David Schaeffer - Chairman, Chief Executive Officer Sean Wallace - Chief Financial Officer - : Walter Piecyk - LightShed Tim Horan - Oppenheimer Nick Del Deo - MoffettNathanson James Breen - William Blair Evan Young - KeyBanc Frank Louthan - Raymond James Angela Zhao - Bank of America Bora Lee - RBC Capital Markets

Good morning. And welcome to the Cogent Communications Holdings First Quarter 2021 Earnings Conference Call. As a reminder this conference call in being recorded, and will be available for replay as www.cogentco.com/. A transcript of this 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 Schaeffer, Chairman and Chief Executive Officer of Cogent Communications Holdings.

Thank you and good morning everyone. Welcome to our first quarter 2021 earnings conference call. I’m Dave Schaeffer, Cogent’s Chief Executive Officer. With me on this morning’s call is Sean Wallace, our Chief Financial Officer. Now, for a few comments on our results: As a number of COVID-19 cases in the United States have begun to decline, and businesses have initiated plans to begin the reopening offices. We have begun to see improving business climate for our corporate segment. We have seen declining unit churn in our corporate segment, sequentially for the last five months, and our churn levels for the first quarter were lower than the elevated levels that we saw in 2020. Our NetCentric business continues to benefit from the greater than expected growth in streaming subscriptions and the segment saw its third sequential quarter of accelerated growth. For the first quarter, our traffic was up 8% on a sequential basis and 36% on a year-over-year basis. Despite these improvements, we remain cautious in our outlook about the uncertainty of the current economic environment and the challenges that the pandemic has brought. Our first quarter results show a higher level of growth in revenues as our revenues grew sequentially by 2% to $146.8 million, an increase of 4.2% on a year-over-year basis. On a constant currency basis, we experienced a revenue growth rate sequentially of 1.7%, and year-over-year growth rate of 2.3%. We continue to operate in an extremely efficient network. Our network serves a growing number of markets, including carrier neutral data centers and multi-tenant office buildings in the central business districts of North American cities, and is able to handle the increase in traffic volume at a relatively fixed cost base. We’ve experienced year-over-year and sequential growth in our non-GAAP gross profit, our non-GAAP gross profit margin and substantial year-over-year growth in our EBITDA and EBITDA margin. Our non-GAAP gross profit grew by 2.7% sequentially and grew by 7.6% on a year-over-year basis. Our non-GAAP gross margin percentages for the quarter improved by 40 basis points sequentially to our record high of 62.5%, and grew by 200 basis points on a full year-over-year basis. Our quarterly EBITDA grew by 10.2% on a year-over-year basis. Our quarterly EBITDA margin increased by 200 basis points from the first quarter of 2020 to 37.8%. The performance of our existing customer base continues to be strong despite the impact of COVID-19. Customer churn, day sales outstanding, and maybe most importantly, cash collections all improved in the quarter, as I noted earlier, and our corporate churn rate fell for the second quarter in a row.

Thank you, Dave. 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.

Thanks Sean. Hopefully, you’ve had a chance to review our earnings press release. Our press release includes a number of historical metrics that we report on a consistent basis. Now for a few comments against our results, against long-term multiyear targets that we have been reaffirming. Our targeted long-term EBITDA annual margin expansion guidance is for an approximately 200 basis points per year of margin expansion. Our targeted multiyear constant currency long-term growth rate is approximately 10%. Our revenue and EBITDA guidance targets are intended to be multi-year goals and are not intended to be used as quarterly guidance. Our corporate business represents 62.7% of our revenues. Our corporate business declined year-over-year by 5.1% from the first quarter of 2020 and declined by 1.8% from the fourth quarter of 2020. Our NetCentric business, which represents 37.3% of our revenues, had yet another strong quarter and showed accelerating growth of sequentially growing 9.2% quarter-over-quarter and grew by 24.6% as compared to the first quarter of 2020. Volatility in foreign exchange rates primarily impact our NetCentric business as approximately half of that business is outside of the U.S. On a constant currency basis, our NetCentric business increased by 18.7% from the first quarter of 2020 and by 8.3% on a sequential basis from the fourth quarter of 2020.

Thanks Dave, and again good morning to everyone. Talking about corporate and NetCentric revenue and customer connections: We analyze our revenues based upon network type, that includes on-net, off-net and non-core, and we also analyze our revenues based on customer type. We classify all of our customers into two types, NetCentric 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 services firms, financial services firms and educational institutions located in multi-tenant office buildings or connecting to our network through our CNDC footprint. Our NetCentric customers buy significant amounts of bandwidth from us in carrier-neutral data centers, and includes streaming companies and content distribution service providers as well as access networks who serve the consumers of content. Revenue from our corporate customers for the quarter fell sequentially by 1.8% to $92.0 million and fell year-over-year by 5.1%. An increase in the USF tax rate had a $0.4 million sequential positive impact on our quarterly corporate revenues and had a $0.8 million positive impact year-over-year. The USF tax rate changes quarterly, and we cannot predict the impact of future USF freight changes on our revenues. As we have discussed in previous earnings calls, we believe that the growth of our corporate revenues was directly impacted by reduced building occupancy in central business districts of major cities as a result of the COVID-19 pandemic. We also found that as a result of the work-from-home environment and general challenges from that pandemic that many of our corporate customers delayed decisions about system upgrades and new network investments. The slowdown in sales, combined with normal historical levels of churn, has contributed to a modest reduction in corporate revenues for the past several quarters. On a positive note, we are seeing some signs that indicate corporate buying patterns are beginning to return to a more normal level. Sales of our largest product by revenue and connections, our one gigabit per second direct Internet access product had its third quarter in a row of rising sales. We are also seeing some of our larger corporate clients begin to expand and reconfigure their networks. And in terms of churn in our corporate base, we are encouraged that churn has fallen in each of the last five months, and most of the churn is derived from our older 100 megabits per second VPN and direct Internet access products, and we continue to see very low levels of churn from our one-gigabit connections.

Thanks, Sean. I’d like to highlight a couple of the strengths of our network, our customer base, and our sales force. As I stated earlier, we saw an acceleration in revenue growth in our NetCentric business during the last three quarters and an impressive NetCentric growth rate of 24.6% year-over-year. Streaming subscriptions, primarily in international markets, continued to outpace analysts’ expectations and we are a direct beneficiary of this trend. I want to highlight some of the key statistics that we believe reflects some of the strength in our NetCentric business. At quarter-end, we connected to 1,274 carrier neutral data centers and 54 Cogent data centers. This is more than any other carrier globally, as measured by independent third-party research. The breadth of this coverage allows our NetCentric customers to better optimize their networks and reduce their latency. We expect that will widen our lead in this market as we project to connect to over an additional 100 carrier neutral data centers per year for the next several years based on the planned construction pipeline of these facilities. At quarter-end, we directly connected to 7,470 networks. This represents a 6.1% increase from a year earlier. This collection of ISPs, telephone companies, cable networks, mobile network operators, and other carriers allows us direct access to the majority of the world’s broadband subscribers and mobile phone users. At quarter-end, we had a sales force of 239 professionals solely focused on the NetCentric market. We believe that this group of professionals gives us one of the largest and most sophisticated sales teams in this industry segment. Now for some comments on our corporate business. We are seeing some positive trends in our corporate business, but they have yet to fully materialize in positive revenue growth. As work-from-home environment becomes established as part of…

Your first question is from the line of Colby Synesael with Cowen & Company.

Hey, this is Michael on for Colby. Two questions if I may. Were there any one time items we should be aware of in the quarter, particularly within the NetCentric business? And as part of that, you know how should we think about the sustainability of the momentum and growth that we’re seeing in the NetCentric business currently? And then also I would ask you, the mentioned improvement, you know the sales backdrop, is there any quantification you could give us on what you’re seeing or the improvement you’re seeing in your corporate sales funnel either quarter-over-quarter or year-over-year? That would be good. Thank you.

Yes, sure Michael, thanks for the three questions. So first of all there were no extraordinary items in our NetCentric business. This was actually a very broad number of customers, both content delivery and access networks increasing the utilization of our network. We benefited from the fact that our new sale price actually increased rather than declined. This is a result both of foreign currency translations since nearly half of that business is outside of the U.S., and the continued broadening of our customer base. Almost 69% of our traffic results in a two sided payment, where both the customer sending and the customer receiving are paying Cogent. Only about 31% of our traffic exits or enters our network through one of our settlement free peers and to remind investors, Cogent does not sell peering or purchase peering or transit as a service. To your second part of the NetCentric question, you know we think that this reflects an accelerated shift in viewership throughout the world, moving from linear video to streaming video, improving resolution, improving content, improving choices and subscription models. All of these things first occurred in the U.S. and are now becoming more internationalized. That should bode very well for the NetCentric business, and in particular Cogent should capture a disproportionate share of that, due to the global nature of our network, the carrier neutral footprint that we described and the sheer number of access networks that connect to us versus any other carrier, give us a sustainable advantage. Now, this is a usage based business. It typically generally does not grow as rapidly on a sequential basis of more months as because people spend more time outside and less time consuming video. This year may be a bit different, particularly because some of the lockdowns throughout…

The next question is from the line of Walter Piecyk with LightShed.

Hi, Dave. So let’s just go back to the corporate, obviously it’s been down. Would you explain USF of 2% or more in the last three quarters sequentially? Aside from the long term returning to growth as people come back, how do the trends look for the current June quarter? Can you maintain flat revenue in the June quarter?

So I actually think we will see continued improvement. The rate of decline has troughed as I commented. The churn numbers have sequentially declined now for five consecutive months and preliminary data for this month indicates it will decline even further. In addition to that based on sales activities, we actually believe that the corporate business will improve on a sequential basis in the second quarter. Whether that is enough to return to an aggregate positive number is yet to be seen. But you know in many parts of the country, probably everywhere except Northeast and Toronto, we’re seeing an increase in office re-openings and an immediate need to accommodate this new hybrid work model.

So, it’s improving? So when you say improving your just seeing like some KPIs within the business, but it’s unclear if that can deliver flat revenue sequentially, do I understand that right?

That’s correct. I do now have visibility – I do have visibility to – is the fact that the rate of revenue decline will improve. Will it improve to a zero rate of decline; it’s too early in the quarter to tell.

Walter, I’ll just add into Dave’s insights. I think we looked – if we look at what happened in 2020, what’s interesting is we look at the two products; the GigE product which is 1,000 megabits per second versus 100. Personally all that churn was in our 100 megabit product. We grew every month on our gigabit product and as we’ve discussed earlier, that mix of products between 100 meg to gig, 100 meg was our biggest product indeed in the first quarter of last year. It’s gone from over 50% of that corporate revenue down to a three, so the impact of that decline is going down. And so the impact of older clients who are disconnecting is going down and we mentioned that as we’ve seen churn go down five months in a row. And we also look at growth in our direct Internet access product. January our units declined, but in February and March we saw the first increases in net units since the beginning of last year. So we see a bunch of green shoots all over the place, lower churn; companies beginning to look at how they’re going to operate their business in the new environment; great growth in our 10-gig VPN product, which is a small product, but tripled in sort of units. So we see all sorts of improvements of the churn that we had suffered over 2020 is going down, end corporates are beginning to reconfigure their network and are beginning to make decisions about what they’re going to do, and that typically means they’re going to increase their capacity and we’re the right company to do that.

Got it, thanks Sean. And can I just ask one quick question also on the balance sheet? When you cite your net debt numbers, you exclude the operating lease liabilities, which obviously increased over the course of the year. Can you just refresh our memory in terms of across 22, why that went from – I guess it was $88 million Q1 last year to $109 million this year. And then is there – if that goes up, is there like an offset in terms of expenses that are not booked as expenses and are just depreciated, and if so, does that factor into kind of the debt covenants that you’re citing when you’re talking about this 3.2x debt leverage?

It’s 3.31 is our current net...

Right, when I include operating lease liabilities, could I assume that the EBITDA includes any benefits from that accounting of having operating lease liabilities, then if you include the $200 million of – excuse me, $109 million – actually, $120 million of operating lease and it takes the leverage up to three-eighths. I’m just trying to understand kind of the puts and takes on the operating lease. I knew that was kind of from an accounting change from a year ago or so, but is there a benefit to EBITDA?

So if you remember, last year FASB changed the rules for lease accounting. You used also have to classify your future contingent obligations, but they were not those types of characterizations as an operating lease liability. As a result, we saw some of our expenses reclassified as capital leases, particularly some long-term O&M contracts on fiber IRUs. Secondly, we saw...

Which helps EBITDA, right?

Which does help EBITDA, and that was clearly disclosed last year in the first quarter. And then, also we have seen the operating lease balance now increase because some of those future obligations now need to be classified as operating leases. And Sean, I don’t know if you want to add any more accounting.

I think that was clear. I’m just trying to get you know – I’m just trying to look at the right net debt leverage, whether we include it. Like if you’re using the three-three, I guess we have to put those expenses back in if we’re excluding operating leases. In any event, it’s obviously your leverage is up year-over-year. Do you think this is kind of the max on leverage? If you just like you know – forget about the last four quarters, even the current quarter annualized, do you think we’ve kind of reached the peak in terms of your leverage, however you’re calculating the numerator and denominator?

Yes, so there is no P&L impact of this accounting change. This is purely a balance sheet gross-up. So there is no impact on our ratios.

And we expect over the next couple of quarters, given the growth in cash flow and given a modest reduction in CapEx that our EBITDA levels – debt-to-EBITDA levels are going to come down marginally quarter-on-quarter.

And finally as I’d mentioned earlier in the call, we anticipate with this proposed refinancing and the effective constant level of debt when going back prior to our repurchase of the 116 – $115.9 million of debt, that we will end up saving about $10 million a year in cash interest expense.

Okay. Thanks Dave, thanks Sean.

Thanks.

Your next question is from the line of Tim Horan with Oppenheimer.

Thanks guys. I might have missed it, could you give the corporate customer connection total this quarter and last if you have it?

Yes, let me get you the exact number. It is I think 40 – it must be...

Corporate connections, is that what you’re asking?

Yes.

So we had 46,719 at the end of this quarter, we had 47,175 at the end of last quarter.

So a decrease of 1%?

1%.

Okay, down, got it. But it’s a little weird and that churn – well, I guess that was due to the off-net churn over the last couple of quarters, why it kind of declined.

That is correct. And the decline in smaller connections. So while we can have unit churn, it is actually possible. because of the ARPU uplift from larger connections to actually see the revenue growth improve. We also get the benefit of the mix shift with more connections and bits being on-net than off-net. Off-net are those primarily secondary offices, so we also get that benefit to our cash flow.

Got it. So the corporate ARPU, that would be – it would have been down slightly year-over-year, just so we’re on the same page, right?

That is correct.

I mean, so I guess how is that climbing if the mix is shifting to gigabit from 100 megs? I would expect that number to have increased?

So you have two things going on. On the on-net side you are seeing an increase in ARPU. On the off-net side, it is declining very rapidly.

Because of all our open tops .

Indeed, that’s part of the strategy. Our lower – our ARPU on off-net has declined sort of 8% to 10% per year, much faster than our changes in our on-net connections.

Got it, got it. And that 9% decline per year, I mean you know what, I guess what’s the average like connection price now and will that stabilize at some point, do you think?

To off-net?

Yes.

Off-net is about $1,725 for a one-gigabit connection. And again, that’s declining in high single digits per year as part of the strategy so that we can become more and more competitive.

I mean the $1,700 just seems a little high. I mean the cable guys are out there with gigabit connections. I mean I know it’s not the same quality, but for a couple of hundred dollars. I know you have .

and that’s really the difference. I remember, 100% of our off-net services, just like our on-net services are only delivered over a fiber connection, there is no co-opt. And you know companies can have surged capacity, but when they have work-from-home employees, they quickly realize that a cable one-gigabit product is not what they believe it is, and it does not support that type of VPN connection.

Got it. So I guess the $1,700, who are you competing with and what’s the market price point out there I guess?

So, let’s go back. First of all, most of our off-net business is sold in conjunction with on-net. So we develop the relationship with the on-net connection, which is most likely a one gig connection in the kind of $500 to $700 price range depending on contract term. The customer then says I want a similar service in an off-net location. We look at our database of nearly four million fiber-served buildings from 90 different vendors. We get the very best loop price in an automated tool and then go and double that to get a 50% gross margin product to offer that customer. Our win rates are much lower in off-net. We’re probably competing with inferior products, delivered over TDM or over co-opt, and we are selling an un – just a naked pipe, we’re not selling bundled services. And again, the off-net business is not a dedicated, viable business, but rather it is an adjunct to our on-net relationship, and that’s why many customers buy from us in many locations.

Yes, and it’s just simplicity. So if you’re a company reconfiguring, you got eight locations and, let’s say four are on-net and four are off-net, it’s much more difficult to go to another vendor to buy that. So when you blend all the costs of our on-net circuit versus our off-net circuit, most corporates will prefer to use one vendor, i.e., Cogent versus having to use multiple vendors for different circuits.

Very helpful, thank you. Lastly Dave, I mean do you expect the traffic growth overall to slow? You know I know it’s been kind of relatively stable here the last five months, just the year-over-year comps could get pretty difficult in the second half of this year.

You know it’s a little hard to answer that question because it is usage based. While we are returning to work in the U.S., much of the rest of the world is behind. The U.K., Singapore, Korea, Israel, there are some markets where we’re seeing pretty good re-openings, but there is still a lot of shutdowns and people required to stay in place. So I actually think we’re going to continue to see elevated traffic growth rates for the foreseeable future. And then we also have this long term phenomenon, which is the reduction in linear packages and the adoption of multiple streaming packages, and I think we’re still at the early stages of people figuring out how many concurrent packages they’re going to have. But the broadening of the streaming supply chain actually helps two ways. It helps us in charging more for a streaming that’s going out, and it means the receivers who are also paying us are probably receiving more bits more hours of the day.

Thanks very much.

Hey, thanks.

Your next question is from the line of Nick Del Deo with MoffettNathanson.

First, on the NetCentric front, you know obviously the improvement there has been pretty stunning. The drivers you call out all make sense, but I feel like they’ve been chugging along for a while, so it’s kind of hard to tie to the changes in growth. Like OTT adoption has been growing for some time; you’ve been pushing overseas for some time; the customer base has been broadening out for some time. I think the pace of traffic growth this quarter even ticked down a little bit. Is there anything else that’s different now that’s having such a dramatic impact on the growth and drove such an inflection?

Okay. So first of all, we’ll start by thanking you for participating in Cogent live. I’ve not had a chance to do that and so I want to thank you for that. But you know I think these are really continuations of long term trends. The NetCentric business tends to be a bit lumpy. These trends tend to take several quarters to fully manifest themselves, and you know, you are right that the sequential traffic growth did tick down slightly as it normally would this time of year. But effectively we have been able to get a higher revenue per bit. You see that two ways: One, the average price of new benefits sold actually slightly went up. That’s a reflection of a broader buyer universe. We also were helped by the fact that more of the access network growth is coming outside of the United States where we are stronger. In the U.S., you know the three largest access networks are not Cogent transit customers in the U.S., but are rather peers. Now all of those three companies do buy transit from us in international markets, but that is not true of the converse for some of our European and Asian peers. They buy from us, or our customers, they buy from us globally, they are not peers anywhere. So this internationalization phenomena I think has a long way to go, and it also is back to the question about impacting COVID. It really has been worse in Continental Europe than it has been in most of the U.S. Probably with the exception of the Northeast, most of the U.S. appears to be reopening.

Nick, I would just add, dare I’d say – Dave may disagree with me, but I think there is clearly more growth overseas. You talk about HBO Max, which has had a slow start but is now begin to really pick up steam. They are indicating that they are going from one market to 61 markets, and as Dave mentioned, they are not a customer in the United States, but outside theoretically they would find Cogent a much more – a much better vendor given that we’re in 47 countries. We’re in all these CNDC’s, and as Dave points out, we have all these access networks. So as streaming goes international and as that happened over the last several months, I think we benefited from an outsized portion versus competitors.

Okay, okay. And then you just – you know maybe one last one on the corporate segment. Kind of thinking about the mechanics of how a business goes from a potential tenant in a building to a Cogent customer, you know how should we think about the time it would typically take from when a business starts looking for space and signs a lease and takes the space and moves in and signs up for a DIA. What does that cycle typically look like?

So, for the new tenant, that’s the best news. They have to make a decision, there’s a forcing event. Typically a company will look anywhere from one month if they are moving into a spec suite that’s pre-built out to as much as a year in advance until they intend to take occupancy if there’s an extensive build-out. I think because many of the new leases tend to be for shorter duration and the landlords in order to improve occupancy have been more willing to build spec suites, I think that window from decision to actual move in on average is shortening. I think the much more important trend though, for Cogent is what is impacting the decision cycle of an existing tenant as they think about bringing their employees back to the office and they are not a Cogent customer today. And there I think there are three key factors: One, the belief that some portion of the workforce will continue to work from home. So therefore I need to make sure I’ve got enough bandwidth both in and out of my network. Two, the applications that I’m deploying are more and more going to be off-prem and the data computing and storage will be more and more off-prem. All these drivers have companies reevaluate their Internet access requirement. Layer on top of that the VPN transition. So as we’ve talked about many times, VPN’s have been dominated by MPLS. That degradation was happening long before the pandemic. Actually in a way, the pandemic provided a lifeline to those MPLS providers, because customers were necessarily in kind of a wait and see mode as opposed to making a new network architecture decision. Now that they’re coming back to the office, and this was to the first question that Michael asked, one of the questions is what’s my new office-to-office connectivity going to look like and that is a very strong positive. So while we’ll win new customers coming in, the bigger opportunity for us is those existing customers or existing tenants who are not Cogent customers when returning to the office, needing a new network architecture.

Okay, got it. Thanks Dave, thanks Sean.

Your next question is from the line of James Breen with William Blair.

Thanks for taking the question. Dave, have you guys had any discussions on the landlord side just around as companies start to downsize our real estate footprint? You know as an opportunity here where your average 50 tenants starts to go up as it tends to take in less space, and you’ve talked in the past about the best opportunity for selling when changes happen. Just give your thoughts on that. Thanks.

Yes, so we have reached out to our roughly 350 institutional owners of MTOB. So 1,800 buildings owned by about 350 different organizations from the largest Brookfield to maybe a small single building owner, and what we have heard as our real estate team is engaged with them is three things: One, the increased need for high-quality bandwidth as a tenant amenity to attract people to their space. So we’ve even seen some of our landlords come to us and say, we have another building that may not have met Cogent’s criteria. We’ll actually give you a free license agreement as opposed to the license agreement you pay for to serve that building up. We may even put part of the bill for you to construct into the building. I can think of a handful of buildings in New York right now that are being repositioned, that were doing exactly that a lot. The second thing we’re seeing is landlords increasing the amount of specs, and those are designed for smaller tenants. What every landlord would love to get, you know the big you know Martindale, Hubbell kind of top 10 law firm for a 15 or 20-year lease. Those leases are hard to come by, so markets are moving down, markets to smaller tenants to attract them. The landlords are spending $150 a foot building out spec suites, hoping the tenants come in, and the good news there is they come quickly and having high speed internet access that’s immediately available is very attractive. The third thing that’s happened is there’s actually a decrease in a proportion of the building that has been used for shared amenities. So there was a bit of a war going on by landlords of how fancy of a gym they could put in, how much of a conference center they can put in, how free beer was available in a party room for tenants, and now we’re seeing people go back to a more traditional leasing model where they say, all I care about is my space. I don’t really care about that shared space, and that means there’s more square footage available for rent paying and internet purchasing tenants. So I think all of these things bode well to increase our total addressable market.

Great, thanks.

Okay, thanks Jim.

Your next question is from the line of Brennan Nispel with KeyBanc.

Hey guys, it’s Evan Young on for Brandon. You’re showing a growing trend in international NetCentric demand. Where do you see the kind of the mix between domestic and international revenue settling in the next few years? Does more international demand affect the average price per bit? Thanks.

So there are really two very different trends. The first one is content production tends to be pretty much an American phenomenon. Yes, there’s Bollywood, there are some other markets, but virtually all of the major streaming services are U.S.-based. Now in order to reduce latency, they may purchase both domestically and internationally from us and the revenue will be reflected accordingly, but they are priced on a global purchase agreement. The second thing is for the receiving access network. The adoption of streaming in the less developed world and even in Europe lags behind the U.S., and that is a positive. Eventually as we look at Internet traffic, the U.S. has declined in 20 years from 85% of global internet traffic to 33%. That will eventually decline to somewhere between 4% and 5%, because that’s what percentage of the world’s population we are. That’s a multi decade trend, because teledensity and infrastructure in most of the world lags behind the U.S. I know we get a lot of things for poor infrastructure. Everybody looks at Korea for example, as this model for broadband. For the most part, there is still more ubiquity and higher speed – much higher prices in the U.S. than the rest of the world and we are seeing significant fiber to the prem-builds being promulgated by government incentives such as U.K. Openreach, the Elliot build in France, are two very strong examples of a national getting fiber in every premise. There is a major effort in Germany to overbuild, major effort in the Netherlands. So I think over time international will represent a larger and larger percentage of our NetCentric business. I think it’s impossible to predict the exact mix three or four years out.

Great! Thanks guys.

Hey, thanks.

Your next question is from the line of Frank Louthan with Raymond James.

Great, thanks. Alright Dave, your probably – I can guess your answer to this one, but are you anyway concerned about some of the fixed wireless claims, some of the larger carriers, particularly for the off-net business for backup type services? It seems like where they’re targeting some of that will be more in some suburban-type areas, where maybe some of your off-net business generally lives. Just give us your thoughts on that.

So as we’ve stated many times Frank, anything that brings more traffic to the Internet is ultimately a positive for Cogent. More access technologies, whether they be fiber to the prem or fixed wireless, domestically or internationally, bodes well for our business. Now, our off-net corporate business is an adjunct to our on-net business. There is no fixed wireless service that is on a per-unit basis anywhere nearly as reliable or cost-effective as our on-net services. We fully admit that our off-net services are more expensive and less reliable, even though they’re delivered over fiber from someone else. We have refused to resell fixed wireless access because of the very high cost per bit. There is a segment of the market that will use that product. Now whether or not that’s going to be material to broadband traffic growth, I’m very skeptical just because the cost per bit is so high. Just as you know we’ve had questions around new satellite ventures such as you know Starlink, venture; very ambitious, generate lots of subscribers, but at the end of the day the constraint, it’s a fixed wireless path that is very, very expensive per bit and it will never compete if there is a terrestrial fiber alternative. It will work in those white unserviceable areas that are the white space that fiber cannot be cost-justified in, but what we’re seeing is a concerted effort and the U.S. and governments around the world to realize that finally, the digital divide needs to be closed and fiber is a necessary infrastructure of society.

Right, great. And just quickly, what is your outlook for sales headcount growth for the year? Where do you expect to end up relative to where you did at the beginning of the year? Thanks.

So our stated goal remains to grow the total sales force at 7% to 10% per year, rolling up 1% right now on a year-over-year basis, so we are lagging. Part of that is the challenges in managing a remote sales force in the pandemic and our lag at managing our underperforming laps. I think we have put those systems in place to be able to monitor rep productivity and that’s why our sales force productivity is increasing. We are hoping for a return to our offices, at least in North America and the U.K. by the end of summer and that should allow us to reaccelerate our hiring and get back to a more traditional onboarding and training program that should get us back on track for that 7% to 10% total sales force growth.

Alright, great. Thanks Dave.

Your next question is from the line of Angela Zhao with Bank of America.

Hi! Thank you for taking my question. This is Angela on for Mike Funk at BoA. So earlier in the call you talked about the new sales force being focused on NetCentric margins. Could you expand on that? And could you talk about the overall margin progression for the remainder of 2021? And two if I may, can you talk about the projected growth in enterprise connections going forward from here? Thanks.

Yes, so let me start with margin. When we add $1 of on-net, it carries 100% gross margin contribution and $0.95 of EBITDA. In our Corporate business, roughly 60% of sales are on-net, 40% are off. In NetCentric, it’s over 90% on and only 10% off. So the increase in NetCentric growth bodes well for gross margin expansion and EBITDA margin expansion. We have guided to a 200 basis point per year multiyear expansion and EBITDA margins with roughly half coming from gross margin expansion and half coming from EBITDA. We actually achieved that, but most of the benefit was on the gross margin side and the increased costs of operating in the pandemic offset some of the SG&A improvement. As we return to the office, we think those factors should normalize and we should be able to continue to say about 200 basis points a year until EBITDA margins plateau at around 50% based on the size of our addressable market. Now to the enterprise connection question, we expect to continue to increase the penetration in the on-net buildings that we have. We also expect that we’ll return to an average of 1.5 connections sold per customer, with half of the customers taking a second connection either for backup or for VPN. We also believe that not all of the secondary offices will be shuttered, only those in the same metropolitan market. So as a result, we think our off-net unit volume growth should mirror that of our on-net business, call it kind of a 11%, 12% grower long term, which has been the long-term averages. But as Sean mentioned earlier, the input cost for loops off-net have been coming down. To Tim Horan’s question about our ARPU for those one-gigabit connections, we’ve seen a 9% or 10% annual cost reduction in those loops, and we expect that to continue as cable and Telco continue to overbuild fiber and put pressure on those suburban infrastructure facilities. You know vertical systems now indicates that 64% of all business premises that have 20 or more employees have one or more fiber suppliers to them. This has greatly expanded our off-net addressable market.

Thank you so much.

Okay, thanks.

Your next question is from the line of Bora Lee with RBC Capital Markets.

You touched on aspects of this during the call. I’m just trying to understand the path that the traffic takes perhaps by in the U.S. as a model. Can you talk about the network patterns you saw in the U.S. as it relates to COVID shutdowns and reopening and where Europe is on that curve, and to the extent that there’s any quantification you can provide?

Yes, sure Bora. So a couple of points. First of all, you know 90% of our traffic is from our NetCentric business. On the corporate side, what we saw, I talked about that 10% first. As people work from home, the bandwidth going in and out of a business actually needed to be symmetric as opposed to in a normal time when the employees are sitting in the office, they’re sending a few request bids out and just pulling information in and the connection can be much more asymmetric, more down than up. I think in a hybrid corporate model, which appears to be what is evolving for businesses, that symmetry is going to become increasingly important. Now, to where 90% of the traffic comes from, and that is content going to consumer, residential consumer. That content is distributed in data centers. We have over 1,300 of them which gives us a competitive advantage. That content wants to be closer to the customer to have greater latent – lower latency, but also needs to have high utilization to justify the space and power expense. We then need direct connectivity to as many access networks as possible; we have that. Now in North America, more of our exiting traffic goes to our peers rather than our customers. We do have several very large cable operators as customers; many independent Telco’s; thousands of small regional players, whether they be CLEX, Highlex in very rural areas or rural Telco’s, but as a percentage of the U.S. customer base they are relatively small. If we pivot over to the international market, we have most of the PTTs in the world buying from us, most of the cable operators and most of the competitive carriers. So internationally, we have a much higher percentage of traffic where we’re getting paid on both sides versus the U.S., and this increased internationalization has improved our effective price per megabit.

Great! And in terms of sales reps, as tenure – I think you’ve said in the past is an indicator of how efficient the sales force is. Can you just provide an updated number given all the moving pieces in the headcount?

Yes. Actually our sales force tenure has actually increased slightly throughout the pandemic. We’ve gone from an average rep life of about 28 months to just around 30 months, which is the optimal point where productivity peaks. Most of our sales force turnover occurs in the first six months of the rep’s tenure at Cogent. The first month is for onboarding and training, and then in the next five months they are expected to hit a number of KPIs that may not include significant quota, but do require a large number of customer spoke-2’s and funnel building activity and that’s really where we have seen the greatest struggle in the pandemic environment, to train reps to build adequate funnels. And what then happens is in that first five or six months of being on the phone, if your funnel is inadequate, there’s no way you can succeed and those reps are then managed out of the business.

Okay, so it sounds like you’re well – the sales force is reasonably well positioned to actually take advantage when and if things reopen?

I believe so. I mean we can always do better, and we are looking to grow the sales force to Frank’s question, but we feel we are absolutely in a position to capture market share as people come back to the office.

Okay, great, and just one last question. It looks like you launched your local peer connect service in the third quarter. Can you just provide a little color on the service, what you’re hoping to achieve and customer interest that you’ve seen since the launch?

Sure. So we are a firm believer that transit is the best way for smaller networks to connect to the public internet. However, there is about 10% of the market that had chosen to use single location exchanges such as . They may be replicated in multiple markets. We took advantage of our unique assets and built a global exchange where there is no distant sensitivity, and there is no fixed port commitment. That has been very well received. We have sold 100s of ports to 100s of networks. Now it does require the networks entering the exchange to affirmatively agree to exchange traffic with one another, where when you purchase transit that becomes the obligation of your upstream provider. The vast majority of our traffic still goes through transit. It’s easier to use; it’s cheaper and it provides more scalability. But there is this 10% of the market that wants that direct control feature of an exchange and I think our exchange has been very successful. You know I do think there is a network effect and you know our transit business has a 20 year head start, but we’re very encouraged by the early adoption of the exchange and the hundreds of customers who have chosen to connect to them.

Great. Thanks, Dave.

Okay.

At this time there are no further questions. I will turn the call back over to the host for any closing remarks.

I just like to thank everyone. I know these calls go long. We did really work on trying to shorten our script, but we did have the capital markets activity that we needed to touch on. So again, I want to thank everyone. Please stay in touch and thank you for your support and stay safe and well. Bye-bye.

Ladies and gentlemen, this concludes today’s conference call. Thank you for your participation and have a wonderful day. You may all disconnect.