover rate. We began and ended the quarter with the same number of full-time equivalent reps selling our service, that is, 230 full-time equivalents.

Productivity on a full-time equivalent basis for the first quarter was 4.4 units per rep per month. This performance was down from the 4.7 units that each rep experienced in the fourth quarter, but continued to be better than our long-term historical average of 4.1 units per rep per month.

As a reminder, our rep productivity rates are not based on contract signings, but rather are calculated upon completed and installed customer services.

Now to the scale of our network. We added 30 buildings to our network in the first quarter, and we ended the quarter with 1609 buildings on our network. The size of our network and its scale continues to grow. Our network now consists of over 15,800 metro fiber miles, and over 53,3000 inter-city route miles.

We recently purchased dark fiber to serve Serbia, which will represent the 32nd network directly on-net, 32nd country directly on the Cogent network. The Cogent network is one of the most inter-connected networks in the world, and today, we have direct connectivity with over 3600 networks that make up the Internet.

We are currently utilizing approximately 16% of the lit capacity in our network. As we have added additional capacity, even though traffic has grown, this number has declined slightly. We believe our network has substantial scale for additional growth. We continue to evaluate additional routes, both in Europe and North America. We are evaluating and have taken advantage of, certain opportunities presented to us and the volatility in the European markets.

We continue to be opportunistic about taking advantage of certain opportunities to accelerate our expansion plans. Traffic continues to grow on our network, and our traffic and revenue are growing faster than the rates of most of our competitors, demonstrating our gains in market share.

We believe that Cogent, as the low-cost provider, and our value proposition is unmatched in the industry. Our pricing strategy has continued to attract new customers, improve rep productivity and reduce customer churn. It has increased our average contract length, and significantly increased the volume and revenue commitments from existing customers.

Our business remains completely based on the Internet, and focused on providing a service that is a necessary utility to our customers. We are evaluating how to optimize our very strong balance sheet, including the proceeds from our senior secured offering for the benefit of our shareholders.

Our Board of Directors has authorized a buyback program of $50 million, similar to the buybacks that we have previously had. While we have not yet implemented this buyback, we will be optimistic in utilizing this authorization for the purchase of shares.

We are putting our operating cash flow to work by continuing to expand our domestic and international footprint and the number of markets we serve and invest in our sales force. We continue to be encouraged by our sales initiatives and our order backlog.

We are committed to providing topline growth of between 105 and 20%, and as I mentioned earlier, we anticipate our EBITDA margins to expand by greater than 200%, which was the range we had previously indicated, and generate free cash for our shareholders.

We (inaudible) and are confident that our network reaches optimal, our product set is right for the market, we have the correct addressable market, and our operating leverage is unsurpassed. In short, we like our business. With that, let me open it up for questions.

Thank you. (Operator Instructions). We'll go first to Jennifer Fritzsche of Wells Fargo.

Thanks, Dave, for taking the question. Great quarter. Could you just talk about just on the model side, SG&A was up only 1% year-over-year, and just kind of wondering trends here, where you think that should go going forward.

And, I guess, a bigger-picture question. We're seeing a lot of CapEx growth throughout the industry as everyone seems to be focused on (inaudible) building, and just kind of wondering your opinion, if we're going back to that overbuilding, with everyone chasing similar opportunities, and are you seeing, to that end, any growing price pressure in that regard. Thanks.

Okay, well, thanks for the questions, Jennifer. First of all, in terms of fiber construction, Cogent's model has always been to acquire fiber from others that have constructed it, so in both our metro footprint and our long-haul backbone, we actually have fiber IRUs that have been purchased from 155 underlying suppliers.

That number continues to increase, and we have a very disciplined approach to what we are willing to pay for that fiber, and we are also focused only on the highest-traffic locations. So, while I do believe, as the cost of capital has come down, a number of providers have been very aggressive in building that fiber, we are going to try to take advantage of that aggressiveness and expand our footprint to the right locations at the right price point.

Now, what Cogent does spend its capital on is increasing the number of buildings connected to our network, so we took (inaudible) the build from the manhole into the building, and in the multi-tenant buildings, we will build the riser facilities, and we expect to do that at a relatively consistent rate going forward.

I think, to the question of pricing pressure, the price of high-speed IP continues to fall and has fallen at an average of probably about 50% for the industry. Over the last couple of years, Cogent's price decline has been much more moderate, at about 25%, and as I mentioned earlier, while our price per megabit for new sales increased, we do think the long-term trend is for pricing to come down, and our ability to grow our revenues in our net-centric business is a combination of that price decline and volume growth, and in the most recent quarter, you saw our net-centric business grow 8.5% sequentially.

For our corporate customers, the competitive dynamic is very different in that they typically buy connection and use only a portion of it, and because (inaudible) we're dealing with an incumbent, we have not seen significant price compression on the cost per connection, and what Cogent does is, delivers this superior value for that connection, and we continue to grow that business, and our growth in that business, at about 3% sequentially, quarter-over-quarter, is consistent with our long-term growth, and our penetration in those buildings remains at 9.6 customers per building, even though we added 30 new buildings with zero customers at the beginning to the network in the quarter, diluting the base.

I'll let Tad take the SG&A question.

Yes, good morning. So, SG&A for the fourth quarter, if you exclude the non-cash amortization of equity-based compensation, was $16 million and $17.6 million for the first quarter. That increase was what we had expected, with the exception that we had a better bad debt performance than we had expected.

Typically, we see from the fourth quarter (inaudible) a couple of increases in SG&A. We have cost-of-living increases, both from-- on salaries and compensation and on other contracts. We have the resetting of payroll taxes, so FICA and Medicare, particularly in the US, that hits everybody in the first quarter. We also have our sales meeting, international sales meeting in the first quarter.

Those are seasonal changes in CapEx, so the increase that we experienced was on plan, with the exception of bad debt being better than we had anticipated.

Great, thank you both.

Thanks, Jennifer.

We'll go next to Michael Bowen of Guggenheim Partners.

Good morning. Good morning, Dave. Good morning, Tad. A couple of questions-- with regard to-- I want to understand in a little bit more detail on the improved churn. I think you mentioned it was (inaudible) and then two items related to each other. I want to also understand, on the EBITDA margin, what do you think is really driving the improvement and the improved outlook, and, related to that, with regard to sales force productivity, last quarter obviously seemed to be a little bit of an aberration.

Should we be thinking about sales force productivity in the kind of 4.2% to 4.4% range for the foreseeable future, or should we think about that in a different light? Thanks.

Hey, thanks, Michael, for the questions. First of all, with regard to churn, on the gross number, there are two factors. One, customer leaving Cogent, and then second, customers doing moves, adds, and changes. We did see a slight decrease in the number of moves, adds, and changes, so, therefore, the differential between the gross and the net number is slightly smaller. Secondly, we have just seen an improvement in our customers paying us.

We saw that both in terms of the DSOs shrinking, the percentage of revenue that is attributable to bad debt declining, and I think customers are becoming more convinced of our value proposition, and find it very difficult to switch to other providers.

For our corporate customers, no other provider is offering a service such as ours, a symmetric, 100 megabit non-oversubscribed service at anything near the price point, and as these customers become accustomed to that much bandwidth, it's very difficult for them to go back to an inferior product.

For our net-centric customers, there has been some turnover in the market as people go between different providers, but because our pricing remains substantially below that of our competitors, and our quality is equal or better than that of our competitors, customers are reluctant to churn.

We always have some of the smaller dot-com and net-centric customers who are dependent on external capital, but our larger customers tend to have self-sufficient business models, and then, finally, we overlay all of that with an improving macro-environment, and bad debt is going down. People are doing a better job of paying their bills.

Now, with regard to the margin expansion, it's really the operating leverage of the business. If you go back and look at our results now for 24 quarters as a public company in 6 years, you've seen we've demonstrated about 200 basis points year-over-year. While there is some volatility in that, and it is somewhat diluted when we go through periods of rapid expansion, we anticipate our margins to continue to expand not only the remainder of this year, but going into next year and the years after that.

We think the operating leverage of our business is very high, and as Tad mentioned, he talked about the 100% contribution margin for 80% of our revenues, that is, our on-net revenues, and the roughly 50% gross margin contribution on the off-net. So, you can see there is just a tremendous amount of growth opportunity here without the need to accelerate capital spending.

Then, on your last question of rep productivity, in fact, our average has increased, just because of the results of the last few quarters. So, we go back and look at 24 quarter history where we've been reporting this number, and it actually-- the average kicked from 4 to 4.1 this most recent quarter because of the last couple of quarters of strong results.

Our rep quotas are set at 5 units of average selling price of the products that the reps typically sell. What we are looking to do in establishing our quota plan is generally set those quotas so about 80% of the reps can achieve those quotas consistently.

We do think that rep productivity does appear to be trending up. If you look at last year, from 3.9 to 4.7, there was a constant improvement throughout the year. We hope that continues, and I think it's a result of some of the programs that we put in place a couple of years ago, so we anticipate our rep productivity remaining at about these levels.

Okay, then, one last thing, if I could, with regard to the average price per megabit, you said the long-term trend remains that you think it will fall, but can you just talk a little bit more about what you think occurred during the quarter to drive the increase?

Well, what occurred in the quarter was pretty straightforward. We had had some very aggressive promotions in the fourth quarter that drove the average price of the new install to $2.59. We then saw those promotions end and they were replaced by different promotions, but the promotions in the first quarter were more targeted at some corporate customers, and therefore, the price per megabit actually, of new sales, increased back towards our more standard price grid, although, long-term, we do expect those prices to continue to come down.

As I said, we've experienced about a 25% annual rate of decline in our price per megabit in the installed base, but yet we've demonstrated over 500 basis points of margin expansion, so it really demonstrates the operating leverage of the business, and I think investors should monitor that number, but really monitor our revenue growth and profitability more than focusing on the average selling price of a megabit.

Okay, thank you. Thank you, guys.

Hey, thanks, Michael.

We'll go to Dave Coleman of RBC Capital Markets.

Hi, just wondered if you could talk about the pricing trends during the quarter, specifically, the on-net ARPU increasing. It would sort of seem to defy sort of elasticity of demand, given the strong customer demand that you're seeing. So, you've talked about pricing decline-- continuing to decline over time, but this quarter would seem to be a bit of an aberration, that you were able to hold the line on pricing, yet still see stronger customer demand.

Secondly, second quarter, typically, in the past has been the strongest sequential EBITDA margin quarter for you. Just wondering if that's something we should anticipate this quarter and if there's any sort of expectations as to what that kind of margin expansion should be.

Okay, great. Thanks, Dave. I'll take the pricing question and I'll let Tad take the expand-- the margin question. You know, in the quarter, first of all, for ARPU, that is the revenue per connection, not the price per megabit, so on-net ARPU is impacted by the relative mix of corporate versus net-centric, and also, for the net-centric, the size of those connections.

What we are seeing is the average connection continuing to get larger for our net-centric customers. As we mentioned, the most commonly-sold product for our net-centric customers is now actually a 10 gigabit interface. Now, that doesn't mean that every 10 gig interface has sold at a full 10 gig line rate, but it allows customers to take up to 10 gigs on that one connection, whereas for our corporate customers, the most common connection remains a 100 meg connection, and the average price of that 100 meg connection on a three-year contract is about $700, and that's remained unchanged.

So, on the corporate side, pricing is very stable. On the net-centric on-net side, the price per megabit is falling, as it did in the quarter, so it is only the new sales that occurred in the quarter that went up, but the installed base actually did fall at about 11% sequentially in the quarter.

When I talk about the long-term trend, I look at the unused capacity in our network, I look at the growth in demand for services and our ability to operate at very high incremental margins, coupled with a constant vigilance on monitoring our cost of revenue acquisition, and we are absolutely committed to being the price leader in the market.

We look at our competitors in this space, who have higher revenues, higher prices per bit, and substantially lower margins. We want to take advantage of that dynamic and rapidly gain share, so on the net-centric side, we will be aggressive, and we do expect price per bit to continue to follow that long-term trend.

Now, to the ARPU question, ARPUs may be going up permanently just because the average connection size is getting bigger, not because the price per megabit has stopped falling.

Tad, you want to take the margin questions?

Sure. We have not been giving quarterly guidance. As Dave mentioned, we do expect the EBITDA margin expansion year-over-year now to be greater than 200 basis points, however, I can talk to some of the seasonality we do experience between the first and second quarter, and indicate that we do expect margins to expand from the first two the second quarter.

Some of the seasonal factors I mentioned earlier are the [COLA] increase we experience, the sales meeting that we have in our first quarter, also the timing of services related to audit and filing our annual report. Those are seasonal factors that-- from the fourth to the first quarter that we do not typically experience from the first to the second quarter. Kind of the variable SG&A costs that we will experience would be bad debt expense. Again, we did better than we expected in the first quarter. The historical average is about 1.5% of revenues recently, so to the extent we're better than that, we will experience better performance than we expect on the SG&A front.

Then, the timing and the number of sales reps that we hire during the quarter, because at the beginning, they are ramping up, so those are kind of the variable factors, but we do expect expansion Q1 to Q2.

Okay, that's helpful, and just maybe asking about the on-net ARPU is the wrong way to approach it, but you mentioned price per meg for new sales went up, but that didn't have an impact on incremental customer growth, it actually increased, so, I guess I'm just wondering, are we at a point where we're reaching stability in pricing, and that you're-- you don't need to be as aggressive on pricing as you have been in the past?

And just a final question, with two of your larger competitors merging, does that also bring in more price stability in the market?

So, I'll take the competitive question first. The market has continued to consolidate over the years, and two of our competitors in the net-centric side of our business are merging, probably our two largest competitors. We remain substantially below the price of either of those companies independently.

We expect that there will be some opportunity for Cogent to pick up business from customers who look for diversity, who may be experiencing a degradation in either billing quality or actual service quality in the transition as the networks combine. So, we think net it will give us some opportunity to gain market share.

We believe, however, that the price declines will continue, maybe at a slightly more moderate rate, but they will continue, whereas-- again, we are committed, with 80% of our lit capacity unused, to being the price leader, where our biggest variable cost is the cost of sales, and the biggest input we have in lowering our sales cost is actually our pricing.

To your question of price per meg and number of new customers added, the customers added are, in part, a result of pricing, but also the growth in traffic is a result of pricing, because for many of our net-centric customers, they may have multiple providers, and what we are seeking to do is, in addition to winning those customers, is over time, becoming the dominant provider to those customers.

So, aggressive pricing also helps us win a greater share of wallet from each of our customers.

That's helpful, thank you.

(Operator Instructions). We'll go next to Colby Synesael of Cowen & Company.

Great. I have two questions. The first one, as it relates to our previous guidance of 150 to 200 basis points of margin improvement, that was obviously below your historical run rate that you've talked about of 200 to 300 basis points, and I believe the reason for that was that you were expecting to perhaps add more fiber in the form of buying dark fiber and then consequently (inaudible).

Now, obviously, you're suggesting that we're going to be above 200. Can you talk about what that implies for your expectations for fiber acquisitions for the remainder of the year, and also with you talking about adding, I think, 390 metro miles this quarter and 2100 inter-city miles, what's the impact on margin as you bring that on in the second quarter?

My second question is going to have to do with the stock buyback. Obviously, that was a very big thing for the stock last year. You did see the stock actually go up when you announced you were going to be doing that, and now, this quarter, you did not make any actual purchases.

Just trying to understand what's the hesitation. What are you actually thinking about? I know you talked about how you're trying to figure out how to best optimize the balance sheet, but trying to understand why we didn't actually see any stock buybacks this quarter. Thanks.

Sure. Thanks for the two questions, Colby. So, first of all, on the expansion, our expansion rate was actually fairly significant in the first quarter, adding 2100 route miles of inter-city, or increasing our long-haul footprint by 4% in one quarter.

We do anticipate some additional fiber purchases throughout the year, but probably at a slightly more moderate rate than we did last year, but about as we expected. I think the improvement in margin comes from three factors. One, our revenue growth seems to be a little bit better than we expected, and we tried to be conservative going into the year, and we still want to be very conservative in what we are projecting, but we also need to be realistic, based on the spectacular results of the most recent quarter. So, with this high operating leverage, I think you will see significant flowthrough.

Two, in terms of fixed costs, our network is a very fixed cost network to run, and we've done a good job of keeping those costs in moderation, and then Tad can comment a little bit on the bad debt, which also, I think, has a big input in our margin expansion.

Sure. On the EBITDA front, we obviously had better improvement than last quarter and the comparable quarter from last year on bad debt, so, 0.9% of revenues. That's a pickup if you just look quarter-over-quarter, of about $400,000.

Also, the margin impact on fiber tends to be related to the maintenance charges on the fiber. Most of these fiber expansions wound up being capital leases, so they are recorded on the balance sheet and hit interest in depreciation, because of their long-term agreements, but we do, when we enter into these, also enter into agreements for maintenance, so the maintenance is a cost of goods sold charge.

So, the impact on margins, on the cost of goods sold line, related, accepting fiber, depends upon the price of that maintenance and when the fiber is actually accepted.

And then with regard to the stock buyback, Colby, we just did the transaction a couple of months ago. We understand the negative carry that we are sustaining by keeping the cash on our balance sheet. As we said, we are very comfortable that we have sufficient cash from operations to grow as rapidly as we can in the market. We are evaluating when and how to buy back our stock.

Our stock has been very volatile in the past. Our belief is that that volatility is generally for non-Cogent reasons, but rather market-related reasons, and just like with all of our deployments of capital, we intend to be opportunistic, and we'll continue to evaluate with the board buybacks and/or dividends as a mechanism to return value to shareholders, and remember, the shareholders still have a claim on that cash which is sitting on our balance sheet, so it hasn't gone anywhere, we're going to be very good stewards of it, and we will buy back stock opportunistically.

Maybe I'm reading into it, but are you leaning more toward a dividend now than perhaps you may have been thinking just three to six months ago?

Well, remember, when we announced the intention to do a buy back in raised debt, the stock increased in value substantially, just on that news. I think the value of the stock may still not reflect the true discounted free cash flow of our business. That's the ultimate value of the business.

We would, obviously, like to return the cash to shareholders as effectively as possible, and all I could say is, we're going to evaluate both opportunities and both mechanisms, and there is no absolute one right answer. I think the buyback does have some tax advantages and some compounding that we like, but we also understand that if we have to wait too long because the macro conditions just continue to remain stable, and we may elect to do a dividend.

It has-- no final decision has been made.

And is there a timeframe on that decision?

No, it is something that we constantly talk with the Board about and evaluate.

Great, thank you.

We'll go next to James Breen of William Blair.

Thanks for taking the question. Just, with respect to the net-centric growth, David, are there any areas where you can say you're seeing a greater pickup in terms of volumes just across industries in general?

Thanks, Jim. Most of the growth in volume are coming from sites that are video sites. As we commented on previous calls, today, north of 75%, between 75% and 80% of total Internet traffic is coming from video sites, and virtually all of the growth is coming from sites that are video.

Now, these can be either social or casual video-type sites, or, increasingly, we're seeing professionally-produced non-linear video being distributed over the top, and I think we're still at the early stages of that.

Video consumption in the Western world remains at about 300 minutes per day, and we've seen over the top, or video on the Internet, go from about 4 minutes a day to about 6 minutes. That's still a very small percentage of those 300 minutes, but it was a 50% increase in just one year, and I think we're seeing an acceleration of that trend, and Cogent actually benefits two ways.

We have both publishers of content as customers, whether they be CDNs, hosting companies, or direct publishers and we also benefit because we have hundreds of access networks around the world who buy upstream connectivity from Cogent.

As I mentioned earlier, we are connected to over 3600 networks. Over 3500 of those 3600 pay us for connectivity. More networks around the world buy connectivity from Cogent than any other network.

Great, thank you.

Thanks, Jim.

We'll go next to Michael Rollins of Citi Investment Research.

Hi, thanks for taking my question. Morning, Dave.

Hey, Mike.

A couple quick questions for you. First one is, just thinking through a little bit of the net-centric business, it seemed like volume growth might have been a little bit slower for part of last year, and it seemed like, at some level, maybe there were some CDN share gains in that traffic-- with the CDNs being passed more through interconnectivity within datacenters versus-- over a long-haul network, and so I'm curious if you're seeing any change in that trend, or any new development, especially as your pricing per bit continues to go down, your connectivity continues to go up.

The other question I had for you was on the sales force, and is that an area where you expect the growth to pick up in the back half of the year, in terms of the number of full-time equivalents? Thanks.

Sure, thanks for your two questions, Mike. So, first of all, the demise of the Internet has been forecasted many times, and I think it has been greatly exaggerated in that somehow cross-connects within the datacenter would eliminate the need for the Internet, or CDNs would somehow eliminate the need for the Internet.

Internet connectivity is distance insensitive, so you pay the exact same cost to send your bit one block as you do to send it around the world. That is a fundamental cost model for the Internet, and that continues to be the case, so CDNs also buy transit.

The average packet travel distance has remained relatively constant at about 2700 miles over the past 6 years that we have been monitoring it, and there's really been two trends going on.

One is the proliferation of distributed content, i.e. CDNs, and most CDNs are actually customer-constructed as opposed to third parties. They are really just distributed hosting companies that then buy transit.

Some of those are located in datacenters, some are in independent facilities or production facilities of the operators. But secondly, the Internet has become increasingly globalized, so in 2000, 85% of Internet traffic, either originated or terminated in the US. Today, that number is below 50%, and continues to fall as the US share.

So, the Internet becomes more global, the content becomes more distributed, and the net result is, these two factors have kept the average packet travel distance about the same. Now, in terms of volume growth, we do tend to see some seasonality in volume growth. Typically, volumes do slow a bit in the summer, but we do anticipate seeing kind of continued year-over-year growth, probably accelerating somewhat due to this video trend that we talked about just a moment ago, and whether that video sits on a CDN or it sits in a single-hosted site, it still consumes transit, and it remains a significant opportunity.

And I think you saw that in the most recent quarter, where our revenues from net-centric grew at 8.5% sequentially while volume on the network grew at 18%. There is an additional factor, which is the utilization rate, and most customers enter into these multi-year contracts with volume commits to get better pricing that does have a-- has some volatility in it, so some quarters, revenues may grow, but volumes could even decline because people are buying forward and putting capacity in place, and utilization rates can fall.

We saw-- we've seen that pattern in past summer months, and I think that's probably going to be at rend going forward. Now, to the sales force question, it's absolutely an area we're focused on, and we do expect to see an acceleration in the number of reps that we hire and, while we would hope we would see a stabilization or even deceleration in the rate at which reps are leaving the Company, most rep turnover is involuntary, and we remain very focused on maintaining high productivity levels.

But we do expect our aggregate number of sales reps and the number of full-time equivalents to increase through the remainder of the year.

Thanks for your help, Dave.

Hey, thanks, Mike.

We'll go next to Michael Funk of Bank of America Merrill Lynch.

Hey, thank you for taking the questions. Two quick ones. The first one, just thinking about sequential trends for 2011. I appreciate your comments about the impact of customers paying their bills, and that impact on the revenue growth that we saw in the last quarter, but looking back at the first quarter and the sales trends during the quarter, everything you know about what occurred, is there any reason to believe we're not going to see a similar lift to revenue in Q2, or why shouldn't we see a similar lift?

Then, I have a second one, a follow-up, when you're finished.

We do expect to see revenues continue to grow into the second quarter at rates comparable to our historical trend. We also will get some benefit from foreign exchange. I think that will help us additionally in the second quarter.

It is true, though, that generally the second quarter begins a period in the latter part of the second quarter and the first part of the third quarter where we see slower traffic growth. We do have a fairly heavy concentration in the educational verticals that tend not to consume as much bandwidth in the summer, and general bandwidth usage generally moderates in the summer, and this is not a Cogent unique phenomenon, but this is true throughout the industry.

But we do absolutely expect to see the revenue growth trends that we saw in the first quarter continuing through the year, maybe at slightly different rates. We feel very comfortable with our long-term growth projections. Obviously, if, for four quarters, we do exactly what we did in the first quarter, we'll be above that, that may or may not be the case, but we feel very comfortable with the ranges we have set, and also the changes we have put in place.

Then, just one more quick one, if I could. You look at the recent consolidation in the space, do you have a view towards potential to pick up divested assets versus current investment activity? Then, I guess, kind of a part B to that, are there logical strategic combinations or partnerships for Cogent in light of the recent consolidation activity?

So, we have been very aggressive in picking up assets from providers, including most of the companies that have recently announced combinations. So, we don't necessarily wait for a forced divestiture, but, rather, as a part of their routine businesses, they sell dark fiber, and if they are in regions that are interesting to us at price points that we're willing to pay, we acquire that fiber.

We would love to acquire customer base, but the challenge is that for most other companies, the customers buy lots of other services, not just Internet access, and the result would be, we would be buying revenue streams that are not our core competency, and we would work to then divest of.

So, I don't think we're necessarily going to see the opportunity buy pure Internet customer bases. We will monitor the situation, and if there are assets that are forced divestitures due to federal requirements, we will look at them.

In terms of combinations, we remain very focused on creating shareholder value. That means either looking to continue to acquire other assets or companies at good prices or to be able to then look to see if Cogent should be part of another company.

That's a constant effort, but we've got a great business that is demonstrating substantial organic growth, substantial operating leverage, and we are nowhere near exhausting either our addressable market or the capacity in our network, and would require additional capital spending, so for all of those regions, we believe that the best use of our time is just to execute, as we did in the last quarter.

Great, thanks for the questions.

And we'll go to David Dixon of FBR Capital Markets.

Thanks, Dave, and good morning. I apologize if this was covered, but I had a question on CapEx and capital leases. I was very impressed with the sequential revenue and EBITDA growth in the quarter, congrats on that, but I wanted to get a sense of whether the first quarter presents a good run-rate for us for both CapEx and cap leases in 2011 and how quickly you would expect that to moderate going forward, and then I had a follow-up on your pricing card in the market.

Sure, Dave. Well, first of all, with regard to CapEx, I think, historically, our CapEx is always the most moderate in the fourth quarter, so, generally, Qs 1, 2, and 3 look very similar. We expect those trends to continue. In terms of new prepaid capital leases, it is very opportunistic when we acquire dark fiber, sometimes that fiber is acquired as a capital expenditure, sometimes as a capital lease that is prepaid, dependent on what the specific terms are, and then we test that against a set of measures to determine whether it is actual capital or a prepaid capital lease.

To the point of our capital lease expenditures in the quarter, it was actually significantly higher in Q1 than our historical run-rate, not in the form of prepaid, but new capital leases entered into. We actually had one of our major suppliers in Southern Europe come to us, provide us some additional new routes, but also work to lower the price of the fiber but substantially extend the length of that agreement, and in that particular agreement, only a portion of it is prepaid, and a portion is in the form of recurring payments.

So, that represented an increase in the capital lease balance. That was somewhat of an anomaly, but I think if you look at the capital number and the prepaid number, i.e. the roughly 12 and 3 number, that's probably a little bit higher than-- if you multiply that times 4, that's probably a little bit higher than we expect to do for the whole year, just expect the fourth quarter to be a little less.

That looks-- that does look high. That answers the question. So, think of a number closer to 50 would be more reasonable?

I think that's right, Dave.

Thanks, Dave, and then just following up, on the pricing card in the market, I'm hearing that there is a new pricing card in the market, and obviously there is new promotions, as you mentioned, on an ongoing basis.

Do you-- are you able to help me understand whether that's being refocused again back on the net-centric segment similar to what we saw in Q4? I'm just trying to reconcile between what I'm maybe seeing there in terms of more pricing aggression, coupled with your comments earlier about Level 3 and Global Crossings being well above Cogent in the marketplace today. What would be driving you to do that?

Yes, so a couple things. First of all, on the corporate side, we do have some promotions in the first quarter, some of those installed, some will install in the second quarter that incented corporate customers to take multiple connections. We also have promotions that were targeted at multi-tenant office buildings where we had lower penetration rates than our average, so we were trying to basically go after the weaker parts of our corporate market.

On the net-centric side, we have constantly offered promotions, and sometimes, those promotions are targeted at very specific customers. We have not adjusted our standard rate card. What we do have is some specifically aggressive programs for customers who may be affected through companies that have either announced combinations or put themselves up for sale, so we're targeting customers that are with competitors who have announced that they are looking for-- or have announced that they are doing a combination, but that's a very small subset of the entire universe of addressable customers.

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

And at this time, I'll turn the conference back over to management for any additional remarks.

Well, again, we thank you all very much. I know we ran a little long, but I did want to try to answer everyone's questions, and we look forward to talking with you on the next call. Take care, everyone.

And that does conclude today's conference call. Thank you for your participation.