Cogent Communications Holdings, Inc. (CCOI) Earnings Call Transcript & Summary

Perfect. I think we are now connected. Thank you, everyone, for joining us. I'm Sami Badri with Crédit Suisse Equity Research. We now have Dave Schaeffer, the CEO of Cogent Communications. Thank you, Dave, for joining us today.

Hey, Sami, thank you for hosting us today. I thank Crédit Suisse for a great venue, and I'd like to thank all the investors for their time and interest in Cogent.

Absolutely. [Operator Instructions] So Dave, I was hoping you could kind of kick us off with just unpacking the Corporate segment growth weakness that we saw in 2Q and 3Q of 2020. I think maybe if you want to talk about those in the context of your business, that would be very helpful for us to really kick things off because we do have a tight time frame of 30 minutes. We have a bunch of questions we want to cover. But maybe starting off with the Corporate growth rate and Corporate revenues would be very helpful for us.

Thanks, Sami. So our Corporate revenues represent roughly 70% of our total revenues. That business has grown organically at an average of 11.5% year-over-year. That growth has substantially decelerated since the pandemic. In trying to understand that deceleration, there are really 3 different trends going on concurrently. At the primary location for customers, we're actually seeing an uptick in sales due to the fact that those customers are more likely to take 1-gigabit connections than 100-megabit connections, which has been our standard corporate offering for the past 20 years. The 2 headwinds to that business have been the remote locations either for dedicated Internet access or virtual private network services. Our off-net revenues actually declined in the quarter, and that is predominantly a Corporate service. So as a result of these multiple trends, our Corporate revenue growth has decelerated to low single digits, about 3%.

Got it. Got it. I think the one big question for the Corporate segment is, when are you expecting to get back to normalized growth for that segment, at least where you have visibility?

So if I knew when the pandemic was going to end, I would have better visibility into that growth. I think for the on-net Corporate business, we're continuing to see strength in those GigE sales and probably for the next couple of quarters, similar type results. For secondary locations, which are a combination of on-net and off-net, I think we're going to continue to see weakness until end users start to return to those secondary offices. At the primary location, they use the connection to support their work-from-home employees who build ad hoc VPNs for their work-from-home environment. So I think probably for Q4 and Q1 and possibly even Q2 of next year, the Corporate business will be below trend line, probably growing in the mid-single digits.

Got it. Got it. And then when you think about the kind of changes you need to make as a company to accommodate some of the by-products of the pandemic, what are some of the key changes you've had to make on the Corporate segment side to adapt to the new norm?

So the bulk of our sales force, 72% actually focuses on our Corporate customer segment. Our biggest changes have been in both our sales organization and our customer support organizations, both of which move to a complete work-from-home environment. So we needed to equip our employees with laptops. We needed to have monitoring systems in place to ensure activity and quality of customer interaction. And then finally, we needed to be able to hire new salespeople remotely. Our sales model has been defined by high sales force turnover since it is an outbound telesales model and as a result, we have needed to adapt and also be able to hire people without getting them into an office. So we needed to be able to develop a way to go ahead and hire these individuals remotely and then bring them into the office only after the pandemic ends. So that's been a fairly significant change in our model. I'll give you a call back. Go ahead.

Yes. And then maybe if we could just segue to the NetCentric segment. I know there has been a growth pickup there that at least have now kind of broken the historical trend line or at least interim or medium term, the last 12 months in terms of like the fact that it was actually declining now for Century reverse course to back to growth, what should we be expecting out of the NetCentric segment, at least in the medium term, at least for the next 12 months versus the last 12 months?

So our NetCentric business, which represents 30% of our revenues, is a usage-based business. Volumes have traditionally grown for Cogent twice as fast as the Internet, and prices have declined in line with market price declines, with Cogent being the price leader offering a 50% discount to any other provider. As a result of these trends, our long-term average growth in that business has been 9% year-over-year. Although for the past 5 years, the NetCentric business has been underperforming with an average low single-digit growth rate of about 2%. We have seen a reacceleration in our NetCentric business to that 9% growth rate. And we actually see continued acceleration in traffic with work-from-home and people being sheltered in place, consuming more streaming content, which is the primary driver of that NetCentric business. So we anticipate 2 things: one, a return to normal trend line growth of 9%; and probably in the short term, possibly overachieving that growth rate for several quarters as we see much of the western world in shelter-in-place orders.

Got it. Got it. And then one big thing, I guess, that would be very helpful is when you think about the growth that's actually coming into the NetCentric business, we think about the big OTT Tier 1s. We think about the mid-tier providers that are maybe experiencing various growth rates. And then we think about the Tier 3 type of providers that could be a lot more spotty. Could you just unpack which customers are driving the majority of the growth rate for Cogent overall? And if you could take into pricing into your explanation, that would also be helpful for us.

Yes. So we offer discounts for volume and for churn. In our NetCentric base, our revenues are roughly 55% from content-generating companies and about 45% from access network operators. We have seen a significant broadening in our content-generating customer base. It's not to say that the largest content generators, the bank companies are not continuing to grow with Cogent, but it is that we are seeing a lot of mid-tier and smaller OTT players also gain market share. So this broadening of our customer base has had a positive impact on our effective price per megabit. So even though the nominal price per megabit is declining at about 23% per year, the volume-weighted price declines can either be more pronounced if all of the growth is coming from the largest players or less pronounced if it's coming from some of the smaller players. What we have seen over the past 6 months, with that broadening of the customer base, is an improvement in the effective price decline.

Got it. I think one thing that we'd like to just kind of dive a little bit deeper into is the sales force productivity rates that we've actually seen recently. And you kind of touched on the way churn has actually changed a little bit. But I was hoping you'd also kind of factor in the change or the switch in CRMs that you're using. How has that affected sales force productivity since it is a more recent development?

Yes. So again, stepping back, our average productivity, as measured by install orders per rep per month, has averaged approximately 5.3 orders per rep per month. For the past several quarters, we have been trending below that at about 3.5 orders per rep per month. There have been, I think, 3 causes for that degradation in rep productivity, and we are seeing improvements in that productivity starting at the end of the third quarter and continuing into the fourth quarter for the 5 weeks that we've been in this quarter. The 3 reasons for that degradation are: one, as we grew the sales force and pivoted to a remote workforce, we were doing a very good job of hiring but not doing as good of a job in managing our underperformance. We began to become more aggressive and put systems in place to manage out those underperformers beginning at the end of the third quarter and continuing into this quarter, meaning that our sales force turnover is going to revert back to more historical norms. The second negative has been just the pandemic and the creation of uncertainty in the minds of many of our potential customers. I think as the pandemic has gone on, customers have, I think, adapted to the new normal. And the paralysis that we saw early on in decision-making has abated. I think the final impact of the sales force has been the CRM system that we deploy. So Cogent has previously had 2 CRMs in our history. We operated on one platform from 2001 through 2014. Late 2014 through mid-2020, we run a SaaS-based platform, which was not really adapting to the way we did business, particularly remotely. So we took advantage of the slower selling months in July and August and installed a new CRM system that initially had some growing pains as any new system, but has more recently actually accelerated rep productivity. And I believe we'll continue to see improvements as a result of this new CRM system.

Got it. Got it. I think, one, just to kind of take a look at margins for a minute. Your long-term guidance is 200 basis points of margin expansion per year. And I think as people try to think about how that is achievable, at what growth rate would Cogent have to grow top line to achieve 200 basis points of operating margin expansion on the adjusted EBITDA level?