Earnings Call Transcript - CCOI Q2 2024

Operator, Operator

Ladies and gentlemen, good morning and welcome to the Cogent Communications Holdings Second Quarter 2024 Earnings Conference Call. As a reminder, this conference call is being recorded and it will be available for replay on Cogent's website. A transcript of this conference call will be posted on Cogent's website when it becomes available. Cogent's summary of financial and operational results attached to its press release can be downloaded from Cogent's website. I would now like to turn the call over to Mr. Dave Schaeffer, Chairman and Chief Executive Officer of Cogent Communications Holdings.

Dave Schaeffer, CEO

Hey, good morning and thanks everyone for joining today's call. Welcome to our second quarter 2024 earnings conference call. I'm Dave Schaeffer, Cogent'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. The press release includes a number of historical metrics that we present on a consistent basis each quarter. Now for a couple of comments on activity in the quarter. In the quarter, we had two debt transactions. On May 2, we closed the issuance of our inaugural $206 million asset-backed securitization of our IPV4 notes at 7.9%. These notes mature in five years and may be extended for up to a 30-year term. This securitization transaction was the first ever of IPV4 lease revenue. We are the owners of approximately $37.8 million IPV4 addresses. We acquired $27.9 million of these addresses when we purchased PSINet and other acquisitions in the early 2000s. We further enhanced our portfolio when we acquired $9.9 million additional IPV4 addresses in May of 2023 as part of our acquisition of the Sprint Global Markets Group from T-Mobile. On June 11, we closed the issuance of our $300 million 7% unsecured notes. These are mirrored notes. These notes have identical terms to our existing $450 million 2027 notes. We used $114.6 million of the proceeds from this offering to prepay a Dark Fiber IRU finance lease at a 12% discount rate, saving $15.6 million in cash. This IRU Dark Fiber lease had monthly cash payments of $4.2 million a month through 2026, all of which have been eliminated and therefore materially improving our cash flow. Through December of 2026, we are leasing approximately $12.8 million of our IPV4 addresses out for a monthly revenue run rate of $3.6 million per month at the end of the quarter. We securitized $3.1 million of these leases in our IPV4 securitization. $11.1 million of the leased addresses and $1.4 million unleased addresses were part of that securitization transaction. The IPV4 Internet addresses are a finite resource. The market price of these addresses has substantially increased over the past several years. In the quarter, we also purchased some of our stock back. In June of 2024, we took advantage of market volatility. We purchased 153,000 shares of our common stock back for a cost of $8 million at an average price of $51.97. We have $22.4 million remaining in our authorization for share repurchases through December of 2024. Now for a comment on expected cost savings. We are in the process of realizing significant cost savings and synergies through the integration of the Sprint assets with the Cogent network. Based upon differences between monthly cost run rates at closing in May of 2023 and monthly cost run rate in June of 2024, we have realized an annualized savings rate of $135 million. This represents 62% of our targeted cost savings of $220 million over a three-year period. Now for some summary results for the quarter, we had a very good quarter. Our revenue for the quarter was $260.4 million. Foreign exchange had a negative sequential impact of $300,000, and changes in USF tax rates had a sequential negative impact of $1.4 million on our quarterly revenues. Adjusting for these two negative impacts of $1.7 million, our sequential revenue did decline by 1.5% primarily due to the decline in our noncore products and the management out of low-margin off-net services. Our on-net revenues increased sequentially by 1.5% in the quarter to $140.8 million. Revenues under our commercial services agreement with T-Mobile increased sequentially by $2.7 million to $5.9 million in the quarter. Traffic on our network increased sequentially by 1.9%. It was up 17.4% on a year-over-year basis. Our off-net revenues decreased by 5.7% to $111.5 million due to the continued elimination of these low-margin services. Our noncore revenues, which generally carry negative gross margin, declined by $1.4 million to $4.6 million in the quarter. Finally, while we have not completed the reconfiguration of the Sprint network, we have installed some wave services. Wave revenue increased modestly by 9% sequentially quarter-over-quarter to $3.6 million, representing a 128.7% increase on a year-over-year basis. We expect this to materially accelerate starting in early 2025 as we complete the network integration and optimization for wave services by year-end. Our EBITDA as adjusted was $106.2 million, with an EBITDA as adjusted margin of 40.8% for the quarter. In accordance with our IP transit services agreement with T-Mobile, we received three payments in the quarter totaling $66.7 million. This compares to the three payments we received in Q1 of $87.5 million. The payments in this quarter included $229.2 million payments and one $8.3 million payment. An additional 41 payments are expected to be made by T-Mobile, each of $8.3 million per quarter continuing through November of 2027. Our Sprint acquisition costs in the quarter were $12.4 million. Included in this cost, a significant portion was the $8 million in final severance reimbursements paid to former T-Mobile employees, which are fully reimbursable by T-Mobile. We achieved significant cost reductions both in our cost of goods sold and our SG&A (selling, general and administrative expenses) in the quarter. Our SG&A decreased by $5 million or 7.1% from the previous quarter and decreased by $12.5 million or 16.1% from Q2 2023. SG&A as a percentage of our revenue decreased to 25% in the second quarter from 26.3% in the previous quarter. Our cost of goods sold decreased by $12.7 million or 7.8% on a sequential basis from Q1 2024. We finalized the purchase accounting associated with our acquisition of the Sprint Global Markets Group, and in this quarter, we received an additional final gain in our bargain purchase, bringing that total bargain purchase gain to $1.4 billion. Our gross debt to trailing last 12 months EBITDA as adjusted ratio was 4.06 at the end of the quarter, and our net debt ratio reduced in the quarter from 3.17 times EBITDA to 3.14. We ended the quarter with $426.2 million in cash and cash equivalents on our balance sheet. Regarding our sales force, our sales rep productivity was four units in Q1 per rep per month and 3.8 units installed per rep full-time equivalent per month in Q2. In conjunction with the Sprint acquisition, we hired 942 employees. At quarter end, 655 of these employees remained employed with us. Now for a couple of comments on our optical transport and wave services. In connection with the acquisition of the Sprint GMG business, we expanded our product offering to include optical wavelength services and optical transport services over our fiber network. We are selling these wavelength services to existing customers as well as new customers. These customers require dedicated optical transport without the capital and ongoing expense of owning and operating their own infrastructure. As of today, we have connectivity and wavelength capability services in 574 locations. However, our provisioning cycles remain elongated at about 90 days. We intend to substantially reduce that provisioning time as we complete the network optimization programs by year-end. We have sold wavelengths in 156 locations. By year-end 2024, we expect to be able to offer wavelength services in over 800 North American locations with substantially reduced provisioning cycles. We have a significant backlog and funnel of wave opportunities representing over 2,700 unique wavelengths. Our Sprint acquisition materially expanded our data center footprint. To date, we have reconfigured 34 of the Sprint acquired facilities and added these new data centers to the 1,602 carrier neutral and 86 data centers that Cogent operates. The Cogent data centers in operation today have 164 MW of protected power. We are decommissioning some legacy Cogent data centers and lease facilities where they are redundant with these simplified owned facilities that we acquired from Sprint. We are in the process of converting an additional 18 former Sprint facilities into Cogent data centers and will continue to optimize our portfolio. With regard to dividends, our Board of Directors reflected on the strong cash flow generating capabilities and investment opportunities and decided once again to increase our quarterly regular dividends sequentially by $0.01 a share, raising our quarterly dividend from $97.5 per share to $98.5 per share. This represents the 48th consecutive sequential quarter where we have grown our dividend. Our dividend growth rate is now at an annualized rate of 4.2%. Now for long-term expectations. Now that we have combined the Sprint and Cogent networks and operations, we anticipate our long-term annual growth rates to be between 5% and 7%, with EBITDA as adjusted margins expanding by approximately 100 basis points annually. Our revenue and EBITDA guidance are intended to be multiyear targets and are not intended to be used for specific quarterly or annual targets. Our EBITDA as adjusted and leverage ratios are impacted by the $700 million IP transit agreement we entered into with T-Mobile. In accordance with this agreement, beginning in June 2024, we began receiving cash payments of $29.2 million per month for 12 months, and then those payments step down for the next 42 months to $8.3 million a month to continue through November 2027. The reduction in monthly cash payments will impact our EBITDA as adjusted and leverage ratios, which are measured on a trailing 12-month basis.

Thaddeus Weed, CFO

Thank you, Dave, and 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. Please refer to our SEC filings for more information on the factors that could cause actual results to differ.

Anonymous, Analyst

Comments on the corporate business for the quarter. Our corporate business represented 45.9% of our revenues for the quarter and our corporate revenue grew by 7.7% year-over-year but decreased sequentially by 4.3%. The sequential decrease was due to the continued grooming of low margin off-net connections and the elimination of non-core products. We had 48,690 corporate customer connections on our network at the end of the quarter. For the quarter, the sequential impact of negative USF on our revenues was minus $1.4 million. Our net-centric business continues to benefit from continued growth in video traffic, activity related to AI or artificial intelligence, streaming and wavelength sales. Our net-centric business represented 35% of our revenues this quarter and grew by 4% year-over-year and by 4.5% on a constant currency basis, but declined sequentially by 0.9%. We had 61,736 net-centric customer connections on our network at the quarter end. On enterprise, our enterprise business represented 19.1% of our revenues this quarter and was $49.8 million. We had 18,356 enterprise customer connections at the end of the quarter and our enterprise revenue increased by 20.8% year-over-year and increased sequentially by 0.9% on revenue and customer connections by network type and on-net revenue. We serve our on-net customers in our 3,386 total on-net multitenant office and carrier neutral data center buildings. We continue to succeed in selling larger 100 gigabit connections and 400 gigabit connections in carrier-neutral data centers, and we also sell 10 gigabit connections in selected multitenant office buildings. Selling these larger connections has the impact of increasing our on-net ARPU, which occurred again this quarter. Our on-net revenue was $140.8 million for the quarter, a year-over-year increase of 10.3% and a sequential increase of 1.5%. Our on-net customer connections were 87,387 at quarter end. On off-net revenue, our off-net revenue was $111.5 million for the quarter, a year-over-year increase of 9.3% and a sequential decrease of 5.7%. Again, the sequential decline in our off-net revenue was partially impacted by our migration of certain off-net customers to on-net and more importantly, the continued grooming and termination of low-margin off-net customer contracts.

Thaddeus Weed, CFO

Our wavelength revenue was $3.6 million for the quarter. That was a sequential increase of 9% and a year-over-year increase of 128.7%. Our wavelength customer connections were 754 at the end of the quarter, which was an 8.8% sequential increase. Some comments on IPV4, our leasing revenue. Our IPV4 leasing business had an excellent quarter. We were leasing 12.8 million addresses at the end of the quarter, a 4.9% increase in leased addresses from last quarter. Our IPV4 leased revenue increased by 4.4% from last quarter to $10.7 million. Our average revenue per IPV4 address sold for the quarter was $0.51 per address, a significant increase from our base at the beginning of the quarter for all addresses which was approximately $0.30. Lastly, our non-core revenue was $4.6 million for the quarter, which was a sequential decrease of $1.4 million or 23.7% as we're ending these non-core products. Non-core customer connections were 7,883 at quarter end, a sequential decline of 21.5%. Some comments on pricing, ARPU and churn. Our average price per megabit for our installed base decreased sequentially by 5% to $0.25. Our average price per megabit for new customer contracts was $0.12, which actually was an increase of 13.5%. ARPU. Our on-net ARPU increased from the impact of selling larger connections. Our off-net ARPU slightly decreased. Our on-net ARPU increased sequentially by 2.1% from 525 to 536. On a year-over-year basis, there was an increase of 11% from 483 from Q2 of last year. Our off-net ARPU slightly decreased sequentially from 1106 to 1103. Year-over-year, that was a decrease of 14.7% as it was 1294 last year. Our wavelength ARPU increased by 2% to 1,670 this quarter, up from 1,638 last quarter. Our average revenue per IPV4 address sold was $0.51 per address for the quarter, a significant increase from $0.30 from the base at the beginning. On churn, our on-net unit monthly churn rate was stable at 1.4%, the same as last quarter. Our off-net churn rate ticked up slightly to 2.3% this quarter, from 2.1% last quarter. We continue to groom and terminate low-margin off-net contracts. Regarding EBITDA, we reconcile our EBITDA to our cash flow from operations in each of our quarterly press releases. Our EBITDA increased sequentially by $8.7 million and our EBITDA margin increased sequentially by 350 basis points to 10.4%. This is EBITDA classic. EBITDA as adjusted and as adjusted margin and as a reminder, our EBITDA as adjusted is adjusted for Sprint acquisition costs and cash payments received under the $700 million IP Transit Services agreement with T-Mobile. We collected $66.7 million under the IP Transit Services agreement this quarter, which was scheduled to climb from $87.5 million under the same agreement last quarter. Our EBITDA as adjusted was $106.2 million for the quarter, which was a $40.8 million decrease. We incurred $12.4 million of Sprint non-capital acquisition costs this quarter, an increase from $9 million last quarter due largely to the end of the severance payments. Included in Sprint acquisition costs for the quarter were $8 million of reimbursed severance costs, while last quarter included $9 million that had $4.3 million of severance. These severance costs are paid by us but are fully reimbursed by T-Mobile. Under U.S. GAAP, the accounting for these severance costs needs to be retroactively reported as an acquired receivable asset in purchase accounting at closing, which results in an increase to our acquired assets and a corresponding increase to our gain on bargain purchase. Again, the total gain after the one-year window for adjustments was $1.4 billion. When we pay the severance to an employee, we record this transaction as Sprint acquisition costs. When we are reimbursed by T-Mobile, the opening balance sheet receivable from T-Mobile is reduced from the cash payment. This is the final quarter for the severance reimbursement, so this is now behind us. Foreign currency impact. Our revenue earned outside of the United States is reported in U.S. dollars and was approximately 17% of our revenues for the 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. The average euro to USD rate this quarter is $1.09 and the average Canadian dollar rate is $0.73. Should these average rates remain at these current levels, we do not expect a material FX impact both sequentially and on a year-over-year basis. Customer concentration. We believe that our revenue and customer base is not highly concentrated. Our top 25 customers accounted for about 20% of our revenues for the quarter. On capital expenditures, our quarterly capital expenditures were $48.8 million this quarter. We are continuing our network integration of the former Sprint network and legacy Cogent network into one unified network and converting former Sprint switch sites into Cogent data centers. We have accelerated our data center conversion program due to the very high level of demand for our power availability. Our finance lease IRU obligations are for long-term dark fiber leases. Our IRU finance lease obligations were $426.4 million at the end of the quarter, a reduction of $91.1 million from last quarter. The significant decrease from last quarter resulted from the early prepayment at a discount of $114.6 million under the IRU lease, partly offset by replacement IRU route cancellations for new routes of $42.2 million for the quarter. We have a very diverse set of IRU suppliers and contracts with 356 dark fiber suppliers at the end of the quarter. At quarter end, our cash and cash equivalents and restricted cash totaled $426.2 million. Of our total $41.8 million of restricted cash, $35.5 million of that was tied to the swap and $6.3 million, which is new, was tied to the customer payment processing requirements under our IPV4 notes. Debt and debt ratios. Our total gross debt at par, including our finance lease obligations, was $1.9 billion at the end of the quarter, and net debt was $1.5 billion. Our total gross debt to last 12 months EBITDA as adjusted ratio was 4.06 at quarter end, and net was 3.14. Our consolidated leverage revenue ratio, as calculated under our notes, was 4.5, while our secured leverage ratio was 2.49, as calculated under our note indentures. Some further comments on the swap. We are party to an interest rate swap agreement that modifies our fixed interest rate obligation with our $500 million 2026 notes to a variable interest obligation based on SOFR for the remaining term of these 2026 notes. The fair value of our swap agreement decreased by $9.3 million from last quarter and was $35.5 million. Changes in the fair value of the swap agreement are now required to be classified in our public filings with interest expense. As of today, the value of our swap agreement was $30.9 million, which has declined. Lastly, on bad debt and days sales outstanding, our days sales improved from last quarter to 26 days versus 27 in the last quarter. Bad debt expense was $2.9 million and accounted for 1.1% of revenues. That's consistent with our historical performance, and I want to recognize our worldwide billing and collections team members for continuing to do a fantastic job serving our Cogent customers.

Dave Schaeffer, CEO

With that, I will turn the call back over to Dave. I'd like to highlight a few of the strengths of our network, our customer base, and our sales force. In our net-centric business, we continue to see significant traffic growth from our customer base. We are direct beneficiaries of over-the-top video, AI activity, and streaming. At quarter end, we have over 1,602 carrier-neutral data centers connected to our network and 86 Cogent data centers, bringing our total connected data center footprint to 1,688, more than any other carrier globally as measured by third-party independent research. The breadth of our coverage enables our net-centric customers to better optimize their networks and reduce latency. We expect we'll continue to widen this lead in the market and are projected to add over an additional 100 carrier-neutral data centers per year to our network over the next several years. With an extended provisioning cycle, we can sell wavelengths today in 574 locations. We are slow to do that because we are focused on the optimization of our network and, therefore, shortening our provisioning cycles across the entire base. By year-end 2024, we expect to be able to sell wavelength services in over 800 carrier neutrals in North America with very reduced provisioning intervals. At quarter end, we directly connected to 8,135 networks. Twenty-three of these networks are peers, and 1,112 are Cogent transit customers. This makes Cogent the most interconnected network globally. This collection of ISPs, telephone companies, cable companies, and mobile phone operators allows us to reach the vast majority of the world's broadband subscribers and mobile phone users directly. We remain focused on our sales force, productivity, and efficacy and continue to manage our underperforming reps. Our sales force turnover rate was 5.6% per month for the quarter, down from a peak of 8.7% during the height of the pandemic and in line with our average sales force turnover rate historically of 5.6%. At quarter's end, we had 280 salespeople focused exclusively on the net-centric market, 364 sales professionals focused on the corporate market, and 12 sales reps focused on the enterprise space. We remain optimistic about our unique position in serving small and midsized businesses in central business districts. We have 1,864 multitenant office buildings on-net with over 1 billion square feet. We also remain focused on selling to large enterprises and are continuing to grow that business. We are enthusiastic and optimistic about the addition of optical transport services or wavelengths to our product portfolio and the expansion of our data center footprint. We have a significant backlog and funnel of these wave opportunities, over 2,700 discrete wavelengths. While we have accentuated provisioning cycles, we hope that with the network reconfiguration work, we can bring these orders installed in much shorter times by year end. We're diligently working to complete the integration of the Sprint network and the Cogent network and the optimization. We remain optimistic and excited about our ability to create cost savings and generate increasing amounts of cash flow. Based on the differences between monthly cost run rates at May of 2023 and June of 2024, we have already achieved $135 million of these savings or 62% of our targeted $220 million in savings. We purchased $8 million of our common stock at the end of the quarter and still have $22.4 million for additional buybacks if warranted. We look to continue to monetize our IPV4 addresses, dark fiber, and our data center spaces on a wholesale and retail basis and are willing to either sell or enter into long-term leases for many of these facilities over the next several years. We remain in active discussion with multiple counterparties for multiple sites. With that, I'd like to open the floor for questions.

Sebastiano Petti, Analyst

Hi, thank you for taking the question. Dave, just starting with EBITDA Classic, you realized 62% of the targeted cost savings you just touched on, which is likely to provide a tailwind and continue to groom or exit unprofitable contracts. Just help us think about expectations for EBITDA Classic margin expansion. Is that something we can continue to see here off of the 10.4 in the second quarter of 2024? And then separately, you may have heard that a competitor recently announced dark fiber deals totaling $5 billion. In the past, you talked about dark fiber and today as a longer-term opportunity, perhaps after you stand up and scale the waves opportunity. I guess, first, are you surprised by that announcement, and does this in any way change how you're thinking about the speed to market on a dark fiber basis? And how are you positioned to get a piece of that action? Thank you.

Dave Schaeffer, CEO

Sure. Hey, thanks for both questions, Sebastiano. So let me take the EBITDA Classic question first. We had significant improvement sequentially in that due to the reduction in our SG&A as well as cost of goods sold. We understand that the IP transit payments from T-Mobile are continuing to step down. In the quarter, we had effectively a $20 million reduction in those payments, but our EBITDA as adjusted was down only $9 million due to the improvements in the underlying Classic EBITDA rate. We expect that trend to continue. We understand that in the third quarter we will only be receiving three of the $8.3 million payments, so we have effectively another $40 million headwind to EBITDA as adjusted. We will continue to see improvement in EBITDA classic. The underlying costs due to these grooming and costs synergy programs will likely continue at a similar pace to what we observed from Q1 to Q2, and I think you'll see that similar pacing from Q2 to Q3 and Q3 to Q4 continuing on. As we add wavelength revenue, which carries very high contribution margins, we'll see further acceleration in the EBITDA Classic number due to the fact that those wavelength services are virtually all on-net. Now that's probably a decent transition into the second question. We have been very clear about our targeted market for wavelengths and our strategy of being very aggressive in gaining market share. We think we have a number of competitive advantages, whether it be ubiquity, speed of provisioning, or reliability once installed and uniqueness of routes. I actually think what was announced by our competitor was more of a defensive action as a result of our entry into the market. That particular competitor had been very reluctant to sell dark fiber. In fact, on multiple occasions, regretted selling 12,900 miles of dark fiber to Cogent, enabling a competitor. We intend to give that fiber back as we migrate off of that fiber and onto the facilities we acquired from Sprint. We also know that we have excess capacity on our network for dark fiber. Now we will sell dark fiber. I think we do have a significant opportunity. I think our routes are unique, but we have been reluctant to do so until we have done the wave enablement of our network. The competitor I think you mentioned derives a significant portion of its cash flow from wavelengths. They dominate the wavelength market, and I think their change in position and willingness to sell dark fiber was a direct result of the acknowledgment that the market is going to become much more competitive with Cogent's entrance. The final point to that is we have had many of the same customers who have placed wavelength orders with us. We've provisioned some of those orders and actually said no to some orders. Many of the hyperscalers are building proprietary single-tenant data centers where they want wavelength services. We have refused to deploy capital at low-single-digit returns where we would be subject to the monopsony power of that single tenant in that location. So we will not go out and build to a specific sole-tenant facility unless there is sufficient de-risking in the form of upfront payments, higher returns, and also long-term contracts. What was announced the other day by this competitor was an acceptance of terms that we found uneconomic.

Greg Williams, Analyst

Great. Thanks for taking my questions. Dave, I just wanted to talk about Waves. It came in a little light at $3.6 million, but you did say it will ramp up early 2025 and you're going to reach the 800 data centers by year end. But we've only got 156 locations sold that you can sell waves to by the end of June. You've got a long way to go with less than five months to get to 800. So just help us feel comfortable with ramping up to the 800 wave data centers? And part and parcel to that, the backlog that you mentioned of 2,700 circuits, can we apply the ARPU on waves of 1,670 to that 2,700 so we get a dollar amount to that backlog? Is that a fair way to do it? Thanks.

Dave Schaeffer, CEO

So, two very different questions, Greg. First of all, we are wave enabled in 574 data centers. As of today, we have actually sold waves in 156 of those 574. The method that we have to use to provision those wavelengths is very cumbersome, similar to the way our competitors provision a wavelength. The foundational work that we are doing, starting with a clean sheet of paper, allows us to build a network on top of the Sprint physical assets that would allow us to provision a wavelength in two weeks without pre-deploying capital for transponders, which is a very capital efficient way based on the number of wave permutations that are possible. Each time we provision a wave today, we take resources away from the network reconfiguration work. We will take that 574 and be at all 800 by year-end. We literally have 226 to go, and we're confident we will make that goal. Two, we are conducting a number of network modifications internal to the network to allow provisioning of a wave to occur end-to-end with only two field dispatches compared to the industry average of probably six to eight dispatches, which is similar to the way we have to do it today. With that, we should be able to rapidly eat into that backlog, but also hopefully build an even larger backlog as customers see we are able to provision much faster than our competitors. Now to the ARPU question. Wavelength pricing is determined by two characteristics: the speed of the wavelength, which comes in three speeds, 10 gig, 100 gig, and 400 gig. The larger the speed, the more expensive. The second dimension of pricing is the distance traversed. If you noticed, our ARPU ticked up 2% sequentially in the quarter with a modest number of incremental waves. More of the backlog is skewed towards 100 and 400 gig waves than 10 gig. That probably means the ARPU of what's in that backlog is slightly larger than the ARPU of the installed base. A big part of our effort is to ensure that we can support all of these speeds across the footprint. As these higher bandwidth applications continue to need more connectivity, we are seeing a transition away from 10 gig. 100 gig remains dominant, but I think over the next year or two 400 gig will be the dominant wavelength, bringing ARPUs up. Beyond that, there will be a migration path based on the equipment we've installed to support 800 and eventually 1.6 terabyte waves. The systems that we are deploying are flex spectrum, meaning they're no longer adhering to the ITU grid standards, allowing us the flexibility to support these higher throughputs as the equipment vendors make them commercially available. Hopefully that was helpful, Greg.

Walter Piecyk, Analyst

Dave, thanks for that explanation on the fiber deals. Just maybe as a counter thought on this, I mean, they needed money, right? They seem to have a free cash flow burn situation. With your TSA payments coming up, your leverage ratio obviously is going to go up. Recognizing that maybe it's single-digit returns, is there still an opportunity to use some of the Sprint dark fiber to do a similar deal except at lower terms, but basically just use it to cash in some money? I mean, it's basically just a construction type deal, right? My thought, I guess, on that is that over some period of time, dark fiber will get used, you'll get higher returns, but then it's like time value in terms of when that may or may not happen in the future.

Dave Schaeffer, CEO

Yes, so I think two parts to that, Walt. We are absolutely willing and expect to sell dark fiber on the routes that we have, i.e. sell our inventory where the return is infinite because we have a negative cost basis in that fiber. We will do that when we have the resources to allocate to the provision of that fiber. The new construction to single-purpose facilities has to be weighed against other uses of our capital. I can't speak to what my competitors' alternatives are; I can speak to what Cogent has, and we have much better places to go to raise cash. We have over a 100 megawatts and a million square feet of surplus data center space. The current market price for that type of asset is about $1.4 million or about $14 million a megawatt compared to our offering price of $10 million per megawatt. So rather than go out and accept a very low-return construction project, it is better for us to take our resources and capital and sell off some of these data centers that again, we have a negative basis in. As Thad mentioned, we pivoted and did increase our capital spending slightly in the quarter to accelerate the availability of these facilities. Again, to remind everyone, these were not built as data centers; they were built as telephone central offices. Many of them are quite large, but we had to remove telephone equipment and condition those spaces to turn them into marketable data centers, and we're in discussions now with dozens of counterparties for dozens of locations. That is a better way to raise cash. We also have our IPV4 inventory. The competitor that you mentioned actually sold off a large portion of their inventory several years ago to raise cash. We chose not to do so. Prices continue to appreciate. We've demonstrated our ability to raise pricing on leasing and securitize that revenue with a very low cost of capital. The fact that we have $462 million of cash on our balance sheet allows us to continue to grow our dividend. We buy back our stock and we are deploying capital as fast as we can in the network, giving us the flexibility to say no to low single-digit IRRs. My goal is not to borrow money at 7% to get a 3% return.

Walter Piecyk, Analyst

That's fair. So Dave, that's a good segue to my next question. I mean, first on the data centers. Yes, you can sell them, but I think you grew on-net data centers and your pace was typically adding carrier-neutral data centers. I'm talking about I think you typically add 100 a year. You seem well ahead of that pace. Just curious about your thought process there. And then on the IPV4, similar question. The growth in the quarter was a little slower than last quarter in terms of the number of leases. Obviously, you implemented a price increase, but is this the type of pace to expect on those IP leases? And given no sales in the quarter, and you're kind of talking about the lease growth there, are sales still on the table? Can you give us some update on thoughts on whether that may or may not happen given the current market, or do you just rather add the lease revenue sequentially every quarter? Thank you.

Dave Schaeffer, CEO

Yes, let me take those in order, Walt. On the data centers, to be honest, it's a reactive process. We operate in 54 countries around the world, and our goal is to get to every carrier-neutral facility in each country where we are licensed. We measure those based on the size of the facility, the quality of the underlying operator, and our cost-effective ability to get to that center. With the rapid influx of capital into the data center market over the past year and continuing, we are seeing a much larger number of data centers coming online. So, it is likely that for the next year or two, we may do over 100 a year just because there are more being built. Regarding IPV4, we are still considering selling addresses. We evaluate the market conditions. We know that the two largest buyers are currently leasing addresses at a significant premium to our even increased prices. As Thad mentioned, we increased pricing from an average of $0.30 an address per month across the base to $0.51 per address and saw a very modest reduction in unit volume, and I think that's somewhat temporary. We will evaluate our ability to raise the existing base with an average contract length of 1.5 months. We have great flexibility in raising prices for existing customers. This is a very sticky business with an annual churn rate of 0.8% per year. We will look at our ability to lease more addresses at a higher rate and the DCF associated with that versus our cost of capital as well as what we can sell those addresses in the marketplace. We remain open to any of those options to maximize returns to our shareholders.

Walter Piecyk, Analyst

Just a question on the pace.

Dave Schaeffer, CEO

It's with any service you're going to depend on specific demand in the quarter, but it appears that the funnel for IP leasing remains strong. Even with the increase in offering price, we are seeing no real diminution in demand.

Tim Horan, Analyst

Thanks, Dave. Just following up on Walt. Would you raise prices on the legacy base and maybe timing or if so, why not for the IPV4 addresses? And then secondly, it looks like Lumen is talking about a substantially larger market. I think they're referencing $7 billion or so or more for the IP, well, the wavelength market broadly speaking. Do you think the market is that large? And they're also talking about obviously doubling the locations they go to and a much better platform to provision services. Are you worried that maybe they will be a better competitor? Are you seeing them lower prices or improve quality there? Thank you.

Dave Schaeffer, CEO

Yes, let me take the IPV4 one first, Tim. We absolutely intend to raise prices on the installed base. We will be doing that later this quarter for a portion of the base and measuring the impact on churn. We will continue to monitor the market for the sale of addresses, and that is definitely not off the table. The goal is to sell at the highest price possible, and I think there is a likelihood that prices will go up. Our wavelength market consists of both wavelengths and dark fiber, with some fungibility; for many customers, dark fiber makes no sense due to the upfront capital and ongoing operational support expense. For others, it may make sense. The global wavelength market is estimated by third parties at $7 billion. Unfortunately, Lumen is only in North America, meaning they can't participate in the $3.5 billion outside North America. That includes both metro and long haul. We are going to have more locations wave-enabled than anyone else. We'll continue to add them to follow up on Walt's question about data center addition: any data center in North America, including Mexico, Canada, and the U.S., that we add will be made wave-enabled from day one. We welcome competition. In the transit business, where we have become the dominant player globally with 25% of the world's traffic, we competed in a market with 200 players. In fact, the competitor you mentioned was the dominant player that we displaced to be the largest player. I wish I could wake up one day and be a monopolist. I'm not. I welcome the competition; we have to win customers every day on the value we deliver. I am confident that Cogent will provide a better value proposition than any of our competitors. If that means being more aggressive on wave pricing, we are absolutely prepared and expect to be able to do so. We will grow that business and generate that incremental revenue.

Tim Horan, Analyst

I guess, well, they're saying there's a potential like $5 billion locked up, but another $7 billion, so $12 billion total. I guess it's at a high level. Do you think the market maybe is much larger, growing much faster than maybe what you thought a year ago because of AI?

Dave Schaeffer, CEO

I think it is somewhat larger. But a big part of what they're referencing is new construction projects, meaning building fiber to facilities that never had fiber before. How big the recurring revenue opportunity is in those facilities is yet to be determined.

Frank Louthan, Analyst

Great. Thanks, Dave; I have a couple of questions. Do you have spare conduits in the GMG network that you could potentially sell, competing with some of these deals? Looking ahead, once all the buildings are configured and ready for selling waves, what do you anticipate a reasonable quarterly run rate for that business to be once it is fully operational? Thanks.

Dave Schaeffer, CEO

In terms of conduits, we do not have spare conduits. The Sprint network was built with direct buried fiber in armored jackets, typically six feet below grade, versus conduit networks built in plastic along public highway right-of-way, two feet below grade. As a result, we have had 50% fewer splices per mile than those other networks even though the network is a decade older. That gives us better loss and better throughput. We absolutely have fiber to sell, not conduits. The fiber that we have is capable of supporting all of the coherent technology for 100, 400, and even 801.6 terabyte wavelengths when that becomes the de facto standard. In terms of the run rate for our wave growth, we have said that five years from acquisition, by May of 2028, we will generate $500 million in wave revenues. We believe that is absolutely a realistic target out of the $2 billion addressable market that we referenced earlier. Perhaps we undersized that market a bit, but we feel quite confident that we will get there. I think once we have normalized our provisioning and our footprint is complete, that growth rate should be fairly linear.

James Schneider, Analyst

Good morning. Thanks for taking my question. Dave, I wanted to ask you about cost control, delivering very strong cost controls on some of the data center transitions and other things. Maybe could you quantify for us how much more there is to go on this? Any other buckets of cost takeout there may be? But more importantly, with those cost takeouts, is that sufficient to potentially get you to an EBITDA non-classic or with a Sprint payments growth situation in 2025?

Dave Schaeffer, CEO

Hey, Jim, well, first of all, welcome to Cogent. Welcome to coverage with us, and thanks for your question. We absolutely have significantly more cost savings to achieve. We have a combination of non-core services, low-margin revenue services, and then additional G&A savings. We also understand that the T-Mobile payments, which were meant to bridge this period of maximum burn, are stepping down. We will now be at a run rate for the next 41 months at the lower rate of $8.3 million per month. That said, we will be in a position in 2025 when we're on an apples-to-apples basis. We look at quarters where we have three monthly payments of $8.3 million in 2024 versus Q3 in 2025. So, it will be Q3 at the $8.3 million that EBITDA will be growing, and we expect that growth to continue. Yes, EBITDA will step down in the remainder of 2024 due to these lower payments because EBITDA is adjusted now to the earlier question. Our EBITDA classic will continue to improve, but that improvement will not fully offset that step down from $87 million down to $25 million. After we normalize to that rate, we absolutely will be in a positive EBITDA growth number. We've achieved only 62% of the targeted $220 million in savings, and we believe that number will eventually go up. I think there are some additional savings opportunities that we will be able to discuss in the quarters to come.

James Schneider, Analyst

Thanks. And maybe a second question. I know I may be piling on waves and dark fiber, but could you characterize for us your view on how many and which routes that Cogent has are unique relative to your competitors? And say something about whether your competitor has any routes, which you believe are particularly unique. Additionally, how you see the landscape for additional deals that could transpire?

Dave Schaeffer, CEO

Yes, we and our competitors serve all of the key North American markets, roughly 100 cities. I think there are at least three or four dark fiber routes between those cities. Now, 90% of the Sprint routes have no other fiber on them. They were built along these unique railroad rights-of-way. There may be a parallel path along a public highway or a pipeline. Most of our competitors built their fiber differently along public highway right-of-way with lower burial distances and in plastic conduit. The conduit gives flexibility but if you pick two cities, just put two pins in a map, say Phoenix to Cleveland, Cogent would have a unique route, but you could also buy a different route from Zayo or Lumen to connect those two cities. It's likely that the other two are not on a unique right-of-way but all three of us would be able to serve those two city pairs.

Nick Del Deo, Analyst

Hey, good morning guys. Thanks for the questions and appreciate all the detail on this call. I guess first you gave us a little color on some of the revenue and connection declines in your prepared remarks, but I was hoping you could dig a bit into the corporate trends specifically. I'm trying to tease out how much of that was a function of bad Sprint revenue and connections rolling off versus what's happening with better Sprint corporate connections and classic Cogent corporate connections.

Dave Schaeffer, CEO

Yes, thanks for the question, Nick. First of all, our on-net revenues grew sequentially in the quarter, despite our net-centric revenue growth declining slightly. We grew on-net corporate revenues, both traditional Cogent business and Sprint business that we migrated from off-net to on-net. There are three buckets of revenue from Sprint that we found less desirable. We have an easy fix for one of those three: traffic in buildings that were off-net to Sprint, now on-net to Cogent, and we are rapidly migrating those customers as those tail circuit contracts mature. We also have non-core products that we want to terminate quickly. You saw our run rate on those products decline by about $2 million sequentially. We still sit at over $4 million a quarter in that non-core revenue bucket that really needs to go to zero and help improve margins. The final bucket is off-net Sprint acquired circuits that are not profitable due to very low speeds often delivered over suboptimal media like coax twisted pair or fixed wireless. We're migrating those speeds, but some of that revenue will go away while most will transition to fiber. In assessing the corporate decline, it was really bad business that we are managing off intentionally, and the good business is growing, which helped achieve our sequential improvement of over 250 basis points and cost of goods sold from eliminating low-margin off-net business.

Nick Del Deo, Analyst

Okay, that makes sense. One other question on costs and EBITDA. Obviously good progress there. Again, we've talked in the past about there being a fair bit of integration costs, lease exit costs, lease remediation costs, etc., that you're not specifically breaking out of EBITDA that likely suppresses the reported number compared to what the real underlying results are. Could you update us on that and how we should think about that progressing in future quarters?

Dave Schaeffer, CEO

Yes, for the past 15 months since the acquisition, we’ve been spending about $5 million a month on OpEx related to integration projects. We do not break that out separately or add it back to EBITDA due to the complexity of the T-Mobile add-back and not wanting to, I think, overly complicate our accounting. We anticipate that $5 million a month drag on EBITDA to be a drag for around three years. That was our initial estimate to go from negative $190 million of acquired EBITDA to, looking at those customers, about $85 million to $90 million of positive EBITDA. I think we are on track to achieve that, and that drag will continue beyond this year and into next year but should begin to taper off. We are ahead of schedule in terms of cutting costs, which allows us to end some of those extraordinary expenses sooner.

Bora Lee, Analyst

Hi, Dave. Thanks for taking the questions. Once the wave enablement is done and the internal team is freed up to turn its attention to dark fiber, what would it take operationally to get the sales force to start offering dark fiber services? And what's sort of a rough timeline for that process?

Dave Schaeffer, CEO

The sales force already knows that dark fiber is coming. They've had multiple requests from customers for specific routes. We'll show a couple of very modest dark fiber sales in Q3, really to help certain customers in specific situations. Each of these requests is based on the calculus of whether we put the big opportunity to optimize the wave network at risk. By year-end, that optimization project will be complete, and we can then pivot resources to provisioning. Operational complexity for dark fiber is more bespoke compared to a standard product and is route-specific. That means leveraging distance, the uniqueness of the route, and total fiber availability. Not every route is the same. A prime example is our sought-after northern route between Chicago and Seattle, which provides the lowest latency path between the East and West Coast. That’s due to the curvature of the Earth; the distance at higher latitudes is shorter than lower latitudes. We don't have enough market data and haven't sold to fully assess pricing yet. However, next year we're positioned to have the wave business functioning optimally and begin building a funnel of dark fiber requests, assessing the optimal pricing thereafter. We have no intention of building new fiber for returns we view as suboptimal, but we aim to sell out our excess inventory.

Bora Lee, Analyst

The monthly on-net ARPU continues to tick up. In the past, you've mentioned that you're benefiting from a transition to higher-capacity connections. I'm wondering if that’s what's driving the ARPU gains this quarter, and if so, can you update us on the mix and trends you've been seeing there?

Dave Schaeffer, CEO

Yes, that is indeed a key driver. On the corporate side, we continue to see an expansion of 10 gig opportunities and in multitenant office buildings. On the net-centric side, we're seeing an increase in the number of 100 gig and even 400 gig transit ports. All of this is helping to drive higher ARPU on-net. Lastly, in terms of the types of counterparties showing the most interest in the data center assets, there are at least five categories of potential buyers we're talking to. These include Tier 2 data center operators keen on some markets, private equity funds looking for a platform to build off of, international carriers wanting a U.S. data center footprint, hyperscalers eyeing these as edge facilities, and AI compute businesses desiring greater power density. Each type of customer sees a time-to-market advantage with these facilities. Thus, all five are in the mix today for these data centers.

Brandon Nispel, Analyst

Great. Hey Dave, thanks for taking the question. Mostly just a housekeeping question. Could you provide what the churn rate was for net-centric corporate and enterprise? As we look at the reported connection net adds or losses by those segments, could you give us an estimate in terms of how many are coming from non-core, low-margin products or other grooming, to help us understand what the underlying run rate is?

Dave Schaeffer, CEO

Yes, we provide our churn rate between on-net and off-net, which is a good triangulation for the corporate churn rate. It's roughly about 1.2% per month, and net-centric was just a little below that this quarter while enterprise churn was slightly further below that. As you saw, enterprise revenues actually grown sequentially. So, in terms of churn rate, there were no material deviations from historical norms. For your second question, you should assume every non-core churn, both in units and dollars, is intentional. We want that business to go away today if we could, but we have contractual obligations that have to go through the end of 2026. Again, that's part of why we continue getting transit payment subsidies from T-Mobile through November 2027. Secondly, for corporate and enterprise customers, there are enterprise locations in countries where we are not licensed to do business. Sprint had been selling those through an agency program that we concluded did not meet our legal compliance threshold. We are selling the ports and having the customer buy the loop separately, which intentionally lowers ARPU by removing the loop of that off-net enterprise customer in an exotic market from our revenue stream. On the corporate side, it's primarily very low-speed broadband services that we are migrating. If those services happen to be in an on-net building, we are migrating them independent of speed and automatically upgrading as needed. If in a location that's very rural, we're terminating those at a significant scale. An example from this last quarter involved a corporate customer, ERCOT, the energy management system in Texas, with several hundred locations tied to very rural substations delivering only 2 megabit connectivity over copper; none of which was upgradable to fiber. The total picture of that customer relationship simply didn't mean providing SCADA backhaul management for 2 meg copper circuits, as that's simply not profitable. We are terminating most of those, even if they tend to have some remaining contract term, a substantial part of this quarter's churn came from that specific, unprofitable corporate customer which ultimately helped enhance our margin.

Michael Rollins, Analyst

Thanks and good morning.

Dave Schaeffer, CEO

Good morning and thanks for hanging in there, Mike.

Michael Rollins, Analyst

Sure, I appreciate you squeezing me in for a question. Just curious to delve a little bit more into the corporate trends, if you can give us a sense of what's happening on the corporate side with respect to unique customers in the buildings and their spending patterns with you, specifically the core transit services, the VPN, and the types of bandwidth that they're buying? Thanks.

Dave Schaeffer, CEO

Yes, we are seeing modest growth in our corporate on-net business, probably in the order of about 4% year-over-year, still substantially below pre-pandemic levels. We continue winning new incremental customers, albeit there are fewer tenants in the building today than there were pre-pandemic. We are also observing a migration of a subset of customers, not all but a few percent of the base, that want 10 gig connections. We’ve seen a transition from 100 gig to now starting to see some 10 gig interest. I don't think that will become dominant for several years, as most customer premise equipment for corporate customers can’t accommodate those connections, but it's boosting ARPU in our corporate on-net services. For VPNs, we've seen significant grooming coming out of the pandemic as companies pare back on multiple remote offices. That has stabilized, and our VPLS sales to corporate customers are about a quarter of new incremental sales, similar to where it was pre-pandemic. While that’s overshadowed by the VPN sales to legacy Sprint customers over MPLS, we’ve observed sequential growth in our enterprise business, partly driven by those large enterprise networks continuing to expand and increase their port speeds. I would like to thank everyone for your patience on the call, and hopefully, we answered all your questions. I look forward to seeing you soon, and take care all. Bye-bye.

Operator, Operator

Ladies and gentlemen, this concludes today's call, and we thank you for your participation. You may now disconnect.