All right, perfect. Thank you everyone for joining us for the Credit Suisse Communications Conference. I'm Sami Badri with Credit Suisse, focusing on communication infrastructure and telecom and network equipment. Right now, we have the CEO of Cogent Communications, Dave Schaeffer. Thank you, Dave, for joining us today.
Hey, Sammy. Thank you for hosting us. I'd like to thank investors for taking time out of their busy schedule in a volatile market to pay attention to Cogent. As always, I'd like to thank Credit Suisse for a great venue.
Absolutely. Thank you. Dave, I wanted to kick it off with a question on your Q1 2022 results, and mainly trying to talk about the improvement that we saw in specifically the corporate segment. Revenues were flat, excluding some parts. I kinda wanted to dig into what you're seeing on the corporate side and where you kinda see the inflection going from here, at least from a business perspective.
Yeah. I think we're still a couple to maybe a few quarters away from returning to our long-term average corporate growth rate sequentially of between 2% and 2.5%. You know, in the pandemic, our corporate customers suffered the most. Our corporate growth rate fell from 2.5% positive to 2.5% negative. In the first quarter of 2022, we returned to effectively a flat sequential growth rate, a significant improvement. We were down 0.1% when adjusting for Universal Service Fund fees.
Mm-hmm.
We are seeing sales activities to corporate customers improve. We're seeing the number of spoke tos continue to increase as they had in the previous quarters, number of proposals issued, and the duration of proposal issuance to contract signing continuing to shrink. We think all of these factors, coupled with the anecdotal discussion with customers, that many of them are ready to now make decisions about their corporate architectures that they've delayed for the past 2 years.
These decisions include increasing the aggregation points for work from home employees, oftentimes growing those ports and adding additional aggregation points. Two, shrinking their office footprint and eliminating redundant or not required offices, shrinking the size of each office, and supporting a workforce that is anticipated to be between 30%-40% remote on any given day.
These are all factors that have led to our re-acceleration in our corporate business and should continue for multiple years and allow us to return to that kind of pre-pandemic growth rate.
Gotcha. One area specifically is there's been a focus on vacancies in some of the major markets, at least in North America. Sorry, that's the next question I wanted to ask. Actually, no, that's right. Sorry, my eyes are skipping just because I noted in between my questions.
One thing I wanted to really touch on is what trends are you seeing from a vacancy badge swipe or even other metric perspective? Are you starting to see the Northeast come back as far as activity, leasings or the multi-tenant office spaces? Anything really starting to inflect upward?
Absolutely, we're seeing a return to office across our entire footprint in the US and Canada, although the pace of that return varies dramatically by geography. The vacancy rates in our nearly 1 billion sq ft of office space increased from 6% pre-pandemic to 16% at peak. Those vacancy rates are beginning to decline. We're seeing net absorption of square footage and leases.
We're seeing the average lease size of new leases signed being about 20% below pre-pandemic levels, which makes sense when you believe that the typical office is anticipating 30%-40% of its workforce on any given day being remote. In addition to that, we are measuring third-party data such as leasing reports, CoStar data, and security badge swipes. Badge swipes are an actual indicator of number of employees entering the building per day.
We have seen that number trough at, you know, only a couple of % of pre-pandemic levels during the initial lockdowns. They kind of reverted to about a 20% badge swipe number for over a year. We've seen that number steadily improve over the past 6 or 7 months, even with the Omicron variant and the subsequent, you know, return to hybrid from that. The differences are fairly significant.
I would say San Francisco is our worst performing market, followed by a couple of our Northeast cities, D.C., Boston, New York, upper Midwest, Chicago, Toronto, a little better, and then south and southeast, probably the best, with cities like Miami returning to between 75% and 80% of pre-pandemic badge swipes.
You know, I think across the entire footprint, we're hovering just below 50% of pre-pandemic levels, but under that average works a great deal of geographic differentiation. Remember, our corporate product is not sold on a metered basis, but rather on a fixed connection basis. Because our companies have some employees in the office, they need the connection.
Then secondly, because those companies are still at similar or even greater staffing levels as we return to pre-pandemic total employment numbers that are effectively flat and there are 10 million job openings in America, many companies have increased their ad hoc VPN aggregation size connections and number of locations. That has been a positive to Cogent and has allowed us to offset any branch office closures.
Got it. Thank you for all that color. I wanted to go back to your, you know, the way you characterize your total addressable market. You use the target buildings that have about 51 tenants on average in a building. Maybe you can tell us if there's an update to that number, but you'd usually serve about 14.5 of those 51 tenants or, you know, ballpark. That's kind of the TAM we were all thinking.
Now, can you provide some perspective on what happens when tenants average lease sizes in those office spaces change? You know, and I guess in this case, they're largely being reduced. Even though the leases are changed, what happens from a Cogent perspective, from a services perspective?
Three very different factors. First, the aggregate vacancy rate in the building needs to revert to kind of a more normalized level. That is going to happen primarily due to the fact that a lot of the inventory in lesser buildings is being taken off market through residential conversion. Many tenants that were in B and C buildings are actually migrating into A buildings.
In every other economic downturn since World War II, we have seen the A buildings, big, tall, shiny skyscrapers, recover the most quickly. Rents typically go down, but occupancy rates return to pre-pandemic levels. The second thing that will happen is with the average new lease and many existing leases shrinking by about 20% to accommodate less employees in the office every day.
In a pre-pandemic office design, an architect would assume that 3% of the workforce would be vacant, either on vacation or sick on any given day. Today's design criteria is more like around 30%-40% of the workforce will be remote. As a result of this and an increase in common meeting areas, we've seen the average square footage shrink by 20%.
Those two statistics, offices returning to pre-pandemic occupancy as percentage of square footage and average lease size shrinking, means our TAM will increase from 51 tenants to roughly 60 tenants per building. You know, with the 14.4 signed today, that will give us both the ability to capture market share that hasn't signed and a bigger total market.
The third point is that because companies are expecting employees to be remote at least part of the time, their dependence on VPN connectivity and the internet have increased. While the internet was important pre-pandemic, it's become indispensable post-pandemic. That is a positive. Our biggest competitor is actually complacency. It's the inertia of doing nothing.
For Cogent, there are three windows when a corporate customer will consider switching, when they first move, when their current network fails, or there's a change in their IT infrastructure. That change in infrastructure is occurring by this transition to a hybrid workforce. We view this combination of factors as positive and sufficient, even if there is an economic downturn due to, you know, a recession resulting in our corporate growth continuing to grow in that 10%-11% year-over-year rate.
Got it. You know, just from a pricing scheme perspective, could you just walk us through any of the changes you're seeing? Even if our actual office footprint is being reduced, is the amount of speed or is the price paid for that speed, is that changing, at all, or is it trending in the right direction from a Cogent perspective?
The effective price per megabit for corporate customers is coming down because customers are using more of the bandwidth they purchased due to these changes in their business models and where their employees work.
The positives for Cogent have been, 1, an acceleration of a trend that was in place pre-pandemic, of migrating from 100 meg connections to gigabit connections, uplifting ARPU by about $200 and more than offsetting the natural kind of 3% per year price erosion, kind of a same store sales price decline due to contract lengthening and competitive pressures.
The second positive factor has been an increasing, but still not statistically significant, portion of the base migrating to 10 gigabit connections, which represents about an additional 4x increase in ARPUs.
The additional factor of adding redundancy, that third factor of adding another location so you don't have a single point of failure for your remote employees, has caused many corporate customers to buy connections in data centers for that second aggregation point. That is a positive. On the negative side, it's this closure of remote offices, and it's the lack of office to office VPNs that have been more difficult post-pandemic.
Putting these five factors together, we think our ARPUs will remain relatively flat to increase in our corporate on net business, and our revenue will increase due to flat to increase in ARPUs and an increase in number of connections.
Okay, got it. Number. Perfect. Thank you for hitting that. I want to shift gears into the NetCentric segment a little bit. We've now had almost about two years of very robust growth in the NetCentric segment, but a lot of businesses that saw the massive pandemic driven growth, including streaming companies, and other OTT type service providers, have started to see a roll down of demand.
What are you seeing on your end as far as how these, you know, pandemic beneficiaries are performing now from a network perspective?
You know, we're continuing to see robust corporate and NetCentric growth. We're continuing to see traffic grow at similar levels to last quarter. While we don't give, you know, specific quarterly guidance, we are doing, I think, pretty well on traffic growth. I know that some of our customers have not grown as quickly. You know, there are a number of factors going on. Half of our NetCentric revenues come from the 7,600 access networks around the world that buy upstream from us.
The other half come from content generators. Within those content generators, we've really seen three things happen. We've seen a broadening of the customer base to more mid-size purchasers. Two, we have seen a slowdown in some of the aggregators, that have functioned as intermediaries, CDNs, and many customers building their own CDNs out as opposed to relying on a third party.
We're seeing continued globalization. The U.S.'s share of the Internet is continuing to decline. All of these factors have actually been a positive to Cogent's ability to grow our revenues and the fact that our effective price per megabit rate of decline is much more benign than the 23% headline number we've averaged over the past 20 years, and the roughly 22% decline on a headline basis last quarter, much in line with historical averages.
We are able to get paid in 73% of the instances by senders and receivers. We're getting paid a higher effective rate because the customer base is more fragmented. Finally, we're getting more of that traffic in more expensive regions of the world that have allowed us to see our effective price decline much more slowly.
Now, with all that positive news, we anticipate our NetCentric growth rate will not continue at these extremely elevated levels, but rather will revert to something closer to our long-term average of 9% year-over-year. Different than the corporate business, the NetCentric area business has always experienced some seasonality and some short-term volatility, but we think that 9% growth rate is sustainable, not the 18% year-over-year growth rate that we delivered in NetCentric last quarter.
Got it. Thank you for hitting that. I wanted to shift gears a little bit onto your sales force. Can you speak to Cogent's ability to attract and ramp new team members given a tighter than normal labor market and, you know, given some of the situation, you know, I guess the economic dynamic that's going on today.
There's clearly some companies hiring and some companies doing the opposite. Could you walk us through how the Cogent sales force is progressing from a hiring and productivity perspective?
Yeah. We actually continued to accelerate our gross hiring throughout the pandemic. We actually hired the most people in Cogent's history in 2020, and then it was succeeded in 2021, and we're on pace to continue that outpaced hiring in 2022. What hurt us in the sales force was an increase in sales force turnover. We went into the pandemic with 5.2% of the sales force churning every month.
That number increased to 8.9% at peak and has subsequently declined to 6.9% of the sales force per month in Q1. We expect that rate of turnover to continue to moderate and get back down to that roughly 5% or 5.2 on a normalized basis. We saw our total sales force headcount decline by about 20%. We continue to have over 15 job applicants per opening.
That's actually up from our historic average. Many of these applicants, though, are not a great fit for Cogent, and we think that our comp packages, even in this period of wage inflation, are substantially better than the prospect's alternatives. Our starting comp for a rep is $80,000 a year plus a robust benefits package that is $40,000 base salary and $40,000 variable.
That variable is guaranteed for the first 3 months. The first full month is entirely training, then followed by, you know, kind of a hybrid training and work model, allowing a rep to start to build a sales funnel. With that funnel, the rep then goes to a $40,000 base, and the $40,000 is completely variable. We, again, think that this is sufficient, even in expensive markets like New York and San Francisco, to attract new hires.
You know, the typical Cogent hire is someone who went to a state school with a less than stellar grade point average and probably a not fully marketable area of specialization, history, English, sociology, in which there are less job opportunities. Typically, we hire someone who's had one or two selling jobs out of college before they join Cogent. It is a high activity job that requires 100 outreaches a day.
That's probably worse than a sell-side analyst, Sami, in terms of how many calls you have to make. You know, it's a rare individual that can keep up that pace to be successful.
You know, we do identify those individuals, and we expect to continue to grow the sales force from the trough that we hit probably in the last couple of quarters where we've been flat by that kind of 7%-10% rate that we were at pre-pandemic, meaning it'll take about two years to recover the ground that we've lost in the pandemic on a net basis and then continue to grow and expand beyond that. We don't believe there is a candidate shortage.
Got it. We only have a little bit of time left, but I wanted to ask you a quick one. Given the market volatility that's been going on and where Cogent stock price is, do you change you know any or would the market volatility that we're seeing compel you to actually change the way you return capital to shareholders? Is dividends still the preference, or at what point would you consider buybacks a bit more aggressively than the last couple of quarters?
Three parts to the answer. One, we are totally committed to returning increasing amounts of capital, and our most recent debt raise gave us additional flexibility to do that. The second is, you know, we have used a systematic dividend growth policy as an effective way to return that capital and now have 39 sequential consecutive quarters of dividend growth.
We value that, but we also, thirdly, recognize that we can monetize volatility. You know, our stock has declined, but maybe not as aggressively as the rest of the market. I think there's probably still some market volatility that has not yet fully worked through the system, so it is something we monitor daily.
I'm not prepared to give investors a specific answer to that question, but I do think that over time, we will be in a position to use both tools to return capital and toggle between them where appropriate.
Got it. All right. Well, I appreciate it, Dave. Thank you everyone else for joining us, and look forward to tuning in for the rest of the conference. Appreciate your time, Dave.
Hey, thanks, Sammy.