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Edited Transcript of CCOI earnings conference call or presentation 21-Feb-19 1:30pm GMT

Q4 2018 Cogent Communications Holdings Inc Earnings Call

Washington Apr 29, 2019 (Thomson StreetEvents) -- Edited Transcript of Cogent Communications Holdings Inc earnings conference call or presentation Thursday, February 21, 2019 at 1:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* David Schaeffer

Cogent Communications Holdings, Inc. - Founder, Chairman, CEO & President

* Thaddeus G. Weed

Cogent Communications Holdings, Inc. - CFO & Treasurer

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Conference Call Participants

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* Frank Garrett Louthan

Raymond James & Associates, Inc., Research Division - MD of Equity Research

* Jonathan David Charbonneau

Cowen and Company, LLC, Research Division - VP

* Nicholas Ralph Del Deo

MoffettNathanson LLC - Analyst

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Presentation

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Operator [1]

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Good morning, and welcome to the Cogent Communications Holdings Fourth Quarter and Full Year 2018 Earnings Conference Call. As a reminder, this conference call is being recorded, and it will be available for replay at www.cogentco.com.

I would now like to turn the call over to Mr. Dave Schaeffer, Chairman and Chief Executive Officer of Cogent Communications Holdings. Sir?

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David Schaeffer, Cogent Communications Holdings, Inc. - Founder, Chairman, CEO & President [2]

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Thank you, and good morning to everyone. Welcome to our fourth quarter and year-end 2018 earnings conference call. I'm Dave Schaeffer, Cogent's Chief Executive Officer; and with me on this morning's call is Tad Weed, our CFO.

We are pleased with our results for the quarter and for the year and continue to be optimistic about the underlying strength of our business and our outlook for 2019 and beyond. Our EBITDA margin for the year increased by 230 basis points to 35.5% from full year 2017, representing our highest annual EBITDA margin percentage in our 19 year history. Our EBITDA for the full year increased by $23.2 million, which is an increase of 14.4% from full year 2017. Our gross margin for the full year of 2018 increased by 100 basis points from full year 2017 to 58.0%. On a constant currency basis, we achieved quarterly revenue growth sequentially of 1.8% and year-over-year revenue growth of 6.2%.

Our quarterly sales rep productivity remains above our long-term average at 5.7% per -- 5.7 units per full-time equivalent rep which is significantly above the 5.1 long-term average per FTE. Our year-over-year quarterly traffic growth was 44% and we achieved sequential traffic growth on our network of 10%. For the year, our traffic growth accelerated full year from 27% last year to 43% for full year 2018 over full year 2017.

During the quarter, we returned $26.5 million to our shareholders through our regular quarterly dividend program. As posted on our website, 55% of our $97.9 million of total dividends for 2018 should be treated by shareholders as a return of capital and 45% should be treated as taxable dividends for U.S. federal tax purposes.

During the quarter, we also purchased 148,000 shares of our common stock for a cost of $6.6 million at an average price of $44.36 per share. At quarter end, we had a total of $34.9 million available for stock buybacks under our stock buyback program which has been authorized by our board to continue throughout 2019 to December 31.

Our gross leverage ratios decreased to 4.36x from 4.46x and our net leverage ratios decreased to 2.87x from 2.89x. Cash held at Cogent Holdings was $131 million at quarter end. This cash is unrestricted and available for use for dividends and buybacks. We continue to remain confident in the growth potential and cash flow generating capabilities of our business. As a result, as indicated in our press release, we have announced yet another $0.02 per share increase in our regular quarterly dividend, increasing that quarterly dividend from $0.56 per share to $0.58 per share. This represents the 26th consecutive sequential quarterly increase in our regular quarterly dividend.

Throughout this discussion, we'll highlight several operational statistics. I will review in greater detail some of the operational trends and highlights of our business and Tad will provide some additional details on our financial performance. Following our prepared remarks, we'll open the floor for questions.

Now I'd like to turn it over to Tad to read our safe harbor language.

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Thaddeus G. Weed, Cogent Communications Holdings, Inc. - CFO & Treasurer [3]

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Thank you, Dave, and good morning, everyone. This earnings conference call includes forward-looking statements. These 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. Cogent undertakes no obligation to update or revise forward-looking statements. If we use any non-GAAP financial measures during this call, you will find these reconciled to the GAAP measurement in our earnings release, which is posted on our website at cogentco.com.

I'll turn the call back over to Dave.

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David Schaeffer, Cogent Communications Holdings, Inc. - Founder, Chairman, CEO & President [4]

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Hey, thanks, Tad. Hopefully, you've had a chance to review our earnings press release. Our earnings press release includes a number of historical metrics reported on a consistent basis.

Now for a few words about expectations against long-term guidance targets. Our corporate business, which represents approximately 2/3 of our revenue for full year 2018, has been growing within our targeted guidance range for long-term revenue growth of between 10% and 20%. And in fact, it grew at 11.8% full year 2018 over full year 2017. However, our NetCentric business has been underperforming, and until that business recovers to its historical long-term growth rates, we are revising our long-term full year revenue growth target to 10%. Our long-term EBITDA annual margin expansion targeted guidance is an annual improvement of approximately 200 basis points. For full year 2018, we exceeded our EBITDA margin annual targeted guidance growth and we achieved annual EBITDA margin expansion of 230 basis points.

Our cash flow, as defined by EBITDA minus CapEx, minus principal payments on our capital leases, grew by 19.2% full year 2018 over full year 2017. Due to the excellent operating leverage in our business, we expect this rate of cash flow growth to continue at similar rates in the future. Our revenue and EBITDA guidance targets are intended to be multiyear goals and are not meant to be used as specific quarterly or annual guidance.

Tad will now cover some additional details relating to the results for our quarter and full year.

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Thaddeus G. Weed, Cogent Communications Holdings, Inc. - CFO & Treasurer [5]

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Thanks again, Dave, and again good morning to everyone. And I'd also like to thank and congratulate our entire Cogent team for their results and continued hard work and efforts during another very busy and very productive quarter and year for Cogent. Some comments on revenues by corporate and NetCentric and customer connections. We analyze our revenues based upon network type, which is on-net, off-net and noncore, and we also analyze our revenues based upon customer type. And we classify all of our customers into 2 types, NetCentric customers and corporate customers. Our NetCentric customers buy large amounts of bandwidth from us in carrier neutral data centers and our corporate customers buy bandwidth from us in large multi-tenant office buildings.

Revenue from our corporate customers for the quarter grew sequentially by 2.8% to $87.9 million and grew year-over-year by 11.7% for the quarter. Revenue for our corporate customers was $337.8 million for the full year which was an increase, as Dave mentioned, of 11.8% over full year 2017. We had 45,189 corporate customer connections on our network at quarter end which represented an increase of 18.9% over 2017. Quarterly revenue from our NetCentric customers declined sequentially by 1% to 44.1 million and declined year-over-year by 5.1% for the quarter. Revenue from our NetCentric customers was $182.3 million for full year 2018 which was a decrease of 0.4% over full year 2017. We had 34,917 NetCentric customer connections on our network at quarter end which was an increase of 3.9% over full year 2017. Our NetCentric revenue growth experiences significant more volatility than our corporate revenues due to the impact of foreign exchange, the size of those customers and other certain seasonal factors.

Comments on revenue and customer connections by network type. Our on-net revenue was $95.4 million for the quarter. That was a sequential increase of 1.7% and the year-over-year increase of 6.7%. Our on-net revenue was $374.6 million for full year 2018 which was an increase of 8.1% over full year 2017. Our on-net customer connections increased by 2.1% sequentially and increased by 12.1% year-over-year. We ended the quarter and year with 68,770 on-net customer connections on our network in our 2,676 total on-net multi-tenant office buildings and carrier neutral data center buildings. Our off-net revenue was $36.6 million for the quarter which was a sequential quarterly increase of 1% and a year-over-year increase of 2.5%. Our off-net revenue was $145 million for full year 2018 which was an increase of 5.2% over 2017. Our off-net customer connections increased sequentially by 2.6% and increased by 10.3% year-over-year. We ended the quarter and year serving 10,974 off-net customer connections in over 6,650 off-net buildings and these buildings are primarily in North America.

Some comments on pricing. Consistent with historical trends, the average price per megabit of our installed base decreased for the quarter. However, the average price per megabit for our new customer contracts was stable. The average price per megabit for our installed base declined sequentially by 7.1% to $0.73 and declined by 26.4% from the fourth quarter of 2017. The average price per megabit for our new contracts for the quarter was flat sequentially and also flat year-over-year at $0.42 for all periods.

Some comments on ARPU. Our on-net and off-net ARPU both decreased sequentially for the quarter. Our on-net ARPU which includes both corporate and NetCentric customers was $467 for the quarter which was a decrease of 0.8% from last quarter. Our off-net ARPU which is comprised predominantly of corporate customers was $1,124 for the quarter and that was a decrease of 1.3%.

Comments on churn. Our on-net unit churn rate was stable and our off-net unit churn rate improved during the quarter. Our on-net unit churn rate was 1% for the quarter which was the same rate as last quarter. Our off-net unit churn rate was also 1% and that was an improvement from 1.2% from last quarter.

Some comments on move-out change orders for NetCentric customers. We offer discounts related to contract term to all of our corporate and NetCentric customers. We also offer volume commitment discounts to our NetCentric customers. During this quarter, certain NetCentric customers took advantage of our volume and contract term discounts and entered into long-term contracts for over 2,800 customer connections and that increased their revenue commitment to Cogent by over $22.2 million.

Some more details on EBITDA and EBITDA as adjusted. Our EBITDA and EBITDA as adjusted are reconciled to our cash flow from operations in all of our quarterly earnings press releases. Seasonal factors that typically impact our SG&A expenses and consequently our EBITDA and EBITDA as adjusted, include the resetting of payroll taxes at the United States at the beginning of each year, annual cost of living or CTI increases, the timing and level of our audit and tax services, net neutrality fees and the timing and amount of our gains on equipment transactions and our annual sales meeting costs, which typically occur in January, and benefit plan annual cost increases.

Our quarterly EBITDA increased by $643,000 or by 1.4% sequentially to $47.6 million and increased year-over-year by $4.3 million or by 10%. Our EBITDA increased by $23.2 million or by 14.4% for full year 2018 over 2017. Our quarterly EBITDA margin decreased 10 basis points sequentially to 36% and increased quarterly year-over-year by 150 basis points. Our full year 2018 EBITDA margin increased by 230 basis points over 2017. And again, as Dave mentioned, this 2018 EBITDA margin percentage of 35.5% represents the largest annual EBITDA margin percentage in our history.

Our EBITDA as adjusted includes gains on our equipment transactions and our equipment gains have recently been declining and were only $92,000 for the quarter, down from $319,000 from the fourth quarter of last year and $416,000 from last quarter. Our equipment gains were $1 million for 2018 as compared to $3.9 million for last year. Our quarterly EBITDA as adjusted increased by $319,000 or by 0.7% sequentially to $47.7 million and increased year-over-year by $4.1 million which was 9.4%. Our EBITDA as adjusted increased by $20.4 million or by 12.3% for the full year and our quarterly EBITDA as adjusted margin decreased sequentially by 30 basis points to 36.1% and increased by 130 basis points year-over-year.

Some comments on earnings per share. Our basic and diluted income per share was $0.16 for the quarter compared to $0.18 rather last quarter and a loss per share for the fourth quarter of 2017 of $0.14. As a reminder, the signing of the Tax Cuts and Jobs Act in December of 2017 reduced the corporate tax rate from a maximum of 35% to a flat 21% rate and resulted in an increase of our noncash deferred income tax expense by about $11.3 million in the fourth quarter of last year and also full year 2017.

Under U.S. GAAP because of the reduction in the income tax rate, our net deferred tax asset was revalued in the fourth quarter of 2017 using the lower income tax rate. The income tax rate change impact represented about $0.25 of loss for basic and diluted share for the fourth quarter of last year and full year 2017.

Some comments on foreign currency and the impact. Our revenues reported in U.S. dollars and earned outside of the United States represented about 22% of our total revenues. About 17% of our revenues this quarter were based in Europe and about 5% of our revenues were related to our Canadian, Mexican, Asia Pacific and Latin American operations. Continued volatility in foreign exchange rates can materially impact our quarterly revenue results and our overall financial results. The foreign exchange impact on our reported quarterly sequential revenue was a negative $0.5 million and the year-over-year foreign exchange impact on our reported quarterly revenue was a negative $0.9 million. For full year 2018, the impact was a positive $4 million.

Our quarterly revenue growth rates on a constant currency basis were 1.8% sequentially, 6.2% year-over-year and 6.4% for full year 2018 over full year 2017. The impact of foreign exchange primarily impacts our NetCentric revenues. The average euro to U.S. dollar rate so far this quarter is $1.14 and the average Canadian dollar exchange rate is $0.75. Should these average foreign exchange rates remain at the current average levels for the remainder of this quarter -- first quarter of 2019, we estimate that the FX conversion impact on our sequential quarterly revenues for this quarter will not be material. However, the year-over-year conversion impact on quarterly revenues is estimated to be material and to be a negative $1.9 million.

Customer concentration. We believe that our revenue and customer base is not highly concentrated, and our top 25 customers represented less than 6.6% of our revenues this quarter.

Comments on CapEx. Our capital expenditures for the quarter declined sequentially by 9.7%. Our capital expenditures were $10.9 million this quarter compared to $10.6 million for the fourth quarter of last year and $12.1 million for the third quarter of 2018. Our capital expenditures were for $49.9 million for the full year as compared to $45.8 million for 2017.

Capital lease and capital lease payments. Our capital lease IRU obligations are for long-term dark fiber leases and typically have initial terms of 15 to 20 years or longer and often include multiple renewal options after the initial term. Our capital lease IRU fiber lease obligations total $163.8 million at year-end. And at quarter end and year-end, we have IRU contracts with total of 239 different dark fiber suppliers. Our capital lease principal payments under these IRU agreements were $2.1 million for the quarter. And if you combine these payments with our CapEx, it was a decrease sequentially by 8% and that total was $13.1 million in this quarter compared to $14.2 million for the third quarter and $12.5 million for the fourth quarter of 2017. Capital lease payments combined with CapEx were $60.2 million this year compared to $57 million last year. We added 37 more buildings to our network in 2018 than we added in 2017 and that is 28% -- an addition of 28% more on-net buildings this year.

Cash and operating cash flow. At year-end our cash and cash equivalents totaled $276.1 million. For the quarter, our cash decreased by $8.5 million. We returned $38.4 million of capital to our stakeholders this quarter. During the quarter, we paid $26.5 million for our dividend, $5.3 million was spent on a semiannual interest payment on our debt, and we bought stock this quarter totaling $6.6 million. Our quarterly operating cash flow increased sequentially by 28.3% to $40.7 million and increased by 29.9% year-over-year. This operating cash flow of over $40 million this quarter was the greatest quarterly operating cash flow in our 19 year history. And our operating cash flow was $133.9 million for the year which was an increase of almost 20% over last year.

Our total gross debt at par, including capital leases, was $809.2 million at year-end, and our net debt was $533.2 million. Our total gross debt to trailing last 12 months EBITDA as adjusted ratio was 4.36 at year-end and our net debt ratio was 2.87. Finally, some comment on bad debt and days sales of accounts receivable. Our bad debt expense was again only 0.7% of our revenues for the quarter and only 0.6% of our revenue for the year, and that total amount was down $300,000 year-over-year for the year. Our days sales outstanding for worldwide accounts receivable was only 25 days. That was the same amount as the end of last year. And I want to again thank and recognize our worldwide billing and collections team members for continuing to just do a fantastic job in serving our customers and collecting from our customers.

And with that, I will turn the call back over to Dave.

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David Schaeffer, Cogent Communications Holdings, Inc. - Founder, Chairman, CEO & President [6]

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Hey, thanks, Tad. I'd like to take a moment and comment on the scale and scope of our network and its expansion. We have over 944 million square feet of multi-tenant office space in North America, directly on our network. We added 170 buildings to our network in 2018. Our network consists of 32,900 metro fiber miles and over 57,400 intercity route miles of fiber.

The Cogent network remains the most interconnected network in the world and we have direct connectivity with over 6,580 networks, which less than 30 of these networks are settlement free peers, the remaining networks are all Cogent transit customers.

We're currently utilizing approximately 31% of the lit capacity in our network. We routinely augment segments of the network to maintain these low utilization rates. For the quarter we achieved sequential traffic growth of 10%. And on a year-over-year basis, our traffic grew by 44% in the quarter. We operate 52 of our own data centers, which comprise 587,000 feet of raised-floor space and are today operating at approximately 32% utilization.

Our sales force turnover was approximately 5% in the quarter, which is better than our long-term sales force turnover rate of monthly 5.7%. Our quarterly sales rep productivity as measured on a monthly basis for full time equivalents was 5.7 installed orders per rep per month. This is above our long-term average of 5.1 orders installed per full time equivalent rep per month. We ended the quarter with 487 sales reps selling our services, which is a significant increase from the 453 reps that we had at the end of Q3 and the most number of sales reps selling our services we've had in our corporate history.

In summary, Cogent is a low cost provider of internet services, transit services and our value proposition remains unmatched in the industry. Our business remains completely focused on the Internet, IP connectivity and data center colocation, all of which are necessary utilities to our customers.

Beginning in April 1, 2018, we began also selling SD-WAN services, which thus far has not been a material contributor to our revenues, but we do expect to continue to grow. Our multiyear constant currency long-term revenue growth target is approximately 10% due to the slowdown in our NetCentric business.

And our long-term EBITDA margin expansion rate is expected to be approximately 200 basis points per year. Our Board of Directors has approved yet another increase to our quarterly dividend of $0.02 per share bringing that quarterly dividend to $0.58 per share per quarter. Our dividend increases demonstrate the continued optimism regarding the cash flow generating capabilities of our business.

We will be opportunistic about the timing of purchase of our common stock. During the quarter, we purchased 148,000 shares of our common stock for $6.6 million at an average price per share of $44.36. At the end of the quarter, we still have $34.9 million remaining under our current authorized buyback program. We are committed to returning an increasing amount of capital to our shareholders on a regular basis.

With that, I'd like to open it up for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question comes from Colby Synesael with Cowen and Company.

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Jonathan David Charbonneau, Cowen and Company, LLC, Research Division - VP [2]

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This is Jon on for Colby. How much has your view on the long-term growth potential for the NetCentric business changed since last quarter, especially given the tweak to your growth targets of 10% now? And how should we be thinking about the growth or trends within that business over the next couple of quarters?

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David Schaeffer, Cogent Communications Holdings, Inc. - Founder, Chairman, CEO & President [3]

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Yes. So I think our long-term view is that NetCentric business will continue to improve and return to its long-term average growth rate of about 9.5% year-over-year. As I mentioned in the last call and have repeated at multiple interactions with investors that business has continued to underperform for a number of reasons. While traffic growth has accelerated, revenue growth has lagged. On a full year basis, revenues were down 0.4%. If you FX adjust that, they were up 2.6% 2018 over 2017, which is substantial with lower growth rate than the 9.5% long-term average.

Based on the slower rate of recovery in that business, it made sense for us to revise our long-term growth rate to be realistic about the amount of time it's going to take for that business to recover. But our ultimate view is traffic growth will continue to accelerate, price declines will be at historical average rates, about 23% per year and Cogent will continue to gain market share, growing about twice as fast as the market. So with those parameters, we do expect to eventually return to NetCentric growth in that 9% to 10% range. And therefore, our total growth rate will be back in the 10% to 20% range. But due to the fact that we do not have visibility to when that will occur, it seemed prudent to reduce the total business' revenue growth target to 10%, which is still substantially better than any other wireline telecom service provider who is growing organically globally.

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Operator [4]

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Our next question comes from Matthew Niknam with Deutsche Bank.

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Unidentified Analyst, [5]

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This is [Benjamin] on for Matt. Just one quick one on the sales force. So you guys noted that there was lower churn this quarter and we also saw sort of the highest net additions there that we have in a while. Just want to dig in there and see if there's anything to call out around, is this lower churn a trend, has your strategy changed around how many people you want to add, just anything in there?

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David Schaeffer, Cogent Communications Holdings, Inc. - Founder, Chairman, CEO & President [6]

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Yes. So we remain pleased with the initiatives that we've put in place and continue to enhance on the sales force. As we've spoken about with investors in the past, we have implemented a much more formalized and rigorous training program that has allowed us to reduce churn. We have experienced lower sales force turnover over the last several quarters and continue to see the ability to improve that number even further.

In terms of total number of sales people, we expect to grow the sales force somewhere between 7% and 10% annually. We achieved that '17 over '18 and we expect similar type aggregate growth in the sales force in 2019 versus 2018. To help facilitate that, we continue to open additional sales offices. Recently, we opened offices in Columbus, Ohio, Singapore and in Montreal to augment the footprint that we have in place.

And then finally, we think that the training efforts that we have put in place had been responsible for enhanced sales force productivity. And our rep productivity at 5.7 orders per full time equivalent rep per month installed continues to be substantially above our on long-term average. So it is this improvement in both the size of the sales force and the efficiency of the sales force that gives us confidence that our aggregate business will continue to grow and our operating margins will continue to improve and therefore, our ability to grow cash flow at nearly 20% and therefore grow the dividend at a similar rate.

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Operator [7]

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Our next question comes from Frank Louthan with Raymond James.

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Frank Garrett Louthan, Raymond James & Associates, Inc., Research Division - MD of Equity Research [8]

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Can you just give us an update on the sales force progression in the NetCentric business? Where you think -- where do you expect that to be over the next 12 months? And is there anything changed in sort of your hiring and so forth with how you've done that organization?

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David Schaeffer, Cogent Communications Holdings, Inc. - Founder, Chairman, CEO & President [9]

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Yes. Hey, Frank. So today we have 141 of our 487 reps are NetCentric. They are effectively equally divided between North America and the rest of the world. We continue to expect to grow both the corporate and NetCentric sales forces at about the same rate. The opening of the office in Singapore is focused purely on the NetCentric market, whereas the Columbus office is mostly focused on the retail market with limited NetCentric opportunities in that part of the country.

We continue to enhance the training of both sales organizations and we feel comfortable that over the long run the NetCentric business will improve from that 2.6% year-over-year growth back to the 9.5%. We just don't know exactly when that's going to happen. So that was the reason for the slightly more conservative guidance targets going forward. But we think we have the right number of NetCentric reps. Their turnover is substantially lower than that of the corporate reps, and we expect their productivity continue to remain at elevated levels just as we're seeing from the entire sales force.

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Frank Garrett Louthan, Raymond James & Associates, Inc., Research Division - MD of Equity Research [10]

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So what is sort of the trick then to get it back up? I mean you've tweaked around a little bit with sort of their focus and is it -- or is it focusing more on web-scale providers and things like that. What exactly do you think it's going to take to get that growth rate back up? So it's a pretty big jump.

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David Schaeffer, Cogent Communications Holdings, Inc. - Founder, Chairman, CEO & President [11]

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Sure. So a couple of points, Frank. First of all, the unit growth has already reaccelerated. The traffic growth numbers have reaccelerated. What we have seen, however, is over the past year most of that unit growth has come from our largest customers, which get the lowest price point. It has been that lower priced traffic that has retarded our revenue growth rate.

We believe that is a temporary phenomenon for 2 reasons. One, some of our NetCentric customers who previously had paid direct connect agreements that they were pressured into in the period of constrained ports when there were violations of net neutrality, are now able to divert that traffic back to Cogent and utilize transit as a lower cost and easier to use service.

Secondly, we have seen organic growth rates of the larger web centric customers, hyperscale providers outpace that of the general market. I think that is a more transitory phenomena and we would expect that over the next year or 2, the market growth rates of both large and small customers to homogenize and become equivalent, whereas today, we are seeing a disproportionate growth from our largest customers.

So there's actually nothing wrong with the NetCentric sales efficiency and efficacy. The issue is to actually selling to big customers, which is depressing the effective price per megabit. And we think that's a temporary phenomenon.

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Operator [12]

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Our next question comes from Dick -- Nick Del Deo with MoffettNathanson.

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Nicholas Ralph Del Deo, MoffettNathanson LLC - Analyst [13]

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First Dave, as you noted in your prepared remarks, you had really strong margin expansion in 2018, again despite revenue growth coming in a bit shy of your goals. It seem to be mostly driven by SG&A controls. Even though SG&A leverage in Q4 was a bit lower than the first 3 quarters of the year. Were there any SG&A drivers that made an outsized contribution to margin expansion during the year? Or other drivers that we should bear in mind as we think about 2019?

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David Schaeffer, Cogent Communications Holdings, Inc. - Founder, Chairman, CEO & President [14]

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So first of all, Nick, roughly 100 basis points of our margin expansion came from COGS efficiency as our cost of goods sold continue to decline as a percentage of revenues. Our gross margins increased from 57% to 58%. We have said that over the long term that roughly 200 basis points per year of margin expansion will come almost equally from COGS efficiency and SG&A efficiency.

On the SG&A part of your question, we are getting more efficacy out of the sales force. We are getting better utilization of our sales infrastructure. As the sales force grows, the management spend sort of control are filling out, and we all are not adding significantly to our G&A headcount. It is really all of those things that have attributed to the SG&A operating leverage in the business.

So on the network side, it's the sale of on-net services and the high operating leverage that comes from that, the lower operating leverage, but still substantial that comes from selling off-net. And on the SG&A side, it's really just utilizing our infrastructure more efficiently.

If we look over the long term, Cogent's EBITDA contribution margins have been 43.7%. That is actually still substantially above the 35.5% that we deliver for full year 2018. But we are also seeing our contribution margins improved, and in fact for 2018, our contribution margins were about 58% which is substantially above that long-term average. We, actually, expect that to continue.

And it is why even though we revised our target for total revenue growth due to the slower revenue growth on the NetCentric portion of the business, we remain confident in our ability in 2019 to deliver approximately 200 basis points of EBITDA margin expansion. We, actually, expect that to continue in the out years as well. Again, this is not short-term guidance but long term.

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Nicholas Ralph Del Deo, MoffettNathanson LLC - Analyst [15]

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And then maybe can you give us any sort of update on your SD-WAN offering in terms of client interest and your sales funnel? And maybe have anything unexpected or interesting you've learned from a marketing or operating perspective since you launched it?

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David Schaeffer, Cogent Communications Holdings, Inc. - Founder, Chairman, CEO & President [16]

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Yes. So I think there are really 3 takeaways from our launch. The customers that have deployed have been happy with the service. Two, I think a lot of prospective customers are confused about what the technology actually can deliver, and where it is superior to our VPLS offerings. So I would actually say that one of the big advantages of offering SD-WAN has actually been the commencement of conversations with MPLS customers who want to switch off of MPLS. And as they evaluate the 2 technologies, some of those customers have actually chosen VPLS over SD-WAN, some have chosen SD-WAN.

And I think universally, what our sales force is saying is, any customer that today is operating an MPLS network is frustrated. They're frustrated with the high cost, the lack of flexibility, and the difficulty of managing that network over the long term. So there are about 1.3 million MPLS ports deployed in North America, and that represents close to $45 billion in spend. We think that all of that is vulnerable to replacement, and will be migrating to SD-WAN or to VPLS.

I think the third point I'd like to make is customers remain confused about what SD-WAN can deliver versus some of the promises that have been made by some of the equipment vendors. And there are a multitude of vendors in the market selling CPE equipment. And they make a number of promises or boast about their equipment that are probably not completely accurate. And a big part of the sales effort has actually been our sales force managing customer expectations and those expectations really are around throughput and feature set. And it's a tradeoff.

If you turn all of the feature sets on in terms of security, control, and multi-vendor interfaces, you then end up sacrificing throughput. If you're focused on throughput, in many ways a VPLS solution is more mature. But we're seeing success with both products and our VPNs delivered over both technologies continue to increase as a percentage of our revenues, and have grown from 17% to 18% of total revenues and are up from 25% to about 27% of corporate revenues. Thanks, Nick.

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Operator [17]

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And I'm not showing any further questions at this time. I'd like to turn the call back over to Mr. Schaeffer for any closing remarks.

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David Schaeffer, Cogent Communications Holdings, Inc. - Founder, Chairman, CEO & President [18]

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Okay. Well, first of all, I'd like to thank everyone for joining us. I know today is a busy day, and there are some other investor events going on, but we remain pleased with our performance. We're encouraged by the cash flow generation that our business is continuing to demonstrate in a market where other wireline carriers have been struggling. And our commitment to returning increasing amounts of cash to our shareholders has been demonstrated by both our buyback and dividend increase strategy. So I want to thank everyone. I want to thank entire Cogent team, and we'll be talking soon.

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Operator [19]

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Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program, and you may all disconnect. Everyone have a wonderful day.