Earnings Call Transcript - CCOI Q1 2024

Operator, Operator

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

David Schaeffer, CEO

Thank you, and good morning to everyone. Welcome to our first quarter 2024 earnings conference call. I'm Dave Schaeffer, Cogent's Chief Executive Officer, and with me on this morning's call is Tad Weed, our Chief Financial Officer. Hopefully, you've had a chance to review our earnings press release. Our press release includes a number of historical metrics we present in a consistent manner each and every quarter. On May 2nd of this year, we closed the issuance of our $206 million IPV4 securitization notes at 7.9%. These notes mature in 5 years, but may be extended for up to a 30-year term. This securitization was the first ever of the securitization of IPV4 lease revenue. Cogent is the owner of approximately 38.8 million IPV4 addresses. We acquired 28.8 million of these addresses when we purchased PSINet and various other acquisitions early in our history. We acquired an additional 9.9 million IPV4 addresses in May of 2023 with the acquisition of the Sprint network assets from T-Mobile. We are leasing approximately 12.2 million of these IPV4 addresses out for a monthly revenue run rate of approximately $3.4 million a month. We have securitized $3.1 million of that monthly leased revenue, and this represents revenue from 11.1 million lease addresses. We also included 1.4 million unleased addresses in the pool of the securitization. The IPV4 Internet addresses are a finite resource. The price of these addresses has substantially increased over the past several years. Now for an overview of our results. Our combined Cogent business had a very good quarter. Our total revenues were $266.2 million in the quarter. This did represent a $5.9 million sequential decline. Our on-net revenues increased by 0.4% to 138.6 million. Our revenue under the commercial services agreement with T-Mobile declined sequentially by $5.8 million. Our non-core revenues declined by $1.2 million. Our wavelength service revenues increased sequentially by 7% to $3.3 million. All of the decline in our revenues was attributable to the decline in commercial services agreements and non-core services, as was expected. Our EBITDA as adjusted for the quarter was $115 million, an increase of $4.5 million sequentially or approximately 4.1%. Our EBITDA as adjusted margin for the quarter was 43.2%. This is up 260 basis points from the 40.6% we reported last quarter. We received 3 payments from T-Mobile for a total of $87.5 million in the quarter. Our Sprint costs are reported separately and were $9 million in the quarter compared to $17 million last quarter. These costs include approximately $4.3 million of severance reimbursement in the quarter as compared to $16.2 million in severance reimbursements in the previous quarter. Despite the seasonally increased costs associated with SG&A in our first quarter, our SG&A did decrease by 6.4% from $74.9 million last quarter to $70.1 million this quarter. These SG&A numbers are net of that severance reimbursement that I mentioned earlier. Our SG&A as a percentage of revenues decreased to 26.3% for the quarter, down from 27.5% last quarter. Our cost of goods sold decreased by 3.2% from the previous quarter. Traffic on our network increased by 1% sequentially and was up 20% year-over-year. Our gross debt to trailing 12-month EBITDA as adjusted and our net debt ratios both significantly improved in the quarter. Our gross debt to trailing last 12 months EBITDA as adjusted was 3.57 in the quarter, and our net debt ratio was 3.17, substantially below the range we have set historically as a target. We are in the process of realizing cost savings and synergies over the next 3 years. We will continue to receive the impact of these savings and achieve an aggregate of $220 million in savings. We anticipate additional SG&A and other cost savings and revenue synergies as well over the next several years. Our recent progress in achieving these cost savings is very encouraging, and we intend to surpass our initial targeted savings goals. Our sales force performed well in the quarter. Our rep productivity in Q4 of 2023 was 3.3 installed orders per rep per month. This improved sequentially to 4 units installed per rep per month in the first quarter of 2024. Our sales rep productivity results do also include the impact of enterprise sales reps that joined us from the acquired Sprint business. These new enterprise sales reps are continuing to receive training in Cogent sales processes and methods and have not yet fully reached their maximum level of productivity. Now for our total headcount. In connection with the Sprint acquisition, we hired 942 total employees. At quarter end, 718 of these employees remained with Cogent. During the quarter, our total sales rep count increased by 20 or a 3% net sequential increase in our sales force. Now for our new wavelength and optical transport service business. In connection with the acquisition of Sprint, we have expanded our offerings to utilize the Sprint network to sell wavelength services or optical transport services across that network. We are selling these services to existing customers to acquired customers and to new customers. These customers require dedicated optical connectivity without the capital cost and ongoing expenses associated with owning and operating their own transport network. We have connectivity and wavelength sales capabilities today in 419 locations. However, these locations do require longer than acceptable sales provisioning cycles. We have sold wavelengths to date in a total of 104 locations. By the end of this year, we will be able to offer wavelength services in over 800 locations across North America with much more rapid provisioning cycles. Our wavelength revenue in the quarter increased sequentially by 7% to $3.3 million for the quarter. Our Sprint acquisition materially expanded our network footprint. To date, we have reconfigured 25 of the acquired Sprint facilities into Cogent data centers and added these data centers to our inventory of 1,586 third-party carrier-neutral data centers and 78 Cogent data centers, which today contain an operational 159 megawatts of power. We are in the process of converting an additional 23 of these facilities to Cogent data centers and optimizing our data center portfolio footprint. In a market where we have a former Sprint data facility that we converted to a data center and a legacy leased Cogent data center, we decommissioned one leased data center in the quarter. Now for a comment on our dividend and buyback strategy. Our first quarter dividend was $45.8 million and was accrued at quarter end and paid on April 9th, due to our expanding the period for our sales call. Our Board of Directors, which reflected on the strong cash flow generating capability and investment opportunities, including the additional opportunities afforded us by the integration of the Sprint assets, decided to increase our quarterly dividend by yet another $0.01 a share, raising our quarterly dividend from $0.965 a share to $0.975 per share per quarter. This increase represents the 47th consecutive sequential increase in our regular quarterly dividend and a 4.3% annual growth rate in dividends. Now for a couple of comments on our long-term goals. Now that Cogent is fully integrated and combined with the former Sprint network, we are anticipating a long-term average revenue growth rate of between 5% and 7% and EBITDA as adjusted margin expansion of approximately 100 basis points annually. Our revenue and EBITDA as adjusted guidance targets are intended to be multiyear targets and are not intended to be used as quarterly or specific annual guidance. Our EBITDA as adjusted and leverage ratios are impacted by the $700 million IP Transit subsidy agreement that we received with T-Mobile in conjunction with the acquisition. Beginning in June of 2024, these payments monthly will be reduced from $29.2 million a month to $8.3 million a month and then will continue for an additional 42 months. This reduction will impact our future EBITDA as adjusted or leverage ratios beginning in the second quarter of 2024, which are always measured on a trailing 12-month basis. We will also be looking to monetize other assets that were acquired in the acquisition. This will include excess data center space and power, additional monetization of our IPV4 address unleased inventory and dark fiber over the next several years. Now I'd like to turn the call over to Tad to read safe harbor language and give some additional operational performance metrics for the quarter. Following these remarks, we will open the floor for questions and answers.

Thaddeus Weed, CFO

Thank you, Dave, and good morning to everyone. This earnings conference call includes forward-looking statements, which reflect our current intent, beliefs, and expectations. These statements, along with any other remarks not related to historical facts, are subject to risks and uncertainties that could lead to different actual results. For further information on these risks, please refer to our SEC filings. Cogent does not commit to updating or revising any forward-looking statements. If we mention non-GAAP financial measures, these will be reconciled with the corresponding GAAP measure in our earnings releases available on our website. We analyze our revenues by network connection type—on-net, off-net, wavelength, and non-core—and by customer type, categorizing our customers as net-centric, corporate, or enterprise. Our Corporate segment is still affected by real estate activity in central business districts, leading us to be cautious in our outlook for corporate revenues amid an uncertain economic environment and ongoing pandemic challenges. Corporate business accounted for 46.9% of our revenues this quarter, decreasing by 1.4% sequentially to $124.9 million, primarily due to the pruning of low-margin off-net connections and discontinuing non-core products. We had 51,821 corporate customer connections on our network at the end of the quarter. The impact of USF on corporate revenues for the quarter was nominal. Our Net-Centric business continues to benefit from increased video traffic, streaming, and wavelength sales. It made up 34.6% of our revenues this quarter and fell by 1.3% sequentially to $92 million, primarily due to a $5.4 million decrease in the commercial services agreement with T-Mobile mentioned earlier. We had 61,599 net-centric customer connections at quarter end. Our Enterprise business represented 18.5% of our revenues this quarter, totaling $49.3 million, and saw a sequential decline of 5.7%, chiefly because of the cessation of non-core products and the pruning of low-margin off-net services. Analyzing revenue by connection type, on-net revenue reached $138.6 million for the quarter, reflecting a sequential increase of 0.4%, with on-net customer connections totaling 87,574. We serve our on-net clients through 3,321 total on-net multi-tenant office and carrier-neutral data center buildings. We continue to successfully sell larger connections such as 100-gigabit and 400-gigabit connections in carrier-neutral data centers and 10-gigabit connections in selected multi-tenant office buildings, positively impacting our year-over-year on-net ARPU. Our off-net revenue for the quarter was $118.2 million, down sequentially by 4.4%, influenced by migrating certain off-net clients to on-net and pruning low-margin off-net contracts. Our off-net customer connections stood at 34,579 at the quarter's end. Wavelength revenue was $3.3 million for the quarter, a sequential increase of 7%, with 693 wavelength customer connections. Non-core revenue reached $6 million, showing a sequential increase of $1.2 million or 16.8%, from our decision to phase out these products. At quarter end, non-core customer connections were 10,037, marking a decline of 16.2%. Regarding pricing, our average price per megabit for our installed base dropped sequentially by 5.8% to $0.26 but rose year-over-year by 5.9%. The average price per megabit for new customer contracts this quarter was $0.11, a sequential increase of 5.1%. Our on-net ARPU rose sequentially by 0.8% from 521 to 525, while year-over-year, it jumped 12.6% from last year's 467. Our off-net ARPU fell sequentially by 1.3% from 1,120 to 1,106, but increased year-over-year by 21.5% from last year's 910. The wavelength ARPU was 1,638. Our quarterly churn rate for on-net and off-net connections combined rose. The on-net monthly unit churn rate was 1.4%, up from 1.2% last quarter, largely due to reduced T-Mobile CSA revenue and associated connections. The off-net monthly unit churn rate was 2.1%, increased from 1.3% last quarter, reflecting low-margin off-net contract pruning and changes to the T-Mobile commercial services contract. For EBITDA and EBITDA margin, we reconcile our EBITDA to cash flow from operations in our quarterly earnings releases. This quarter, we incurred $9 million in Sprint non-capital acquisition costs, down from $17 million last quarter, with $4.3 million of severance costs included in the current quarter. Last quarter's $17 million in Sprint acquisition costs comprised $16.2 million of severance costs, which are paid by us but reimbursed by T-Mobile. We expect to incur some additional severance costs in Q2 '24, but none thereafter. Under U.S. GAAP, these costs are recognized as a receivable at the closing date and categorized as post-acquisition costs and part of the bargain purchase gain. Our EBITDA as adjusted, which accounts for the Sprint acquisition costs and cash payments received under our $700 million IP Transit services agreement with T-Mobile, was $115 million for the quarter, reflecting a 43.2% EBITDA as adjusted margin. This marks a sequential increase of $4.5 million in EBITDA and a 260 basis point margin improvement over last quarter. Historically, our first quarter sees a decline in EBITDA margin due to cost of living salary increases, which occurred this year, along with resetting payroll taxes and audit fees, but this did not happen this quarter. Regarding foreign currency impact, about 17% of our revenues this quarter originated outside of the United States, consistent with prior quarters. Around 11% of our revenues were based in Europe, and 6% related to operations in Canada, Mexico, Oceanic, South America, and Africa, with an average euro to dollar exchange rate of $1.07 and a Canadian rate of $0.73 so far this quarter. If these foreign exchange rates hold steady for the remainder of the quarter, we project a negative $0.4 million impact on sequential revenues and a negative $0.5 million year-over-year impact. We feel that our revenue and customer base lack significant concentration, with our top 25 customers accounting for about 18% of total revenues this quarter. Our capital expenditures were $40.9 million this quarter, a 6.3% decrease from last quarter, as we continue integrating the former Sprint and legacy Cogent networks into a unified network while transforming former Sprint switch sites into Cogent data centers. Our finance lease IRU obligations for long-term dark fiber leases generally have an initial term of 15 to 20 years or more, with multiple renewal options thereafter. Our IRU finance lease obligations totaled $517.5 million at the end of the quarter, including an unprofitable finance lease from Sprint. We have a diverse array of IRU suppliers and maintain contracts with 328 different dark fiber suppliers globally. By the end of the quarter, our cash and cash equivalents, along with restricted cash, amounted to $163.3 million, of which $44.8 million is restricted due to the estimated fair value of our interest rate swap agreement. Our operating cash flow is significantly influenced by the timing and amount of our payments under the TSA agreement with T-Mobile for transition services, as well as how we present payments from our $700 million IP Transit agreement. Under U.S. GAAP, payments under this agreement are classified as cash receipts from investing activities rather than operating expenses. This quarter, we reported positive operating cash flow of $19.2 million, a significant improvement from the negative $48.7 million reported in the previous quarter of last year. Payments under the IP Transit agreement, classified as investing activities, were $87.5 million for both this quarter and last quarter. Regarding debt and debt ratios, total gross debt at par, including finance lease IRU obligations, reached $1.5 billion at quarter end, while net debt stood at $1.3 billion. Both total gross debt to last 12 months EBITDA as adjusted and net debt ratios showed considerable improvement this quarter. The total gross debt to last 12 months EBITDA as adjusted ratio was 3.57 at quarter end, while the net debt ratio was 3.17, compared to 4.07 and 3.75 last quarter, respectively. Our consolidated leverage ratio, as measured by our note indentures, was 3.51, and the secured leverage ratio was 2.33. Regarding our swap agreement, we have an interest rate swap that changes our fixed interest rate obligation related to our $500 million 2026 notes to a variable interest rate based on the secured overnight financing rate for the remaining term. At each reporting period, we assess the estimated fair value of the swap agreement, resulting in non-cash gains or losses due to market interest rate fluctuations. The fair value of the swap increased by $6.2 million from last quarter to a liability of $44.8 million. We are required to hold a restricted balance with the counterparty that matches this liability. Currently, the swap agreement holds a value of $35.5 million. Finally, on bad debt and days sales outstanding, our days sales outstanding were significantly impacted by converting all former Sprint clients to our billing system in November 2023. DSO for worldwide accounts receivable improved significantly from year-end and is returning to historical levels, ending the quarter at 27 days compared to 37 days last quarter, reflecting a 10-day improvement. Our bad debt expense for the quarter was $2.6 million, constituting 1% of our revenues, consistent with past performance. I would like to express appreciation for the excellent work of our worldwide billing and collection teams in serving our Cogent customers. Now, I will hand the call back to Dave.

David Schaeffer, CEO

Thanks, Tad. Now for a few highlights on the strength of our network, our customer base and sales force. Our Net-Centric business continued to experience significant traffic growth in our business from streaming and other customers. We are a direct beneficiary of the continued migration of video to over the top. At quarter's end, we were on-net in 1,586 third-party carrier-neutral data centers and 78 of Cogent's owned data centers for a total of 1,664 data centers. This is more data centers connected by a network than any other carrier as measured by third-party research. The breadth of this coverage enables us to serve our Net-Centric customers and a larger number of locations and help them reduce latency on their network. We continue to expand our footprint and anticipate adding approximately a 100 carrier-neutral data centers to our network per year over the next several years above and beyond the additional 23 data centers that Tad mentioned earlier, that we are adding due to the conversion of the Sprint switch sites into data centers. We are continuing to experience extended provisioning cycles for wavelengths, but we now can offer wavelength services in 419 locations. By year-end, we will have over 800 carrier-neutral locations connected to our network throughout North America with substantially reduced provisioning cycles that will mirror the provisioning times that we are able to achieve with our transit services. At quarter's end, we were directly connected to 8,098 networks. This collection of ISPs, telephone companies, cable companies, global operators and other carriers allows us to reach the vast majority of the world's broadband and mobile phone users. Cogent remains the most interconnected network in the world. Our Corporate customers are aggressively integrating new applications that become part of their working world, such as video conferencing. These usages will require higher speed connections both inside and outside of their premises. Our Enterprise customers continue to groom their networks and are focused on our core connectivity products of DIA and virtual private network services, including both VPLS and MPLS managed network services. Now for a highlight on our sales force. We remain focused on growing our sales force and increasing the productivity of those sales reps. We continue to expand and modify our training programs, and we routinely manage out underperforming sales reps. Our sales rep turnover in the quarter was 5.5% per month, which was down from a peak of 8.7% per month at the peak of the pandemic and is in line with our historical averages, which have been at 5.6% of the sales force leaving the company each month. We continue to train new reps as well as provide supplemental training for the reps that joined us from the Sprint business. Our sales rep productivity increased sequentially 23% to 4 installed units per rep per month. At quarter's end, we had a sales force of 284 sales professionals globally focused on the net-centric market, 379 sales reps focused on the corporate market, and 14 sales reps focused on our enterprise market segment. In summary, we remain very optimistic about our unique position to be able to serve the connectivity needs of small, medium and large businesses in major cities across North America in the central business districts. We have 1,861 on-net multi-tenant office buildings connected to our network with over 1 billion square feet of office space. We remain excited and optimistic about our enterprise customer base and the ability to provide connectivity services to those companies globally and our opportunity to repurpose assets acquired from Sprint. The repurposing of the network to sell wavelength or optical transport services is progressing well. And the conversion of former Sprint switch sites into data centers is also progressing, increasing Cogent's data center footprint and available power. We have a significant backlog and funnel of over 2,400 wavelength opportunities. However, due to these longer provisioning cycles, we are uncertain if all of these orders will remain with us through our ability to provision them. We will be able to reduce that provisioning cycle as we complete our network optimization and mirror the provisioning windows that we are able to achieve in our IP business. Key indicators show that office activity is improving. Workplace re-entry and leasing activity remained substantially below pre-pandemic levels. However, many tenants are returning to offices and leasing activity for commercial offices has begun to improve in many areas. We are working diligently to continue to reduce costs and integrate Sprint assets. We are optimistic about the cash flow capabilities of this combined business. Over the next 3 years, we anticipate continuing to achieve annual cost savings and exceeding our initial $220 million of annual cost synergies that were projected at the signing of our transaction with T-Mobile. We look forward to monetizing many underutilized assets, whether it be excess data center space, our IPV4 addresses or the substantial inventory of dark fiber that we have in our network. Our Sprint acquisition costs do not include separately identified integration costs related to the operating expenses associated with the integration. This has reduced our EBITDA and EBITDA margins as adjusted, but we felt that it was more appropriate to just include these in our standard run rate. Finally, I want to take a moment to address a question that several shareholders have raised with me, and that is my sale of a portion of my Cogent Holdings. Unfortunately, I have a large real estate portfolio outside of Cogent, and that portfolio has been under significant pressure. My stock sales are solely attributable to supporting that portfolio and have no reflection on my optimism of Cogent. In fact, I'm more optimistic today about Cogent's prospects to both grow its revenues and expand its profitabilities than I have been in Cogent's entire history. With that, let me open up the floor for questions.

Operator, Operator

Your first question comes from Sebastian Kati with JPMorgan.

Unknown Analyst, Analyst

We are still experiencing challenges with provisioning on the wave side. What gives you confidence in reaching the 800 locations by year-end? How should we consider the trajectory or revenue ramp-up as you move through the year and possibly over the next 12 to 18 months? Additionally, can you help us understand the decline in Enterprise? You mentioned that much of the revenue drop is linked to non-core and legacy revenues diminishing. Specifically, what is the outlook for Enterprise? Is it expected to continue declining, or might it stabilize in the upcoming quarters before potentially returning to growth?

David Schaeffer, CEO

Since the acquisition was finalized, we have enabled 419 locations for wave services within the last 12 months. This enablement includes four key tasks. First, we need to install a transponder shelf in each of our carrier-neutral data centers to handle the wavelengths. Next, we must reconfigure our metropolitan networks for optimal wavelength delivery. Additionally, we need to physically extend the Sprint network to connect with our metropolitan networks. Finally, we will deploy a reconfigurable add/drop multiplexer where the intercity and intracity networks intersect. All these efforts are currently underway at all 800 locations. The project consists of multiple subprojects and constraints, most of which have been resolved and are now within our control. All our markets are now interconnected, and each has a clear project plan in place. We expect to see a steady increase in the number of enabled locations from 419 on May 9th to 800 by December 31, 2024. A key advantage for Cogent in the wavelength market is the standardization of our products and our ability to provision these services within a two-week timeframe, significantly better than the historical industry standards. Previously, when Cogent began offering high-capacity transit services, the average provisioning time was over 90 days. We revolutionized the industry by reducing this to an average of 9 days for installation, which contributed to Cogent becoming the largest transit provider globally. In terms of wavelength services, most carriers offer customized or bespoke provisioning. We've designed our network to be more standardized. Each data center will be equipped with the necessary transponder shelf, and provisioning will involve three critical steps. The initial steps consist of connecting a pluggable optic at each endpoint, which requires coordination with field technicians. Given that all these locations are in carrier-neutral data centers and we have nearly 500 personnel in our field services team, we expect to complete this within 2 to 3 days after order validation. Once these initial tasks at both endpoints are accomplished, our network operation center will create the physical path through the intermediate devices. This work has been automated and scripted and will be carried out by nearly 250 professionals in our customer care and operations support team. This process has been part of our support for the Cogent IP network for years, although previously unseen by customers, it will now be more visible. We anticipate that this will greatly reduce provisioning times. Currently, Cogent averages more than 120 days to provision a wavelength, so we are looking at a tenfold improvement as we transition from custom provisioning to a modularized, standardized program. We are confident in our resources and infrastructure to achieve this, and as these sites become fully wave-enabled, the need for custom engineering will significantly decrease. Shifting to your other question regarding the Enterprise sector, one challenge that the global Enterprise market faces is that service providers often sell products and services that do not align with their core competencies in order to maximize revenue. After acquiring the Sprint business, we found a vast number of non-core services spanning 24 different product categories. We have been systematically phasing out these services, reducing our non-core revenue by another $1.2 million sequentially, which is a deliberate strategy since these products have a negative gross margin and add no value to Cogent. These mainly include security management and land administration services offered alongside connectivity. Cogent differentiates itself by focusing on a limited range of products; our five key offerings are Internet access, VPN services, wavelength services, Internet address space, and data center space and power. In the Enterprise sector, we are undertaking two simultaneous initiatives: eliminating non-core products and scrutinizing our connectivity offerings on a circuit-by-circuit basis. We are aggressively transitioning from off-net to on-net options, evident in our noticeable margin improvements and lower costs. We are also discontinuing circuits that are not sustainable, across delivery methods, and are consolidating onto a fiber-based platform to enhance scalability. Moreover, we are pulling back from unprofitable countries and markets where Sprint offered services without the necessary regulatory support. For these reasons, we are refining our less profitable business segments. We believe the Enterprise sector will stabilize in the coming quarters, providing an opportunity for growth as many global service providers are exiting this market.

Operator, Operator

Your next question comes from the line of Greg Williams with TD Cowen.

Gregory Williams, Analyst

Maybe I can follow up on the waves question, just ask it differently. You had $3.3 million in waves revenue. Last fall, I think you said you're going to get a run rate of about $20 million in revenue annualized by around now. Of course, you rescinded that goal. But when could we reach the $20 million? Or any other target you can give for waves? Just help us figure out the cadence and the confidence in the wave revenue increase? And then the second question is just on the integration cost for Sprint. You noted $9 million in Sprint acquisition cost. But at the end of your scripted remarks, I think you were mentioning separate identified integration costs and that's reducing your EBITDA. What is that number? How much of this onetime sort of integration cost of Sprint do you have? And where is that going throughout the course of the next year or 2?

David Schaeffer, CEO

Those are two very good questions, Greg. First, regarding wavelengths, we continue to expand our funnel. We're currently encouraging customers to wait until we can provide more realistic provisioning timelines. The demand for our routes and targeted data centers is stronger than we initially anticipated. We expect our wave business to reach a run rate of approximately $500 million five years post-acquisition. Our plan was for gradual growth, aiming for an increase of $100 million annually, reaching $200 million in the second year. We based this on the idea that the limited locations we serve would align with market demand. However, we found that wave demand is more widespread across many data centers. The demand is certainly there, but it's not concentrated in the facilities we can currently provision. We still believe we'll achieve a $500 million run rate by May 2028. We understand this timeline may seem long and that investors prefer nearer targets. The network reconfiguration is underway, and we are more than halfway through adding the necessary sites. However, we are not yet positioned for standardized delivery as I mentioned earlier. We expect this will be implemented by year-end, which should help reduce our backlog and facilitate new sales, as we'll feel more confident taking orders with standardized provisioning timelines. Regarding specific financial targets, I'm careful not to commit to anything that could lead to disappointment. We anticipate a more linear path toward achieving the $500 million target by spring 2028, acknowledging that initial demand didn't match our location offerings, but we will catch up as more sites become operational. Now, concerning your second question about integration costs. The operational integration of the business does entail significant costs. Companies often allocate a budget for these, and investors may overlook them, considering them transitory rather than ongoing. We already faced considerable accounting complexity with this transaction, which is rather unusual. Typically, a company pays for a transaction and integrates it over time, but our situation involved additional factors that led us to consult with the Chief Accountant of the Securities and Exchange Commission for guidance on proper accounting treatment. We included the Transit service payment agreement from T-Mobile, the $700 million in EBITDA as adjusted, to avoid adding yet another extraordinary adjustment. Numerous operational costs arise from converting our back-office and billing systems, but we haven't publicly quantified these yet. We believe reporting yet another adjusted EBITDA metric would be overly complicated. However, you can expect continued operational improvements moving forward, including headcount rationalization, site optimization, and network integration, which will gradually reduce these integration costs. These costs are factored into our overall guidance, which anticipates at least 100 basis points of annual margin expansion. You may have noticed a significant impact this quarter, with a sequential improvement in EBITDA margins of 260 basis points in a period that typically sees a decline.

Thaddeus Weed, CFO

I would like to add something regarding the Sprint costs that we include. These are professional fees related to the acquisition, which are non-recurring. Additionally, according to U.S. GAAP accounting, we must record the severance amount as a receivable at the closing date. This means that the asset is recognized on our balance sheet, which increases the gain, even though we are reimbursed when we actually pay those severance costs. These severance costs are also recorded as an expense. Thus, they are directly linked to the acquisition and are part of the Sprint costs. I hope that clarifies things.

Operator, Operator

Your next question will come from the line of David Barden with Bank of America.

David Barden, Analyst

Dave, you mentioned the IPV4 contribution of $3.4 million per month. Can you provide insight into what that might look like in terms of sequential and year-over-year growth as it relates to the Corporate revenue line? Additionally, you've talked about the IPV4 reservoir and the midstream data center opportunity, as well as dark fiber. Can you explain how we can monetize those? Is there a plan to pursue more ABS-type financings for reinvestment in the business, or have you received interest in potential sales of these assets?

David Schaeffer, CEO

Okay. A couple of great questions, Dave. So first of all, the growth rate in the IPV4 revenue stream has been running between 2% and 3% sequentially per month for the past 1.5 years, and we anticipate that growth to continue. As part of focusing on the IPV4 value, we did a few things. We modified our compensation structure for the sales force to increase their commission rates to make leasing of address space equivalent to that of selling bandwidth. And 2, we have incrementally raised prices on addresses. Now we did not raise the installed base, but for new sales we have increased prices because of the pricing umbrella established by both Amazon through AWS and Microsoft through Azure. So I would expect this business to continue to grow at a similar rate. We are also evaluating should we sell some of the addresses, because it may take us too long at this growth rate to fully recognize value out of them by leasing them. That final decision has not been made. We today are leasing out about 1/3 of our inventory, meaning 2/3 are unutilized. We'll continue to aggressively raise prices and increase sales and then may also choose to pare our inventory by selling. Again, a final decision has not been made. And it's somewhat dependent on market conditions. I think the IPV4 purchase market was more robust 6 months ago. It slacked off a little bit. I think that will come back and that may impact our decision on timing and exact magnitude of potential sales. Now with regard to the data centers, there we have a lot of foundational work. So independent of everything that I've described on the network reconfiguration, there is a dedicated team of individuals working on clearing out these sites and then converting them into modern data centers. That work is well underway. We have converted 25 of the facilities. We have 23 more that are in the process of conversion. And even of the 25 that have been converted, there is still some additional remedial work. Within those facilities, we are basically dividing the facility into 3 areas. There is a small PoP room that is being established, that will house our network equipment. Typically, that utilized is about 0.5 megawatt of power at about 1,000 square feet of the facility. Secondly, we are establishing a retail Cogent data center in each of these locations. These will range from 5,000 to 10,000 square feet and will typically be between 0.5 and 1 megawatt of power, and they will look exactly like the inventory of data centers that Cogent had previously and the customer bases typically take 1 and 2 racks of space at a time with typically 2 to 5 kilowatts per rack. That leaves a substantial amount of inventory, approximately a million square feet and about 100 megawatts of power today as surplus. We have begun the process of marketing that to third parties on a wholesale basis. That will either be direct users or other data center operators. We have offered those participants 2 different models. They can lease space from us on a per megawatt basis or they can elect to purchase the facility along with the power. We've gone out to about 117 counterparties and have begun those negotiations. We have 3 LOIs in hand after 2 weeks, offering 3 specific facilities. It is probably too early for us to bake that into our financial model, but probably over the next quarter or 2, we'll be in a position to comment on the monetization. And if they are leases, they'll be long-term streams of revenue that we would look to securitize if we want cash or just harvest. If they are sales, they would obviously reduce our leverage on our balance sheet and give us additional capital. And then on dark fiber, we have a substantial footprint of dark fiber. However, we have not been willing to sell that, not because of any philosophical reason, but because the team that's involved in provisioning that dark fiber is the exact team of people that are full speed ahead on delivering our wave network reconfiguration. By year-end, that wave reconfiguration will be substantially complete and then we can turn our attention to figuring out how deep and what is the right pricing model for the dark fiber in our network. So all of these assets are ones that we will ultimately create value out of, what we need to sequence us properly. Hopefully, that was helpful, Dave.

Operator, Operator

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

Frank Louthan, Analyst

Dave, can you comment on kind of where the non-core revenue bottomed out? I assume it doesn't necessarily go to 0. But when you get rid of the negative gross margin and other products and so forth, how should we think about where that revenue line kind of bottoms out? And how long do you think it will take to get there? And is there any part of it that you might consider putting in discontinued ops since you're clearly kind of pushing it out? First question. Secondly, can you comment on the usage of the circuits to T-Mobile thing? Or are they cash payments? Are they using those? And is there a potential for them to grow and do more business with you beyond that?

David Schaeffer, CEO

Yes. 2 very different questions. So in the non-core business, prior to the Sprint acquisition, Cogent had about $100,000 a month of non-core revenue, about $300,000 a quarter. And that was services that were left over from acquisitions that were 18 years or more earlier. So there is a very long tail on these services. We are actually still providing hosted e-mail to PSINet customers 21 years after the acquisition. We kind of wish it goes away, it produces some margin and we support it. The Sprint services were much more complex and probably much lower margin. Our goal is to get rid of them as quickly as possible. Our expectation is they will be substantially gone by the end of 2026, which is the longest dated contract that were obligated to support. But there probably will be some residual tail beyond that. We are also looking at the enterprise customer base and realizing that some of the services they are getting for connectivity are not economically viable. The locations are very remote. The services are delivered over inferior transmission, off-net circuits and the margins are very low. We are doing a combination of raising prices and migrating traffic. First and foremost, anything that's off-net that we can bring into on-net, we're doing that. And you see that show up in both our numbers in terms of on-net connections and also revenue improvement as well as margin improvement. We have no intention of putting these services into a separate bucket of discontinued operations. There is already too much accounting complexity here at Cogent.

Thaddeus Weed, CFO

Yes. Just comparing the amounts related to this non-core revenue and the associated cost, it's really not material enough to group into a discontinued operations bucket.

Operator, Operator

Your next question will come from the line of Walter Piecyk with LightShed Ventures.

Walter Piecyk, Analyst

Dave, I just want to go back to Barden's question on the IPV4 stuff. So 2.5%, does that mean that 1 year ago you had about $3 million of revenue? And when exactly did that revenue start for you in Corporate, Dave?

David Schaeffer, CEO

Okay. So first of all, we began leasing IPV4s in 2015. One thing I did not correct in Dave's question was the breakdown between Corporate, Net-Centric and Enterprise. Let me give that. In IPV4 leasing, 85% of the revenues are Net-Centric. 14% are Corporate and 1% are Enterprise. Between 2015 and midyear 2022, we would only lease addresses to companies that also purchased bandwidth from us at the same time. In the summer of '22, we relaxed that restriction. At that point, the growth rate in this business materially accelerated. The second thing that we did in the beginning of this year was to normalize the commission structure. So we would pay the sales force the same payout ratio if they lease addresses as opposed to just selling bandwidth. That had a positive impact on the sales rate. And then the third thing that we implemented actually April 1st is an increase in pricing. This was a relatively small part of Cogent's business and something that, quite honestly, we had not focused on initially. We were approached by a number of banks to potentially do an asset-backed securitization of our network. We reviewed that and concluded that would be impractical due to the fact that our network traverses 12,000 municipal, local and national jurisdictions, perfecting a security interest and that broad of a network is just not practical. Second, 60% of our network is based on IRU. While there is precedent to securitize that, it's more challenging. And third, there was not a huge amount of customer diversity. As we looked in our aggregate balance sheet, we thought that it would make sense for us to reach out to ABS investors as a new group of investors and realized that our V4 revenues were an optimal candidate, widely diffused customer base, 8,000 customers, 12,000 unique agreements, a very sticky customer base. The churn rate in IPV4 leasing is 0.8% annually, almost 15 times better than the churn rate in our bandwidth business. And it is an extremely high-margin business with no real operating cost. So it was an ideal candidate for this market. Now what turned out to be challenging in doing this transaction were 2 things: the complexity involved in securitizing not only domestic but international revenue streams; and then secondly, educating investors on a new asset that they had never seen before. So it was a lengthy process. But our business for IPV4 leasing has some significant tailwinds and the decision by Microsoft and Amazon to lease out at 12 times Cogent's rates at the time in 2023 created quite a high umbrella for us in terms of pricing and giving us the confidence that we have the ability to move prices up.

Walter Piecyk, Analyst

Well, you mentioned that last quarter, Dave, about Amazon and Microsoft. So it's been 90 days, it doesn't look like growth accelerated there or you sold. And then I think in answering Barden's question you said, I guess, the market looked a little softer for IPV4. So I mean who knows what happens given what can happen with IPV6? It would seem like there would be some immediacy to either increase price at the existing leases, try and lease more aggressively or sell it more aggressively in case that market disappears. So just comments on that? And also as it relates to Corporate, I know this is more of a Net-Centric business, but I think your buildings dropped for the first time. I look back in my model. I think I go back to like 2008, I don't think I've ever seen your multi-tenant buildings actually drop. What's going on with that? Because you usually add buildings, which obviously gives you incremental potential capacity for some corporate growth.

David Schaeffer, CEO

I'll address those points in reverse order. After the pandemic, we have slowed the pace of adding multi-tenant buildings. Although we added a few buildings this quarter, we also converted several buildings from office to residential use. This resulted in a slight net decrease of one building, going from 1,862 to 1,861, which is quite minor. In fact, the overall square footage has increased because the new buildings are larger than those converted. We anticipate that our multi-tenant footprint will keep growing, but at a slower pace. It makes more strategic sense for us to redirect that capital towards enhancing data center connectivity, which is a more dynamic and expanding market. Now, regarding your question about IPV4 monetization, IPV6 has been around since 1998 and currently holds about 7% of Internet traffic. In 2010, the U.S. Federal Government mandated that all agencies transition to IPV6 within 18 months, yet today, less than 2% have completed the switch. This transition is taking a long time, and the costs associated with renumbering are significant. Even when IPV6 is available, the cost of leasing addresses is so low that it is often not worth it. Many companies will take a significant amount of time to make the switch, as no one wants an incomplete view of the Internet. The primary reason for the decrease in sale prices over the last six months is that Amazon and Microsoft have stepped back from the purchasing market after achieving their initial goals. However, I believe both companies will re-enter the market eventually, and there remains a broad and active market. Prices for larger blocks are still on the rise, so we will look into sales opportunities. We are confident in our ability to grow the leasing business and will take the necessary steps to maximize long-term shareholder value from our data center and fiber assets. There is no question that Cogent possesses valuable assets that can be monetized.

Walter Piecyk, Analyst

But in the absence of a sale, maybe you can just give us some sense of, without having the IPV4s in order to secure that incremental financing? I mean, obviously, these TSA payments are going to drop from $87 million to $24 million. So that drop alone, I think, takes your EBITDA to a level that I'm not sure it covers CapEx and cash interest expense. I mean, it's just math, right? The leverage is obviously going to go up. So the only question is what is the rate when you have to borrow more? what do you think the rate on that new debt is going to look like?

David Schaeffer, CEO

Yes. First, Walter, I recall your aggressive questions from previous quarters regarding our aggregate leverage. As previously mentioned, it peaked at a net leverage target of 4.6, significantly above our stated range of 2.5 to 3.5. We have successfully reduced that leverage to 3.17, well below the upper limit of that range, and we expect it to decrease further next quarter as it is tied to an LTM tax. We will review our aggregate balance sheet to optimize it through various means such as high yield, securitization, or asset sales. We have multiple options available. We’ve been open about the decreasing payments from T-Mobile, which are declining; however, we are generating substantial cost savings beyond our initial expectations. Last quarter, you expressed doubts about our ability to achieve this, but our improved EBITDA clearly demonstrates our capacity to significantly reduce costs in both SG&A and COGS. Therefore, we anticipate a combination of cost reductions and revenue growth. As the wavelength business expands at a more normalized rate with high contribution margins, our aggregate EBITDA should start to rise. As noted in the last call, we recorded $352 million in EBITDA in 2023, up from $233 million in 2022. While we’re not providing precise guidance, we expect similar results in 2024. In 2025, the effects of wavelengths, IPV4 monetization, and data center monetization, along with growth in the core IP business, should boost our EBITDA and margin expansion. I mentioned that it's a top-line business growing at 5% to 7% with 100 basis points margin expansion each year. I also want to clarify a question I didn't answer for Frank regarding T-Mobile's utilization, which has two parts. Firstly, their commercial services, primarily connectivity and Colo, are moving away from our facilities and ceasing use for backhaul. In many instances, we are purchasing it and reselling it to them, contributing to the decline in off-net revenues. They are progressing significantly with this transition, resulting in a sequential revenue decline of about $5 million. Secondly, the transit services were always intended to be a subsidy payment to Cogent, and they are currently using a small percentage of what we provide. They could utilize it all, and that would be acceptable to us, as it's fully provisioned. However, I’m uncertain about any significant additional opportunities with T-Mobile.

Walter Piecyk, Analyst

So what is the incremental rate when you're not using IPV4 to support the cash needed for the dividend? Because yes, the leverage is decreasing, that's just math, right? You're receiving TSA payments. But when those payments drop from $87 million to $24 million, the EBITDA falls too, and then EBITDA can't cover CapEx or cash interest. I mean, it's just math, right? The leverage is obviously going to increase.

David Schaeffer, CEO

I will agree with your calculations. I think you're...

Walter Piecyk, Analyst

Okay. We will just see how it plays out. Dave, just one last question. Just on the synergies, just ballpark, like what have you realized so far? And what's left in the bucket when we try and come up with EBITDA estimates? And we know what the targets are, so you don't need to review them, just kind of percentage realized or dollars already realized?

David Schaeffer, CEO

Yes. We're probably 40% through the synergy realization.

Operator, Operator

Michael Rollins with Citi will ask the next question.

Michael Rollins, Analyst

I'm just curious, if we take a step back, can you simplify either how Heritage growth rate in corporate Net-Centric are performing? And if you'd rather do it pro forma given the integration of the business? It's just some way to kind of appreciate the level of growth that you're achieving relative to what you're used to over the long-term. And if you see things in those growth rates inflecting more positively or pulling back in terms of that rate of growth as you look out over the next few quarters and you look at the sales trends, the volumes, et cetera?

David Schaeffer, CEO

Yes, absolutely. Mike, good questions. So Cogent has 2 market segments. It has a Net-Centric segment that it focuses on transit sales, that continued to grow. T-Mobile as a customer was a Net-Centric customer. They're a service provider. If you just net out their decline in revenue, that business grew. Traffic grew sequentially 1%, roughly 20% year-over-year, and that business on a Heritage basis is probably growing around 10%. In the Heritage business, that represented about 40% of Cogent's aggregate revenues. The other larger business, Heritage, was Cogent's corporate customer base. That Corporate customer business was actually declining during the pandemic, far worse than its long-term average growth rate of 11%. And today is probably at a growth rate of around 3% to 4% year-over-year. Still far worse than what we had experienced for nearly 15 years between going public and the beginning of the pandemic. That business is slowly improving, but I've given up trying to predict when everybody is going to be back in the office at the same level of occupancy pre-pandemic. There is improvement. That business is improving sequentially and year-over-year, but it is at a slow pace. We now have a singular integrated customer base. We report now on 3 customer types, and we report on some additional products that were not material. Non-core, we always reported on, but was immaterial. Now it's more material, and we now have wavelengths as a service. So yes, Cogent became more complicated when we acquired Sprint. We got new customers and new products. But the trends in the underlying Heritage business are reasonable. They're not at peak, but they're doing pretty well. I mean a 10% growing Net-Centric base and a kind of 3% to 4% Corporate is not terrible.

Michael Rollins, Analyst

And 2 follow-ups, if I could. Just first on the corporate side. Just given where your share is in your buildings of unique customers, what do you see as the catalyst to try to improve share? Is there anything competitively that's shifting in that market that could help or hurt this performance?

David Schaeffer, CEO

It's been a gradual shift. Everybody in our footprint is already using Internet connectivity. And if they need a VPN service, they already have a VPN service. So they need to either relocate or they need to change their usage patterns. I think video conferencing was a huge tailwind to that as people became dependent on it, that max out their connections. However, many, many companies were reluctant to enter into new IP contracts until they had some clarity around their office real estate requirements. I think companies are now kind of settling into what that new real estate requirements footprint looks like. So I think we're seeing this gradual improvement, but there are still leases that have term left on them that people intend to exit or downsize from. And until they make that final real estate decision, they're not going to make a permanent bandwidth decision. Bandwidth is a utility to support their office occupancy. I don't know if there's another killer application that's going to drive things, but I do think the dependence on video conferencing is a significant shift in the world from pre-pandemic to post-pandemic. And I think as companies figure out, I'm going to stay in this office, this is how many square feet, they're going to be much more interested in signing a long-term higher cap bandwidth connection. It was interesting. 5 years ago, our average corporate on-net user was using about 18% of a 100 meg connection at peak. Today, our average Corporate customer is using 13% of a 1 gigabit connection at peak. So they're using 8 times more bandwidth than they were 5 years ago. I think video conferencing is probably the one thing I'd point to. And remember, they're doing that with 40% less employee days in the office. Hopefully, that was helpful.

Operator, Operator

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

Nicholas Del Deo, Analyst

How are your plans to use the proceeds from the securitization? Are you going to buy out that uneconomic dark fiber lease that you've seen from Sprint you've talked about? And if that's the case, can you talk about the mechanics and the benefits?

David Schaeffer, CEO

Yes, sure. So I'll start with the benefits of mechanics. So the lease has a provision that allows us to buy out at a 12% discount rate. This is a lease that is fiber, that we don't need and would like to exit as quickly as possible. There is about a $130 million liability associated with that lease today. The payment stream on that is $4.2 million a month, and we would have to write a check for probably about $112 million, $113 million to buy out. I don't necessarily know we would use all of our cash to do that that we received. So we did $206 million and with an ABS securitization that were both substantial costs and reserve accounts established, our net proceeds were about $200 million, of which about $6 million were restricted in reserve accounts. So $194 million of debt proceeds, and I'm not sure I want to use $112 million of that in cash. So we are looking at the points that Walt raised, do we raise more money. So I think what we're going to do is keep some cash on the balance sheet. We will look to buy out of this lease and continue to be able to invest in the business at the appropriate rates, which include the conversion of the data centers, the wave enablement of the network and our ability to demonstrate, I think, kind of all 3 legs of the value proposition that we were anticipating from Sprint. We've been able to, I think, validate the worth of our IP address inventory. I think we have to show the value of the wavelength and dark fiber assets and the colocation. And I think these proceeds will be used to help demonstrate all of that.

Nicholas Del Deo, Analyst

And then 2 clarifications on EBITDA. So first, it looks like your unfavorable lease amortization went from $10.3 million in Q4 to $2.5 million in Q1. So I think if we were to look at it on like a cash basis, I think the sequential improvement would have been even stronger than you showed. Is that fair?

Thaddeus Weed, CFO

Yes. The unfavorable lease liability had to be adjusted and increased for the extension in renewal terms, that we had already recorded under leases themselves, so the lease liabilities that are on the balance sheet, kind of as a gross up, but the unfavorable lease needed to be matched to that. So that was one of the corrections that was made in the quarter that resulted in a net of a $5.5 million reduction in the gain and the $1.4 billion gain for the bargain purchase.

David Schaeffer, CEO

Yes. So we would have been a little better without that accounting adjustment. And listen, there are so much complexity to Cogent's accounting for this transaction. We are working very diligently to report everything in a consistent and non-confusing way for investors.

Thaddeus Weed, CFO

But going forward, in terms of changes to the purchase accounting, we'll have additional severance and perhaps an adjustment to the tax rate could be an adjustment to the deferred tax liability. That is all that is expected in the second quarter.

David Schaeffer, CEO

Yes. We also have an anticipated substantial tax refund coming as a result of this. We had overpaid based on Cogent's run rates going in our Federal estimated tax and have approximately $18 million of a pending tax refund.

Thaddeus Weed, CFO

Right. So that will be split. We'll get some prior to filing the tax return and the remainder when the tax return is filed.

Nicholas Del Deo, Analyst

And just to be clear on the amortization point, the reduction versus Q4, you're saying it went into the gain rather than an expense reduction?

Thaddeus Weed, CFO

Yes, that's correct.

Nicholas Del Deo, Analyst

And then second, just a quick one. I think you called out indication accruals in Q1. Tad, did you say that you did not have audit expenses in Q1 because you normally have those?

Thaddeus Weed, CFO

We absolutely did. So...

David Schaeffer, CEO

I'm sorry, but the text provided is not sufficient to rewrite the earnings call remark as it only contains "[indiscernible]." Please provide a complete remark for me to rewrite.

Thaddeus Weed, CFO

Yes. Those associated just with the Sprint acquisition, which was valuation services, are in the Sprint cost. But the traditional audit, we paid over $2 million. You can read it in the proxy on a regular audit, that's included in the first quarter costs. And the variation vacation, if you look at fourth quarter to first quarter, it's a couple of million dollars in...

Nicholas Del Deo, Analyst

I agree with your comment. Did you have your sales meeting this quarter? Is that in Q2?

David Schaeffer, CEO

We're actually not going to have it this year because it would end up just a large distraction. We've got so much integration work going on. Now what we have done is ramped up our regional learning manager program, hire some additional resources and are doing it on a more regionalized basis as opposed to a global meeting. We'll resume that next year. But we felt with all that was going on with the integration that there just wasn't enough cycles to do that. We think there's great value in it, but we're kind of taking a less impactful strategy in doing it just through regional meetings.

Operator, Operator

And we have no further questions at this time. I'll hand the call back to Dave Schaeffer for any closing remarks.

David Schaeffer, CEO

As always, our calls tend to be a little long. I want to thank everyone for their patience. I think hopefully, we've been clear in answering questions, and we look forward to seeing each and every one of you as we get together at conferences. Take care soon. See you soon. Bye-bye.

Operator, Operator

That will conclude today's meeting. Thank you all for joining. You may now disconnect.