Cogent Communications Holdings, Inc.

Good morning and welcome to the Cogent Communications Holdings Third Quarter 2022 Earnings Conference Call. As a reminder, this call is being recorded and it will be available for replay at www.cogentco.com. A transcript of this conference call will be posted on the same website when it becomes available. Cogent's summary of financial and operational results attached to its press release can be downloaded from the Cogent website. I would now like to turn the call over to Mr. Dave Schaefer, Chairman and Chief Executive Officer of Project Communication Holdings.

Thank you, and good morning, everyone. Welcome to our third quarter 2022 earnings conference call. I'm Dave Schaefer, Coach and CEO, and with me on this morning's call is Tad Weed, our Chief Financial Officer. Hopefully, you've had a chance to review our earnings press release. Our press release includes a number of historical metrics that we present in a consistent manner for every quarter. Our revenue growth accelerated this quarter, and our corporate revenues increased sequentially by four-tenths of one percent from the first quarter, the first time since the beginning of the pandemic, and is impartial due to the increase in USF revenues. Excluding the $670,000 sequential increase in USF revenues, our corporate revenues were essentially flat sequentially for the quarter. Our total revenues increased sequentially by 1% to exactly $150 million, an increase of 1.4% year over year. Our total revenues and our net centric revenues were materially impacted by the negative impact of foreign exchange in the quarter and the continuing strengthening of the US dollar. For the quarter, the sequential negative impact of foreign exchange was $1.5 million and was negative $4.2 million on a year-over-year basis. On a constant currency basis, our revenues grew sequentially by 2%, and grew by 4.3% year over year. Our corporate business continues to be influenced by real estate activities in the central business districts of major North American cities. Two key statistics, including the level of security card swipes in buildings and leasing activities, indicate that year-to-date The real estate market and leasing activities in these central business districts have seen some improvement, but have not yet returned to their pre-pandemic levels. Leasing activity across major markets and workers' return to offices continue to improve, albeit slowly. On a U.S. gap, our corporate revenues increased sequentially four-tenths of a percent for the first time since the second quarter of 2020. We continue to remain cautiously optimistic in our outlook for improvement in our corporate revenues in these uncertain economic times and continuing to deal with the challenges of COVID-19. Our net-centric business continues to benefit from continued growth in video traffic and streaming. For the quarter, our network traffic was up 2% sequentially, and traffic accelerated to a year-over-year growth rate of 21% in the third quarter. On a U.S. GAAP basis, our net-centric revenues grew sequentially by 1.9%, and grew by 9.6% on a year-over-year basis. On a constant currency basis, our net centric revenues grew sequentially 4.3%, an increase by 16.8% from the third quarter of 2021. For EBITDA margins, as adjusted for the $2 million extraordinary expense associated with the acquisition of T-Mobile Wireline, or known as the Sprint GMG business, that were incurred in the quarter increased sequentially by 50 basis points and by 90 basis points on a year-over-year basis to 39.9%. This EBITDA margin represents the highest adjusted EBITDA margin in the company's 23-year history. Our Salesforce rep productivity was 4.6 units per rep per full-time equivalent as compared to 4.9 in the last quarter. While this is a decline of 6.1%, it still represents a 7% year-over-year improvement. We significantly increased the size of our sales force by adding 45 sales reps, a 9.4% sequential increase, representing the largest ever net increase in sales force and coaching's history. This did impact our rep productivity. We entered the quarter with 522 reps, and 465 full-time equivalents, a 3.6% increase in full-time equivalent sales reps. Now for a couple of words on the acquisition of the Sprint wireline business. We are diligently working through the approval process to complete our acquisition of Sprint's numerous various regulatory agencies around the world. We anticipate the acquisition will close in the second half of 2023. We incurred $2 million of professional fees in the third quarter in conjunction with the acquisition. We anticipate those professional fees to be dramatically reduced in the subsequent quarters. We anticipate that the Sprint wireline revenues that were approximately $560 million for fiscal year 2021 will be approximately $450 million annual run rate at the close date. We expect that the number of Sprint wireline products will be reduced dramatically from the approximately 30 products offered today down to four by closing. Over the next three years, we anticipate annualized savings of $180 million on the North American network, primarily by utilizing the cogent metro footprint and our on-net building portfolios. We also anticipate $25 million of annual savings on the international network by migrating off of a lease network onto the owned Cogent network globally. And we thirdly expect about a $15 million reduction in Cogent's operating and maintenance expenses associated with an IRU that we will be abandoning. There will be additional SG&A savings that include headcount reduction and other general operating cost synergies. During the quarter, we returned $42.7 million to our shareholders through our regular dividend program. We did not purchase any stock during the quarter and have $30.4 million available under our buyback program, which the board extended to 2023. Our board of directors, reflecting on the strong cash flow generating capabilities, investment opportunities in front of the company, decided to increase our quarterly dividend sequentially by one cent per share, raising our quarterly dividend from 90.5 cents per share to 91.5% per share. This increase represents the 41st consecutive sequential increase in our regular quarterly dividend. A 4.4% annualized dividend growth rate is now in line with our growth rate and free cash flow generation. Now for a couple of comments around long-term expectations. Our targeted long-term EBITDA margin expansion guidance is for approximately 200 basis points per year. Our targeted multi-year constant currency growth rate is targeted to be 10%. Once our entities, that is Cogent and Sprint, are combined, we anticipate that for the combined entity, the annual revenue growth rate will be between 5% and 7%, and the EBITDA margin expansion annually after initial synergies are achieved will be about 100 basis points per year. Our revenue and EBITDA guidance targets are intended to be multi-year targets and are not intended to be used for either quarterly or even specific annual guidance. Now I'd like to ask Tad to read some safe harbor language, provide some additional operating performance data, and then after that, we will open the call for questions and answers.

Thank you, Dave, and good morning to 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 our forward-looking statements. If we use non-GAAP financial measures during this call, you will find these reconciled to the corresponding GAAP measurement in our earnings releases, which are posted on our website at CogentCo.com. Comment on COVID-19 and risk updates. Like many companies, we continue to be impacted by the COVID-19 pandemic. And our risks related to COVID-19 and other risks are described in more detail in our annual report on Form 10-K for 2021, and in our quarterly reports on Form 10-Q for the first and second quarter, and this quarter's report, which will be filed Friday. Corporate and net-centric revenue and customer connections. We analyze our revenues based upon network connection type, which is on-net, off-net, and non-core. And we also analyze our revenues based upon customer type. We classify all of our customers into two types, net-centric customers and corporate customers. Our corporate customers buy bandwidth from us in large multi-tenant office buildings or in carrier-neutral data centers. These customers are typically professional service firms, financial service firms, educational institutions, located in multi-tenant office buildings or connected to our network through our carrier-neutral data center footprint. Our Net Center customers buy significant amounts of bandwidth from us in carrier-neutral data centers and include streaming companies and content distribution service providers, as well as access networks who serve consumers and business customers. Our corporate business represented 57% of our revenues this quarter, and our corporate revenue declined year over year by 4% to $85.5 million from the third quarter of last year, but as Dave mentioned, increased sequentially by 0.4% for the first time since the second quarter of 2020. We had 45,176 corporate customer connections on our network at quarter end, which was a sequential increase of 0.2%, and a year-over-year decline of 0.8%. Our total revenues and our corporate revenues are impacted by changes in the USF tax rates, which are updated quarterly. For the quarter, the impact of USF on our revenues was a positive 0.7 million, and the impact was negative year-over-year by the same amount, 0.7 million. Our net-centric business, which represented 43% of our revenues this quarter, and despite material FX headwinds, had another solid quarter and grew by 1.9% to $64.5 million sequentially and grew by 9.6% on a U.S. GAAP and a year-over-year basis. Volatility in foreign exchange rates primarily impacts our net-centric revenue, and the impact was materially negative both sequentially and year-over-year. On a constant currency basis, our net centric revenue increased year over year by 16.8%, which was an increase from the constant currency revenue increase last quarter of 16.2%, and grew sequentially by 4.3%, which also was an increase from last quarter, which was 2.5%. We had 51,145 net-centric customer connections on our network at quarter end. That was a sequential increase of 0.9%, and a year-over-year increase of 7.8%. On revenue and customer connections by network type, our on-net revenue was $113.2 million for the quarter, which was a sequential increase of 1.1%, and a year-over-year year increase of 1.9%. Our on-net customer connections increased by 0.4% sequentially to 82,614 and increased by 3.1% year over year. We serve our on-net customers in our 3,126 total on-net multi-tenant office and carrier-neutral data center buildings. We continue to succeed in selling larger connections, 100 gigabit connections and 400 gigabit connections in selected locations, and that has had the impact of increasing our on-net ARPA. Our off-net revenue was $36.6 million for the quarter, a sequential increase of 0.9%, and a small year-over-year decrease of 0.1%. Our off-net revenues are impacted by incorporating the cost savings we obtain from lower local loot prices into our pricing. The introduction of these customers into our off-net revenue base lowers our off-net ARPU. Our off-net customer connections increase sequentially by 1.5% to 13,359 off-net connections. That was a 6.9% year-over-year increase. and we ended the quarter serving our off-net customers in about 8,100 off-net buildings. These off-net buildings are primarily located in North America. Our average price per megabit of our installed customer base decreased for the quarter, and our average price per megabit for our new customer contracts was flat. The average price per megabit for our installed base declined sequentially by 6.3% to 27 cents and declined year-over-year by 20.8%. This annual rate of decline was better than our historical long-term rate of decline for our installed base of 21.5%. The average price per megabit for our new customer contracts for the quarter was 15 cents. That was the same as last quarter, and a year-over-year decline of 24.2%. This annual rate of decline was compared to our long-term rate rate of decline of 22.1%. Selling larger connections results in a change in our connection mix and has the effect of lowering our average price per megabit at a greater rate than changes in our ARPU. Our on-net ARPU slightly increased and our off-net ARPU continued to decline but at a slight rate from lower pricing we are obtaining from our off-net circuit vendors that we pass on to our off-net customers. Our on-net ARPU, which includes both corporate and net central customers, increased sequentially by 0.5% from $455 to $458. Our off-net ARPU, which is predominantly comprised of corporate customers, climbed sequentially by 0.8% from $927 to $920. Some comments on churn. Our sequential Quarterly churn rates for both on-net and off-net connections were relatively stable, and they continued to hover around 1%. Our on-net unit churn rate was 1.1% this quarter compared to 1% last quarter, and our off-net unit churn rate was 1% this quarter and 1.1% last quarter. In order to reduce our customer turnover, we employ a dedicated sales group that works to retain customers who have indicated that they are considering terminating their service with us. We may offer pricing discounts to these customers in order to induce them to reverse their termination decision, to purchase additional services from us, and or extend the term of their cogent contract. During the quarter, certain of our on-net customers, NetCentral customers, took advantage of our volume and contract term discounts and entered into long-term contracts with us for over 2,350 customer connections, and that increased their total revenue commitment to Cogent by over $21.5 million. Some comments on EBITDA and EBITDA margin. We reconcile our EBITDA to our cash flow from operations in each of our quarterly earnings releases. Seasonal factors that typically impact our EBITDA and our SG&A expenses in particular include the resetting of payroll taxes in the United States at the beginning of each year, annual cost of living or CPI increases, seasonal vacation periods, the timing level of our audit and tax services, and more recently, Sprint acquisition costs and our annual benefit plan cost increases. Our EBITDA, if you include the $2 million of Sprint acquisition professional fee costs, decreased sequentially by $0.6 million and increased slightly year-over-year by $0.1 million. Our EBITDA, excluding these sprint acquisition costs, increased sequentially by $1.4 million and $2.1 million year-over-year. The negative impact of foreign exchange reduced our year-over-year EBITDA growth by $1.8 million. Our quarterly EBITDA margin, including the sprint acquisition costs, decreased sequentially by 80 basis points to 38.6%, and year-over-year by 40 basis points. Our quarterly EBITDA margin, excluding the $2 million of sprint acquisition costs, increased sequentially by 50 basis points to 39.9%, and increased year-over-year by 90 basis points. Comments on earnings per share. We did incur a net loss this quarter due to the 16.9 million non-cash increase in the valuation of our swap agreement, and our basic and diluted loss per share was 17 cents for the quarter. Foreign exchange gains and losses on the translation of our 2024 Euro notes into USD until we extinguish them in June 30, 2022. Losses on the extinguishment of debt and the non-cash changes in the valuation of our interest rate swap agreement have been the primary contributors to the variability in our net income and consequently our per share results. Further comments on foreign currency. Our revenue earned outside of the United States is reported in US dollars and was approximately 24% of our total quarterly revenues this quarter. About 16% of our revenues this quarter were based in Europe, and 8% of our revenues were related to our Canadian, Mexican, Asia Pacific, and South American and African operations. As we experienced again this quarter, volatility in foreign exchange rates can materially impact our quarterly reported U.S. GAAP results. The foreign exchange impact on our revenue this quarter was materially negative both sequentially and year over year, and is expected again to be materially negative in the fourth quarter. The average Euro to U.S. dollar rate so far this quarter, so our fourth quarter, is 98 cents, and the average Canadian dollar exchange rate is 73 cents. Should these average foreign exchange rates remain at the current levels for the remainder of the fourth quarter of this year, we estimate that the FX conversion impact on our sequentially quarterly revenues for the fourth quarter would be a negative $1 million, and the year-over-year conversion impact on our quarterly revenues would be a negative $4.3 million. We believe that our revenue and customer base is not highly concentrated, and our top 25 customers represent about 6% of our revenues for the quarter, consistent with the past. Some comments on CapEx. Our quarterly capital expenditures did increase sequentially to 24 million. Supply chain uncertainty and purchases in anticipation in the closing of our Sprint acquisition have caused us to shift our typical purchasing schedule for network equipment. These anticipatory investments are designed to ensure that we have satisfactory inventory levels of network equipment to accommodate our growth plans, and that includes our new Wavelength product offering, as a result of the Sprint wireline acquisition and the interconnection of our two networks together in multiple locations and to meet our cogent customer needs. Finance leases and finance lease payments. Our finance 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 IRU finance lease obligations were $287.9 million at quarter end. We have a very diverse set of IRU suppliers and have IRU contracts with 306 different Darkfire suppliers across the world. Cash and operating cash flow. At quarter end, our cash and cash equivalents and restricted cash was $323.7 million. Our $54.7 million of restricted cash is directly tied to the estimated fair value of our interest rate swap agreement as collateral. Our cash flow from operations was $53.6 million this quarter, a cogent record, and an increase of $6.2 million from the third quarter of last year and a significant increase of $19.2 million from last quarter. Some comments on debt and ratios. Our total gross debt at par, including finance IRU lease obligations, was $1.2 billion at quarter end, and our net debt was $914.2 million. Our total gross debt to trailing last 12 months EBITDA as adjusted for our sprint acquisition costs ratio was 5.31 at quarter end, and our net debt ratio was 3.93. Our consolidated leverage ratio as calculated under the note indentures was slightly different, 5.30, and our secured leverage ratio was 3.37. Our fixed coverage ratio as calculated under our note indentures was 3.93. Some comments on the swap. We are party to an interest rate swap agreement that modifies our fixed interest rate obligation associated with our $500 million 2026 notes to a variable interest rate obligation based on the secured overnight financing rate, or SOFR, for the remaining term of the 2026 notes. We record the estimated fair value of the swap agreement each reporting period, and we incur corresponding non-cash gains and losses due to changes in market interest rates. At quarter end, the fair value of the swap agreement increased by $16.9 million from last quarter to a net estimated liability of $54.7 million. We are required to maintain a restricted cash balance with the counterparty equal to the net estimated liability. The settlement payments under our swap agreement are made in November and May. Our initial settlement payment, which we made in November of last year, was a net cash savings of $0.6 million. Under the settlement payment we made in May of last year, we exceeded achieved a net cash savings of $1.2 million for the period from November 2021 to April 30, 2022. That was a total combined savings of $1.8 million for those two payments. But under the settlement payment that we are making on November 3rd, there will be a net cash interest expense of $3.4 million for the period from May 1 through October 31st. Lastly, some comments on VAD debt and DSO, which both improved. Our VAD debt expense was only 0.7% of our revenues for the quarter. One change from last quarter, but a significant improvement from 0.7% in the third quarter of last year. And our day sales outstanding, or DSO, for worldwide accounts receivable improved and was 21 days, improved by one day from 22 days last quarter. Again, excellent collection. activity results. And we want to thank and recognize our worldwide billing and collection team members for continuing to do just a fantastic job serving our customers and collecting from our customers. And with that, I will turn the call back over to Dave.