Cogent Communications Holdings, Inc.

Good morning and welcome to the Cogent Communications Holdings second 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 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 Cogent Communications Holdings. Please go ahead.

Thank you and good morning to everyone. I'm going to start by apologizing for the possible length of this call. There are a number of new topics that we are going to be chatting about, but we will try to be complete in answering everyone's questions. Welcome to our second quarter 2023 earnings conference call. I'm Dave Schaefer, Cochran's Chief Executive Officer. 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 and our 10Q for the quarter. Our press release includes a number of historical quarterly metrics that we present on a consistent basis every quarter. We've included a number of additional metrics this quarter related to our acquisition of Sprint, and we will continue to provide these metrics each quarter going forward. Our press release metrics now include corporate, net-centric, and enterprise revenue, and customer connections and metrics related to the Sprint network assets. Now for a few summaries around our results. We closed our acquisition of the Sprint wireline business purchased from T-Mobile on May 1st, 2023. This transaction significantly expanded our network, our customer base, our employee talent, and materially increase the scope and scale of our business. We now have an annualized revenue run rate in excess of $1 billion. We acquired a number of large enterprise customers, many Fortune 500 companies. Cogent, the customers are larger than the typical customers and Cogent's corporate customer base. We acquired a significant fiber network of owned assets and owned real estate facilities. We acquired a number of right-of-way agreements and relationships. It would have been virtually impossible to assemble the set of assets on our own. We hired many valuable, experienced employees from the wireline business. The majority of these employees had been with the company for over 22 years. We acquired a network with a current value of over $1 billion for $1. We received a $700 million cash commitment from T-Mobile to help offset the operating losses of the business that we acquired. $350 million of this will be paid in the first year in monthly installments of $29.2 million per month. In months 13 through 42, we will receive monthly payments of $8.3 million per month or approximately another $350 million. We're very optimistic about the cash flow generating capabilities of the combined operation. A recent analysis shows immediate and substantial cost savings will be achieved in multiple areas. Many of these will exceed our initial expectations from the due diligence that we conducted prior to closing. Our legacy cogent business had a very good quarter. Our total Cogent legacy revenues grew by 5.3% sequentially and 9% year over year. Cogent's legacy net centric revenues grew by 11.1% sequentially and 19.3% year over year. Cogent's legacy corporate revenues experienced growth of seven-tenths of a percent sequentially and six-tenths of a percent year over year. Cogent's legacy EBITDA was a record $61.7 million for the quarter and an EBITDA margin of 38.1 percent. This is the first time in Cogent's history that its business has achieved EBITDA in excess of $60 million, a sequential EBITDA margin increase in the legacy business with 160 basis points. Now for a couple of comments around the transaction and the purchase price. Under the purchase agreement, we paid $1 for the wireline business that we acquired. Under the working capital provisions in the agreement, we paid $61.1 million and were provided $47.1 million in acquired cash for a total net payment of $14.4 million. Under the purchase agreement, we also will receive payments from T-Mobile for 50% of the assumed short-term lease liabilities and four equal monthly payments at the end of the IP transit service agreement period, this being months 55 through 58. Currently, those payments are estimated to total $57.1 million. This transaction resulted in a material bargain purchase gain. In connection with the accounting for the acquisition, we recorded a gain on a bargain purchase of $1.2 billion, or approximately $24 per share. Included in the $1.2 billion gain is the discounted present value of the $700 million IP transit services agreement with T-Mobile. We had initially expected to account for the IP Transit Services Agreement on a streamlined basis as revenue over the contract term. However, in consultation with our auditors and with the Securities and Exchange Commission via a pre-clearance process, we concluded in conjunction with the SEC in early August, it was determined we should report these as consideration from T-Mobile related to the acquisition and therefore not as revenue, resulting in the purchase gain. The acquired network, including the real estate assets, fiber routes, right-of-way agreements, and network equipment, was appraised by an independent Big Four accounting firm at a valuation of approximately $1 billion. The total fair value of the net assets acquired was $569 million. So including the net present value paid to us by T-Mobile under the IP services agreement of $596 million, the 569 plus 596 totals approximately a $1.2 billion bargain purchase gain. Now for a couple of comments on our anticipated synergies and cost savings. Over the next three years, we continue to believe that we will achieve annual cost savings in three areas, approximately $180 million annual run rate savings in the optimization of the North American network, a $25 million savings annualized on the Sprint International wireline network, and an additional $15 million in reduced operation and maintenance expenses for the legacy Cogent network. We also anticipate achieving additional SG&A savings and other cost and revenue synergies over the next several years. Our recent progress in achieving these cost savings is very encouraging, and we intend to surpass the targets that we have laid out. Now for a couple of comments on revenue and our new class of customers. Our revenue for the quarter increased by 56.1% to $239.8 million and an increase by 61.5% on a year-over-year basis. Revenue from the Sprint Wireline business was $78 million for the two-month period from May 1st, 2020 until June 30, 2023, the quarter end. All amounts related to the wireline business that we disclose on this call are for a two-month period in the second quarter of 2023. Excluding the $78 million of revenue from the wireline business, our revenues would have increased 5.3% sequentially, and 9% year-over-year. In connection with the Sprint acquisition, we are now reporting revenues for our enterprise customers. We've classified revenues we acquired from the Sprint wireline business as 52% enterprise, 32% corporate, and 16% net centric, using definitions that Cochran has historically used. We define enterprise customers as large corporations, typically Fortune 500 companies, with greater than $5 million in annual revenue, running large wide area networks, which typically encompass from several dozen to several hundred sites. These enterprise customers typically purchase services in multiple locations on a discrete basis. Our Salesforce productivity substantially increased from the 4.0 we reported last quarter, that is installed orders per full-time equivalent, to 9.2 orders per FTE in this quarter. Included in REP productivity for the quarter were 9,000 units and $7.3 million of revenue sold to T-Mobile outside of the IP transit agreement under a traditional commercial services contract. The revenues from these commercial services contracts are in addition to the $700 million IP transit services agreement. Adjusting for these units, our rep productivity would have been approximately four orders installed per rep per month, the same as last quarter. Rep productivity includes enterprise customer sales reps that we acquired and are still being trained on cogent systems and processes. Salesforce size and composition. In connection with the Sprint acquisition, we hired a total of 942 total employees. Inclusive in this are 75 quota-bearing sales reps and a total of 114 people in the sales organization. The wireline business included many talented, experienced, and dedicated employees. This represents a tremendous asset to the combined company going forward. The average tenure of these wireline employees has been over 22 years. During the quarter, we increased the number of our sales reps by 85, a 15% sequential increase in our sales force. We ended the quarter with 647 sales reps, 567 full-time equivalent reps, a 5% sequential increase in our full-time equivalent sales reps. Now for a comment on the sale of new products, our wavelength and optical transport products. In conjunction with the acquisition of the wireline business, we have expanded our offerings to include optical wavelength services and optical transport over our fiber optic network. We are selling these wavelength services to our existing customers, the acquired customers of Sprint, and to new customers. These customers require dedicated, deterministic optical transport connectivity without a capital expense or ongoing operational expenses and owning and operating a network. Our wavelength revenue for the quarter was $1.6 million, and there were 414 discrete wavelengths connected in the quarter at quarter end. We have sold these services in 35 discrete locations with shorter provisioning cycles. We have connectivity to approximately 200 locations that still have longer provisioning cycles. Over a two-year period, we expect to be able to offer wavelengths in over 800 carrier-neutral locations in North America. Now for a comment on our expanded footprint. Our Sprint acquisition materially expanded our network footprint. We have added 18,905 route miles of owned intercity fiber, 1,257 route miles of owned metropolitan fiber. We will reconfigure 44 acquired Sprint facilities and add 44 new data centers to our footprint. We have already reconfigured one of those facilities. Our total carrier neutral footprint is 1,526 facilities and there are 56 cogent data centers in addition to that. We have converted one of the legacy sprint switch sites, and we are in the process of completing those additional conversions. We also added approximately 11,400 route miles of intercity IRU fiber and approximately 4,500 route miles of metropolitan IRU fiber to the cogent network. Some of these are redundant with fiber that we already have and will be eliminated as an area of cost savings. Now for a comment on the transition services agreement. On the closing date, we entered into a transition services agreement with T-Mobile for certain services in order to ensure the orderly transition of the wireline business. These transition services are related to information technology support, back office, finance, real estate, facilities management, vendor and supply chain management, including processing of invoices and paying wireline vendors on our behalf as costs and certain human resources services are consumed. We are providing services under a reverse transition services agreement to T-Mobile that include information technology and network support, finance and back office, and other wireless business support. During the quarter, we recorded $118.8 million due to T-Mobile under the transition services agreement. These are primarily expenses related to the reimbursement of vendor invoices made on T-Mobile's behalf for the benefit of Cogent. We recorded approximately $7 million due from T-Mobile under the reverse transition services agreement. The amounts billed under the TSA and reverse TSA are due in 30 days from receipt of invoice. As of June 30th, 2023, under these agreements, we owe T-Mobile 118.8 million and T-Mobile owed us 7 million. For a comment on our dividend and return of capital program. During a quarter, we returned $44.9 million to our shareholders through our regular quarterly dividend program. Our board of directors, which routinely reflects on our business and recognize the strong cash flow generating capabilities and investment opportunities inclusive of the Sprint acquisition program, decided to increase our dividend by another one cent per share this quarter, sequentially raising our quarterly dividend from 93.5 cents per share to 94.5 cents per share. This increase represents the 44th consecutive sequential increase in our regular quarterly dividend which is now growing at an annualized rate of 4.4%. A comment against expectations. Now that we are a combined company with the Sprint Wireline business, we anticipate long-term annual revenue growth rates of 5% to 7% for the combined business, and we expect EBITDA margin expansion to be approximately 100 basis points annually. Our revenue and EBITDA guidance targets are intended to be multi-year and should not be used as specific quarterly or annual guidance. Now I'd like to turn the call over to Tad Weed, our CFO, to read the Safe Harbor language and provide some additional operating and specific metrics to our performance in the quarter. Following our remarks, we will open the floor for questions. Ted?

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 can cause actual results to differ. Cogent undertakes no obligation to update or revise our forward-looking statements. We use non-GAAP financial measures during this call. You will find these reconciled to the corresponding GAAP measurement in our earnings releases that are posted on our website at cogentco.com. some comments on revenue by corporate, net-centric, and now wavelength and non-core. We analyze our revenues based upon network connection type, which is on-net, off-net, wavelength services, and non-core services. We also analyze our revenues based upon customer type, and as Dave mentioned, we now classify all of our customers into three types, net-centric, corporate, and enterprise customers. Our corporate customers buy bandwidth from us in large multi-tenant office buildings or in carrier-neutral data centers. And 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 data center footprint. Our net center customers buy significant amounts of bandwidth from us and carrier-neutral data centers and include streaming companies, content distribution service providers, as well as access networks who serve consumer and business customers. Our enterprise customers generally purchase our services on a price per location basis. and are typically larger than our legacy cogent customer base. On revenue classifications, reclassifications. In connection with the Sprint acquisition, we reclassified a small portion of legacy cogent revenue to enterprise revenue and enterprise customer connections. We classified 300,000 of legacy monthly recurring revenue to enterprise revenue and 387 legacy cogent customer connections to enterprise customer connections. Corporate business. Our corporate business continues to be influenced by real estate activity in central business districts. Two key statistics, including the level of card swipes in buildings and leasing activity, indicate that year-to-date, the real estate market and leasing activity in central business districts where we operate have seen some improvement but has not returned to pre-pandemic levels in most geographic regions. We continue to remain cautious in our outlook for our corporate revenues given the uncertain economic environment and other challenges from the pandemic. Our corporate business represented 46.3% of our revenues this quarter, and our quarterly corporate revenue increased year over year by 30.2% to $111 million from the second quarter of last year and was a sequential increase of almost 30%. We had 61,284 corporate customer connections on our network at quarter end, and that was a sequential increase of 37.5% and a year-over-year increase of 35.9%. Corporate customer connections from the wireline business were 17,571 at quarter end. Corporate revenue from the wireline business was $25.2 million. Legacy corporate customer connections decreased by 1.1% sequentially and by 2% year-over-year. Legacy corporate revenue increased modestly by 0.1% sequentially and by 0.6% year-over-year. For the quarter, the sequential impact of USF on our revenues, which some is included in the wireline business, was a positive $6.8 million and a positive year-over-year impact of $7.6 million. The USF taxes related to the wireline business was $7 million for the two-month period in this quarter. On net-centric, our net-centric business continues to benefit from continued growth in video traffic and streaming, For the quarter, our network traffic growth accelerated and was up 4% sequentially and up 21% year-over-year. Our net-centric business represented 36.5% of our revenues this quarter and grew sequentially by 28.9% to 87.6 million. That was a 38.4% year-over-year growth. We had 66,711 net-centric customer connections on our network at the end of the quarter, an increase of 26.2% year-over-year, sequentially, and year-over-year, 31.6%. Net-centric customer connections from the wireline business were 5,607 at quarter end, and the related revenue was $12.1 million. Legacy cogent net centric connections increased by 15.6% sequentially and by 20.6% year over year. Our legacy cogent net centric revenue increased sequentially by 11.1% and by 19.3% year over year. Our enterprise business was 17.2% of our revenues this quarter. end. Enterprise revenue from the wireline business was $40.7 million and enterprise customer connections were $23,034. On revenue and connections by network type, our on-net revenue was $127.7 million for the quarter, which was a 9.9% sequential increase and 14% year-over-year. On-net customer connections were $92,846 at quarter end. On-net revenue from the wireline business included $2,546 on-net customer connections and $4.1 million. Our legacy cogent on-net revenue increased sequentially by 6.4% and by 10.3% year over year. We serve our on-net customers in 3,227 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, which has the impact of increasing our on-net ARPU, which again occurred this quarter. Our off-net revenue was at 102 million for the quarter. That was a sequential increase. and a year-over-year increase of 181.1%. Off-net customer connections were $38,762 at quarter end. Off-net revenue from the wireline business included $24,243 off-net customer connections at quarter end and was $63.9 million. Our legacy cogent off-net revenue increased sequentially by 2.1% and by 4.9% year over year. Including the new off-net locations from the wireline business, we now serve off-net customers in over 28,000 off-net buildings. And these off-net buildings are primarily located in North America. Wavelength revenue was $1.6 million for the quarter and 414 customer connections. Wavelength revenue from the wireline business was 404 customer connections and 1.6 million. Lastly, non-core revenue. Our non-core revenue was 8.6 million for the quarter and 19,408 customer connections. Non-core revenue from the wireline business totaled 19,021 customer connections and was 8.4 million. Comments on pricing. The average price per megabit for our installed base increased sequentially by 12.3% to $0.28 and declined year over year, but by only 4.6%. The average price per megabit for our new customer contracts for the quarter was $0.10, which was the same price per megabit for new customer contracts as last quarter, and our year over year price declined 31%. Selling larger connections results in a change in our connection mix and can have the effect of lowering our average price per megabit at a greater rate than changes in our ARPU. With respect to ARPU, our on-net and off-net ARPUs for the quarter both increased. Our on-net ARPU increased sequentially by 3.5% from 467 to 483. and our off-net ARPU increased sequentially by 42.2% from 910 to 1,294, primarily from the pricing impact of these off-net customers we acquired in the wireline business. Churn, our substantial churn rates for our on-net and off-net customer connections. For the combined business increase from the impact of the wireline business, our legacy cogent churn rates were relatively stable. Our on-net unit churn rate was 1.4% for the quarter compared to 1% last quarter, and off-net was 1.6%, also 1% last quarter. On EBITDA and EBITDA margin, we reconcile our EBITDA to our cash flow from operations in each of our quarterly earnings press releases and now incorporate a component from our cash flow statement. We incurred 0.7 million of Sprint acquisition costs during the quarter. Our EBITDA for the quarter, including Sprint acquisition costs and not including any payments from the IP Transit Services Agreement, decreased sequentially by 31.9 million and by 34.3 million year-over-year. Our EBITDA margin decreased to 10.1%. Our EBITDA for the wireline business by itself for the two months was negative $37.6 million. Excluding the negative impact of the wireline business, our EBITDA would have been $61.7 million for the quarter, so the cogent legacy business EBITDA, which was a 10% sequential increase and a 6% year-over-year increase. and that margin would have been 38.1%. EBITDA as adjusted, our EBITDA as adjusted as the past few quarters includes an add-back for Sprint acquisition costs and now includes cash payments received under the 700 million IP transit services agreement we have with T-Mobile. We billed for two months during the quarter, so 58.3 million, under the ip transit services agreement during the quarter and only one cash payment was due so we collected cash of 29.2 million during the quarter our ebitda as adjusted for the sprint cost and the ip transit services agreement adding that was 54.1 million for the quarter which was a 22 and a half percent ebitda as adjusted margins In subsequent quarters, three monthly payments under the IP Transit Services Agreement will be included in our EBITDA as adjusted, and that will be a total of $87.6 million for the three payments. We had both of the payments, $29.2 million payments, included in the EBITDA as adjusted for the quarter. Our margin would have been about 35%. All amounts billed under the IP Transit Services Agreement have been paid on time. Some comments on foreign currency. Our revenue earned outside of the United States is reported in U.S. dollars and was about 18% of our revenues this quarter. About 11% of our revenues were based in Europe and 6% of our revenues were related to our Canadian, Mexican, Oceanic, South American, and African operations. Sprint's, the wireline business, international revenue was only about 3% of total wireline revenues. The average Euro to US dollar rate, the average for this quarter so far is $1.11, and the average Canadian dollar exchange rate is about 76 cents. If these averages continue for the remainder of the third quarter, we estimate that our positive FX impact Consequential revenues will be about a half million, and year over year, a positive 2.3 million. Customer connections. We believe that our revenue and customer base, or concentration rather, we believe that our revenue and customer base is not very highly concentrated, but it is more concentrated after the wireline business acquisition. Including that impact, our top 25 customers represented approximately 18 of our revenues this quarter we acquired a number of larger enterprise customers with the wireline business on capex our quarterly capex was 37.4 million supply chain uncertainty 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, including the conversion of data centers to Cogent data centers and including new wavelength product offerings from the Sprint acquisition and the interconnection of our two networks together in multiple locations and to meet customer needs. Finance leases and lease payments. Our finance lease IRU obligations are for long-term dark fiber leases. and typically have terms of 15 to 20 years or longer on initial term and often include multiple renewal options after the initial term. Our IRU finance lease obligations totaled $331.5 million at quarter end. There were no finance lease obligations acquired in the wireline business. We have a very diverse set of IRU suppliers and have IRU contracts with over 320 suppliers. different dark fiber suppliers we acquired relationships with several new suppliers of dark fiber with the wireline business and all of those IRU leases were treated as operating leases fiber and network in connection with our sprint acquisition we acquired numerous right-of-way agreements across the United States these right-of-way agreements represent a significant acquired asset and would be extremely difficult to obtain on their own. We also acquired 482 technical buildings. One of those technical buildings has been converted to a cogent data center and we will convert another 44 buildings to cogent data centers. We acquired a significant amount of owned dark fiber and significantly expanded our network. we acquired 19,135 intercity route miles of owned dark fiber, 1,259 metro route miles of owned dark fiber. So our network now consists of following with respect to fiber, 72,694 leased intercity route miles of dark fiber, And that's 11,376 from Sprint and 61,318 Legacy Cogent intercity route miles. 22,556 leased metro route miles of Dark Fiber. That's 4,527 Sprint metro route miles and 18,029 Legacy Cogent metro route miles. 240,430 leased intercity fiber miles of dark fiber. This includes 122,648 sprint intercity fiber miles and 117,782 legacy cogen intercity fiber miles. Lastly, 74,577 Leased metro fiber miles, dark fiber, and that's $32,346 from Sprint and $42,231 legacy cogent metro fiber miles.