Cogent Communications Holdings Inc (CCOI) 2011 Q3 法說會逐字稿

Good day, everyone, and welcome to the Cogent Communications Group, Inc. third quarter 2011 earnings conference call and webcast. Today's call is being recorded and will be available for replay at www.cogentco.com.

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

Good morning, and thank you, everyone. Welcome to our third quarter 2011 earnings call. I'm Dave Schaeffer, Cogent's Chief Executive Officer. With me on this morning's call is Tad Weed, our Chief Financial Officer. We are pleased with our results for the quarter. During the quarter, we experienced sequential revenue growth, gross margin expansion, EBITDA margin expansion, reduction [in charge], acceleration in traffic growth and an increase in the number of buildings connected to our network.

Our revenue grew from the first quarter -- from the second quarter by 2.4% sequentially and on a year-over-year basis grew by 15.8% from the third quarter of 2010. Our EBITDA margin expanded by another 90 basis points sequentially from the second quarter of 2011 to 34.5% and expanded by 410 basis points from the third quarter of 2010.

Our EBITDA increased sequentially by 4.9% from the second quarter and 31.1% from the third quarter of 2010 to $26.7 million due to our revenue growth and a significant operating leverage in our business. During the quarter, traffic on our network grew by over 44% from the third quarter of 2010, and on a sequential basis grew by 10% from the second quarter of 2011.

Since the end of the second quarter, we continued to expand our footprint by adding 38 additional buildings to our network, over 600 metro fiber miles and over 1,100 inner-city fiber route miles to our network. During the quarter, our sales rep productivity was 4.6 units of installed business per rep per month. Again, this is above our historical average of 4.1 units per rep per month.

Also during the quarter, we began the implementation of our authorized share buyback program. During the quarter, we purchased 230,000 shares for a cost of $2.9 million, purchasing those shares at an average price of $12.78 per share.

Throughout this discussion, we will highlight several operational statistics that we believe demonstrate our increasing market share, expanding scale, the size of our network and the operating leverage of our business model. We've assembled a unique set of assets and infrastructure, and operations that efficiently generate cash while selling a product at a lower price than our competitors with better and increasing margins and these products are in rapidly growing demand.

We continue to believe there is a significant barrier of entry for anyone to replicate the network and the assets that Cogent has assembled and our position as the lowest cost, most efficient operator in the sector, targeting the most traffic rich locations provide us a great opportunity going forward.

We are optimistic about our outlook for the remainder of 2011 and for the full year of 2012. We remain encouraged by our historical results, recent trends, and our order funnel and our order level backlogs, order signed, but not yet installed on our network.

I will review in greater detail certain operational highlights and continued expansion strategies. Tad will provide some additional details on our financial performance. Following these remarks, we'll open the call for questions and answers.

Now I'd like Tad to read our Safe Harbor language.

Thank you, Dave, and good morning, everyone. This third quarter 2011 earnings report and this earnings conference call discuss Cogent's business outlook and contain forward-looking statements within the meaning of Section 27A and 21E of the Securities Act. The 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 our supplement statements made on this call.

Also, during this call, if we use any non-GAAP financial measures as defined by the SEC, you will find these reconciled to the GAAP measurement in our earnings release and on our website at cogentco.com. Now I'll turn the call back over to Dave.

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

Our third quarter 2011 revenue was $77.4 million, an increase of 2.4% from our second quarter 2011 revenue and an increase of 15.8% from our Q3 2010 revenues. As a reminder, we evaluate our components of revenues based on product class that is, on-net, off-net, and non-core. Tad will cover these in greater detail.

We also evaluate our revenues by the types of customers that purchase our service. Our customer types are two major groups, net-centric customers and corporate customers. Our net-centric customers buy large amounts of bandwidth from us typically in carrier and neutral datacenters. Our corporate customers buy bandwidth from us to support their non-Internet focused businesses and 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 by 1.8% sequentially from the second quarter of 2011. Corporate customers represent 53% of our total customer connections at the end of the quarter and represent approximately 49% of our Q3 2011 revenues. Revenues from our net-centric customers increased sequentially from the second quarter 2011 by 2.9%. Our net-centric customers represent 47% of our total number of customer connections and 51% of our revenues in the third quarter.

Now for some discussion around pricing. Our most widely sold corporate product remains a 100 megabit connection and our most widely sold net-centric product is a 10 gigabit connection. We continue to offer discounts related to contract term for corporate and net-centric customers, we also offer volume discounts for our net-centric customers.

During the quarter, over 980 existing net-centric customers took advantage of our volume and term discounts and entered into longer-term contracts with Cogent, increasing their total future revenue commitment to Cogent by over $9.4 million. Customers also continue to express confidence in Cogent by entering into longer-term contracts with us. Our average contract term increased yet again by an additional 1.3% for the quarter over the second quarter.

More than one out of every three Cogent customers entered into contracts in 2011 with contract terms of two or three years. As a reference point, two years ago, these multi-year contracts represented less than one in 10 customer contracts. Now for some discussion around price per megabit, which does impact our net-centric business. Price per megabit for our installed base continued to decline as expected. Our average price per megabit for our installed base decreased sequentially by 5.3%. The price per megabit declined from an average price in the installed base of $3.96 in the second quarter to $3.75 per megabit in the third quarter of 2011. The decline was 24.1% when compared to third quarter of 2010, when the average price in our installed base was $4.94.

The price per megabit of new contracts entered into, in the quarter, was $2.65, a 10.5% decline from the $2.96 sold in the second quarter. The decline in new contract pricing on a year-over-year basis was 27.4% when compared to the third quarter of 2010 when the average new contracts signed was at $3.65. These declines were partially attributable to certain promotional activities that we initiated in response to recent M&A activity in our industry.

Now for some ARPU, our average revenue per user. Our on-net ARPUs decreased by 4.4% in the second quarter. Our on-net ARPU was $855 in the second quarter, and decreased to $817 in the third quarter of 2011, primarily due to the average price per megabit declining from our net-centric customers as a result of the promotional activities I mentioned earlier. Our off-net ARPUs continue to increase and increased by another 3.9% from the second quarter of 2011 as the average size of our off-net connections continues to increase. Our off-net ARPU increased from $1,512 in the second quarter of this year to $1,571 in the third quarter of 2011.

Before Tad provides some additional details on the quarter, I'd like to address our results and expectations against our long-term revenue and EBITDA target. As a reminder, we have previously announced that we expect our topline revenue to grow at between 10% and 20%. For the third quarter of 2011, our revenues grew sequentially by 2.4% and by 15.8% on a year-over-year basis. For the first nine months of this year, revenues grew by 16.7% over the same nine-month period in 2010. As we have announced in our previous earnings calls, we expect our EBITDA margin to expand by greater than 200 basis points for full year 2011 over 2010.

We expect the year-over-year EBITDA margin [expansion] actually be much greater than that and approximately 400 basis points on a year-over-year basis based on our recent results. Our EBITDA margin for the quarter grew by 90 basis points sequentially and 410 basis points on a year-over-year basis when comparing third quarter 2010 to third quarter 2011. Our EBITDA margin for the first nine months of 2011 when compared to the comparable nine-month period in 2010 grew by 450 basis points. We continue to remain comfortable with our revenue and now revised upward 2011 EBITDA margin targets.

Now let's talk slightly about 2012. An expected topline revenue increase in 2012 should remain in that 10% to 20% range. We expect our EBITDA margin expansion for 2012 to be approximately 200 basis points above our 2011 EBITDA margin rates. And as we have mentioned previously, we expect a reduction in the absolute level of capital spending in 2012 as compared to 2011.

Now Tad will spend a few moments giving you some additional details on our results.

Thank you, Dave. And, again, good morning to everyone. I would also like to thank and congratulate our entire team and our hard work and efforts during this third quarter. I'll begin by providing additional details on our revenue by product class. Our on-net revenue was $58.7 million for the quarter, which was an increase of 1.2% sequentially. Again, approximately 85% of our new sales for the quarter were for our on-net services. On-net customer connections increased by 1,175 connections or by 5% for the quarter and we ended the quarter with 24,535 on-net customer connections on our network.

Our revenue from our off-net business was $18 million for the quarter, which was an increase of 7% from the second quarter. Off-net customer connections increased by 105 or 2.8% for the quarter. And we ended the quarter serving 3,864 off-net customer connections at approximately 3,700 off-net buildings. We continued to experience an increase in the size of our off-net connections due to the increase in the availability of off-net Ethernet services.

Non-core revenues represented less than 1% of our revenues and about 580 customer connections at the end of the quarter. Churn, our on-net and off-net gross monthly churn rates both improved for the quarter as Dave mentioned. As a reminder, we have consistently reported our churn numbers on a gross basis. As a result, the customer who remains with us, but enters into an amended Cogent contract is counted as churn and included in our gross churn rates.

Our on-net monthly gross churn rate was 2.2% for the quarter, an improvement from our monthly churn rate of 2.4% from the second quarter. If you exclude the increase in move/add/change contracts, on-net monthly churn rate was unchanged from quarter-to-quarter at 1.1%. Our off-net gross monthly churn rate was 2.4% for the third quarter, which was an improvement from our monthly churn rate of 2.5% from the second quarter. Again, if you exclude the increase in move/add/change contracts, our off-net monthly churn rate also improved to 1.5% from 1.6% from the previous quarter.

The operating leverage of our business continued to result in healthy and expanding gross and EBITDA margins. Our EBITDA margin was 34.5% from the third quarter and net EBITDA margin represents the highest EBITDA margin percentage in the Company's history, beating the record we established last quarter and demonstrating the tremendous operating leverage of our business.

EBITDA, as adjusted, was $26.7 million for the quarter, which is an increase of 4.9% from the second quarter and an increase of 31.1% from the third quarter of 2010. Our gross profit margin increased by 50 basis points from the quarter to 56.7% and by 240 basis points from the third quarter of 2010. Comparing the nine-month period of 2011 to 2010, we are up 180 basis points on gross margin percentage. Our on-net revenues continue to carry a 100% direct -- incremental direct gross profit margin and our off-net revenues continue to carry an approximate 50% incremental direct gross profit margin.

Occasional lumpiness in our EBITDA and gross margins can and does occur. If you examine our quarterly metrics for the last 26 quarters, which are included in each of our press releases, you will notice lumpiness in our quarterly margin expansion rates. This lumpiness can occur due to seasonal factors such as the resetting of payroll taxes and cost of living increases that occurs in our first quarter and the timing of our order and tax services and also the timing and scope of our expansion activities.

However, our long-term trend has demonstrated increase in EBITDA margins and we expect that long-term trend to continue. Earnings per share, our basic and diluted earnings per share was $0.01 for this quarter. The previous quarter of 2011 was $0.05 earnings per share. However, included in the net income per share for the second quarter was a gain related to the cancellation of an IRU capital lease agreement of $2.7 million. That amount represented $0.06 per share for the second quarter, so if you exclude that gain, the basic and diluted loss per share for the second quarter would have been a loss of $0.01 per share. So, as a result net of that lease gain, earnings per share quarter-to-quarter change was an improvement of $0.02 per share.

Foreign currency impact, about 30% of our revenues are derived from international operations. And for the third quarter approximately 21% of our revenues were based in Europe and about 7% of our revenues were related for Canadian and Mexican operations. Fluctuations in foreign exchange rates can materially impact our revenues and in particular our net-centric revenues.

From the third quarter of 2010 to the third quarter of 2011, foreign exchange positively impacted our revenue growth by $1.7 million. However, on a sequential quarter basis, so from the second quarter of 2011 to the third quarter of 2011, foreign exchange negatively impacted our sequential revenue growth by about $330,000. Our third quarter 2011 revenue increase of 50.8% from the third quarter of 2010 was 13.2% on a constant currency basis. And our third quarter 2011 sequential quarterly revenue increase of 2.4% was 2.8% on a constant currency basis.

The average euro to the US dollar rate thus far for the fourth quarter is approximately $1.37 and as we've all seen, very volatile. That $1.37 is a relatively significant decline from the average rate of $1.41 we experienced in the third quarter. So should the average foreign exchange rates for the fourth quarter remain at their current rates, we estimate -- at their current average rates rather, we estimate that the FX conversion impact on sequential quarterly revenues from the third quarter to the fourth quarter will be a decline in sequential revenues of approximately $700,000. That will partially offset our rate of sequential revenue growth.

Capital expenditures. On a quarterly basis, we can and have extraordinarily experienced seasonal variations in CapEx and 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 experienced our lowest level of CapEx in our fourth quarter. Our CapEx totaled $9.4 million for the third quarter, which is a decline from the $13.2 million in the second quarter and also a decline from the $16.5 million we incurred in the third quarter of 2010.

We added another 38 buildings to the network and we have added 168 buildings to our network since the end of Q3 2010. We expect to continue our network expansion in 2012, but at a slightly more moderate pace than we experienced in 2010 and 2011. Capital lease payments including prepaid capital leases were $6 million in the third quarter, an increase from the $4.4 million in the second quarter and a decline from the $8.6 million from the third quarter of 2010.

On balance sheet items. At the end of the quarter, our cash and cash equivalents were $224.1 million and for the quarter, our net cash decreased by $3.2 million. Operating cash flow was $15.9 million for the quarter, which was a 17% decrease from the $19.2 million of operating cash flow for our second quarter. However, included in the operating cash flow for this quarter was our $8.1 million payment for the interest that had accrued since the January 2011 issuance of our $175 million of senior notes. Adjusting for that payment, our operating cash flow significantly increased by 25% to $24 million for the quarter. Our operating cash flow will be impacted by the interest payments on our senior notes that occur each February and August through their maturity in 2018. That payment is about $7.3 million semi-annually.

Our operating cash flow was offset by $9.4 million of CapEx and $6.0 million of IRU capital lease payments and $2.9 million paid to purchase stock under our stock purchase plan. That resulted in the $3.2 million net decrease in cash for the quarter. If you adjust for the debt interest payment of $8.1 million and the $2.9 million paid under the stock buyback program, net cash flow for the quarter was an increase of $7.8 million.

We have about $92 million of our original $200 million of face value of convertible notes remaining and those notes mature in June 27, and may be redeemed by us or put by the holders beginning in June 2014. The notes are reported on our balance sheet at $75.2 million, which is net of their on unamortized discount. Capital lease IRU obligations are for long-term dark fiber leases and typically have initial terms of 15 to 20 years or longer and typically include multiple renewal options. These capital lease IRU fiber leased obligations were $134 million at the end of the quarter and about $10 million of that is a current liability. Our capital lease obligations were $135.6 million at the end of the second quarter. We assumed $7.5 million of present value of capital lease obligations in this quarter.

Our days sales outstanding for worldwide accounts receivable was 26 days at September 30, which is a significant improvement from the 29 days that were outstanding at the end of the second quarter. And that 26 days sales in accounts receivable is the best in the Company's history. Again this quarter, I want to personally thank and recognize our worldwide billing and collections team for continuing to do a fantastic job on customer collections and credit monitoring. Further, demonstrating excellent customer collections, our bad debt was only 1.1% of our revenues for the quarter, which was an improvement from the 1.4% we experienced in Q2.

Lastly, as Dave mentioned, our average contract term continued to increase and increased by another 1.3% for the quarter. And increases in the average contract term can and has impacted revenue recognized under US GAAP. For example, when you increase the average contract term and estimated customer life that results in a longer period over which to recognize installation revenues. Therefore, that reduces the amount of revenue that is recognized under US GAAP.

I will now turn the call back over to Dave.

Yes, hey, thanks, Tad. Now I would like to take a moment and talk about our sales force and their activities. We're going to talk about number of sales reps and their productivity. We began the third quarter with 251 sales reps and we ended the quarter with 266 sales representatives selling our services bearing a quota.

We hired 62 reps in the quarter and 47 reps left the Company during the quarter. Our monthly rep turnover was 6.1% in the third quarter, which is better than our long-term historical rate of rep turnover of 6.9%. We began the third quarter with 232 full-time equivalent reps, these are reps that have fully ramped through their initial start training period and ended the quarter with 240 full-time equivalent rep selling our services.

Productivity on a full-time equivalent basis for our sales reps in the third quarter was 4.6 units of installed business per rep per month. This performance was a slight reduction from the 5.4 units we experienced in the second quarter, but about 12% better than our long-term historical average of 4.1 units per rep. As a reminder, these sales rep productivity numbers are based not on contract signings, but rather based only upon services being deployed, installed and beginning to build and generate revenue.

Now to the scale of our network. We added 38 buildings to our network in the third quarter of this year. We have a total of 1,707 buildings on-net at the end of the third quarter. We added 16,000 -- our network now consists of over 16,600 metro fiber miles and over 54,500 miles of inter-city fiber. The Cogent network, is one of the most interconnected networks in the world, will reconnect to over 3,800 additional networks. Approximately, 60 of those networks are settlement-free peers, the remaining 3,740 networks are Cogent customers.

We are currently utilizing about 17% of the lit capacity in our network, we routinely augment portions of our network to maintain this low utilization rate. We believe our network has substantial additional capacity to accommodate additional growth. We continue to evaluate additional fiber routes in Europe and in North America. We are evaluating these routes and try to take advantage of certain opportunities presented to us due to recent volatility in the European financial markets. We continue to be opportunistic and take advantage of these opportunities to expand our footprint.

So in summary, traffic on our network is growing at an accelerating rate and revenues are growing at a faster rate than most of our competitors showing that we are continuing to gain market share. We believe that we've remained the low-cost provider in our industry and our value proposition to our customers is truly unmatched.

Our pricing strategy has continued to attract many new customers, allowing our sales force productivity and cost of revenue acquisition to be substantially better than industry average. We experienced lower churn rate, longer contract terms, increased volume commitments and increased revenue commitments from our customers.

Our business remains entirely focused on the Internet, the fastest growing segment of our industry and a necessary utility for our customers. You can see that demonstrated in our reduction in days of sales outstanding and our continued improvement in bad debt experience, we continue to evaluate how to optimize our very strong balance sheet and use the proceeds from our senior secured offering for the benefit of our equity holders.

Our Board has authorized a stock buyback program of $50 million. This amount is similar to previous programs that we have had authorized and completed. We tend to be opportunistic about the timing of purchase of our shares. At the end of the third quarter, we have purchased approximately 230,000 shares for $2.9 million at an average cost of $12.78 under this program. We continue to be extremely encouraged by our sales initiatives and targeted sales programs and the backlog that we have in our funnel.

We are committed to providing topline revenue growth of between 10% and 20%, continue to expand our EBITDA margins, generate increasing amounts of free cash flow for equity holders. In short, we like our business, we are confident in our network reach, our product set, our addressable market, and our operating leverage. We are I believe in the best position of any company in our sector.

With that, now I would like to open the floor for Q&A.

(Operator Instructions) Colby Synesael, Cowen & Company.

Great. Just a few questions. First off, on the promotions that you did during the quarter, I was curious if we've seen the full impact in terms of revenue during the third quarter, if you expect more in the fourth quarter. Second, you indicated that you expect margins to be about 400 basis -- excuse me, margins to be up about 400 basis points for the year and they've been up about 450 basis points year-to-date, curious if that's meant to imply that you expect margins to go down sequentially in the fourth quarter.

And then finally, if I could just sneak one more in there, on the buyback about $3 million year-to-date, obviously you mentioned a $50 million total program. I think if I recall correctly, you had indicated that by January or February of 2012, you would make a decision on how best to allocate capital back to investors, whether that was to complete the stock buyback program or perhaps do something else, I was curious if you have an update on how you are thinking about that. Thanks.

Yes, hey, thanks for the questions, Colby. First of all, with regard to our targeted promotional activities, two points; one, we have not seen all of the impact yet as some of those orders have still not installed. Many have and they installed ratably throughout quarter. There was very little impact of that in the second quarter as -- while there were some of those orders sold very few had installed in the second quarter, some in the third, more in the fourth. And because some of the M&A activity has not yet completed or in many cases the integrations have not yet really begun, we continue to run some very aggressive targeted programs at customers that we feel would benefit from Cogent's network connectivity. So we expect to see continued impact both in the fourth quarter and beyond.

With regard to EBITDA margin, quite honestly, we're just trying to be realistic and conservative. We do not anticipate a sequential decline in EBITDA margin in the fourth quarter from the third quarter. And then to the buyback question, we, in conjunction with the Board, consistently evaluate how to best create value for our shareholders. We have tried to take advantage of market volatility and as many investors know, the markets have been extremely volatile and we're trying to buy back as much equity as we can with our authorization, we'll continue to evaluate that and kind of real time continue to adjust our thinking. And if there are any major changes on our thoughts, we will obviously consult with our Board and maybe a more formal evaluation process at our upcoming first quarter Board meeting.

So there is no formal timeline at least that we're aware of -- we should be aware of at least right now to help think that some type of decision would need to be made by certain time that's not out there right now?

That's correct, Colby. Although, as you could see, we did try to take advantage of some volatility when the market presented it to us and we quite honestly bought all of the stock we could during that period. We had some orders with limits on certain days, actually went unfulfilled.

Okay. Thank you.

Dave Coleman, RBC Capital Markets.

Great. Thanks a lot. Just wondering if you could talk about the overall impact I guess on an annual basis from the mid year of promotional activity. And then just regarding CapEx for 2012 indicated, it should be lower than 2011. Can you indicate or guide us to as to how much lower that should be and is that sort of a first step down in CapEx reductions or is it just a sort of a one-time reduction? Thanks.

Okay. So let's start with promotional activities. So Cogent historically run a number of various promotional activities throughout the year and we expect that to continue going forward. The most aggressive promotional activity was actually run in targeting these M&A opportunities or customers that would be dislocated or impacted by that. We continue to run those, we expect to continue to see the results of those flow through next year. And therefore, we remain comfortable with our long-term guidance results.

We also see that the promotional activities do have an impact on pricing. And just to understand, in particular, in our net centric business where there is the most significant price changes. Price per megabit of the installed base on a year-over-year basis went down 24%. During that same period, traffic went up 44%. That resulted in a revenue increase in our net-centric revenues of 19.5% on a year-over-year basis. And we were able to do this while still demonstrating much better margin expansion than we had initially expected and therefore revised upward our guidance to 400 basis points for full-year '11 over full-year '10.

With regard to CapEx, what we have told investors is that 2010 was really the peak year in our network expansion program. We expected that expansion program to moderate. We've remained very opportunistic in trying to take advantage of good pricing to expand our footprint, but we've remained disciplined about it. It's a little difficult for us to give exact guidance because we really buy when someone is willing to sell at our price points, but we do expect continued decline in capital spending for both 2012 and 2013.

And I think if you just look at the nine months of 2011 over '10, you also see that reduction both in absolute capital spending and prepaid capital leases. We expect those trends to continue. We think over the next few years, you'll see our total capital expenditures decline to about $35 million. This year they're going to be below $50 million.

Just to follow-on to the CapEx comments. Tad, you mentioned that 4Q is typically the lowest quarter as far as CapEx spend. Is that -- should that be the case this year? And then just on the ARPU, the promotional activity that you're in, targeting new logo net-centric customers. Because a lot of ARPU compression, I'm assuming, because a lot of those customers haven't been fully installed during the quarter, would it be unreasonable to think that 4Q on that ARPU could actually increase from 3Q levels? Thanks.

Yes. Historically, if you look back over the last five or so years, you would see, as we mentioned that the fourth quarter is typically lower. During the third quarter, we did have a few items that were pushed into the fourth quarter. I would expect the fourth quarter to be relatively consistent with what we have in the third quarter, so we may not see the same seasonal dip. However, the rate for the year, as Dave mentioned will be less than 50.

Yes, and then with respect to ARPU, I think, you'll still see ARPUs decline and much of the promotional activity results in a lower price per megabit, partially offset by larger utilization rates and larger connection rates, we typically see traffic growth accelerate throughout this portion of the year. You saw that on a sequential basis when traffic growth grew on a quarter-over-quarter basis by 10%. On a year-over-year basis, our traffic growth also accelerated. Just to remind you, last quarter, so in Q2, on a year-over-year basis, traffic grew 38%, this quarter it grew 44%. That should help us see revenue growth continue strong throughout the quarter.

Great. Thanks a lot.

Robert Dezego, SunTrust Robinson Humphrey.

Hey, Dave. Thanks for taking the questions. Just a quick question on the pipeline, today versus where it was in the last three quarters. Can you quantify that pipeline for us a little bit maybe not in a dollar amount, but maybe in just as a kind of directionally or a percentage change that you've seen in your pipeline going into this quarter versus the last couple of quarters? And if I could follow up on the sales front, you did a really good job this quarter getting new sales hedge in the door, we've seen that have been pretty flat for a while. Any update on where you think that can go over the next couple of quarters and kind of couple that with what you -- kind of expectations for productivity?

Yes, sure. Well, first of all, thanks for the questions, Rob. In terms of the pipeline, it continues to (inaudible) it's probably at its highest level, but proportionally against this installed base, it remains about where it was for the past couple quarters. So, as the installed base gets larger, you would obviously expect to maintain the percentage revenue growth, the size of the pipeline to grow. We are encouraged to, however, that we have a number of reps coming off of ramp and becoming full-time equivalents.

So, as you saw the increased number of reps did not exactly correspond to the increased number of full-time equivalents, who'll get the benefit of that in the fourth quarter. We believe that we'll continue to see above long-term historical trend lines in terms of rep productivity. So far in this quarter, we've been tracking to very good rep productivity going forward. And we expect at least in the near term for that to remain above that [4.1] historical rate.

In terms of number of reps, we've talked about this previously, we've implemented a number of programs to increase retention, you're seeing that in our turnover rate go down. We've increased our [spends] of control and therefore reduction in a number of reps per manager. And we also have implemented some retention bonus programs that have helped us hang on to the best producing reps.

If I look back at 2010, probably my biggest failure, when I was [greeted] by the Board was we didn't the grow the sales force fast enough. And we've taken a number of actions, increased the number of sales recruiters to help us do that. And you should expect to see a continued increase in the number of quota-bearing reps at least for the next couple of quarters.

We constantly monitor our cost of revenue acquisition both on a per unit basis and a dollar of revenue produced basis. They've remained extremely low, much lower than the industry averages and we feel that there is ample addressable market. So with those metrics, we expect to see continued growth in headcount as well as additional productivity program.

Okay. Thanks, Dave. And if I could, one follow-up. Could you talk about the percentage of growth you're seeing from your existing base versus the new customers that are coming in the door? And now I think you maybe give us a little bit of insight of what your existing customers are telling you as far as their near-term and longer-term needs, demands?

Yes. So, historically, and this is also true in the most recent quarter, about 70% of our growth comes from brand new customers, customers, new logos to Cogent that have never been connected to our network. About 30% of our growth comes from existing customers. Within our two customer bases, that growth is very different. For our corporate customers, it almost always is additional office locations. It is not more bandwidth at the same locations.

In fact, our corporate utilization rate, actually has dipped slightly and it's about 9%. So the average corporate customers are only using about 9% of the bandwidth that they have purchased. So there's very little upsell at the same location to the same corporate customer. Almost, all of that growth, that 30% of corporate growth comes from those customers needing Cogent services at secondary and tertiary office locations.

In our net-centric business, the growth pattern is entirely different. Again, the 70-30 mix is true, 70% of revenue comes from new logos, but the 30% of growth comes from existing customers taking more bandwidth. And that increasing bandwidth will come about for one of two reasons. Either their businesses are growing and they just need more bandwidth or we are displacing other providers. Most, in fact, the vast majority of our net-centric customers, multi-home, meaning, they have more than one provider.

But a lot of our growth comes from those customers getting comfortable with the quality of our network and our service and over time we get a larger and a larger share of their wallet. We expect those trends to continue, particularly, because a lot of the promotional activity we initiated had caps at those very low prices on how much bandwidth we would sell. These were somewhat smaller than some of our customers wanted and what we're hoping is that as they get comfortable with Cogent, they will come back and buy more bandwidth, they'll potentially buy that at a higher price than those initial offers.

Okay. Thanks for taking the questions, Dave.

Thanks.

Michael Funk, Bank of America Merrill Lynch.

Great. Thank you, Dave. I just have two quick questions. I mean, firstly on net corporate revenue, came in a little wider as expecting, one of you comment on first the impact from longer customer lives there? And second, maybe what other impact you saw on that revenue? And then finally, second, on the growth of customer locations among the corporate base, wanted to get a sense of what your share of wallet is now for the corporate customers and the opportunity there?

Hey, sure. Thanks a lot, Mike, for the questions. First of all, on the corporate on-net growth rate, I think all corporate customers generally slow down their buying decisions, no matter how compelling the value proposition when there is economic uncertainty. And I think in the last quarter, the headline news was bad many days. So people just push slower in entering into new contracts than they would be in a more stable or normal economic environment.

We actually saw our penetration rate in the corporate buildings kick up. Part of that was because we actually added a few less buildings this quarter than the previous quarter, but we're up to 9.8 customers per building out of 51 potential opportunities on the corporate on-net side.

We think we have a significant additional opportunity in those buildings to get more new logos. Now, to the existing customers who have additional locations, therefore, we can get more of their Internet spend across multiple locations. There I think, we've got a long way to go in that many of our customers have 10, 15, 20 locations, in many cases, Cogent only has two, three, four of those locations.

If they are on-net, we tend to get them very quickly. If they are off-net, the installation times are longer and the value propositions not as compelling. So we have -- little tougher selling or lower win rate, but we do continue to win that business as well. And you saw our off-net customer connections actually increase faster than our on-net corporate connections this quarter showing that we're getting a greater share of that wallet.

The final piece of the wallet picture however is their total communication spend and how much of that goes to the Internet versus other services. And I think there, we benefit two ways. One, we sell only Internet services, so therefore, we don't have a problem of revenue attrition due to product substitution, i.e., the Internet replacing other services. Second way we benefit is that the Internet is increasingly becoming the network of choice, as people disconnect other forms of connectivity to move to the Internet. We are seeing that on the residential side, we are also seeing it on the business side.

So while people may disconnect their [parts] landlines or their ATM circuits or their frame-relay circuits, we see almost no businesses saying, I'm going to disconnect my Internet and now rely only on plain old telephone service or ATM or frame relay for my connectivity. So I think you're seeing total wireless spend on communication services go down, but Internet as a percentage of that total spend go up. This is all good news for Cogent. And I think we've got a lot of revenue opportunity in our existing base and equally importantly, we've got plenty of addressable market that we can go after on the corporate side.

Thank you for taking the question.

Thanks, Michael.

David Dixon, FBR Capital Markets.

Thanks. Good morning, Dave.

Hey, Dave.

Dave, I wanted just to dig into the free cash flow outlook a bit more. We might be at an important inflection point here. I wanted to just to go back to when you and I spoke back in '07, when we talked about the opportunity get to levels of around $4 to $5 of free cash flow per share by 2012-ish timeframe. And we didn't see that pan out, but I'd like to dig into this now because we're [not] calling for a significant reduction in CapEx from 2012, and that could be a great catalyst if revenue growth continues. So, I wanted to explore fully your confidence levels today on the free cash flow outlook from [hereon]. I wanted if you could talk a bit about where the CapEx reductions coming from and maybe compare and contrast the growth opportunities in both revenue and EBITDA in the jurisdictions that we are operating in US, Latin America and some of the interesting things you're doing in Europe?

Okay. Well, first of all, thanks for the questions, Dave. And our confidence in increases in cash flow generation come from really three factors. First of all, our consistent revenue growth. So through a very turbulent economic period, we have demonstrated 26 consecutive quarters as a public Company of sequential, organic revenue growth in an industry that's declined. In fact, that revenue growth is averaged about 15% year-over-year during that period, right exactly at the midpoint of our guidance range.

We look at our addressable market and feel that we can absolutely maintain that same level of revenue growth going forward. Therefore, we are comfortable with our guidance. We understand there are things such as currency fluctuations, macroeconomic concerns, and those can impact the rate to either a higher end or lower end, but we feel very comfortable about that range.

Secondly, we have guided and I think also demonstrated a long-term ability to grow our EBITDA margins at a base of about 200 basis points year-over-year. When we expand the network, that actually increases capital spending and also retards the rate of margin expansion as you pick up the OpEx for those new routes in advance of actually delivering service on those routes.

We have a targeted number of markets and countries and ultimately buildings that we wish to serve. We are near the end of that expansion period. So part of our increased capital spending in the '09 and '10 timeframe was a result of just having the opportunity to buy these routes at deeply discounted prices helping us accelerate our growth, but also retard our rate of margin expansion.

That shopping list is about complete now, so what we see is continued increases actually in our maintenance CapEx as our network is bigger and cost more to maintain and as we add more capacity to the existing network. What will slow, however, is the number of new markets. So, from '07 till today, we've over-doubled the number of markets. We went from 80 markets to 170 markets. We've increased our long-haul network, doubling it, and we've increased our metro footprint by about 75%. We do not say that route expansion continuing and definitely, in fact, slowing.

So we think what is today a 54,500-mile network kind of ends up fully matured at 60,000 miles that 16,600 of metro matured at about 17,500 to 18,000. The 170 markets fully matured about [185,000]. The country count going from 32 maybe to 37 or 38. We obviously have tremendous opportunity in a lot of the newer markets whether they be newer buildings in North America or newer data centers throughout the world. And many of the European -- particularly Eastern European markets are relatively new for Cogent and they tend to have better growth rates in some of the more developed markets.

With regard to your Latin American point, we do not have direct network in Latin America or Africa, but we sell to a number of carriers. We are the dominant carrier in Africa, we are not the dominant carrier in Latin America, even though we have no network. We think that our growth will continue. And the final point on that question is, 90% of Cogent's growth for the past three years -- each year has come out a footprint that existed at the beginning of a year. So we can absolutely maintain our current growth rate even with a slowdown in the rate of network expansion.

So if you do the arithmetic on that topline revenue growth, the margin expansion and the moderation in capital spendings that we've all outlined and actually have demonstrated over the past several years, you could easily get to the free cash flow objectives of the Company. And we're also going to work diligently on trying to shrink our share account when and if it makes a lot of sense. So with all of that, we absolutely feel we can produce that $4, $5 even $6 a share of free cash in the future.

And, Dave, just in terms of managing the risk to that free cash flow thesis, one of the [reasons] is the changing in the peering landscape, but do you see yourselves avoiding some of those higher usage CDNs to manage that risk better than other companies because we are seeing that pressure in terms of those relationships with the end user carriers as they reach mature levels of broadband penetration. So, really delving into the cost line now and looking at ways to manage that cost outlook. So is that something you've been doing strategically? It seems though you've been doing that with likes of Akamai and [Loan Litton] those are the CDNs that I think you moved away from couple of years ago?

Okay. So a few points. First of all, we are the most interconnected network in the world. Most networks pay to connect to Cogent, only about less than 60 networks connect to us for free and we pay no networks to connect whether they be last mile or global backbone operators or fully integrated networks.

Secondly, 98% of our traffic, so therefore, the load on the network and those interconnections are from our net-centric customers. Our net-centric customer base is about equally divided between content companies and access network operators. So over 70 international phone companies who are access network operators in their local countries buy upstream from Cogent. Most of the cable companies, most of the competitive carriers globally buy from us.

We also though sell to content companies. Now content-based networks can either be proprietary or they can be third-party CDNs. We continue to sell to both. We do not compete with our customers, we are not a CDN. We have the largest number of networks connected, but more important than that, we actually have those connections at more locations than anyone else around the world. And we have the largest size of connection between our network and other networks than anyone else.

Recently I was working with a major European telco, who had pushed back on us and said that, they felt it was unfair that we were so much larger than them in connections. And they were truly shocked, when we said, let's increase the number of places we interconnect from [six] to actually 100 locations globally. And we operate our network as a furthest exit router network or cold potato router network, which gives us the ability to bear that cost and alleviate the cost from those other access network operators. So we feel very comfortable about the peering dynamic, and as I said, it has no impact today on our cost structure because we don't pay anything, it is not in our cost of goods sold.

Okay, Dave. Very helpful. Thank you.

Thanks, Dave.

(Operator Instructions) Donna Jaegers, D.A. Davidson.

Hi, Dave. Just a quick question. On the upgrade towards 40 gig and 100 gig circuits on your network, have you guys done any sort of ballpark estimates of what that would cost to upgrade your network to those -- to the high -- to the [faster electronics]?

Yes, sure, Donna. So first of all, we actually have 40 gig operating in our network today. We have multiple routes that we have 40 gigs on and in fact, on these routes, we actually have multiple wavelengths carrying 40. So we have routes, where on the routes, some of the wavelengths are carrying 10, some are carrying 40. That capital, which these are new cards, these were not cards that came from acquisitions, is included in our maintenance number. Today, probably about 5% or 6% of our total number of links that is from router to router are running over 40 gig transport.

We also have been very effective at eliminating the number of region sites in the network and increasing the [spend]. That allows us to be much more efficient as we expand the wavelength count. We also have running in the network, but only in test mode 100 gig on several routes. It is running error free, and we are in early field trials with some vendors on that equipment, we have not placed it in commercial service.

Ultimately, it's a real simple calculus. We look on a given route as it becomes exhausted, can we add more waves or do we need to increase the number of bits per wave and make that calculus and decide, is it cheaper to do what was 40 or 100? We believe that we have no capacity issues, and the migration to 40 and 100 will be both graceful and is anticipated in that declining aggregate capital budget.

Just a quick follow-up on that. Doesn't your backplane runs the 400 gigabits? So doesn't that -- isn't that sort of a limiting factor as far as how many 40 gig waves and 100 gig waves you can put on there without upgrading the entire backplane?

The backplane is in the routers. Today, that is the state-of-the-art technology. There is, in the next couple of months, route processors that can be added to existing chassis that will increase backplane capacity from 400 gigs to 800 gigs in the router. The second thing you give is you actually cluster routers in a given location. So in 24 of our largest hub markets, we actually run clusters of four routers, so you actually have 1.6 terabits of backplane capacity because you have four routers functioning as a single router and effectively a HyperCube type scenario going to 3.2 terabits.

There is roadmaps to increase that backplane capacity even further. Actually, the bigger limiting factor comes in terms of slot density and just exhausting the physical real estate in the chassis and we operate about another 400 core boxes in various aggregation modes to help us alleviate that. We don't envision either at the transport layer or at the routing layer, any real significant impediments to our ability to see not only continued traffic growth at same rates, but accelerating traffic growth. And do that by continuing to decrease our capital spending.

Great. Thanks a lot, Dave.

Okay. Thanks, Donna.

Currently, we have no questions in the queue. I would now like to turn the conference back over to our host for any closing or additional remarks.

Well, again, I want to thank everyone. I did keep it's only an hour and ten minutes. I know it took a little heat last time for taking too many questions. We thank everyone for their interest in Cogent. Again, we remain extremely pleased with our business, our position in the market, our pricing strategy and our traffic and revenue growth, and we expect those trends to continue going forward. Thank you all very much. Take care. Bye-bye.

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