Cogent Communications Holdings, Inc.

Good morning and welcome to the Cogent Communications Holdings first quarter 2023 earnings conference call. As a reminder, this conference call is being recorded and it will be available for replay at www.cogentco.com. A transcript of this conference call will be posted at Cogent's 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 Cogent Communications Holdings. Dave, please go ahead.

Hey, good morning and thank you and welcome to all. Our first quarter 2023 earnings conference call. I'm Dave Schaefer, Cogent CEO. 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 quarterly metrics that we present on a consistent basis each quarter. Now for an overview of our results. Our revenue for the quarter increased sequentially by 1.1% to $153.6 million and increased 3% year over year. On a constant currency basis, our revenue for the quarter year over year grew by 4%. Our corporate business continues to be influenced by real estate activity in the central business districts of major cities. Two key statistics, including the level of security badge entries into a building and leasing activities indicate that year to date, the real estate market and leasing activity in these central business districts has continued to see improvement, but has not yet returned to pre-pandemic levels. We continue to remain cautious in our outlook for our corporate revenues, given the uncertain economic environment and other challenges that are a result of the after effects of the pandemic. Our net centric business continues to benefit from continued growth in video traffic and streaming. For the quarter, our traffic was up sequentially 3% quarter over quarter and increased 20% on a year over year basis. On a US GAAP basis, our net centric revenues grew sequentially by 2.7% and grew by 7.8% year over year. However, adjusting for currency fluctuations on a constant currency basis, our net centric revenues increased by 10.2% from the first quarter of 2022. Our sales force productivity increased from 3.8 orders installed per month per full-time equivalent last quarter to four units per month per full-time equivalent salesperson. We also increased the number of sales reps in this quarter by 14, or a 2.6% sequential increase. We ended the quarter with 562 sales reps and 539 full-time equivalent sales reps. This represents a sequential increase of 7.2% of full-time equivalent sales reps from the fourth quarter of 2022 to the first quarter of 2023. Now for some overviews on our recently announced closure of the acquisition of the Sprint Global Markets Group business, or T-Mobile's wireline business. We closed that transaction on May 1st, ahead of our initially planned closing. We incurred approximately $400,000 in professional fees in the first quarter and have spent a cumulative expense of about $2.6 million and professional fees associated with the closing of this transaction. The Sprint Wireline revenues were approximately $570 million annually for the fiscal year 2022. The Sprint Wireline revenue run rate at closing is approximately $490 million. We expect this number to decline and exit the year at year end with a run rate of the acquired customer base of $440 million, which we then expect to remain stable. The primary reason for this reduction in revenue is the continued elimination of non-core products. We expect that number of products will be reduced from approximately 30 products that were offered when our agreement was signed down to four core products at year end. Over the next three years, we expect to achieve significant annual savings due to synergies of the combination of these businesses. we expect that $180 million will be saved on the North American network of Sprint, primarily through the use of our on-net footprint and the elimination of off-net services. Internationally, we will be shutting down the existing Sprint network and migrating all of that traffic onto the owned Cogent network as opposed to the leased Sprint network, resulting in about $25 million in annualized savings. And then finally, we will be able to exit a significant IRU in North America that will save Cogent approximately $15 million annually in operation and maintenance expense for that network when our next anniversary that allows us to exit occurs within the next couple of years. We anticipate achieving additional synergies through SG&A savings and other cost reductions as well as positive revenue synergies. On the closing date, we paid $1 to the seller And we funded $61.1 million in cash for working capital as set forth in the purchase agreement. This working capital payment was primarily related to the injection of approximately $43.4 million in approximately 30 international subsidiaries to have sufficient liquidity in these facilities to continue operations as we migrate those customers, those vendors, and those employees onto the cogent international entities. Additionally, the working capital adjustment includes an estimated payment of approximately $31 million that we will receive from T-Mobile for acquired lease obligations These will be paid in four equal 25% installments in months 55 through 58 post-closing. Now for a little overview of our product expansion. In connection with the acquisition of the wireline business, we are beginning to sell optical wavelength and optical transport services. We intend to sell these services to existing customers, acquire customers from Sprint Communications, and to new customers. These customers require dedicated optical connectivity without spending capital and the associated ongoing operational expense of owning and operating their own network infrastructure. As part of our transaction with T-Mobile, we entered into a IP transit services agreement on May 1st, 2023. T-Mobile will be purchasing an aggregate of $700 million of transit services over the next 54 months from cogent this consists of equal payments over the next 12 months totaling 350 million dollars or approximately 29 million dollars a month we will then receive for the subsequent 42 months an additional 350 million dollars equally spread out monthly or approximately $9 million a month. We will recognize the associated $700 million of transit revenue services from T-Mobile on a straight line basis over 54 months or approximately $13 million a month. To remind investors, this is a product that carries a 100% EBITDA margin contribution as it is completely on net and the available capacity to deliver these services already exists in Cochran's infrastructure. In addition, we signed a series of transition related agreements. On closing, we entered into a transition services agreement in order to receive specific services in order to maintain an orderly transition of the business. These transition services are primarily related to information technology, back office and finance support, facilities and real estate vendor and supply chain management, and human resources support from T-Mobile. These services will be provided under a transition services agreement. In addition, we entered into a reverse transition services agreement where we will be providing necessary technology, network support, finance, and back office support to support the remaining wireless components that are located in facilities that we acquired. Our initial transition services expense monthly is anticipated to be approximately $1.7 million to be paid to T-Mobile. And the costs under the reverse transition services agreement paid for by T-Mobile to Cogent will approximately be $100,000 per month. These initial transition costs may fluctuate and are expected to diminish over time as each party migrates into its own systems the services that were previously rendered under the transition services agreement. The transition services agreement calls for these services being able to be provided for a two-year period with the ability of either side to request a one-year extension. Third-party costs incurred in providing these services will be passed on at cost with no additional margin. Either party can transition off of these services with 30 days written notice. In addition to the transition services, we will be selling commercial services to T-Mobile outside of the transit agreement. Our commercial relationship with T-Mobile includes the services of co-location, space and power, connectivity at either layer one or layer two. This commercial services agreement will result in T-Mobile paying Cogent approximately $2.7 million a month in cash for these initial services, and this may also fluctuate and diminish over time. This is in addition to the $700 million IP transit services that we'll be providing to T-Mobile over the next 54 months. T-Mobile has indicated that on day one, they will initially use a portion of these services. we have the opportunity at Cogent to materially expand our network reach and footprint. We are adding 45 Sprint data centers to the 55 Cogent data centers that we operate. All of these facilities that we're acquiring from Sprint are fee-simple owned, so the 100 Cogent data centers are in addition to the 1,490 carrier neutral data centers that the combined company connects to. We are adding 18,905 route miles of owned inner city fiber. We are also adding 1,257 route miles of owned metropolitan fiber. And finally, in conjunction with this acquisition, we are adding approximately 11,400 miles of intercity IRU fiber acquired from Sprint and 5,560 route miles of metropolitan IRU fiber also acquired from Sprint. Now for a comment on our dividends. During the quarter, we returned $45.3 million to our shareholders for a regular quarterly dividend. Our board of directors reflected on the strong cash flow generating capacity of our business, the investment opportunities inclusive of the Sprint acquisition and all of its requisite cash flow streams, and decided to increase our quarterly dividend sequentially by one cent, raising our sequential quarterly dividend to 93.5 cents from 92.5 cents. This represents our 43rd consecutive sequential month of growing our regular dividend. Our dividend growth rate now stands annualized at 6.3%. Now, in terms of guidance, the company does not give specific quarterly guidance. However, with the combination of the Sprint Wireline business and the Cogent business, we anticipate a long-term growth rate of approximately between 5% and 7% annually. EBITDA margins for the combined business should expand at an annualized rate of about 100 basis points a year once we have been able to achieve these initial synergies. This does not include the expectation of the $700 million in IP transit revenue from T-Mobile. Our growth is exclusive of that acquired revenue stream. Our revenue and EBITDA guidance are meant to be multi-year goals and are not intended to be specific quarterly or annual goals. Now I'd like to ask Tad to read our safe harbor language provide some further details on our operating performance for the quarters, and then following that, I'll conclude with a few statements, and then we'll open the floor for questions.

Ted? Yep, 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. CoGEN undertakes no obligation to update or revise our forward-looking statements, and if we use non-GAAP financial measures during this call, you will find these reconciled. the corresponding gap measurement, and our earnings releases, which are posted on our website at covenco.com. Like many companies, we continue to be impacted by the COVID-19 pandemic. Our risks related to COVID-19 and other risks are described in more detail in our annual report on our 2022 Form 10-K and in our quarterly reports on Form 10-Q. Comments on revenue. We analyze our revenues based upon network connection type, which is on-net, off-net, and non-core, and we also analyze our revenue based upon customer type. We currently classify our customers into two types, net center customers and corporate customers, and with the Sprint acquisition, we will be adding enterprise customers to our mix. Our corporate customers buy bandwidth from us in large multi-tenant office buildings or in carrier-neutral data centers. These customers are typically professional services firms, financial services firms, and educational institutions located in multi-tenant office buildings or connecting to our network through our carrier-neutral data center footprint. Our net-centric customers buy significant amount of bandwidth from us in carrier-neutral data centers and include streaming companies and content distribution service providers as well as access networks to serve consumer and business customers. Our corporate customer business represented 55.8% of our revenues for the quarter. Our quarterly corporate revenue declined year over year slightly by 0.6% to 85.6 million from the first quarter of last year and decreased sequentially but by only 0.2%. We had 44,570 corporate customer connections on our network at quarter end, which was a sequential decrease of 0.6% and a year-over-year decline of 1.8%. For the quarter, the sequential impact of USF on our revenues was not significant, and year-over-year, the impact was positive at about $0.5 million from the first quarter of last year. Our net-centric business, which represented 44.2% of our revenues for the quarter, had another solid quarter and grew sequentially by 2.7% to $68 million and grew by 7.8% on a year-over-year basis. Volatility and foreign exchange rates primarily impacts our net-centric revenue, and on a constant currency basis, our quarterly net-centric revenue increased year-over-year by 10.2%. We had 52,857 net-centric customer connections on our network at quarter end. That was a sequential increase of 2.3% and a year-over-year increase of 6.8%. Beginning with our next quarterly report, we will begin to report enterprise customer revenue as a new customer type, as I mentioned. Our on-net revenue was 116.1 million for the quarter That was a sequential increase of 1.1% and year-over-year 3.1%. Our on-net customer connections were 83,268 at quarter end, and we serve our on-net customers in 3,190 total on-net multi-tenant office and carrier-neutral data center buildings. We continue to succeed in selling larger 100 gigabit connections and 400 gigabit connections in selected locations. And this has the impact of increasing our on-net ARPU, which again happened this quarter. Our off-net revenue was $37.3 million for the quarter. That was a sequential increase of 1% and a year-over-year increase of 2.5%. Our off-net revenues are impacted by Incorporated. The cost savings we obtained from lower loop local prices into our pricing, and that is the impact of decreasing our off-net ARPU, which again happened this quarter. Our off-net customer connections were 13,785 at quarter end, and we serve these off-net customers in about 8,400 off-net buildings. These off-net buildings are primarily located in North America. Comments on pricing. The average price per megabit for our installed base declined sequentially by 6.7% to 25 cents, and year-over-year by 20.4%, consistent with long-term averages. The average price per megabit of our new customer contract for the quarter was 10 cents. That was a sequential decline of 20.9%, and year-over-year of 41.6%. And this was impacted by entering into some larger customer contracts during the quarter. Selling larger connections and larger contracts results in a change to our connection mix and has the effect of lowering our average price per megabit at a greater rate change than changes in our ARPU. Related to ARPU, our on-net ARPU for the quarter increased and our off-net ARPU continued to decline but at a modest rate. This is from lower pricing. Again, we're obtaining for off-net circuit vendors. We pass that savings on to our off-net customers. Our on-net ARPU, which includes both corporate and net-centric customers, increased sequentially by 0.6% to 467 from 464. Our off-net ARPU, which is predominantly comprised of corporate customers, declined sequentially by 0.5% from $914 to $910 per connection. Churn is very stable. Our sequential quarterly churn rates for both on-net and off-net was around 1%, and that's what they were for the quarter. Both on-net and off-net were 1% for this quarter, and that was the same as 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 services to 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 contracts with us. During the quarter, certain customers took advantage of our volume of contract term discounts and entered into long-term contracts with us. For over 22,380 customer connections, that increased their revenue commitment to Cogent by over $21.9 million. On EBITDA and EBITDA margin, we reconcile our EBITDA to our cash flow from operations and each of our quarterly earnings press releases. Seasonal factors that typically impact our EBITDA and our SG&A expenses 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, year-end bonuses paid to our employees, and the timing and level of order and tax services, and recently Sprint acquisition costs, and also annual benefit plan cost increases. During the quarter, we incurred 400,000 of Sprint acquisition costs, and our EBITDA for the quarter, including these costs, decreased sequentially by 1.1 million and by 1.1 million year over year. Our EBITDA results were impacted by our materially increased sales rep headcount, annual CPI compensation increases, and circuit and power costs related to our international expansion. Our quarterly EBITDA margin, including 400,000 of Sprint acquisition costs decreased sequentially by 110 basis points to 36.5% and year-over-year by 180 basis points. Our revenue earned outside of the United States is reported in US dollars and was approximately 26% of our total quarterly revenues this quarter. About 17% of our revenues this quarter were based in Europe and 9% of our revenues were related to the rest of world operations, which is Canadian, Mexican, Oceanic, South American, and African operations. The average Euro to USD rate so far this quarter is $1.10, and the average Canadian dollar exchange rate is 74 cents. These averages remain at the current level for the remainder of this quarter. we estimate that the FX conversion impact on sequential revenues will be positive at about 0.6 million, and year-over-year would also be positive at about $0.4 million. Customer concentration, our revenue and customer base is not highly concentrated, and our top 25 customers for the quarter were only about 6% of our revenues. Our quarterly CapEx for the quarter was $23.2 million. Supply chain uncertainty in purchases and anticipation of the closing of our Sprint acquisition caused us to shift our typical purchasing schedule for network equipment. These anticipatory investments were designed to ensure that we have satisfactory inventory levels of network equipment to accommodate our growth plans, including new wavelength product offerings as a result of our Sprint wireline acquisition and the interconnection of our two networks together in multiple locations and to meet our customer needs. 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 $320.4 million at quarter end. We have a very diverse set of IRU suppliers, and we have IRU contracts with a total of 319 different dark fiber suppliers. Our quarter-end cash and cash equivalents and restricted cash was $234.4 million. The $50.3 million of restricted cash is tied to the estimated fair value of our interest rate swap agreement. Our total gross debt at par, including finance, lease obligations, was $1.3 billion at quarter end and net debt was $1 billion. Our total gross debt to trailing last 12 months EBITDA as adjusted for Sprint acquisition costs, that ratio was 5.47 at quarter end and our net debt ratio was 4.46. Our consolidated leverage ratio as calculated under our note indentures was 5.42 and our secured leverage ratio was 3.50. Our fixed coverage ratio as calculated under our note indentures was 3.24. We are party to an interest rate swap agreement that modifies our fixed interest rate obligation with our $500 million of 2026 notes to a variable interest rate obligation based on the secured overnight financing rate or SOFR for the remaining term of these notes. We record the estimated fair value of the swap agreement each reporting period and we occur corresponding non-cash gains or losses due to the changes in the value of the swap from changes in market interest rates. At quarter end, the fair value of the swap agreement decreased by $1.8 million from last quarter to a liability of $50.3 million. We are required to maintain a restricted cash balance with the counterparty equal to the estimated liability. Finally, some comments on bad debt and day sales outstanding. Our bad debt expense was 0.8% of our revenues for the quarter. Our day sales outstanding was 22 days, which was the same at year end and is an excellent metric. These metrics may be impacted by our sprint acquisition going forward. And with every quarter, I want to personally thank and recognize our worldwide billing and collections team members for continuing to do a fantastic, amazing job in serving our customers and collecting from them. I will turn the call back over to Dave for some final remarks.