Good morning, and welcome to the Cogent Communications Holdings First Quarter 2023 Earnings Conference Call [Operator Instructions]. 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 Web site when it becomes available. Cogent's summary of financial and operational results attached to its press release can be downloaded from the Cogent Web site. I would now like to turn the call over to Mr. Dave Schaeffer, Chairman and Chief Executive Officer of Cogent Communications Holdings.

Hey, good morning, and thank you, and welcome to all on our first quarter 2023 earnings conference call. I'm Dave Schaeffer, Cogent's CEO. With me on this morning's call is Thad 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 NetCentric 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 U.S. GAAP basis, our NetCentric 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 NetCentric 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 4 units per month per full-time equivalent sales person. We also increased the number of sales…

Thank you, Dave, and good morning to everyone. This earnings conference call includes forward-looking statements. These forward-looking statements are based upon our current intent, belief and expectations. These forward-looking statements and all other statements that may be made on this call that are not historical facts are subject to a number of risks and uncertainties and actual results may differ materially. Please refer to our SEC filings for more information on the factors that could cause actual results to differ. Cogent undertakes no obligation to update or revise our forward-looking statements. And if we use non-GAAP financial measures during this call, you will find these reconciled to the corresponding GAAP measurement in our earnings releases, which are posted on our website at cogentco.com. 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. Some 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 2 types, NetCenteric 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 on-net -- NetCentric customers buy a significant amount of bandwidth from us in carrier -neutral data centers that includes streaming companies and content distribution service providers as well as access networks who…

Thanks, Thad. I'd like to now highlight some of the strengths of our network, our customer base and our sales force. First, we'll start with NetCentric. We've achieved excellent revenue growth in our NetCentric business. We continue to benefit from the increased transition of video to over-the-top and streaming, particularly in international markets. At quarter's end, we were on-net in 1,490 third-party carrier-neutral data centers and 55 Cogent-owned data centers for a grand total of 1,545 data centers, more than any other carrier is measured by third-party research. The breadth of our coverage enables us to serve our NetCentric customers and allow them to optimize their networks and reduce latency. We expect we'll continue to widen our lead in this market as we project adding an additional 100 carrier-neutrals per year to our network over the next several years. In addition, we are adding 45 acquired Sprint data centers to the Cogent-owned footprint. We significantly expanded our network footprint with both acquired IRUs and owned fiber route miles. At quarter's end, we directly connected to 7,864 networks. Again, this is more than any other carrier in the world. This represents a constellation of ISPs, telephone companies, cable companies, mobile operators and other carriers that allow Cogent direct connectivity to the vast majority of the world's broadband and mobile phone subscribers. At quarter's end, we had a sales force of 222 professionals focused solely on the NetCentric market. This is most likely the largest group of sales professionals focused exclusively on this segment in the industry. This sales force will be predominantly responsible for the sale of our wavelength products that we'll begin offering with the closing of the Sprint transaction. Now for a couple of comments on [Indiscernible]. We are seeing some positive trends in our corporate business as work…

[Operator Instructions] Our first question comes from the line of David Barden from Bank of America.

Congrats on closing the deal on Monday, Dave. I guess if I could ask three questions on the Sprint transaction. First, Dave, thanks for that color around the reporting. I guess just to be more clear, that you're going to be adding a revenue line to the reporting structure and then adding these 2 incremental customer count numbers. Any other disclosures that you plan on sharing on a go-forward basis would be helpful on that basis. The second would be, should we be expecting any kind of CapEx requirements to either integrate or perfect the Sprint asset to accomplish some of what you hope to achieve on both the revenue and the savings targets? And then the last one, if I could, is you have a spectrum of pricing strategies that you've come to market with that have been successful over the years, super aggressive in data centers, moderately aggressive in bandwidth connectivity for buildings. How do you think about approaching these new opportunities in dark fiber wavelengths and lit services from a pricing and profitability strategy standpoint?

Thanks for the three questions, Dave, and I'll try to take these in order. Our goal is to continue to be very transparent and consistent in the way we report revenues. We will have a third class of customers. We historically have sold to SMBs, which we classify as corporate and to service providers, whether they be content or -- content or access, which have been classified as NetCentric. With the acquisition of the Sprint GMG business, we are picking up a significant number of large enterprise customers. I think it will be very helpful for investors to see that customer type called out separately, both by unit number of connections and revenue. We also will be reporting on products as we do today. We report our Internet access revenues, which are about 81% of Cogent's revenues, our VPN services, which are primarily VPLS with a small amount of SD-WAN at about 16% of revenues. And then our colocation revenues as space and power and about 3% of revenues. To those 3 products, we will be adding a fourth product that will be the optical transport networking or wave line services. We intend to report the number of wavelengths in service each quarter, and we intend to report the dollar revenue associated with those wavelengths. I think this will allow investors to track accurately our progress in achieving our revenue objectives. We also anticipate an increase in our noncore reporting line due to the fact that while we are actively trying to end of life, many of these noncore gross margin negative products, the transaction did close sooner than anticipated. We do have more of that revenue than we expected, and we are burning it off. And as we said, we anticipate the revenues to go from a run rate…

Let me go back just to the revenue classification. So when we look at what the face of the income statement is going to look like in the 10-Q for the second quarter, we'll continue to have on-net, off-net and noncore, and that will include the Cogent, I'll call it Cogent Classic operation, and the Sprint acquired business will be included into those categories, along with some existing wave business, which will have a separate line that was acquired from Sprint and then new wave sales. So we'll have on-net, off-net, noncore wave revenue will also because of its materiality, need to separately one line the revenue from the IP transit agreement, the $700 million recognized straight line over the term as a one line. And we'll also disclose the revenue from the commercial arrangement with Sprint that starts at the initial rate that we mentioned in the script. So that's what the face of the income statement will look like. Underneath that, in the metrics, we will disclose the customer categories, which will include enterprise customers, the new classification for this quarter. I hope that helps.

Our next question comes from the line of Walter Piecyk from LightShed Walter.

I'm trying to -- so when you -- on the KPI type stuff, you have like sales force and then full-time equivalent reps. I'm not sure which one is more correlated corporate, but they both seem to be up like 15% over the past 3 quarters. I'm just curious if that should be indicative of maybe returning to growth in corporate in the upcoming quarters? I mean, do you see -- I understand that the productivity initially is low, but as these new people ramp up and your churn is lower, I guess, on employees. Is that going to lead to some growth in corporate in the next couple of quarters? And then I think kind of tied to that because I know that you'd like to give very full answers. In your prepared remarks, you were referencing corporate in terms of like customers adding more capacity for employees outside of the office totally get that. But what about the kind of narrative that you were giving, I don't know, about a year ago of this concept of like if the law firm goes from three floors to one floor, they can lease out two more floors and now we're seeing that corporate vacancies are not, in fact, recovering and no one is taking those two additional floors. So in terms of growth driven by actually signing up new corporate customers? Or are we all just leaning heavily on hoping that everyone is getting fatter and fatter pipes?

So let's start with some clarifications and definitions on the sales force. We disclosed the total number of salespeople. We also disclosed a full-time equivalent, which is someone who's undergone three months of training. For those first three months, they don't have a quota responsibilities. Therefore, they're not [Technical Difficulty] a full-time equivalent, meaning they're carrying a quota. We've also disclosed that average rep productivity typically linearly improves from the end of that FT transition from trainee to full time equivalent to about month 30 where they mature. We also are growing the total sales force, but are still below our pre-pandemic sales headcount numbers. We peaked at slightly over 600. We're at about 560 today. Now we troughed during the pandemic at about 470. The primary reason for that trough was the elevated level of turnover due to the lack of performance. Now we attribute that both to market conditions but also the inability to train reps as effectively and manage them most effectively remotely. So Cogent return to the office and remains a 5-day in the office company. In terms of the split, we actually disclosed the number of reps that focus on NetCentric, the number of reps that focus on corporate. We will also begin to disclose the number of reps that focus exclusively on large enterprise. So we'll have 3 categories, and you could track their growth or decline in each category, each quarter. The productivity metric is one that is spread across all groups. So it's a little, I think, too much data and not really additive to break down productivity by rep type, they're relatively equivalent. And the goal here is to give useful KPIs and not KPIs that obfuscate key trends. Now to your underlying question about corporate growth rates. We did have…

Doesn't it concern you that a lot of these economists are talking about how recession will specifically hit that market, so that if it went from six to 18, maybe down to 17, maybe down to 16, but by the end of the year, it's going to get worse rather than better.

So again, we have been in operation through at least four other recessions, including the Great Recession, which was probably a more profound shock to the system. And our tenant base tends to be more recession-proof because they tend to preselect the most desirable buildings with the highest credit screenings and are generally not the businesses that go out of business in a recession. I do believe that the underlying owners of these real estate assets are in significant trouble. I as a real estate owner, myself, can tell you the pressures are material. Most of the lending, the office market comes from regional banks who are under tremendous pressure. And while rent rolls are down, the banks need liquidity and are basically not willing to refinance assets as they mature. That's what's putting more pressure on the real estate market than necessarily the increase of vacancy rates. And while I do think monetary policy is going to continue to slow the economy and most likely cause a recession. I don't think that's going to materially impact the tenants that we sell to.

And just -- that's a good segue to my final question, which is, can you just remind us on the capital leases, what you're paying, what rate you're paying there? And is there anything in terms of maxing that out? Because obviously, when you're -- if your dividend is consuming more than the free cash flow it's the gross debt increase is showing up in capital leases. Is there a max on that? And is it -- what's the rate you're paying? I mean we had to call with SBA earlier. They had a loan that they're obviously paying down rather than buying stock back. Is that part of the consideration for that part of your debt instrument.

So first of all, in both of our indentures, we have no limitation on our ability to enter into capital leases. In many cases, these leases are prepaid, meaning we pay an upfront fee and don't pay anything else other than a maintenance fee over time. The underlying interest rate that's imputed depends on the rates when the lease was signed. I'll let Tad touch on that.

The average which we disclosed in the 10-Q for all the leases is about 8%. And as Dave...

But Tad -- right, which is not low. And then if you -- if that rises, your capital lease balance rises, like, let's say, went up to $15 million, $20 million. What's the new $15 million coming on at?

No, the lease is recorded when the route is accepted at the rate at that time, and it's not changed. So the rate used for the next month is the new range. And if the rate goes up, the value of the leases will actually come down on new leases.

Understood.

But the existing leases are not floating into…

Yes, but they don't change.

Our next question comes from the line of Nick Del Deo of MoffettNathanson.

Dave, first, I wanted to ask kind of the same question I've asked since you announced the Sprint deal, which is basically, can you update us regarding customer interest and any commercial traction you've had in waves and dark fiber. It seems like it's been pretty positive to date, and it'd be interesting how it's evolved now that the sales team had a few months under their belt to sell waves and whether you've closed any dark fiber deals that you may have been negotiating pre-deal?

So two different answers to two different questions. On waves, which is a product that we've standardized and began selling on a resale agreement with Sprint. We've sold several dozen waves pre-closing and have a backlog of several hundred in the Q that we can now process since they are truly on-net. We no longer have a two step process to get those waves approved. We also looked at albeit a test bed, the Sprint Wave product and are simplifying that product to make selling even easier. We have integrated the ability to sell waves into our CRM system, which allows for instantaneous quoting as opposed to a multi-day process previously at Sprint. And I would say the demand for waves has actually been more robust than we anticipated. Secondly, we've been surprised at the ability to cross-sell, meaning existing customers taking waves, but also we've had customers that were in our prospect funnel NetCentric customers that we haven't sold to that now are interested in buying from us because we can sell them both waves and transit. So we have laid out a target to grow the wavelength business from a run rate and acquisition of about $8 million, and that was purely a test product for T-Mobile to within 7 years, a $500 million revenue run rate for Cogent. We feel quite confident based on the backlog, we're probably going to beat our internal estimates of how quickly we will get there. So we remain really positive on the wavelengths. Dark Fiber is different. It's very route-specific. Some routes are in more demand than others. We quite honestly have a lot of experience as a buyer, not a lot of experience as a seller. And because these are long-term agreements, we're going to enter into them cautiously. We have actually only executed 1 dark fiber agreement that actually we couldn't consummate until the deal closed. So it was a conditional agreement. But we are going to be selective. We have not factored dark fiber into our revenue projections. We view that as additive. And I think we'll be prepared maybe in a few quarters to have enough experience on market demand to really lay out a realistic set of expectations for investors. But today, it's not in our guidance, it's not in kind of our forecast and it will be viewed as an opportunistic sale.

That's all very encouraging, especially in waves. Should we think that ARPU for wave is being a few thousand bucks a month per unit, something in that range?

Yes, I think it will actually be a little bit higher than that, Nick. So today, the market is dominated by 100-gig waves, but there are still some 10-gig waves. The Sprint product divided the country into 3 zones, and it was sold on kind of a zone basis. Are you in Zone 1? Do you go between Zone 1 and 2 or Zone 1, two and three, much like the London subway system. We're actually going to collapse that down to two. We also don't have the same constraints in metro that they had where they typically had to go out and buy a metro link to then complete the wave sale. So I think we'll do -- we'll dippy down to two. I think for 100-gig waves, probably the $2,500 range is the way to think about it. For 10-gig waves, probably $800, $900 is a reasonable price in the market. Again, a little bit of variance, whether it's one or two zones. And then there is a nascent but developing 400-gig wave market that we'll participate in. I think that will become realistic in '24. And I would suspect the percentages of 10-gig waves to continue to decline and eventually the 400s will replace some of the 100s and become its own category. While we have not established pricing for that, and there's not really much of an existing market today, the pattern has been that if you 4x the capacity, you roughly double the price, so call it a $5,000 product. I think it's probably a reasonable way to think of a 400-gig wave, but that's something we won't be selling until sometime in '24.

And maybe Dave, can we just touch on kind of traffic growth and NetCentric growth? I think you said traffic growth was 3% sequentially kind of soft for what's seasonally usually a strong quarter for you. NetCentric growth decelerated quite noticeably Q-over-Q. Anything we should be aware of or concerned about when viewing those trends? And what should we expect out of that business from here kind of near term and long term?

So we grew 3% sequentially, 20% quarter over -- year-over-year. There was some deceleration. It tends to be lumpy around customers just as price per megabit of new sales. Now over the long run tends to kind of even out in the quarter, more of our sales were to very large customers, that kind of reversed the trend of the past year, where it was more smaller customers. The trend is still international growing faster than domestic, and it also is a trend of us gaining market share. I would suspect the NetCentric business that on a revenue basis, constant currency was a 10.2% grower. It's still above long-term trend line. It is slower than the peak of the pandemic, but it does appear the funnel looks pretty good, and we will probably continue to grow above trend line for the next year. That's probably the visibility we have.

Our next question comes from the line of Michael Collins from Citi.

Curious if we could go back to the corporate segment. And just curious if you can unpack a little bit more about the types of demand you're seeing in terms of the connections per customer in the corporate building and then the demand around VPN and off-net. And for the other services beyond the core connection that you offer, do you see that as a tailwind for corporate revenue growth in the future or a possible headwind in some way?

So I think three different questions there and one. So the vacancy rate in the building is materially up. So there are less businesses. Even though the new leases are smaller in response to Walt's question, they're not a material part of the base yet. So the TAM is today smaller than it was pre-pandemic, but it is growing. Second, the average connection size is getting bigger, which is pulling up ARPU. Third, more and more customers, not yet quite a majority but a significant minority are also taking ports in data centers. That's a kind of post-pandemic trend and the realization that they need redundancy for their ad hoc VPN concentration. The fourth point is dedicated VPNs, whether they be VPLS or SD-WAN are less important than they were pre-pandemic. More customers are willing to just use the Internet, but VPN still remain approximately 16% of our total revenues and about 16% of new sales. So we have not seen a significant shift away from encrypted or encapsulated services over the Internet, where the shift is away from VPNs that don't ride the Internet. And while we saw a slowdown in the rate of MPLS conversion during the pandemic, we're starting to see a reacceleration of the transition to either DIA or VPLS or SD-WAN. So I don't think that is a material headwind. The final part of your question results in branch offices. There is a continued grooming of companies removing branch offices, shutting them down, that is a headwind. But that has been actually more than offset by the availability of fiber to more endpoint locations. All of the regional fiber overbuilds, which are predominantly focused right now on residential customers also expand the commercial footprint. And we are now able to buy off-net fiber-based services in over 5 million commercial buildings. That's a 25% increase over the past 18 months. I mean that's a pretty rapid increase and where we can sell off-net. And as a result of that, we can actually now see off-net revenues continuing to grow, even though ARPUs are declining because of competitive pressures between the various off-net providers. And if you look at our numbers, that's really been the case for the past couple of years, and that trend is going to continue. So when we kind of net out both the headwinds and tailwinds, I think that they're kind of neutral. And we're really dependent on corporate customers just making a decision and not procrastinating than necessarily going out of business. It was really the premise of one of the earlier questions.

Do you go back to some of those free promotions you used to get in and show how you work and how the service performs and then get the attacks when they're ready to renew with whatever cycle that they're on? Is that the -- was that a good approach last time that you used it?

It was an excellent approach. We are not doing that at this point in time. But promotions are meant to be temporary. And our expectation is we will have some try and buy promotions later this year.

Our next question comes from the line of Frank Louthan from Raymond James.

Can you give us an idea of some of the main areas where the Sprint unit is seeing the EBITDA pressure? And what are some of the things you can do to get those costs out. I think you said it would take maybe two years to get to breakeven, how quickly can you do that? And then lastly, when can you begin to take down some circuits and move some of that traffic over to GMG to get some better savings?

So we actually started the process of moving circuits pre-closing through a series of agreements with T-Mobile. Our primary area of focus was initially international. And the reason for that is 100% of Sprint's network outside of the U.S. was on leased facilities. Almost all of Cogent's network outside of the U.S. is on IRU fiber. We are continuing that process and anticipate being able to bring all of the international savings out probably in the first year. Domestically, it's more difficult for a couple of reasons. One is a lot more customers. Cogent is approximately 75% on-net. Sprint is approximately 7% on-net. So we are migrating several thousand customers from being off-net to on-net. That process has begun, but just because of the customer count and customers' contractual terms, it's going to take more than a year to complete that exercise. We also will be taking out lease circuits that Sprint had domestically. We will be eliminating some of that Sprint IRU fiber because it's duplicative with what we have. We also will be densifying our off-net footprint and consolidating our contracts. Now because there are existing Sprint take-or-pay contracts that still have term, we -- no matter how fast we move, we can't take all of those costs out in year 1. And that's why we've laid out this waterfall of cost savings. The work has already begun. We got the burn rate at signing down from negative $300 million of EBITDA to negative $190 million or $180 million between USD180 million and USD190 million at closing, and we'll get that down to negative $80 million within a year after closing and get it down to 0, 2 years post closing, which when you layer on the additional transit revenue that we'll be receiving from T-Mobile means that we're cash flow accretive from day 1. We're pretty confident that we're moving as quickly as possible and investors will see the savings.

Our next question comes from the line of Brandon Nispel from KeyBanc Capital Markets.

It's Evan Young on for Brandon. I was just looking to see if you could provide any more color on your OpEx throughout the rest of the year. And if you think that Q1 would be the high watermark for the year?

So Q1 tends to be our highest quarter in terms of extraordinary expenses or audit expenses. We did have some bonuses last quarter in Q4 that were extraordinary to offset CPI increases, so instead of CPI, we granted onetime bonuses. But I think we should continue to see some improvement in SG&A. Part of that, though, will be offset by our anticipated growth in sales force. We also will have a number of onetime expenses on the OpEx side related to perhaps further severance and employees. Many of those costs under our purchase agreement with Sprint or reimbursed by Sprint. I'll let Tad maybe give you any other detail.

The first quarter, Dave mentioned and I think in the prepared remarks, we mentioned, obviously, we have the resetting of payroll taxes and there's also a lot of vacations taken in the fourth quarter, and you're rebuilding the vacation reserves in the first quarter. So those cumulative amounts are a couple of million dollars in the first quarter, plus-plus compared to the fourth quarter. We're also -- we are going to have in the second quarter, we had our annual sales meeting. So that's going to be about $1.5 million in a nonrecurring expense. We had that in April. So net-net, we should see a decline in SG&A from Q1 to Q2, depending upon how many sales reps we've managed to hire by the end of the quarter.

There are no further questions at this time. I turn the call back over to our speakers.

All right. Well, I'd like to thank investors for their time today. I appreciate the interest in Cogent. Hopefully, we've given you some additional granularity and color on our future reporting. We also want to provide this information in a consistent way that will help you model Cogent, hold us accountable for the commitments that we're making and give you the clarity around the key trends in our business. So again, I want to thank everyone for their time. We look forward to seeing you soon at conferences and are most excited about the opportunity to take the Sprint asset, which has been underappreciated and under use and generate meaningful free cash flow quickly. Thank you all very much. Take care. Bye-bye.