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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the Transition Period Ended
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
Commission File No.
(Exact Name of Registrant as Specified in Its Charter)
(State or other jurisdiction of Incorporation or organization) | (I.R.S. Employer | |
Identification Number) |
(Address of Principal Executive Offices and Zip Code)
(
(Registrant’s Telephone Number, Including Area Code)
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class |
| Trading Symbol |
| Name of Each Exchange on which Registered |
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
☒ | Accelerated filer | ☐ | |
Non-accelerated filer | ☐ | Smaller reporting company | |
Emerging growth company |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Common Stock, $.001 par value
INDEX
| |||
3 | |||
3 | |||
4 | |||
5 | |||
6 | |||
Notes to Interim Condensed Consolidated Financial Statements (Unaudited) | 7 | ||
Management’s Discussion and Analysis of Financial Condition and Results of Operations | 24 | ||
44 | |||
44 | |||
45 | |||
45 | |||
46 | |||
46 | |||
47 | |||
48 | |||
CERTIFICATIONS | |||
Page 2 of 48
PART I FINANCIAL INFORMATION
ITEM 1.
FINANCIAL STATEMENTS
COGENT COMMUNICATIONS HOLDINGS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
AS OF SEPTEMBER 30, 2023 AND DECEMBER 31, 2022
(IN THOUSANDS, EXCEPT SHARE DATA)
| September 30, |
| December 31, | |||
2023 | 2022 | |||||
(Unaudited) | ||||||
Assets | ||||||
Current assets: | ||||||
Cash and cash equivalents | $ | | $ | | ||
Restricted cash | | | ||||
Accounts receivable, net of allowance for credit losses of $ |
| |
| | ||
Due from T-Mobile, IP Transit Services Agreement, current portion, net of discount of $ | | — | ||||
Due from T-Mobile, Transition Services Agreement | | — | ||||
Prepaid expenses and other current assets |
| |
| | ||
Total current assets |
| |
| | ||
Property and equipment: | ||||||
Property and equipment | | | ||||
Accumulated depreciation and amortization | ( | ( | ||||
Total property and equipment, net | | | ||||
Right-of-use leased assets |
| |
| | ||
Intangible assets, net | | — | ||||
Deposits and other assets |
| |
| | ||
Due from T-Mobile, IP Transit Services Agreement, net of discount of $ | | — | ||||
Due from T-Mobile, Purchase Agreement, net of discount of $ | | — | ||||
Total assets | $ | | $ | | ||
Liabilities and stockholders’ (deficit) equity | ||||||
Current liabilities: | ||||||
Accounts payable | $ | | $ | | ||
Accrued and other current liabilities |
| |
| | ||
Due to T-Mobile – Transition Services Agreement | | — | ||||
Due to T-Mobile – Purchase Agreement | | — | ||||
Current maturities, operating lease liabilities | | | ||||
Finance lease obligations, current maturities | | | ||||
Total current liabilities |
| |
| | ||
Senior secured 2026 notes, net of unamortized debt costs of $ |
| |
| | ||
Senior unsecured 2027 notes, net of unamortized debt costs of $ | | | ||||
Operating lease liabilities, net of current maturities | | | ||||
Finance lease obligations, net of current maturities |
| |
| | ||
Deferred income tax liabilities | | | ||||
Other long-term liabilities |
| |
| | ||
Total liabilities |
| |
| | ||
Commitments and contingencies: | ||||||
Stockholders’ equity (deficit): | ||||||
Common stock, $ |
| |
| | ||
Additional paid-in capital |
| |
| | ||
Accumulated other comprehensive loss |
| ( |
| ( | ||
Accumulated deficit |
| ( |
| ( | ||
Total stockholders’ equity (deficit) |
| |
| ( | ||
Total liabilities and stockholders’ equity (deficit) | $ | | $ | | ||
The accompanying notes are an integral part of these condensed consolidated balance sheets.
Page 3 of 48
COGENT COMMUNICATIONS HOLDINGS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2023 AND SEPTEMBER 30, 2022
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
| Three Months Ended |
| Three Months Ended | |||
September 30, 2023 | September 30, 2022 | |||||
| (Unaudited) |
| (Unaudited) | |||
Service revenue | $ | | $ | | ||
Operating expenses: | ||||||
Network operations (including $ |
| |
| | ||
Selling, general, and administrative (including $ |
| |
| | ||
Acquisition costs – Sprint Business | | | ||||
Depreciation and amortization |
| |
| | ||
Total operating expenses |
| |
| | ||
Loss on lease transactions | — |
| ( | |||
Operating (loss) income | ( | | ||||
Interest expense |
| ( |
| ( | ||
Loss on bargain purchase – Sprint Business | ( | — | ||||
Change in valuation – interest rate swap agreement | ( | ( | ||||
Interest income – IP Transit Services Agreement | | — | ||||
Interest income – Purchase Agreement | | — | ||||
Interest income and other, net |
| |
| ( | ||
Income before income taxes |
| ( |
| ( | ||
Income tax benefit (expense) | | ( | ||||
Net loss | $ | ( | $ | ( | ||
Comprehensive loss: | ||||||
Net loss | $ | ( | $ | ( | ||
Foreign currency translation adjustment |
| ( |
| ( | ||
Comprehensive loss | $ | ( | $ | ( | ||
Net loss per common share: | ||||||
Basic net loss per common share | $ | ( | $ | ( | ||
Diluted net loss per common share | $ | ( | $ | ( | ||
Dividends declared per common share | $ | | $ | | ||
Weighted-average common shares - basic | | | ||||
Weighted-average common shares - diluted |
| |
| | ||
The accompanying notes are an integral part of these condensed consolidated statements.
Page 4 of 48
COGENT COMMUNICATIONS HOLDINGS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2023 AND SEPTEMBER 30, 2022
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
Nine Months Ended | Nine Months Ended | |||||
| September 30, 2023 |
| September 30, 2022 | |||
(Unaudited) | (Unaudited) | |||||
Service revenue | $ | | $ | | ||
Operating expenses: |
|
|
| |||
Network operations (including $ |
| |
| | ||
Selling, general, and administrative (including $ |
| |
| | ||
Acquisition costs – Sprint Business | | | ||||
Depreciation and amortization |
| |
| | ||
Total operating expenses |
| |
| | ||
Gains on lease terminations | — | ( | ||||
Operating (loss) income |
| ( |
| | ||
Interest expense |
| ( |
| ( | ||
Gain on bargain purchase – Sprint Business | | — | ||||
Change in valuation – interest rate swap agreement | ( | ( | ||||
Foreign exchange gain on 2024 Euro Notes | — | | ||||
Loss on debt extinguishment and redemption- 2024 Euro Notes |
| — |
| ( | ||
Interest income – IP Transit Services Agreement |
| |
| — | ||
Interest income – Purchase Agreement |
| |
| — | ||
Interest income and other, net |
| |
| ( | ||
Income before income taxes | | | ||||
Income tax benefit (expense) | | ( | ||||
Net income | $ | | $ | | ||
|
|
| ||||
Comprehensive income (loss): | ||||||
Net income | $ | | $ | | ||
Foreign currency translation adjustment |
| ( |
| ( | ||
Comprehensive income (loss) | $ | | $ | ( | ||
|
|
| ||||
Net income per common share: | ||||||
Basic net income per common share | $ | | $ | | ||
Diluted net income per common share | $ | | $ | | ||
Dividends declared per common share | $ | | $ | | ||
|
| |||||
Weighted-average common shares - basic | | | ||||
|
| |||||
Weighted-average common shares - diluted | | | ||||
The accompanying notes are an integral part of these condensed consolidated statements.
Page 5 of 48
COGENT COMMUNICATIONS HOLDINGS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2023 AND SEPTEMBER 30, 2022
(IN THOUSANDS)
| Nine Months Ended |
| Nine Months Ended | |||
| September 30, 2023 |
| September 30, 2022 | |||
(Unaudited) | (Unaudited) | |||||
Cash flows from operating activities: | ||||||
Net income | $ | | $ | | ||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||
Depreciation and amortization |
| |
| | ||
Amortization of debt discount and premium |
| |
| | ||
Amortization of discounts, due from T-Mobile, IP Transit Services & Purchase Agreements | ( | — | ||||
Equity-based compensation expense (net of amounts capitalized) |
| |
| | ||
Gain on bargain purchase – Sprint Business | ( | — | ||||
Gains - equipment transactions and other, net | ( | | ||||
Loss on debt extinguishment and redemption – 2024 Euro Notes | — | | ||||
Foreign currency exchange gain on 2024 Euro Notes | — | ( | ||||
Deferred income taxes | ( | | ||||
Changes in operating assets and liabilities: | ||||||
Accounts receivable | ( | ( | ||||
Prepaid expenses and other current assets | ( | ( | ||||
Change in valuation – interest rate swap agreement | | | ||||
Due to T-Mobile – Transition Services Agreement | | — | ||||
Due from T-Mobile – Transition Services Agreement | ( | — | ||||
Unfavorable lease liabilities | ( | — | ||||
Accounts payable, accrued liabilities and other long-term liabilities | | | ||||
Deposits and other assets |
| ( |
| | ||
Net cash provided by operating activities |
| |
| | ||
Cash flows from investing activities: | ||||||
Cash receipts - IP Transit Agreement – T-Mobile | | — | ||||
Acquisition of Sprint Business, net of $ | ( | — | ||||
Purchases of property and equipment |
| ( |
| ( | ||
Net cash provided by (used in) investing activities |
| |
| ( | ||
Cash flows from financing activities: | ||||||
Dividends paid |
| ( | ( | |||
Redemption and extinguishment – 2024 Euro Notes | — | ( | ||||
Net proceeds from issuance of senior unsecured 2027 Notes - net of debt costs of $ | — | | ||||
Proceeds from exercises of stock options | | | ||||
Principal payments on installment payment agreement | — | ( | ||||
Principal payments of finance lease obligations | ( | ( | ||||
Net cash used in financing activities |
| ( |
| ( | ||
Effect of exchange rates changes on cash |
| |
| ( | ||
Net decrease in cash, cash equivalents and restricted cash |
| ( |
| ( | ||
Cash, cash equivalents and restricted cash, beginning of period |
| |
| | ||
Cash, cash equivalents and restricted cash, end of period | $ | | $ | | ||
Supplemental disclosure of non-cash financing activities: | ||||||
Fair value of equipment acquired in leases | $ | — | $ | | ||
Finance lease obligations incurred | $ | | $ | | ||
The accompanying notes are an integral part of these condensed consolidated statements.
Page 6 of 48
COGENT COMMUNICATIONS HOLDINGS, INC., AND SUBSIDIARIES
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. Description of the business:
Reorganization and merger
On May 15, 2014, pursuant to the Agreement and Plan of Reorganization (the “Merger Agreement”) by and among Cogent Communications Group, Inc. (“Group”), a Delaware corporation, Cogent Communications Holdings, Inc., a Delaware corporation (“Holdings”) and Cogent Communications Merger Sub, Inc., a Delaware corporation, Group adopted a new holding company organizational structure whereby Group is now a wholly owned subsidiary of Holdings. Holdings is a “successor issuer” to Group pursuant to Rule 12g-3(a) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). References to the “Company” for events that occurred prior to May 15, 2014 refer to Cogent Communications Group, Inc. and its subsidiaries and on and after May 15, 2014 the “Company” refers to Cogent Communications Holdings, Inc. and its subsidiaries. Cogent Communications, Inc. is wholly owned by Group and the vast majority of the Company’s assets, contractual arrangements, and operations are executed by Sprint Communications Company LP and Cogent Communications, Inc.
Description of business
The Company is a facilities-based provider of low-cost, high-speed Internet access, private network services, and data center colocation space and power. The Company’s network is specifically designed and optimized to transmit packet switched data. The Company delivers its services primarily to small and medium-sized businesses, communications service providers and other bandwidth-intensive organizations in
The Company offers on-net Internet access services exclusively through its own facilities, which run from its network to its customers’ premises. The Company offers its on-net services to customers located in buildings that are physically connected to its network. As a result, the Company is not dependent on local telephone companies or cable TV companies to serve its customers for its on-net Internet access and private network services. The Company’s on-net service consists of high-speed Internet access and private network services offered at speeds ranging from
The Company provides its on-net Internet access and private network services to its corporate, net-centric and enterprise customers. The Company’s corporate customers are located in multi-tenant office buildings that typically include law firms, financial services firms, advertising and marketing firms, as well as health care providers, educational institutions and other professional services businesses. The Company’s net-centric customers include bandwidth-intensive users that leverage its network either to deliver content to end users or to provide access to residential or commercial internet users. Content delivery customers include over the top media service providers, content delivery networks, web hosting companies, and commercial content and application software providers. Access customers include access networks comprised of other Internet Service Providers, telephone companies, mobile phone operators and cable television companies that collectively provide internet access to a substantial number of broadband subscribers and mobile phone subscribers across the world. These net-centric customers generally receive the Company’s services in carrier neutral colocation facilities and in the Company’s own data centers. The Company operates data centers throughout North America and Europe that allow its customers to collocate their equipment and access the Company’s network.
In addition to providing on-net services, the Company provides Internet access and private network services to customers that are not located in buildings directly connected to its network. The Company provides these off-net services primarily to corporate customers using other carriers’ circuits to provide the “last mile” portion of the link from the customers’ premises to the Company’s network. The Company also provides certain non-core services that resulted from acquisitions, including the acquisition of Sprint Communications (as discussed below). The Company continues to support but does not actively sell these non-core services.
In connection with the Company’s acquisition of Sprint Communications (as discussed below), the Company began to provide optical wavelength services and optical transport services over its fiber network. The Company is selling these wavelength services to its existing customers, customers of Sprint Communications and to new customers who require dedicated optical transport connectivity without the capital and ongoing expenses associated with owning and operating network infrastructure. Additionally, the Sprint Business customers include a number of companies larger than the Company’s historical customer base. In connection with the acquisition of Sprint Communications, the Company expanded selling services to these larger “Enterprise” customers.
Page 7 of 48
Recently Adopted Accounting Standards
In October 2021, the FASB issued ASU 2021-08, Business Combinations (Topic 805): Accounting for Contract Assets and Contract Liabilities from Contracts with Customers ("ASU 2021-08"). ASU 2021-08 requires an acquirer in a business combination to recognize and measure contract assets and contract liabilities in accordance with Revenue from Contracts with Customers (Topic 606), as if the acquirer had originated the contracts at the date of the business combination. ASU 2021-08 is effective for annual reporting periods beginning after December 15, 2022 and interim periods within those fiscal years. Early adoption is permitted.
The Company adopted ASU 2021-08 in connection with its acquisition of Sprint Communications (as discussed below), at which time it became applicable to the Company and was applied in the accounting for the acquisition. The adoption did not have a material impact on the provisional opening balance sheet recorded and there was no retrospective impact to our consolidated financial statements as a result of the adoption.
Acquisition of Sprint Communications
On September 6, 2022, Cogent Infrastructure, Inc., a Delaware corporation (the “Buyer”) and a direct wholly owned subsidiary of the Company, entered into a Membership Interest Purchase Agreement (the “Purchase Agreement”) with Sprint Communications LLC, a Kansas limited liability company (“Sprint Communications”) and an indirect wholly owned subsidiary of T-Mobile US, Inc., a Delaware corporation (“T-Mobile”), and Sprint LLC, a Delaware limited liability company and an indirect wholly owned subsidiary of T-Mobile (the “Seller”), pursuant to which the Company acquired the U.S. long-haul fiber network (including the non-U.S. extensions thereof) of Sprint Communications and its subsidiaries (the “Sprint Business”). The Purchase Agreement provides that, upon the terms and conditions set forth therein, the Company purchased from the Seller all of the issued and outstanding membership interests (the “Purchased Interests”) of Wireline Network Holdings LLC, a Delaware limited liability company that, following an internal restructuring and divisive merger, holds Sprint Communications’ assets and liabilities relating to the Sprint Business (such transactions contemplated by the Purchase Agreement, collectively, the “Transaction”). The Purchase Agreement includes customary representations, warranties, indemnities and covenants, including regarding the conduct of the Sprint Business prior to the closing of the Transaction (the “Closing”). In addition, the Closing was subject to customary closing conditions, including as to the receipt of certain required regulatory approvals and consents, all of which have been received. The Company has agreed to guarantee the obligations of the Buyer under the Purchase Agreement pursuant to the terms of a Guaranty, dated as of September 6, 2022, by and between the Company and the Seller (the “Parent Guaranty”). The Parent Guaranty contains customary representations, warranties and covenants of the Company and the Seller.
The Company believes it is in a unique position to monetize the Sprint Business and its network and management expects to achieve significant cost reduction synergies and revenue synergies from the Transaction. Revenue and pre-tax loss for the Sprint Business included in the Company’s condensed consolidated statements of comprehensive loss for the three-month period ended September 30, 2023 were $
Purchase Price
The Transaction closed on May 1, 2023 (the “Closing Date”). On the Closing Date, the Buyer consummated the Transaction pursuant to the terms of the Purchase Agreement, providing a purchase price of $
The Purchase Agreement also includes an estimated payment of $
Page 8 of 48
Payment amount that was accounted for by the Seller as a service agreement and not as a finance lease. As of September 30, 2023, the Company reclassified $
IP Transit Services Agreement
On the Closing Date, Cogent Communications, Inc. and T-Mobile USA, Inc., a Delaware corporation and direct subsidiary of T-Mobile (“TMUSA”), entered into an agreement for IP transit services (“IP Transit Services Agreement”), pursuant to which TMUSA will pay an affiliate of the Company an aggregate of $
The Company accounted for the Transaction as a business combination under ASC Topic 805 Business Combinations (“ASC 805”). The Company evaluated what elements are part of the business combination and the consideration exchanged to complete the acquisition. Under ASC 805, the Company has concluded that the $
Transition Services Agreement
On the Closing Date, the Buyer entered into a transition services agreement (the “TSA”) with the Seller, pursuant to which the Seller will provide to the Buyer, and the Buyer will provide to the Seller on an interim basis following the Closing Date, certain specified services (the “Transition Services”) to ensure an orderly transition following the separation of the Sprint Business from Sprint Communications. The services to be provided by the Seller to the Buyer include, among others, information technology support, back office and finance, real estate and facilities, vendor and supply chain management, the payment and processing of vendor invoices for the Company and human resources. The services to be provided by the Buyer to the Seller include, among others, information technology and network support, finance and back office and other wireless business support.
The Transition Services are generally intended to be provided for a period of up to
Either party to the TSA may terminate the agreement (i) with respect to any individual service in full for convenience upon
Page 9 of 48
Seller for the Company until these vendors are fully transitioned to the Company. The amounts due from the Seller are primarily reimbursements for severance costs related to Sprint Business employees and services provided by the Company for the Seller.
Other Services Provided to Seller
In addition, on the Closing Date, the Buyer and TMUSA entered into a commercial agreement (“Commercial Agreement”) for colocation and connectivity services, pursuant to which the Company will provide such services to TMUSA for a per service monthly fee plus certain third-party costs incurred in providing the services. During the three and nine months ended September 30, 2023 the Company recorded $
Acquisition-Related Costs
In connection with the Transaction and negotiation of the Purchase Agreement, the Company has incurred a total of $
Consideration
During the three months ended September 30, 2023, the Company updated its Working Capital Adjustment resulting in an additional $
(In thousands) |
| May 1, 2023 | |
Estimated working capital payments made to the Seller (a) | $ | | |
Estimated Purchase Agreement payment to be received from the Seller, net of discount of $ |
| | |
Amounts due from the Seller – IP Transit Services Agreement, net of discount of $ |
| | |
Total to be received from the Seller |
| | |
Total net consideration to be received from the Seller (d) |
| | |
Fair Value of Assets Acquired and Liabilities Assumed and Gain on Bargain Purchase
The Company accounted for the Transaction as a business combination under ASC 805. Under ASC 805, the identifiable assets acquired and liabilities assumed were recorded at their fair values as of the Closing Date. Assigning fair market values to the assets acquired and liabilities assumed at the date of an acquisition requires the use of significant judgment regarding estimates and assumptions. For the fair values of the assets acquired and liabilities assumed, the Company used the cost, income and market approaches, including market participant assumptions. The fair value of the identifiable assets acquired (including amounts due under the IP Transit Services Agreement) were in excess of the liabilities assumed and the net consideration to be paid resulting in a gain on bargain purchase of $
During the third quarter, the Company recorded a measurement period adjustment to reclassify $
The Transaction is considered an asset purchase for income tax purposes. The tax basis of the acquired business is the consideration paid ($
Page 10 of 48
The following table summarizes the fair values for each major class of assets acquired and liabilities assumed at the Closing Date. The Company retained the services of certified valuation specialists to assist with assigning values to certain acquired assets and assumed liabilities. The amounts presented are provisional and are subject to change as the Company refines the estimates and inputs used in the calculations of the assets acquired and liabilities assumed.
May 1, 2023 | |||
Assets |
|
| |
Current assets: |
|
| |
Cash and cash equivalents | $ | | |
Accounts receivable |
| | |
Prepaid expenses and other current assets |
| | |
Total current assets |
| | |
Total property and equipment |
| | |
Right-of-use leased assets |
| | |
Intangible assets |
| | |
Deposits and other assets |
| | |
Total assets | $ | | |
Liabilities |
|
| |
Current liabilities: |
|
| |
Accounts payable | $ | | |
Accrued and other current liabilities |
| | |
Current maturities, operating lease liabilities |
| | |
Current maturities, finance lease liabilities | | ||
Total current liabilities |
| | |
Operating lease liabilities, net of current maturities |
| | |
Finance lease liabilities, net of current maturities | | ||
Deferred income tax liabilities |
| | |
Other long-term liabilities |
| | |
Total liabilities |
| | |
Fair value of net assets acquired | $ | | |
Gain on bargain purchase | |||
Fair value of net assets acquired | $ | | |
Total net consideration to be received from the Seller, net of discounts (b) (c) (d) | | ||
Gain on bargain purchase | $ | | |
(a) Includes $
IP Transit Services Agreement
(b) Under the Purchase Agreement, 50% of the assumed short-term operating lease liabilities totaling $
(c) The IP Transit Services Agreement payments totaling $
(d) Cash consideration was $
Page 11 of 48
Intangible Assets
Intangible assets include $
Asset Retirement Obligations
In connection with the Transaction, the Company assumed $
Pro Forma Information
The following unaudited pro forma financial information gives effect to the Transaction as if it had been completed on January 1, 2022. The pro forma adjustments are based on historically reported transactions by the respective companies. The pro forma results do not include anticipated synergies or other expected benefits of the acquisition. The pro forma results for the nine months ended September 30, 2023 include the historical results of the Sprint Business through April 30, 2023 and the combined results of the Company and the Sprint Business for the five months ended September 30, 2023. The unaudited pro forma information is based upon available information and certain assumptions that the Company believes are reasonable under the circumstances. Actual results may differ materially from the assumptions within the accompanying unaudited pro forma financial information. The purchase adjustments are preliminary and subject to change as additional analyses are performed and finalized. The selected unaudited pro forma condensed combined financial information is provided for illustrative purposes only and does not purport to represent what the actual consolidated results of operations would have been had the Transaction actually occurred on January 1, 2022, nor do they purport to project the future consolidated results of operations.
| Nine Months |
| Nine Months | |||
Ended | Ended | |||||
(In thousands) | September 30, 2023 | September 30, 2022 | ||||
Service revenue | $ | | $ | | ||
Operating loss from continuing operations |
| ( |
| ( | ||
Net income |
| |
| | ||
The pro forma results for the nine months ended September 30, 2022 include estimates for the gain on bargain purchase related to the Transaction of $
The pro forma results for the nine months ended September 30, 2023 include the gain on bargain purchase related to the Transaction of $
Page 12 of 48
million and an increase to interest expense of $
Basis of presentation
The accompanying unaudited condensed consolidated financial statements have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission. In the opinion of management, the unaudited condensed consolidated financial statements reflect all normal recurring adjustments that the Company considers necessary for the fair presentation of its results of operations and cash flows for the interim periods covered, and of the financial position of the Company at the date of the interim condensed consolidated balance sheet. Certain information and footnote disclosures normally included in the annual consolidated financial statements prepared in accordance with U.S. generally accepted accounting principles, (“GAAP”) have been condensed or omitted pursuant to such rules and regulations. The operating results for interim periods are not necessarily indicative of the operating results for the entire year. While the Company believes that the disclosures are adequate to not make the information misleading, these interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes included in its annual report on Form 10-K for the year ended December 31, 2022.
The accompanying unaudited condensed consolidated financial statements include all wholly owned subsidiaries. All inter-company accounts and activity have been eliminated.
Use of estimates
The preparation of consolidated financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results may differ from these estimates.
Financial instruments
At September 30, 2023 and December 31, 2022, the carrying amount of cash and cash equivalents, restricted cash, accounts receivable, prepaid and other current assets, accounts payable, and accrued expenses approximated fair value because of the short-term nature of these instruments. The Company measures its cash equivalents and restricted cash at amortized cost, which approximates fair value based upon quoted market prices (Level 1). Based upon recent trading prices (Level 2—market approach) at September 30, 2023, the fair value of the Company’s $
Restricted cash and interest rate swap agreement
Restricted cash represents amounts held in segregated bank accounts by our clearing broker as margin in support of our Swap Agreement as discussed in Note 3 and was $
Gross receipts taxes, universal service fund and other surcharges
Revenue recognition standards include guidance relating to taxes or surcharges assessed by a governmental authority that are directly imposed on a revenue-producing transaction between a seller and a customer and may include, but are not limited to, gross receipts taxes, excise taxes, Universal Service Fund fees and certain state regulatory fees. Such charges may be presented gross or net based upon the Company’s accounting policy election. The Company records certain excise taxes and surcharges on a gross basis and includes them in its revenue and network operations expense. Excise taxes and surcharges billed to customers and recorded on a gross basis (as service revenue and costs of network operations) were $
Page 13 of 48
Basic and diluted net income per common share
Basic earnings per share (“EPS”) excludes dilution for common stock equivalents and is computed by dividing net income or (loss) available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted EPS is based on the weighted-average number of shares of common stock outstanding during each period, adjusted for the effect of dilutive common stock equivalents. Shares of restricted stock are included in the computation of basic EPS as they vest and are included in diluted EPS, to the extent they are dilutive, determined using the treasury stock method.
The following details the determination of diluted weighted-average shares:
| Three Months |
| Three Months |
| Nine Months |
| Nine Months | |
Ended | Ended | Ended | Ended | |||||
September 30, 2023 | September 30, 2022 | September 30, 2023 | September 30, 2022 | |||||
Weighted-average common shares - basic | |
| |
| |
| | |
Dilutive effect of stock options | — |
| — |
| |
| | |
Dilutive effect of restricted stock | — |
| — |
| |
| | |
Weighted-average common shares - diluted | |
| |
| |
| |
The following details unvested shares of restricted common stock as well as the anti-dilutive effects of stock options and restricted stock awards outstanding:
Three Months | Three Months | Nine Months | Nine Months | |||||
Ended | Ended | Ended | Ended | |||||
| September 30, 2023 |
| September 30, 2022 |
| September 30, 2023 |
| September 30, 2022 | |
Unvested shares of restricted common stock | |
| |
| |
| | |
Anti-dilutive options for common stock | |
| |
| |
| | |
Anti-dilutive shares of restricted common stock | |
| |
| |
| |
Page 14 of 48
Stockholders’ (Deficit) Equity
The following details the changes in stockholders’ (deficit) equity for the three and nine months ended September 30, 2023 and September 30, 2022, respectively (in thousands except share data):
Accumulated | |||||||||||||||||
Additional | Other | Total | |||||||||||||||
Common Stock | Paid-in | Comprehensive | Accumulated | Stockholders’ | |||||||||||||
| Shares |
| Amount |
| Capital |
| Income (Loss) |
| Deficit |
| Equity (Deficit) | ||||||
Balance at June 30, 2022 | | $ | | $ | | $ | ( | $ | ( | $ | ( | ||||||
Forfeitures of shares granted to employees |
| ( |
| — |
| — |
| — |
| — |
| — | |||||
Equity-based compensation |
| — |
| — |
| |
| — |
| — |
| | |||||
Foreign currency translation |
| — |
| — |
| — |
| ( |
| — |
| ( | |||||
Issuances of common stock |
| |
| — |
| — |
| — |
| — |
| — | |||||
Exercises of options |
| |
| — |
| |
| — |
| — |
| | |||||
Dividends paid |
| — |
| — |
| — |
| — |
| ( |
| ( | |||||
Net (loss) |
| — |
| — |
| — |
| — |
| ( |
| ( | |||||
Balance at September 30, 2022 |
| | $ | | $ | | $ | ( | $ | ( | $ | ( | |||||
| Accumulated | ||||||||||||||||
Additional | Other | Total | |||||||||||||||
Common Stock | Paid-in | Comprehensive | Accumulated | Stockholders’ | |||||||||||||
|
| Shares |
| Amount |
| Capital |
| Income (Loss) |
| Deficit |
| Equity (Deficit) | |||||
Balance at June 30, 2023 | |
| $ | |
| $ | |
| $ | ( |
| $ | ( |
| $ | | |
Forfeitures of shares granted to employees |
| ( |
|
| — |
|
| — |
|
| — |
|
| — |
|
| — |
Equity-based compensation |
| — |
|
| — |
|
| |
|
| — |
|
| — |
|
| |
Foreign currency translation |
| — |
|
| — |
|
| — |
|
| ( |
|
| — |
|
| ( |
Issuances of common stock |
| |
|
| — |
|
| — |
|
| — |
|
| — |
|
| — |
Exercises of options |
| |
|
| — |
|
| |
|
| — |
|
| — |
|
| |
Dividends paid |
| — |
|
| — |
|
| — |
|
| — |
|
| ( |
|
| ( |
Net (loss) |
| — |
|
| — |
|
| — |
|
| — |
|
| ( |
|
| ( |
Balance at September 30, 2023 |
| |
| $ | |
| $ | |
| $ | ( |
| $ | ( |
| $ | |
Accumulated | |||||||||||||||||
Additional | Other | Total | |||||||||||||||
Common Stock | Paid-in | Comprehensive | Accumulated | Stockholders’ | |||||||||||||
| Shares |
| Amount |
| Capital |
| Income (Loss) |
| Deficit |
| Equity (Deficit) | ||||||
Balance at December 31, 2021 |
| | $ | | $ | | $ | ( | $ | ( | $ | ( | |||||
Forfeitures of shares granted to employees |
| ( |
| — |
| — |
| — |
| — |
| — | |||||
Equity-based compensation |
| — |
| — |
| |
| — |
| — |
| | |||||
Foreign currency translation |
| — |
| — |
| — |
| ( |
| — |
| ( | |||||
Issuances of common stock |
| |
| — |
| — |
| — |
| — |
| — | |||||
Exercises of options |
| |
| — |
| |
| — |
| — |
| | |||||
Dividends paid |
| — |
| — |
| — |
| — |
| ( |
| ( | |||||
Net income |
| — |
| — |
| — |
| — |
| |
| | |||||
Balance at September 30, 2022 |
| | $ | | $ | | $ | ( | $ | ( | $ | ( | |||||
Page 15 of 48
Additional | Other | Total | |||||||||||||||
Common Stock | Paid-in | Comprehensive | Accumulated | Stockholders’ | |||||||||||||
| Shares |
| Amount |
| Capital |
| Income (Loss) |
| Deficit |
| Equity (Deficit) | ||||||
Balance at December 31, 2022 |
| |
| $ | |
| $ | |
| $ | ( |
| $ | ( |
| $ | ( |
Forfeitures of shares granted to employees |
| ( |
|
| — |
|
| — |
|
| — |
|
| — |
|
| — |
Equity-based compensation |
| — |
|
| — |
|
| |
|
| — |
|
| — |
|
| |
Foreign currency translation |
| — |
|
| — |
|
| — |
|
| ( |
|
| — |
|
| ( |
Issuances of common stock |
| |
|
| |
|
| — |
|
| — |
|
| — |
|
| |
Exercises of options |
| |
|
| — |
|
| |
|
| — |
|
| — |
|
| |
Dividends paid |
| — |
|
| — |
|
| — |
|
| — |
|
| ( |
|
| ( |
Net income |
| — |
|
| — |
|
| — |
|
| — |
|
| |
|
| |
Balance at September 30, 2023 |
| |
| $ | |
| $ | |
| $ | ( |
| $ | ( |
| $ | |
Revenue recognition
The Company recognizes revenue under ASU No. 2014-09, Revenue from Contracts with Customers (“ASC 606”), which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. Under ASC 606, installation fees for contracts with terms longer than month-to-month are recognized over the contract term. The Company believes that the installation fee does not give rise to a material right as defined by ASC 606 for contracts with terms longer than month-to-month. The Company recognizes revenue over the estimated average customer life for installation fees associated with month-to-month contracts, because the installation fee represents a material right as defined by ASC 606. The Company capitalizes certain contract acquisition costs that relate directly to a customer contract, including commissions paid to its sales team and sales agents, and amortizes these costs on straight-line basis over the period the services are transferred to the customer for commissions paid to its sales team (estimated customer life) and over the remaining original contract term for agent commissions. Management assesses these costs for impairment at least quarterly and as “triggering” events occur that indicate it is more likely than not that an impairment exists.
The Company’s service offerings consist primarily of on-net and off-net telecommunications services. Fixed fees are billed monthly in advance and usage fees are billed monthly in arrears. Amounts billed are due upon receipt and contract lengths range from month to month to
To achieve this core principle, the Company follows the following five steps:
| 1) | Identification of the contract, or contracts with a customer |
| 2) | Identification of the performance obligations in the contract |
| 3) | Determination of the transaction price |
| 4) | Allocation of the transaction price to the performance obligations in the contract |
| 5) | Recognition of revenue when, or as, the Company satisfies its performance obligations |
Page 16 of 48
Fees billed in connection with customer installations are deferred (as deferred revenue) and recognized as noted above. To the extent a customer contract is terminated prior to its contractual end the customer is subject to termination fees. The Company vigorously seeks payment of these termination fees. The Company recognizes revenue for termination fees as they are collected.
| Three Months |
| Three Months |
| Nine Months |
| Nine Months | |||||
Ended | Ended | Ended | Ended | |||||||||
(in thousands) | September 30, 2023 | September 30, 2022 | September 30, 2023 | September 30, 2022 | ||||||||
Service revenue recognized from balance at beginning of period | $ | | $ | | $ | | $ | | ||||
Amortization expense for contract costs |
| |
| |
| |
| | ||||
Leases
In February 2016, the FASB issued ASU No. 2016-02, Leases (“ASU 2016-02”). ASU 2016-02 replaced most existing lease accounting guidance. The operating lease liability under ASU 2016-02 is not considered a liability under the consolidated leverage ratio calculations in the indentures governing the Company’s senior unsecured and senior secured note obligations. The Company has made an accounting policy election to not apply the recognition requirements of ASU 2016-02 to its short-term leases - leases with a term of one year or less. The Company has also elected to apply certain practical expedients under ASU 2016-02 including not separating lease and non-lease components on its finance and operating leases.
| Three Months |
| Three Months |
| Nine Months |
| Nine Months | ||||||
Ended |
| Ended | Ended |
| Ended | ||||||||
(Amounts in thousands) |
| September 30, 2023 |
| September 30, 2022 |
| September 30, 2023 |
| September 30, 2022 | |||||
Finance lease cost |
|
|
| ||||||||||
Amortization of right-of-use assets | $ | | $ | | $ | | $ | | |||||
Interest expense on finance lease liabilities |
| | | | | ||||||||
Operating lease cost |
| | | | | ||||||||
Total lease costs | $ | | $ | | $ | | $ | | |||||
| Nine Months |
| Nine Months | ||||
Ended | Ended | ||||||
September 30, 2023 | September 30, 2022 | ||||||
Other lease information (amounts in thousands) | |||||||
Cash paid for amounts included in the measurement of lease liabilities | |||||||
Operating cash flows from finance leases | $ | ( | $ | ( | |||
Operating cash flows from operating leases | ( | ( | |||||
Financing cash flows from finance leases | ( | ( | |||||
Right-of-use assets obtained in exchange for new finance lease liabilities | | | |||||
Right-of-use assets obtained in exchange for new operating lease liabilities | | | |||||
Weighted-average remaining lease term — finance leases (in years) | |||||||
Weighted-average remaining lease term — operating leases (in years) | |||||||
Weighted-average discount rate — finance leases | | % | | % | |||
Weighted-average discount rate — operating leases | | % | | % | |||
Page 17 of 48
Finance leases—fiber lease agreements
The Company has entered into lease agreements with numerous providers of dark fiber under indefeasible-right-of use agreements (“IRUs”). These IRUs typically have initial terms of
Operating leases
The Company leases office space and certain data center facilities under operating leases. In certain cases, the Company also enters into short-term operating leases for dark fiber. Right-of-use assets represent the Company’s right to use an underlying asset for the lease term and lease liabilities represent its obligation to make lease payments under the lease. Operating lease right-of-use assets and liabilities are recognized at the lease commencement date based on the present value of lease payments over the reasonably certain lease term. The implicit rates within the Company’s operating leases are generally not determinable and the Company uses its incremental borrowing rate at the lease commencement date to determine the present value of its lease payments. The determination of the Company’s incremental borrowing rate requires some judgment. The Company determines its incremental borrowing rate for each lease using its current borrowing rate, adjusted for various factors, including the level of collateralization and term, to align with the term of the lease. Certain of the Company’s leases include options to extend or terminate the lease. The Company establishes the number of renewal option periods used in determining the operating lease term based upon its assessment at the inception of the operating lease of the number of option periods for which failure to renew the lease imposes a penalty in such amount that renewal appears to be reasonably certain. The option to renew may be automatic, at the option of the Company or mutually agreed to between the landlord or dark fiber provider and the Company. Once the Company has accepted the related fiber route or the facility lease term has begun, the present value of the aggregate future minimum operating lease payments is recorded as an operating lease liability and a right-of-use leased asset. Lease incentives, deferred rent liabilities and unfavorable lease liabilities for facilities operating leases are presented with, and netted against, the right-of-use leased asset. Lease expense for lease payments is recognized on a straight-line basis over the term of the lease.
The future minimum payments under these operating lease and finance lease agreements are as follows (in thousands):
| Operating |
| Finance | |||
For the Twelve Months Ending September 30, | Leases | Leases | ||||
2024 |
| $ | |
| $ | |
2025 | |
|
| | ||
2026 | |
|
| | ||
2027 | |
|
| | ||
2028 | |
|
| | ||
Thereafter | |
|
| | ||
Total minimum lease obligations | |
|
| | ||
Less—amounts representing interest | ( |
|
| ( | ||
Present value of minimum lease obligations | |
|
| | ||
Current maturities | ( |
|
| ( | ||
Lease obligations, net of current maturities | $ | |
| $ | | |
Page 18 of 48
Unfavorable lease liabilities
In connection with the Transaction, the Company recorded $
Allowance for credit losses
As of January 1, 2020, the Company maintained an allowance for credit losses to cover its current expected credit losses on its trade receivables arising from the failure of customers to make contractual payments. The Company estimates credit losses expected over the life of its trade receivables based on historical information combined with current conditions that may affect a customer’s ability to pay and reasonable and supportable forecasts. While the Company uses various credit quality metrics, it primarily monitors collectability by reviewing the duration of collection pursuits on its delinquent trade receivables. Based on the Company’s experience, the customer’s delinquency status is the strongest indicator of the credit quality of the underlying trade receivables, which is analyzed monthly.
|
| Current-period |
|
| ||||||||
Provision for | Write-offs | |||||||||||
Beginning | Expected Credit | Charged Against | Ending | |||||||||
Description |
| Balance |
| Losses (a) |
| Allowance |
| Balance | ||||
Allowance for credit losses (deducted from accounts receivable) (in thousands) |
|
|
|
| ||||||||
Three months ended September 30, 2023 | $ | |
| $ | |
| $ | ( |
| $ | | |
Three months ended September 30, 2022 | |
| |
| ( |
| | |||||
Nine months ended September 30, 2023 | |
| |
| ( |
| | |||||
Nine months ended September 30, 2022 | |
| |
| ( |
| | |||||
| Three Months |
| Three Months |
| Nine Months |
| Nine Months | |||||
Ended | Ended | Ended | Ended | |||||||||
(in thousands) | September 30, 2023 | September 30, 2022 | September 30, 2023 | September 30, 2022 | ||||||||
Net bad debt expense (a) | $ | |
| $ | |
| $ | |
| $ | | |
Bad debt recoveries |
| |
|
| |
|
| |
|
| | |
| (a) | Net bad debt expense related to the Wireless Business to reestablish an allowance for credit losses was $ |
2. Property and equipment:
Depreciation and amortization expense related to property and equipment and finance leases and capitalized compensation costs of employees directly involved with construction activities were as follows (in thousands):
| Three Months |
| Three Months |
| Nine Months |
| Nine Months | |||||
Ended | Ended | Ended | Ended | |||||||||
(in thousands) | September 30, 2023 | September 30, 2022 | September 30, 2023 | September 30, 2022 | ||||||||
Depreciation and amortization expense | $ | |
| $ | |
| $ | |
| $ | | |
Capitalized compensation cost |
| |
|
| |
|
| |
|
| | |
Page 19 of 48
3. Long-term debt:
As of September 30, 2023, the Company had outstanding $
Limitations under the indentures
The indentures governing the 2027 Notes and the 2026 Notes (the “Indentures”), among other things, limit the Company’s ability to incur indebtedness; to pay dividends or make other distributions; to make certain investments and other restricted payments; to create liens; to consolidate, merge, sell or otherwise dispose of all or substantially all of its assets; to incur restrictions on the ability of a subsidiary to pay dividends or make other payments; and to enter into certain transactions with its affiliates. There are certain exceptions to the limitations on the Company’s ability to incur indebtedness under the Indentures, including IRU agreements incurred in the normal course of business and any additional indebtedness if the Company’s consolidated leverage ratio, as defined in the Indentures, is less than
Interest rate swap agreement
As of September 30, 2023, the Company was party to an interest rate swap agreement (the “Swap Agreement”) that has the economic effect of modifying the fixed interest rate obligation associated with its 2026 Notes to a variable interest rate obligation based on the Secured Overnight Financing Rate (“SOFR”) so that the interest payable on the 2026 Notes effectively became variable based on overnight SOFR. The critical terms of the Swap Agreement match the terms of the 2026 Notes, including the notional amount and the optional redemption date on February 1, 2026. The Company did not elect hedge accounting for the Swap Agreement. The Swap Agreement is recorded at its fair value at each reporting period, and the Company incurs gains and losses due to changes in market interest rates. By entering into the Swap Agreement, the Company has assumed the risk associated with variable interest rates. Changes in interest rates affect the valuation of the Swap Agreement that the Company recognizes in its consolidated statements of comprehensive income. The values that the Company reports for the Swap Agreement as of each reporting date are recognized as “change in valuation – interest rate swap” with the corresponding amounts included in assets or liabilities in the Company’s consolidated balance sheets. As of September 30, 2023, the fair value of the Swap Agreement was a net liability of $
Page 20 of 48
Under the Swap Agreement, the Company pays the counterparty a semi-annual payment based upon overnight SOFR plus a contractual interest rate spread, and the counterparty pays the Company a semi-annual fixed
4. Commitments and contingencies:
Current and potential litigation
In accordance with the accounting guidance for contingencies, the Company accrues its estimate of a contingent liability when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. Where it is probable that a liability has been incurred and there is a range of expected loss for which no amount in the range is more likely than any other amount, the Company accrues at the low end of the range. The Company reviews its accruals at least quarterly and adjusts them to reflect the impact of negotiations, settlements, rulings, advice of legal counsel, and other information and events pertaining to a particular matter. The Company has taken certain positions related to its obligations for leased circuits for which it is reasonably possible could result in a loss of up to $
In the ordinary course of business, the Company is involved in other legal activities and claims. Because such matters are subject to many uncertainties and the outcomes are not predictable with assurance, the liability related to these legal actions and claims cannot be determined with certainty. Management does not believe that such claims and actions will have a material impact on the Company’s financial condition or results of operations. Judgment is required in estimating the ultimate outcome of any dispute resolution process, as well as any other amounts that may be incurred to conclude the negotiations or settle any litigation. Actual results may differ from these estimates under different assumptions or conditions and such differences could be material.
5. Income taxes:
The components of income (loss) before income taxes consist of the following (in thousands):
Three Months Ended |
| Three Months Ended |
| Nine Months Ended |
| Nine Months Ended | ||||||
| September 30, 2023 | September 30, 2022 | September 30, 2023 | September 30, 2022 | ||||||||
Domestic | $ | ( |
| $ | ( |
| $ | |
| $ | | |
Foreign |
| ( |
|
| ( |
|
| ( |
|
| ( | |
Total | $ | ( |
| $ | ( |
| $ | |
| $ | | |
6. Common stock buyback program and stock options and award plan:
The Company’s Board of Directors has approved purchases of shares of the Company’s common stock under a buyback program (the “Buyback Program”) through December 31, 2024. As of September 30, 2024, there was $
During the three months ended March 31, 2023, the Company granted
Page 21 of 48
In May 2023, the Company’s stockholders approved an increase of available shares for issuance under its 2017 Incentive Award Plan of
7. Dividends on common stock:
On November 1, 2023, the Company’s Board of Directors approved the payment of a quarterly dividend of $
The payment of any future dividends and any other returns of capital, including stock buybacks will be at the discretion of the Company’s Board of Directors and may be reduced, eliminated or increased and will be dependent upon the Company’s financial position, results of operations, available cash, cash flow, capital requirements, limitations under the Company’s debt indentures and other factors deemed relevant by the Company’s Board of Directors. The Company is a Delaware corporation and under the General Corporation Law of the State of Delaware, distributions may be restricted including a restriction that distributions, including stock purchases and dividends, do not result in an impairment of a corporation’s capital, as defined under Delaware law. The Indentures limit the Company’s ability to return cash to its stockholders.
8. Related party transactions:
Office leases
The Audit Committee of the Company's Board of Directors (the "Audit Committee") reviews and approves all transactions with related parties.
The Company’s headquarters is located in an office building owned by Sodium LLC whose owner is the Company’s Chief Executive Officer, David Schaeffer. The fixed annual rent for the headquarters building is $
On January 6, 2023, the Company entered into two lease agreements (the “New Leases”), one with Thorium LLC ('Thorium") and one with Germanium LLC (“Germanium”), entities owned by the Company’s Chief Executive Officer, David Schaeffer. The first of the New Leases is with Thorium for
On July 25, 2023 the Company entered into a Second Amendment to the lease agreement (the “Amendment”), with Germanium which amends the Network Operations Lease to lease an additional
The Company paid $
Page 22 of 48
9. Segment information:
The Company operates as
Three Months Ended September 30, 2023 | ||||||||||||||
Revenues |
| On-net |
| Off-net |
| Wavelength |
| Non-core |
| Total | ||||
North America | $ | |
| $ | |
| |
| $ | |
| $ | | |
Europe |
| |
|
| |
| — |
|
| |
|
| | |
South America | |
|
| |
| — |
|
| |
|
| | ||
Oceania | |
|
| |
| — |
|
| |
|
| | ||
Africa | |
|
| |
| — |
|
| — |
|
| | ||
Total | $ | |
| $ | |
| |
| $ | |
| $ | | |
Three Months Ended September 30, 2022 | ||||||||||||||
Revenues |
| On-net |
| Off-net |
| Wavelength |
| Non-core |
| Total | ||||
North America | $ | | $ | | — | $ | | $ | | |||||
Europe | | | — | | | |||||||||
South America | | | — | — | | |||||||||
Oceania | | | — | — | | |||||||||
Africa | | | — | — | | |||||||||
Total | $ | | $ | | — | $ | | $ | | |||||
Nine Months Ended September 30, 2023 | ||||||||||||||
Revenues |
| On-net |
| Off-net |
| Wavelength |
| Non-core |
| Total | ||||
North America | $ | |
| $ | |
|
| $ | |
| $ | | ||
Europe | |
|
| |
| — |
|
| |
|
| | ||
South America | |
|
| |
| — |
|
| |
|
| | ||
Oceania | |
|
| |
| — |
|
| |
|
| | ||
Africa | |
|
| |
| — |
|
| — |
|
| | ||
Total | $ | |
| $ | |
| |
| $ | |
| $ | | |
Nine Months Ended September 30, 2022 | ||||||||||||||
Revenues |
| On-net |
| Off-net |
| Wavelength |
| Non-core |
| Total | ||||
North America | $ | | $ | | — | $ | | $ | | |||||
Europe | | | — | | | |||||||||
South America | | | — | | | |||||||||
Oceania | | | — | | | |||||||||
Africa | | | — | — | | |||||||||
Total | $ | | $ | | — | $ | | $ | | |||||
September 30, | December 31, | |||||
| 2023 |
| 2022 | |||
Long-lived assets, net | ||||||
North America | $ | | $ | | ||
Europe and other |
| |
| | ||
Total | $ | | $ | | ||
The majority of North American revenue consists of services delivered within the United States.
Page 23 of 48
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
You should read the following discussion and analysis together with our condensed consolidated financial statements and related notes included in this report. The discussion in this report contains forward-looking statements that involve risks and uncertainties, such as statements of our plans, objectives, expectations and intentions. The cautionary statements made in this report should be read as applying to all related forward-looking statements wherever they appear in this report. Our actual results could differ materially from those discussed here. Factors that could cause or contribute to these differences include, but are not limited to:
Our acquisition of Sprint Communications (as defined below), including difficulties integrating our business with the Sprint Business, which may result in the combined company not operating as effectively and efficiently as expected; transition services required to support the Sprint Business and the related costs continuing for a period longer than expected, the COVID-19 pandemic and accompanying government policies worldwide; vaccination and in-office requirements, delays in the delivery of network equipment or optical fiber, loss of key right-of-way agreements, future economic instability in the global economy, including the risk of economic recession and recent bank failures and liquidity concerns at certain other banks, which could affect spending on Internet services; the impact of changing foreign exchange rates (in particular the Euro to US dollar and Canadian dollar to US dollar exchange rates) on the translation of our non-US dollar denominated revenues, expenses, assets and liabilities into US dollars; legal and operational difficulties in new markets; the imposition of a requirement that we contribute to the US Universal Service Fund on the basis of our Internet revenue; changes in government policy and/or regulation, including rules regarding data protection, cyber security and net neutrality; increasing competition leading to lower prices for our services; our ability to attract new customers and to increase and maintain the volume of traffic on our network; the ability to maintain our Internet peering and right-of-way arrangements on favorable terms; our ability to renew our long-term leases of optical fiber and right-of-way agreements that comprise our network; our reliance on a limited number of equipment vendors, and the potential for hardware or software problems associated with such equipment; the dependence of our network on the quality and dependability of third-party fiber and right-of-way providers; our ability to retain certain customers that comprise a significant portion of our revenue base; the management of network failures and/or disruptions; our ability to make payments on our indebtedness as they become due and outcomes in litigation, risks associated with variable interest rates under our Swap Agreement as well as other risks discussed from time to time in our filings with the Securities and Exchange Commission, including, without limitation, this report and our quarterly reports on Form 10-Q for the quarterly periods ended March 31, 2023 and June 30, 2023 and our annual report on Form 10-K for the year ended December 31, 2022.
General Overview
We are a facilities-based provider of low-cost, high-speed Internet access, private network services, and data center colocation space and power. Our network is specifically designed and optimized to transmit packet switched data. We deliver our services primarily to small and medium-sized businesses, communications service providers and other bandwidth-intensive organizations in 54 countries across North America, Europe, South America, Oceania and Africa. We are a Delaware corporation, and we are headquartered in Washington, DC.
We offer on-net Internet access services exclusively through our own facilities, which run from our network to our customers’ premises. We offer our on-net services to customers located in buildings that are physically connected to our network. As a result, we are not dependent on local telephone companies or cable TV companies to serve our customers for our on-net Internet access and private network service. Our on-net service consists of high-speed Internet access and private network services offered at speeds ranging from 100 megabits per second (“Mbps”) to 400 gigabits per second (“Gbps”).
Our on-net revenues represented 47.2% of our revenues for the three months ended September 30, 2023, 75.5% of our revenues for the three months ended September 30, 2022, 55.9% of our revenues for the nine months ended September 30, 2023 and 75.5% of our revenues for the nine months ended September 30, 2022. We provide our on-net Internet access and private network services to our corporate, net-centric and enterprise customers. Our corporate customers are located in multi-tenant office buildings (“MTOB’s”) which typically include law firms, financial services firms, advertising and marketing firms, as well as health care providers, educational institutions and other professional services businesses. Our net-centric customers include bandwidth-intensive users that leverage our network either to deliver content to end users or to provide access to residential or commercial internet users. Content delivery customers include over the top (“OTT”) media service providers, content delivery networks, web hosting companies, and commercial content and application software providers. Our net-centric customers include 7,971 access networks comprised of other Internet service providers (“ISPs”), telephone companies, mobile phone operators and cable television companies that
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collectively provide internet access to a substantial number of broadband subscribers and mobile phone subscribers across the world. These net-centric customers generally receive our services in carrier neutral colocation facilities and in our data centers. We expanded selling our services to enterprise customers in connection with our acquisition of the Sprint Business. We define “enterprise” customers as large corporations (typically, Fortune 500 companies with greater than $5 billion in annual revenue) running Wide Area Networks (“WAN”) with several dozen to several hundred sites. Our enterprise customers generally purchase our services on a price per location basis. We operate data centers throughout North America and Europe that allow our customers to collocate their equipment and access our network.
In addition to providing our on-net services, we provide Internet access and private network services to customers that are not located in buildings directly connected to our network. We provide these off-net services primarily to corporate customers using other carriers’ circuits to provide the “last mile” portion of the link from the customers’ premises to our network. Our off-net revenues represented 47.6% of our revenues for the three months ended September 30, 2023, 24.4% of our revenues for the three months ended September 30, 2022, 40.4% of our revenues for the nine months ended September 30, 2023 and 24.4% of our revenues for the nine months ended September 30, 2022.
Wavelength and Optical Transport Services
In connection with our acquisition of the Sprint Business, we expanded our offerings of optical wavelength services and optical transport services over our fiber network. We are selling these wavelength services to our existing customers, customers of Sprint Communications and to new customers who require dedicated optical transport connectivity without the capital and ongoing expenses associated with owning and operating network infrastructure. We are increasing the number of locations where we can sell wavelength services to meet customer demand. Revenues related to our optical wavelength services were $3.0 million and $4.6 million for the three and nine months ended September 30, 2023, respectively.
We also provide certain non-core services because of certain acquisitions, including our acquisition of the Sprint Business. We continue to support but do not actively sell these non-core services. We expect that our revenues from non-core services will decline. Our non-core revenues represented 4.2% of our revenues for the three months ended September 30, 2023, 0.1% of our revenues for the three months ended September 30, 2022, 3.0% of our revenues for the nine months ended September 30, 2023 and 0.1% of our revenues for the nine months ended September 30, 2022.
Acquisition of Sprint Communications
On May 1, 2023 (the “Closing Date”), Cogent Infrastructure, Inc., a Delaware corporation and our direct wholly owned subsidiary, closed on its acquisition of the U.S. long-haul fiber network (including the non-U.S. extensions thereof) of Sprint Communications and its subsidiaries (the “Sprint Business”) in accordance with the terms and conditions of the Membership Interest Purchase Agreement (the “Purchase Agreement”), dated September 6, 2022, by and among us, Sprint Communications LLC, a Kansas limited liability company (“Sprint Communications”) and an indirect wholly owned subsidiary of T-Mobile US, Inc., a Delaware corporation (“T-Mobile”), and Sprint LLC, a Delaware limited liability company and an indirect wholly owned subsidiary of T-Mobile (the “Seller”). On the Closing Date, we purchased from the Seller all of the issued and outstanding membership interests (the “Purchased Interests”) of Wireline Network Holdings LLC, a Delaware limited liability company that, following an internal restructuring and divisive merger, holds Sprint Communications’ assets and liabilities relating to the Sprint Business (such transactions contemplated by the Purchase Agreement, collectively, the “Transaction”).
Purchase Price
The Transaction closed on May 1, 2023 (the “Closing Date”). On the Closing Date, we consummated the Transaction pursuant to the terms of the Purchase Agreement, providing a purchase price of $1 payable to the Seller for the Purchased Interests, subject to customary adjustments, including working capital (the “Working Capital Adjustment”), as set forth in the Purchase Agreement. As consideration for the Purchased Interests, the Working Capital Adjustment (primarily related to acquired cash and cash equivalents of an estimated $43.4 million at the Closing Date in order to fund the international operations of the Sprint Business) was $66.1 million, of which $61.1 million was paid to the Seller on the Closing Date.
The Purchase Agreement also includes an estimated payment of $52.3 million from Seller to Buyer related to acquired short-term lease obligations (the “Short-term Lease Payment”). After further analysis, the Short-term Lease Payment was reduced by $4.8 million from $57.1 million at June 30, 2023 to $52.3 million at September 30, 2023. The Short-term Lease Payment will be paid from
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the Seller to us in four equal payments in months 55 to 58 after the Closing Date. The Short-term Lease Payment was recorded at its present value resulting in a discount of $15.6 million. The interest rate used in determining the present value was derived considering rates on similar issued debt instruments with comparable durations, amongst other market factors. The determination of the discount rate requires some judgment. The amortization of the discount resulted in interest income of $0.7 million and $1.2 million for the three and nine months ended September 30, 2023, respectively. A final determination of the Working Capital Adjustment and the Short-term Lease Payment is expected by the end of 2023.
IP Transit Services Agreement
On the Closing Date, Cogent Communications, Inc. and T-Mobile USA, Inc., a Delaware corporation and direct subsidiary of T-Mobile (“TMUSA”), entered into an agreement for IP transit services (“IP Transit Services Agreement”), pursuant to which TMUSA will pay us an aggregate of $700.0 million, consisting of (i) $350.0 million in equal monthly installments of $29.2 million per month during the first year after the Closing Date and (ii) $350.0 million in equal monthly installments of $8.3 million per month over the subsequent 42 months. We concluded that the $700.0 million cash consideration was not separately identifiable from the business combination. As a result, the IP Transit Services Agreement was recorded in connection with the Transaction. During the three and nine months ended TMUSA paid us $87.5 million and $116.7 million, respectively, under the IP Transit Agreement. On October 3, 2023 an additional $29.2 million payment was received. On November 2, 2023, an additional $29.2 million payment was received.
Transition Services Agreement
On the Closing Date, we entered into a transition services agreement (the “TSA”) with the Seller, pursuant to which the Seller will provide to us, and we will provide to the Seller on an interim basis following the Closing Date, certain specified services (the “Transition Services”) to ensure an orderly transition following the separation of the Sprint Business from Sprint Communications. The services to be provided by the Seller to us include, among others, information technology support, back office and finance, real estate and facilities, vendor and supply chain management including payments to vendors of the Sprint Business for us reimbursed at cost and human resources. The services to be provided by us to the Seller include, among others, information technology and network support, finance and back office and other wireless business support.
The Transition Services are generally intended to be provided for a period of up to two years following the Closing Date, although such period may be extended for an additional one-year term by either party upon 30 days’ prior written notice. The fees for the Transition Services are calculated using either a per service monthly fee or an hourly rate for the employees allocated to provide such services. Any third-party costs incurred in providing the Transition Services are passed on to the party receiving such services at cost for the two-year period and at cost plus 20 percent, if the TSA is extended.
Either party to the TSA may terminate the agreement (i) with respect to any individual service in full for convenience upon 30 days’ prior written notice for certain services and reduced for other services after a 90-day period. The TSA may be terminated in its entirety if the other party has failed to perform any of its material obligations and such failure is not cured within 30 days. The TSA provides for customary indemnification and limits on liability. During the three and nine months ended September 30, 2023 we were billed $101.2 million and $218.0 million as due to the Seller under the TSA, respectively, primarily for reimbursement at cost of payment to vendors of the Sprint Business. During the three and nine months ended September 30, 2023 we paid $153.1 million to the Seller under the TSA. Amounts billed under the TSA are due 30 days from receipt of the related invoice. As of September 30, 2023, we owed $69.6 million to the Seller and the Seller owed $16.8 million to us under the TSA. The amounts due from the Seller are primarily reimbursements for severance costs related to Sprint Business employees and services provided by the Company for the Seller.
Other Services Provided to Seller
In addition, on the Closing Date, we entered into a commercial agreement with TMUSA (“Commercial Agreement”) for colocation and connectivity services, pursuant to which we will provide such services to TMUSA for a per service monthly fee plus certain third-party costs incurred in providing the services. During the three and nine months ended September 30, 2023 we recorded $8.0 million and $15.3 million, respectively, from TMUSA under the Commercial Agreement. As of September 30, 2023, TMUSA owed $3.2 million to us under the Commercial Agreement.
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Competitive Advantages
We believe we address many of the data communications needs of small and medium-sized businesses, communications service providers and other bandwidth-intensive organizations by offering them high-quality, high-speed Internet access and private network services at attractive prices. With our acquisition of the Sprint Business, we began offering services to larger enterprise customers. We believe that our organization has the following competitive advantages:
Low Cost of Operation: We believe that the wireline telecom industry is undergoing, and will continue to face, significant price deflation for its applications and services. This price deflation is a result of a variety of factors including increased competition, enhanced substitutability of certain products and services and the continued impact of Moore’s Law, which has driven down the cost of technology, particularly for fiber optic Wavelength Division Multiplexing (“WDM”) equipment and optically interfaced routers. Faced with the backdrop of continued price deflation in our industry, we have made a series of discreet choices around our network design, operating strategy and product offerings that are consistent with our objective of becoming the low cost operator in our industry. Since our initiation of operations, this strategy has resulted in a rapid decline in our cost to transmit bits, which has increased our margins and decreased our capital intensity as measured by our capital expenditures per total revenues. Over the last five fiscal years, our cost of goods sold per bit delivered for our customers has declined at a compounded annual rate of 21.0%. Important components of our low cost operating strategy include:
| ● | One Network Protocol. Upon our founding, we selected to operate our network solely using Ethernet protocol. We made this selection in order to take advantage of the significantly greater installed base and lower cost of Ethernet network equipment versus other protocols, the substantially lower costs associated with operating and maintaining one network protocol and the continued benefits of the rapid price performance ratio improvements of Ethernet-related equipment. Our single network design allows us to avoid many of the costs that our competitors who operate circuit-switched, time-division multiplexing (“TDM”) and hybrid fiber coaxial networks incur related to provisioning, monitoring and maintaining multiple transport protocols. Selecting one operating protocol has also had positive effects in terms of our operating overhead and the simplicity of our organization. We believe the vast majority of our competition currently operates their networks with multiple protocols and we believe that attempts to upgrade their networks to one protocol would be operationally challenging and costly. |
| ● | Widespread Access to Fiber on a Cost Effective, Long-Term Basis. We have acquired a large portfolio of dark fiber leases from around the world sourced from the excess inventory of existing networks. This choice to lease rather than build reduces our capital intensity and the operating costs of our intercity and metro networks. The nature of this portfolio and the individual leases provide us long-term access to dark fiber at attractive rates and, in many cases the opportunity to extend these leases for multiple terms. On average, a modest number of our dark fiber leases come up for renewal each year. We have relationships with over 320 dark fiber vendors across the globe, enabling us to lease dark fiber on a long-term, cost-effective basis to virtually any geographic route or facility we require. The acquisition of the Sprint fiber network provides us significant additional fiber assets |
| ● | Narrow and Focused Product Set. Since our founding, we have strategically focused on delivering a very narrow product set to our customers. The vast majority of our revenue is driven by or related to our high-capacity, bi-directional, symmetric internet access services which can be accessed on-net in MTOBs and carrier neutral data centers (“CNDCs”) or off-net through other carriers’ “last mile” connections to customer facilities. There are significant cost advantages as a result of this narrow product set. We believe that the relative size of our salesforce training, support and overhead is lower than comparable telecom providers that tend to offer a broader, one-stop shop product set to their client base. |
| ● | Scalable Network Equipment and Hub Configurations. Due to our single network protocol and narrow product set, our transmission and network operations rely mainly on two sets of equipment for operation. In order to further scale our operating leverage, we have systematically reused older equipment in less dense portions of our network. Due to interoperability between the generations of products, we are able to transfer older equipment from our core, high-traffic areas to newer, less congested routes. The result of this dynamic grooming process is that we are able to utilize our equipment for materially longer periods than the expected life of this equipment, thereby reducing our capital investment in our network. We design and build all of our network hubs to the same standards and configurations. This replication strategy provides us scale benefits in equipment purchases, training, and maintenance. |
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| ● | Low cost right-of-way agreements. In connection with our acquisition of the Sprint Business, we acquired numerous right-of-way agreements. Many of these right-of-way agreements are at favorable rates and these agreements would be difficult to obtain. |
Greater Control and Superior Delivery. Our on-net service does not rely on circuits that must be provisioned by a third-party carrier. In our on-net MTOBs we provide our customers the entire network, including the “last mile” and the in-building wiring connecting to our customer’s suite. In our CNDCs we are collocated with our customers. As a result, only a cross-connection within the data center is required to provide our services to our customers. The structure of our on-net service provides us with more control over our service, quality and pricing. It also allows us to provision services more quickly and efficiently than provisioning services on a third-party carrier network. The vast majority of our on-net services can be installed in less than two weeks, which is materially faster than the installation times for some of our incumbent competitors.
High-Quality, Reliable Service. We are able to offer high-quality Internet service due to our network design and composition. We believe that we deliver a high level of technical performance because our network is optimized for packet switched traffic. Its design increases the speed and throughput of our network and reduces the number of data packets dropped during transmission compared to traditional circuit-switched networks. We believe that our network is more reliable and carries traffic at lower cost than networks built as overlays to traditional circuit-switched, or TDM networks.
Large Addressable Market. We have systematically evaluated and chosen our network extensions to buildings, data centers and markets based upon a rigorous set of criteria to evaluate the economic opportunity of network locations. Additional factors relevant to our pursuit of new buildings include the willingness of building owners to grant us access rights, the availability of optical fiber networks to serve those buildings, the costs to connect buildings to our network and equipment availability. We have also begun to evaluate the sustainability of new locations by evaluating the LEED Green Rating of Buildings, the potential to source renewable energy at potential locations and the potential impact of climate change on a location including access to water and the risk of flooding. Our network is connected to 3,257 total buildings located in 227 metropolitan markets. These buildings include 1,860 large MTOBs (totaling 1.0 billion square feet of office space) in major North American cities where we offer our services to a diverse set of high-quality corporate customers within close physical proximity of each other. These buildings also include 1,528 CNDCs located in 1,337 buildings in North America, Europe, South America, Oceania and Africa where our net-centric customers directly interconnect with our network. We also operate 60 of our own data centers (four of which converted from facilities acquired with the Sprint Business) across the United States and in Europe, which comprise over 808,000 square feet of floor space and are directly connected to our network. We believe that these network points of presence strategically position our network to attract high levels of Internet traffic and maximize our revenue opportunities and profitability.
Balanced, High-Traffic Network. Since its inception, our network has grown significantly in terms of its geographic reach, customer connections, and traffic. We currently serve 7,971 access networks as well as numerous large and small content providers and 55,045 corporate customer connections. Because of these growing bases of customers who distribute (content providers) and receive (access networks) content on our network, we believe that the majority of all the traffic remains “on-net” by both originating and terminating on our network. This control of traffic is an important differentiator as it increases our service reliability and speed of traffic delivery. The increasing share of traffic delivered from content providers to access networks also enhances our margins as we are compensated by both the originating customer and terminating customer. The breadth of our network, extensive size of our customer base, and the volume of our traffic enables us to be one of a handful of Tier 1 networks that are interconnected on a settlement-free basis. This Tier 1 network peering status broadens our geographic delivery capability and materially reduces our network costs.
Proven and Experienced Management Team. Our senior management team is composed of seasoned executives with extensive expertise in the telecommunications industry as well as knowledge of the markets in which we operate. The members of our senior management team have an average of over 20 years of experience in the telecommunications industry and many have been working together at the Company for several years. Several members of the senior management team have been working together at the Company since 2000. Our senior management team has designed and built our network and, during our formative years, led the integration of network assets we acquired through 13 significant previous acquisitions and managed the expansion and growth of our business. We anticipate that our management team will successfully manage the integration of the Sprint Business into our current operations.
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Our Strategy
We intend to become the leading provider of high quality, high-speed Internet access and private network services and to continue to improve our profitability and cash flow. The principal elements of our strategy include:
Grow our Corporate Customer Base. Our on-net corporate customers are typically small to medium-sized businesses connected to our network through MTOBs or connected to our network through one of our CNDCs. We generally sell two types of services to our corporate customers: dedicated internet access and private network services. We typically sell dedicated internet access at the same price per connection as our competitors, but our customers benefit from our significantly faster speeds and rapid installation times. These customers are increasingly integrating off-site data centers and cloud services into their IT infrastructure in order to take advantage of the safety, security and redundancy that is offered by locating company processing power, storage and software at a data center. An important part of this new infrastructure is a high-speed, dedicated internet connection from the corporate premises to the data center and the Internet and from one corporate premises to other corporate premises. We believe that the importance of data centers will increasingly lead tenants to reconfigure their communications infrastructure to include dedicated internet access across their locations. With our acquisition of Sprint Business, we began offering services to larger enterprise customers.
Increase our Share of the Net-Centric Market. We are currently one of the leading providers of high-speed internet access to a variety of content providers and access networks across the world. We intend to further load our high-capacity network as a result of the growing demand for high-speed internet access generated by these types of bandwidth-intensive applications such as over-the-top (“OTT”) media services, online gaming, video, Internet of Things (“IoT”), voice over IP (“VOIP”), remote data storage, and other services. We expect that we will continue to grow our shares of these segments by offering our customers a series of attractive features including:
| ● | Geographic breadth – We have the broadest CNDC footprint in the industry and currently offer network services in 54 countries – as net-centric customers seek a more international audience this footprint is a significant advantage; |
| ● | High capacity and reliability – We offer 100 Mbps to 100 Gbps ports in all of the CNDCs and 400 Gbps in selected locations on our network, which differentiates the capacity choices we provide our net-centric clients; |
| ● | Balanced customer base – Our leading share of content providers and access networks increases the amount of traffic that originates and terminates on our network thereby reducing latency and enhancing reliability; |
| ● | Large and dedicated salesforce – Our team of net-centric sales professionals is one of the largest salesforces in this industry segment and enables us to better serve this customer segment while also identifying new sales opportunities and gaining new business and customers; and |
| ● | The customers of the Sprint Business will include a number of large enterprise customers, a type of customer that we have not traditionally served. |
Pursue On-net Customer Growth. Our high-capacity network provides us with the ability to add a significant number of customers to our network with minimal direct incremental costs. We intend to increase usage of our network and operational infrastructure by adding customers in our existing on-net buildings, as well as developing additional markets and connecting more MTOBs and CNDCs to our network. We emphasize our on-net services because they generate greater profit margins and we have more control over service levels, quality and pricing, and our on-net services are provisioned in considerably less time than our off-net services. Our fiber network connects directly to our on-net customers’ premises and we pay no local access (“last mile”) charges to other carriers to provide our on-net services.
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Continue to Improve our Sales Efforts and Productivity. A critical factor in our success has been our investment and focus on our sales and marketing efforts. We seek to maintain a consistent level of sales productivity as measured by the number of connections sold per salesperson per month, taking into account adjustments to the changing mix of products sold and installed. In order to gain market share in our targeted businesses, we expect to continue our sales efforts including introducing strategies and tools to optimize and improve our sales productivity. We have developed several training programs that are directed toward increasing our sales representative tenure and increasing our sales representative productivity. In addition, we have required all of our employees to work in the office on a full-time basis, thereby providing additional opportunities for management coaching and oversight in order to increase productivity.
Expand our Off-net Corporate Internet Access Business. We have agreements with over 580 national and international carriers providing us last mile network access to over 6 million commercial buildings that are lit by fiber optic cable across North America and that are not currently served by our network. We believe these agreements broaden our addressable market for corporate dedicated internet access and enhances our competitive position through the ability to provide enterprise-wide connectivity for corporate customers. In order to take advantage of this large set of commercial buildings we have developed an automated process to enable our salesforce to identify opportunities in the off-net market for dedicated internet access and to quickly offer pricing proposals to potential customers. We continue to negotiate reduced pricing under our numerous carrier agreements that enable us to reduce our cost of off-net services, which enhances our competitive position in the marketplace.
Expand our Product Offerings to Include Wavelength and Optical Transport Services. In connection with the Transaction, we expanded our offerings of optical wavelength and optical transport services over our fiber network. We are selling these services to our existing customers, customers of Sprint Communications and to new customers who require dedicated optical transport connectivity without the capital and ongoing expenses associated with owning and operating network infrastructure. We operate data centers throughout North America and Europe that allow our customers to collocate their equipment and access our network. In connection with the Transaction, we will also expand our colocation offerings.
Results of Operations
Three Months Ended September 30, 2023 Compared to the Three Months Ended September 30, 2022
Our management reviews and analyzes several key financial measures in order to manage our business and assess the quality and variability of our service revenue, operating results and cash flows. The following summary tables present a comparison of our results of operations with respect to certain key financial measures. The comparisons illustrated in the tables are discussed in greater detail below.
Three Months Ended |
| ||||||||
September 30, | Percent |
| |||||||
| 2023 |
| 2022 |
| Change | ||||
(in thousands) |
| ||||||||
Service revenue | $ | 275,429 | $ | 150,000 | 83.6 | % | |||
On-net revenue |
| 130,049 |
| 113,219 |
| 14.9 | % | ||
Off-net revenue |
| 130,970 |
| 36,611 |
| 257.7 | % | ||
Wavelength revenue | 2,992 | — | NM | ||||||
Non-core revenue |
| 11,417 |
| 170 |
| NM | |||
Network operations expenses (1) |
| 173,594 |
| 57,220 |
| 203.4 | % | ||
Selling, general, and administrative (“SG&A) expenses (2) | 65,308 | 39,114 | 67.0 | % | |||||
Acquisition costs – Sprint Business | 351 | 2,004 | (82.5) | % | |||||
Depreciation and amortization expenses |
| 86,734 |
| 22,897 |
| 278.8 | % | ||
Change in valuation - interest rate swap agreement | 4,825 | 16,923 | NM | ||||||
Loss on bargain purchase – Sprint Business | 3,332 | — | NM | ||||||
Interest income – IP Transit Services Agreement | 10,299 | — | NM | ||||||
Interest expense | 24,198 | 17,948 | 34.8 | % | |||||
Income tax (benefit) expense |
| (13,623) |
| 969 |
| NM | |||
| (1) | Includes non-cash equity-based compensation expenses of $370 and $176 in the three months ended September 30, 2023 and 2022, respectively. |
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| (2) | Includes non-cash equity-based compensation expenses of $7,041 and $6,035 in the three months ended September 30, 2023 and 2022, respectively. |
NM – not meaningful
September 30, | Percent |
| |||||||
| 2023 |
| 2022 |
| Change |
| |||
Other Operating Data |
| ||||||||
Average Revenue Per Unit (ARPU) |
|
|
|
|
|
| |||
ARPU - on-net | $ | 475 |
| $ | 458 |
| 3.8 | % | |
ARPU - off-net | $ | 1,156 |
| $ | 920 |
| 25.6 | % | |
ARPU - wavelengths | $ | 2,312 |
| $ | — |
| NM |
| |
Average Price per Megabit — installed base | $ | 0.30 |
| $ | 0.27 |
| 9.6 | % | |
Customer Connections—end of period |
|
|
|
|
|
|
| ||
On-net |
| 89,623 |
|
| 82,614 |
| 8.5 | % | |
Off-net |
| 36,766 |
|
| 13,359 |
| 175.2 | % | |
Wavelengths |
| 449 |
|
| — |
| NM |
| |
Non-core |
| 11,187 |
|
| 348 |
| NM | ||
Service Revenue. We continually work to grow our total service revenue by increasing the number of potential customers that we can reach on our network. We do this by investing capital to expand the geographic footprint of our network, increasing the number of buildings that we are connected to, including CNDC’s and MTOB’s, and increasing our penetration rate into our existing buildings. These efforts broaden the global reach of our network and increase the size of our potential addressable market. We also seek to grow our service revenue by investing in our sales and marketing team. We typically sell corporate connections at similar pricing to our competitors, but our clients benefit from our significantly faster speeds, greater aggregate throughput, enhanced service level agreements and rapid installation times. In the net-centric market, we offer comparable services in terms of capacity but typically at significantly lower prices.
Our service revenue increased by 83.6% from the three months ended September 30, 2022 to the three months ended September 30, 2023. Exchange rates positively affected our increase in service revenue by $1.8 million. All foreign currency comparisons herein reflect results for the three months ended September 30, 2023 translated at the average foreign currency exchange rates for the three months ended September 30, 2022. We increased our total service revenue by expanding our network, adding additional buildings to our network, increasing our penetration into the buildings connected to our network and gaining market share by offering our services at lower prices than our competitors. Revenue from the Sprint Business for the three months ended September 30, 2023 was $113.0 million.
Revenue recognition standards include guidance relating to any tax assessed by a governmental authority that is directly imposed on a revenue-producing transaction between a seller and a customer and may include, but is not limited to, gross receipts taxes, Universal Service Fund fees and certain state regulatory fees. We record these taxes billed to our customers on a gross basis (as service revenue and network operations expense) in our consolidated statements of comprehensive income. The impact of these taxes including the Universal Service Fund resulted in an increase to our revenues of $10.4 million from the three months ended September 30, 2022 to the three months ended September 30, 2023. Excise taxes from the Sprint Business for the three months ended September 30, 2023 were $10.8 million.
Revenue and customer connections by customer type
Our corporate customers generally purchase their services on a price per connection basis. Our net-centric customers generally purchase their services on a price per megabit-metered basis. We began to serve enterprise customers in connection with our acquisition of the Wireless Business. We define “enterprise” customers as large corporations (typically, Fortune 500 companies with greater than $5 billion in annual revenue) running Wide Area Networks (“WAN”) with several dozen to several hundred sites. Our enterprise customers generally purchase our services on a price per location basis. Revenues from our corporate, net-centric customers and enterprise customers represented 43.7%, 34.5% and 21.8% of total service revenue, respectively, for the three months ended September 30, 2023. Revenues from our corporate and net-centric customers represented 57.0% and 43.0% of total service revenue, respectively, for the three months ended September 30, 2022. Revenues from corporate customers increased by 40.9% to $120.5 million for the three months ended September 30, 2023 compared to the three months ended September 30, 2022. Revenues from our
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net-centric customers increased by 47.2% to $94.9 million for the three months ended September 30, 2023 compared to the three months ended September 30, 2022. Revenues from our enterprise customers were $60.0 million for the three months ended September 30, 2023. Certain of our historical corporate and net-centric customers (in total approximately 400 customers representing approximately $0.3 million in monthly recurring revenue) have been reclassified from our legacy net-centric and corporate revenue and customer connections to enterprise revenue and customer connections. Certain of the customer connections we acquired in the Sprint Business were classified as corporate and net-centric revenue and customer connections. We acquired 17,823 corporate customer connections, 5,711 net-centric customer connections and 23,209 enterprise customer connections with the Sprint Business. In connection with our acquisition of the Sprint business, we classified the Sprint Business revenue as $20.1 million of monthly recurring revenue as enterprise revenue, $12.9 million of monthly recurring revenue as corporate revenue and $6.5 million of monthly recurring revenue as net-centric revenue.
Our revenue from our corporate customers increased primarily due to corporate customer connections acquired with the Sprint Business. Our corporate customers take advantage of our superior speeds, greater aggregate throughput, service levels and installation times versus our competitors. The growing trend of customers installing second lines for redundancy in order to construct virtual private networks (“VPNs”) has also led to our ability to increase our corporate revenues. Beginning with and throughout the COVID-19 pandemic, we witnessed a deteriorating real estate market in and around the buildings we service in central business districts in North America. Because of the rising vacancy levels and falling lease initiations or renewals, we experienced a slowdown in new sales to our corporate customers, which negatively affected our legacy corporate revenue results. During the three months ended September 30, 2023, we slowly began to see declining vacancy rates and rising office occupancy rates. In addition, we began to see positive trends in our corporate business. As the option to fully or partially work from home becomes permanently established at many companies, our corporate customers are integrating some of the new applications that became part of the remote work environment, which benefits our corporate business as these customers upgrade their Internet access infrastructure to higher capacity connections. Further, if and when companies eventually return to the buildings in which we operate, we believe it will present an opportunity for increased sales. However, the exact timing and path of these positive trends remains uncertain, and as the after effects of the COVID-19 pandemic linger, we may continue to see increased corporate customer turnover, fewer upgrades of existing corporate customer configurations and fewer new tenant opportunities, which would negatively affect our corporate revenue growth.
Our revenue from our net-centric customers increased primarily due to an increase in our number of net-centric customers, growth in network traffic from these customers and from net-centric customer connections acquired with the Sprint Business partly offset by a decline in our average price per megabit. Our net-centric customers purchase our services on a price per megabit basis. The net-centric market exhibits significant pricing pressure due to the continued introduction of new technology, which lowers the marginal cost of transmission and routing, and the commodity nature of the service where price is typically the only differentiating factor for these customers. Our average price per megabit of our installed base of customers increased by 9.6% from the three months ended September 30, 2022 to the three months ended September 30, 2023 from the impact of the price per megabit customers acquired in the Sprint Business. The impact of foreign exchange rates has a more significant impact on our net-centric revenues.
Revenue and customer connections by network connection type
Our on-net revenues increased by 14.9% from the three months ended September 30, 2022 to the three months ended September 30, 2023. Our on-net revenues increased as we increased the number of our on-net customer connections by 8.5% at September 30, 2023 from September 30, 2022. On-net revenue increased at a greater rate than on-net customer connections primarily due to an increase in our on-net ARPU from the three months ended September 30, 2022 to the three months ended September 30, 2023. ARPU is determined by dividing revenue for the period by the average customer connections for that period. On-net revenues from customers acquired in the Sprint Business were $6.3 million for the three months ended September 30, 2023.
Our off-net revenues increased by 257.7% from the three months ended September 30, 2022 to the three months ended September 30, 2023. Our off-net revenues increased primarily from the 175.2% increase in the number of our off-net customer connections from September 30, 2022 to September 30, 2023. Off-net revenues from customers acquired in the Sprint Business were $92.4 million for the three months ended September 30, 2023.
In connection with our acquisition of the Sprint Business, we expanded our offering of optical wavelength and optical transport services over our fiber network. Wavelength revenues from customers acquired in the Sprint Business were $3.0 million for the three months ended September 30, 2023.
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Our non-core revenues increased from the three months ended September 30, 2022 to the three months ended September 30, 2023 primarily from the acquisition of non-core revenues from customers acquired in the Sprint Business. Non-core revenues from customers acquired in the Sprint Business were $11.3 million for the three months ended September 30, 2023.
Network Operations Expenses. Network operations expenses include the costs of personnel associated with service delivery, network management and customer support, network facilities costs, fiber and equipment maintenance fees, leased circuit costs, access and facilities fees paid to building owners and excise taxes billed to our customers and recorded on a gross basis. Our network operations expenses, including non-cash equity-based compensation expense, increased by 203.4% from the three months ended September 30, 2022 to the three months ended September 30, 2023. Non-cash equity-based compensation expense is included in network operations expenses consistent with the classification of the employee’s salary and other compensation. The increase in network operations expense is primarily attributable to an increase in costs related to our network and facilities expansion activities, an increase in power costs and $101.6 million of network operations expense from our acquisition of the Sprint Business for the three months ended September 30, 2023.
Selling, General, and Administrative (“SG&A”) Expenses. Our SG&A expenses, including non-cash equity-based compensation expense, increased by 67.0% from the three months ended September 30, 2022 to the three months ended September 30, 2023. Non-cash equity-based compensation expense is included in SG&A expenses consistent with the classification of the employee’s salary and other compensation. SG&A expenses increased primarily from an increase in salaries and benefits from an 91.2% increase in our total headcount, including 942 employees added to our headcount from our acquisition of the Sprint Business. Our sales force headcount, inclusive of sales management, was 833 at September 30, 2023 and 669 at September 30, 2022, and our total headcount was 1,990 at September 30, 2023 and 1,041 at September 30, 2022. The Sprint Business added 114 employees to our sales force headcount. SG&A expense from our acquisition of the Sprint Business was $29.9 million for the three months ended September 30, 2023.
Depreciation and Amortization Expenses. Our depreciation and amortization expense increased by 278.8% from the three months ended September 30, 2022 to the three months ended September 30, 2023. The increase is primarily due to the depreciation expense associated with the increase in deployed fixed assets and $59.0 of depreciation and amortization expense from assets, including a finance lease totaling $160.9 million being amortized over forty-four months, acquired with the Sprint Business.
Gain on Bargain Purchase
We accounted for our acquisition of the Sprint Business as a business combination. The identifiable assets acquired and liabilities assumed were recorded at their fair values as of the acquisition date. Assigning fair market values to the assets acquired and liabilities assumed at the date of an acquisition requires the use of significant judgment regarding estimates and assumptions. The fair value of the identifiable assets acquired was $1.5 billion (including amounts due under the IP Transit Services Agreement) and was in excess of the $1.0 billion liabilities assumed and the $0.6 billion net consideration to be received from the Seller resulting in a gain on bargain purchase of $1.2 billion. During the three months ended September 30, 2023, certain adjustments were made to the purchase price resulting in a reduction to the total gain on bargain purchase of $3.3 million.
Interest Income - IP Transit Services Agreement
On the Closing Date, we entered into the IP Transit Services Agreement with T-Mobile USA, Inc., (“TMUSA”), pursuant to which TMUSA will pay us an aggregate of $700.0 million, consisting of (i) $350.0 million in equal monthly installments during the first year after the Closing Date and (ii) $350.0 million in equal monthly installments over the subsequent 42 months.
We accounted for the Transaction as a business combination under ASC Topic 805 Business Combinations (“ASC 805”). Under ASC 805, we concluded that the $700.0 million of payments to be made represent consideration received to complete the acquisition of a distressed business. We also evaluated whether the IP Transit Services Agreement was in the scope of ASU No. 2014-09 Revenue from Contracts with Customers (“ASC 606”). We concluded that TMUSA did not represent a “customer” as defined by ASC 606, the stated contract price did not represent consideration for services to be delivered, and the transaction did not satisfy the definition of revenue, which excluded this arrangement from the scope of ASC 606. As a result, the IP Transit Services Agreement was recorded in connection with the Transaction at its discounted present value resulting in a discount of $79.6 million. The amortization of the discount resulted in interest income of $10.3 million for the three months ended September 30, 2023.
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Interest Expense. Our interest expense resulted from interest incurred on our $500.0 million aggregate principal amount of 3.50% Senior Secured Notes due 2026 that we issued in May 2021 (the “2026 Notes”), interest incurred on our $450.0 million aggregate principal amount of 7.00% Senior Unsecured Notes due 2027 that we issued in June 2022 (the “2027 Notes”) and interest incurred on our finance lease obligations. Our finance leases include a lease totaling $160.9 million being amortized over forty-four months, acquired with the Sprint Business. Our interest expense increased by 34.8% from the three months ended September 30, 2022 to the three months ended September 30, 2023. The increase was primarily due to the impact of the finance lease acquired with the Sprint Business and an increase in interest rates on our 2027 Notes as compared to the 2024 Notes.
Change in Valuation - Interest Rate Swap Agreement. As of September 30, 2023, the fair value of our Swap Agreement was a net liability of $56.4 million. We recorded unrealized losses for the non-cash change in the valuation of the Swap Agreement of $4.8 million in the three months ended September 30, 2023 and $16.9 million in the three months ended September 30, 2022 from an increase in interest rates.
Under the Swap Agreement settlement payment made in November 2021, we received $0.6 million from the counterparty for a net cash savings of $0.6 million for the period from August 9, 2021 (the Swap Agreement inception date) to October 31, 2021, in May 2022, we received $1.2 million from the counterparty for a net cash savings of $1.2 million for the period from November 1, 2021 to April 30, 2022. Under the Swap Agreement settlement payment made in November 2022, we paid $3.4 million to the counterparty for a net cash interest cost of $3.4 million for the period from May 1, 2022 to October 31, 2022. Under the Swap Agreement settlement payment made in May 2023, we paid $9.5 million to the counterparty for a net cash interest cost of $9.5 million for the period from November 1, 2022 to April 30, 2023. Under the Swap Agreement settlement payment made in November 2023, we paid $12.0 million to the counterparty for a net cash interest cost of $12.0 million for the period from May 1, 2023 to October 31, 2023.
Income Tax (Benefit) Expense. Our income tax benefit was $13.6 million for the three months ended September 30, 2023 and our income tax expense was $1.0 million for the three months ended September 30, 2022. The decrease in our income tax expense is primarily related to projected operating results related to the Sprint Business acquisition, the reversal of deferred tax liabilities acquired with the Sprint Business and the reversal of a valuation allowance on our business interest expense deferred tax asset.
Buildings On-net. As of September 30, 2023 and 2022, we had a total of 3,257 and 3,126 on-net buildings connected to our network, respectively. The increase in our on-net buildings was a result of our disciplined network expansion program. We anticipate adding a similar number of buildings to our network for the next several years.
Nine Months Ended September 30, 2023 Compared to the Nine Months Ended September 30, 2022
Our management reviews and analyzes several key financial measures in order to manage our business and assess the quality and variability of our service revenue, operating results and cash flows. The following summary tables present a comparison of our
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results of operations with respect to certain key financial measures. The comparisons illustrated in the tables are discussed in greater detail below.
Nine Months Ended |
| ||||||||
September 30, | Percent |
| |||||||
2023 | 2022 | Change |
| ||||||
(in thousands) |
| ||||||||
Service revenue |
| $ | 668,822 |
| $ | 447,625 |
| 49.4 | % |
On-net revenue |
| 373,856 |
|
| 337,829 |
| 10.7 | % | |
Off-net revenue |
| 270,234 |
|
| 109,279 |
| 147.3 | % | |
Wavelength revenue |
| 4,578 |
|
| — |
| NM |
| |
Non-core revenue |
| 20,154 |
|
| 517 |
| NM |
| |
Network operations expenses (1) |
| 369,734 |
|
| 171,183 |
| 116.0 | % | |
Selling, general, and administrative (“SG&A) expenses (2) |
| 194,046 |
|
| 119,129 |
| 62.9 | % | |
Acquisition costs – Sprint Business | 1,490 | 2,004 | (25.6) | % | |||||
Depreciation and amortization expenses |
| 164,403 |
|
| 68,659 |
| 139.4 | % | |
Foreign exchange gain on 2024 Notes |
| — |
|
| 31,561 |
| NM |
| |
Loss on debt extinguishment and redemption – 2024 Notes |
| — |
|
| 11,885 |
|
| ||
Change in valuation – interest rate swap agreement |
| 4,283 |
|
| 45,703 |
| NM |
| |
Interest income – IP Transit Services Agreement |
| 17,968 |
|
| — |
| NM |
| |
Gain on bargain purchase – Sprint Business | 1,152,386 | — | NM | ||||||
Interest expense |
| 71,855 |
|
| 45,594 |
| 57.6 | % | |
Income tax (benefit) expense |
| (33,599) |
|
| 10,063 |
| NM |
| |
| (1) | Includes non-cash equity-based compensation expenses of $750 and $465 in the nine months ended September 30, 2023 and 2022, respectively. |
| (2) | Includes non-cash equity-based compensation expenses of $19,491 and $17,709 in the nine months ended September 30, 2023 and 2022, respectively. |
NM – not meaningful
Nine Months Ended |
| ||||||||
September 30, | Percent |
| |||||||
2023 | 2022 | Change |
| ||||||
Other Operating Data |
|
|
|
|
|
| |||
Average Revenue Per Unit (ARPU) |
|
|
|
|
|
| |||
ARPU—on-net | $ | 482 |
| $ | 460 |
| 4.9 | % | |
ARPU—off-net | $ | 1,194 |
| $ | 933 |
| 28.0 | % | |
ARPU – Wavelengths | $ | 2,266 | $ | — | NM | ||||
Average Price per Megabit — installed base | $ | 0.27 |
| $ | 0.29 |
| (5.8) | % | |
Customer Connections—end of period |
|
|
|
|
| ||||
On-net |
| 89,623 |
|
| 82,614 |
| 8.5 | % | |
Off-net |
| 36,766 |
|
| 13,359 |
| 175.2 | % | |
Wavelengths |
| 449 |
|
| — |
| NM |
| |
Non-core |
| 11,187 |
|
| 348 |
| NM |
| |
Service Revenue. We continually work to grow our total service revenue by increasing the number of potential customers that we can reach on our network. We do this by investing capital to expand the geographic footprint of our network, increasing the number of buildings that we are connected to, including CNDC’s and MTOB’s, and increasing our penetration rate into our existing buildings. These efforts broaden the global reach of our network and increase the size of our potential addressable market. We also seek to grow our service revenue by investing in our sales and marketing team. We typically sell corporate connections at similar pricing to our competitors, but our clients benefit from our significantly faster speeds, greater aggregate throughput, enhanced service level agreements and rapid installation times. In the net-centric market, we offer comparable services in terms of capacity but typically at significantly lower prices.
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Our service revenue increased by 49.4% from the nine months ended September 30, 2022 to the nine months ended September 30, 2023. Exchange rates negatively affected our increase in service revenue by $1.8 million. All foreign currency comparisons herein reflect results for the nine months ended September 30, 2023 translated at the average foreign currency exchange rates for the nine months ended September 30, 2022. We increased our total service revenue by expanding our network, adding additional buildings to our network, increasing our penetration into the buildings connected to our network and gaining market share by offering our services at lower prices than our competitors. Revenue from the Sprint Business was $191.0 million from May 1, 2023 (the closing date) to September 30, 2023.
Revenue recognition standards include guidance relating to any tax assessed by a governmental authority that is directly imposed on a revenue-producing transaction between a seller and a customer and may include, but is not limited to, gross receipts taxes, Universal Service Fund fees and certain state regulatory fees. We record these taxes billed to our customers on a gross basis (as service revenue and network operations expense) in our consolidated statements of comprehensive income. The impact of these taxes including the Universal Service Fund resulted in an increase to our revenues of $18.5 million from the nine months ended September 30, 2022 to the nine months ended September 30, 2023. Excise taxes from the Sprint Business were $17.8 million from May 1, 2023 (the closing date) to September 30, 2023.
Revenue and customer connections by customer type
Our corporate customers generally purchase their services on a price per connection basis. Our net-centric customers generally purchase their services on a price per megabit-metered basis. We began to serve enterprise customers in connection with our acquisition of the Sprint Business. We define “enterprise” customers as large corporations (typically, Fortune 500 companies with greater than $5 billion in annual revenue) running Wide Area Networks (“WAN”) with several dozen to several hundred sites. Our enterprise customers generally purchase our services on a price per location basis. Revenues from our corporate, net-centric customers and enterprise customers represented 45.0%, 41.1% and 13.9% of total service revenue, respectively, for the nine months ended September 30, 2023. Revenues from our corporate and net-centric customers represented 57.4% and 42.6% of total service revenue, respectively, for the nine months ended September 30, 2022. Revenues from corporate customers increased by 17.1% to $300.7 million for the nine months ended September 30, 2023 compared to the nine months ended September 30, 2022. Revenues from our net-centric customers increased by 44.0% to $274.9 million for the nine months ended September 30, 2023 compared to the nine months ended September 30, 2022. Revenues from our enterprise customers were $93.3 million, from May 1, 2023 (the closing date) to September 30, 2023. Certain of our historical corporate and net-centric customers (in total approximately 400 customers representing approximately $0.3 million in monthly recurring revenue) have been reclassified from our legacy net-centric and corporate revenue and customer connections to enterprise revenue and customer connections. Certain of the customer connections we acquired in the Sprint Business were classified as corporate and net-centric revenue and customer connections. We acquired 17,823 corporate customer connections, 5,711 net-centric customer connections and 23,209 enterprise customer connections with the Sprint Business. In connection with our acquisition of the Sprint Business, we classified the Sprint Business revenue as $20.1 million of monthly recurring revenue as enterprise revenue, $12.9 million of monthly recurring revenue as corporate revenue and $6.5 million of monthly recurring revenue as net-centric revenue.
Our revenue from our corporate customers increased primarily due to an increase in our number of corporate customers and from corporate customer connections acquired with the Sprint Business. Our corporate customers take advantage of our superior speeds, greater aggregate throughput, service levels and installation times versus our competitors. The growing trend of customers installing second lines for redundancy in order to construct virtual private networks (“VPNs”) has also led to our ability to increase our corporate revenues. Beginning with and throughout the COVID-19 pandemic, we witnessed a deteriorating real estate market in and around the buildings we service in central business districts in North America. Because of the rising vacancy levels and falling lease initiations or renewals, we experienced a slowdown in new sales to our corporate customers, which negatively affected our corporate revenue results. During the nine months ended September 30, 2023, we slowly began to see declining vacancy rates and rising office occupancy rates. In addition, we began to see positive trends in our corporate business. As the option to fully or partially work from home becomes permanently established at many companies, our corporate customers are integrating some of the new applications that became part of the remote work environment, which benefits our corporate business as these customers upgrade their Internet access infrastructure to higher capacity connections. Further, if and when companies eventually return to the buildings in which we operate, we believe it will present an opportunity for increased sales. However, the exact timing and path of these positive trends remains uncertain, and as the after effects of the COVID-19 pandemic linger, we may continue to see increased corporate customer turnover, fewer upgrades of existing corporate customer configurations and fewer new tenant opportunities, which would negatively affect our corporate revenue growth.
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Our revenue from our net-centric customers increased primarily due to an increase in our number of net-centric customers and growth in network traffic from these customers and from net-centric customer connections acquired with the Sprint Business. Our net-centric customers purchase our services on a price per megabit basis. The net-centric market exhibits significant pricing pressure due to the continued introduction of new technology, which lowers the marginal cost of transmission and routing, and the commodity nature of the service where price is typically the only differentiating factor for these customers. Our average price per megabit of our installed base of customers decreased by 5.8% from the nine months ended September 30, 2022 to the nine months ended September 30, 2023. The impact of foreign exchange rates has a more significant impact on our net-centric revenues.
Revenue and customer connections by network connection type
Our on-net revenues increased by 10.7% from the nine months ended September 30, 2022 to the nine months ended September 30, 2023. Our on-net revenues increased as we increased the number of our on-net customer connections by 8.5% at September 30, 2023 from September 30, 2022. On-net customer revenues increased at a greater rate than on-net customer connections primarily due to an increase in our on-net ARPU from the nine months ended September 30, 2022 to the nine months ended September 30, 2023. ARPU is determined by dividing revenue for the period by the average customer connections for that period. On-net revenues from customers acquired in the Sprint Business was $10.4 million from May 1, 2023 (the closing date) to September 30, 2023.
Our off-net revenues increased by 147.3% from the nine months ended September 30, 2022 to the nine months ended September 30, 2023. Our off-net revenues increased primarily from the increase in the number of our off-net customer connections from September 30, 2022 to September 30, 2023. Off-net revenues from customers acquired in the Sprint Business were $156.4 million from May 1, 2023 (the closing date) to September 30, 2023.
In connection with our acquisition of the Sprint Business, we expanded our offering of optical wavelength and optical transport services over our fiber network. Wavelength revenues from customers acquired in the Sprint Business were $4.6 million from May 1, 2023 (the closing date) to September 30, 2023.
Our non-core revenues increased from the nine months ended September 30, 2022 to the nine months ended September 30, 2023 primarily from the acquisition of non-core revenues from customers acquired in the Sprint Business. Non-core revenues from customers acquired in the Sprint Business were $19.7 million from May 1, 2023 (the closing date) to September 30, 2023.
Network Operations Expenses. Network operations expenses include the costs of personnel associated with service delivery, network management and customer support, network facilities costs, fiber and equipment maintenance fees, leased circuit costs, access and facilities fees paid to building owners and excise taxes billed to our customers and recorded on a gross basis. Our network operations expenses, including non-cash equity-based compensation expense, increased by 116.0% from the nine months ended September 30, 2022 to the nine months ended September 30, 2023. Non-cash equity-based compensation expense is included in network operations expenses consistent with the classification of the employee’s salary and other compensation. The increase in network operations expense is primarily attributable to an increase in costs related to our network and facilities expansion activities, an increase in power costs and $174.0 million of network operations expense from our acquisition of the Sprint Business from May 1, 2023 (the closing date) to September 30, 2023.
Selling, General, and Administrative (“SG&A”) Expenses. Our SG&A expenses, including non-cash equity-based compensation expense, increased by 62.9% from the nine months ended September 30, 2022 to the nine months ended September 30, 2023. Non-cash equity-based compensation expense is included in SG&A expenses consistent with the classification of the employee’s salary and other compensation. SG&A expenses increased primarily from an increase in salaries and benefits from an 91.2% increase in our total headcount, including 942 employees added to our headcount from our acquisition of the Sprint Business. Our sales force headcount, inclusive of sales management, was 833 at September 30, 2023 and 669 at September 30, 2022, and our total headcount was 1,990 at September 30, 2023 and 1,041 at September 30, 2022. The Sprint Business added 114 employees to our sales force headcount. SG&A expense from our acquisition of the Sprint Business was $73.1 million from May 1, 2023 (the Closing date) to September 30, 2023.
Depreciation and Amortization Expenses. Our depreciation and amortization expense increased by 139.4% from the nine months ended September 30, 2022 to the nine months ended September 30, 2023. The increase is primarily due to the depreciation expense associated with the increase in deployed fixed assets and $86.1 of depreciation and amortization expense from assets, including a finance lease totaling $160.9 million being amortized over forty-four months, acquired with the Sprint Business.
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Gain on Bargain Purchase
We accounted for our acquisition of the Sprint Business as a business combination. The identifiable assets acquired and liabilities assumed were recorded at their fair values as of the acquisition date. Assigning fair market values to the assets acquired and liabilities assumed at the date of an acquisition requires the use of significant judgment regarding estimates and assumptions. The fair value of the identifiable assets acquired was $1.5 billion (including amounts due under the IP Transit Services Agreement) and was in excess of the $1.0 billion liabilities assumed and the $0.6 billion net consideration to be received from the Seller resulting in a gain on bargain purchase of $1.2 billion.
Interest Income - IP Transit Services Agreement
On the Closing Date, we entered into the IP Transit Services Agreement with TMUSA, pursuant to which TMUSA will pay us an aggregate of $700.0 million, consisting of (i) $350.0 million in equal monthly installments during the first year after the Closing Date and (ii) $350.0 million in equal monthly installments over the subsequent 42 months.
We accounted for the Transaction as a business combination under ASC Topic 805 Business Combinations (“ASC 805”). Under ASC 805, we concluded that the $700.0 million of payments to be made represent consideration received to complete the acquisition of a distressed business. We also evaluated whether the IP Transit Services Agreement was in the scope of ASU No. 2014-09 Revenue from Contracts with Customers (“ASC 606”). We concluded that TMUSA did not represent a “customer” as defined by ASC 606, the stated contract price did not represent consideration for services to be delivered, and the transaction did not satisfy the definition of revenue, which excluded this arrangement from the scope of ASC 606. As a result, the IP Transit Services Agreement was recorded in connection with the Transaction at its discounted present value resulting in a discount of $79.6 million. The amortization of the discount resulted in interest income of $18.0 million from May 1, 2023 (the closing date) to September 30, 2023.
Foreign Exchange Gain 2024 Notes. Our 2024 Notes were issued in Euros and were reported in our reporting currency – US Dollars until they were fully extinguished in June 2022. The gain on foreign exchange on our 2024 Notes from converting our 2024 Notes into USD was $31.6 million for the nine months ended September 30, 2022.
Interest Expense and Loss on Debt Extinguishment and Redemption. Our interest expense resulted from interest incurred on our 2024 Notes until these notes were fully extinguished in June 2022, interest incurred on our $500.0 million aggregate principal amount of our 2026 Notes, interest incurred on our $450.0 million aggregate principal amount of our 2027 Notes and interest incurred on our finance lease obligations. Our interest expense increased by 57.6% from the nine months ended September 30, 2022 to the nine months ended September 30, 2023. The increase was primarily due to the increase in interest rates on our 2027 Notes as compared to the 2024 Notes, $9.5 million of interest expense paid in May 2023 associated with our Swap Agreement and the impact of the finance lease acquired with the Sprint Business. Our finance leases include a lease totaling $160.9 million being amortized over forty-four months, acquired with the Sprint Business. In June 2022, we extinguished our 2024 Notes at 101.094% of par value resulting in a loss on debt extinguishment and redemption of $11.9 million.
Change in Valuation - Interest Rate Swap Agreement. As of September 30, 2023, the fair value of our Swap Agreement was a net liability of $56.4 million, and we recorded an unrealized loss for the non-cash change in the valuation of the Swap Agreement of $4.3 million in the nine months ended September 30, 2023 and $45.7 million in the nine months ended September 30, 2022 from an increase in interest rates.
Under the Swap Agreement settlement payment made in November 2021, we received $0.6 million from the counterparty for a net cash savings of $0.6 million for the period from August 9, 2021 (the Swap Agreement inception date) to October 31, 2021, in May 2022, we received $1.2 million from the counterparty for a net cash savings of $1.2 million for the period from November 1, 2021 to April 30, 2022. Under the Swap Agreement settlement payment made in November 2022, we paid $3.4 million to the counterparty for a net cash interest cost of $3.4 million for the period from May 1, 2022 to October 31, 2022. Under the Swap Agreement settlement payment made in May 2023, we paid $9.5 million to the counterparty for a net cash interest cost of $9.5 million for the period from November 1, 2022 to April 30, 2023. Under the Swap Agreement settlement payment made in November 2023, we paid $12.0 million to the counterparty for a net cash interest cost of $12.0 million for the period from May 1, 2023 to October 31, 2023.
Income Tax (Benefit) Expense. Our income tax benefit was $33.6 million for the nine months ended September 30, 2023 and our income tax expense was $10.1 million for the nine months ended September 30, 2022. The decrease in our income tax expense is
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primarily related to projected operating results related to the Sprint Business acquisition, the reversal of deferred tax liabilities acquired with the Sprint Business and the reversal of a valuation allowance on our business interest expense deferred tax asset.
Buildings On-net. As of September 30, 2023 and 2022, we had a total of 3,257 and 3,126 on-net buildings connected to our network, respectively. The increase in our on-net buildings was a result of our disciplined network expansion program. We anticipate adding a similar number of buildings to our network for the next several years.
Liquidity and Capital Resources
In assessing our liquidity, management reviews and analyzes our current cash balances, accounts receivable, accounts payable, accrued liabilities, capital expenditure commitments, and required finance lease and debt payments and other obligations. As our business has grown as a result of an increasing customer base, the Transaction, broader geographic coverage and increased traffic on our network, we have produced a growing level of cash provided by operating activities. Because of the operating leverage of our network, our annual capital expenditures measured as a percentage of revenues has fallen over the last decade. Increasing our cash provided by operating activities is, in part, dependent upon expanding our geographic footprint and increasing our network capacity. Supply chain issues may adversely affect our ability to grow our network and revenue.
We have also had increasing success in raising capital by issuing notes and arranging financing and leases that have had a lower cost and more flexible terms. The combination of this improved operating performance and access to capital has enhanced our financial flexibility and increased our ability to make distributions to stockholders in the form of cash dividends or through share repurchases. Since our initial public offering, we have returned over $1.4 billion to our stockholders through share repurchases and dividends. We will continue to assess our capital and liquidity needs and, where appropriate, return capital to stockholders.
Over the next several years, we have significant contractual and anticipated cash outlays including our indicative dividend payments on our common stock, our maturing debt obligations, interest payments on our debt obligations and our projected capital expenditure requirements in order to help execute our business plan including the acquisition of the Sprint Business. Based upon the historical growth rate of our dividend, we expect that we would have to provide approximately $375 million in order to meet our expected quarterly dividend payments over the next two years, inclusive of payments under the IP Transit Services Agreement. Our $500.0 million of 2026 Notes accrue interest at 3.50%, mature in May 2026 and include annual interest payments of $17.5 million until maturity. In June 2022, we redeemed our 2024 Notes with the proceeds from our issuance of $450.0 million of our 2027 Notes. Our 2024 Notes accrued interest at 4.375% and our 2027 Notes accrue interest at 7.00%. Our $450.0 million of 2027 Notes mature in June 2027 and include annual interest payments of $31.5 million until maturity.
Under our Swap Agreement, we pay the counterparty a semi-annual payment based upon overnight SOFR plus a contractual interest rate spread, and the counterparty pays us a semi-annual fixed 3.50% interest payment. These settlement payments are made in November and May of each year until the Swap Agreement expires in February 2026. As of September 30, 2023, $56.4 million of our cash and cash equivalents are restricted for use under our Swap Agreement. We have made a $57.6 million deposit with the counterparty to the Swap Agreement. If the fair value of the Swap Agreement exceeds a net liability of $57.6 million, we will be required to deposit additional funds with the counterparty equal to the net liability fair value. As of September 30, 2023, $56.4 million of the deposit was restricted and $1.2 million was unrestricted. The valuation of the Swap Agreement reduced to $43.8 million as of November 6, 2023.
We may need to, or elect to, refinance all or a portion of our indebtedness at or before maturity and we cannot provide assurances that we will be able to refinance any such indebtedness on commercially reasonable terms or at all. In addition, we may elect to secure additional capital in the future, at acceptable terms, to improve our liquidity or fund acquisitions or for general corporate purposes. In addition, in an effort to reduce future cash interest payments as well as future amounts due at maturity or to extend debt maturities, we may, from time to time, issue new debt, enter into interest rate swap agreements, enter into debt for debt, or cash transactions to purchase our outstanding debt securities in the open market or through privately negotiated transactions. We will evaluate any such transactions in light of the existing market conditions. The amounts involved in any such transaction, individually or in the aggregate, may be material. We or our affiliates may, at any time and from time to time, seek to retire or purchase our outstanding debt through cash purchases and/or exchanges for equity or debt, in open-market purchases, privately negotiated transactions or otherwise. Such repurchases or exchanges, if any, will be upon such terms and at such prices as we may determine, and will depend on prevailing market conditions, our liquidity requirements, contractual restrictions and other factors. The amounts involved may be material.
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Acquisition of Sprint Communications
The Sprint Business’s cash flow was negative at the time of negotiations and during its recent history. Due to the dire financial condition of the Sprint Business, it was understood that a payment from T-Mobile to any potential buyer would be required to execute a transaction to give a buyer sufficient cash inflows to offset losses that would be expected until a buyer could optimize the business. Based on management’s internal modeling at the culmination of the due diligence process, management determined this cash payment to be $700.0 million. Management intends to reduce the negative cash flow of the Sprint Business through the payments from the IP Transit Services Agreement, reducing operating costs and increasing revenue primarily by providing optical wavelength and optical transport services over our fiber network, including the owned network we acquired with the Sprint Business. We are selling these services to our existing customers, customers we acquired with the Sprint Business and to new customers who require dedicated optical transport connectivity without the capital and ongoing expenses associated with owning and operating network infrastructure. As part of the Transaction, we began incurring costs associated with the TSA. The amount of these costs will be dependent upon our ability to integrate the operations of the Sprint Business into our operations. Our cash flow requirements related to the acquisition of the Sprint Business will be dependent upon our ability to reduce the acquired operating costs, our success in retaining the acquired customers and our ability to sell optical wavelength and optical transport services over our fiber network.
In light of the economic uncertainties associated with the global recessionary economy, the cash flow requirements of the Sprint Business, the lingering impact of the COVID-19 pandemic and recent bank failures and liquidity concerns at certain other banks, our executive officers and Board of Directors have continued to carefully monitor our liquidity and cash requirements. Based on current circumstances, we currently plan to continue our current dividend policy. Given uncertainties regarding the lingering business impact of the pandemic, the cash flow requirements of the Sprint Business and the timing for economic recovery, we will continue to monitor our capital spending. As we do each year, we will continue to monitor our future sources and uses of cash, and anticipate that we will make adjustments to our capital allocation strategies when, as and if determined by our Board of Directors.
Cash Flows
The following table sets forth our consolidated cash flows.
Nine Months Ended September 30, | ||||||
(in thousands) |
| 2023 |
| 2022 | ||
Net cash provided by operating activities | $ | 66,043 | $ | 137,384 | ||
Net cash provided by (used in) investing activities |
| 16,607 |
| (59,380) | ||
Net cash used in financing activities |
| (193,116) |
| (76,548) | ||
Effect of exchange rates changes on cash |
| 626 |
| (6,416) | ||
Net decrease in cash and cash equivalents and restricted cash | $ | (109,840) | $ | (4,960) | ||
Net Cash Provided by Operating Activities. Our primary source of operating cash is receipts from our customers who are billed on a monthly basis for our services. Our primary uses of operating cash are payments made to our vendors, employees and interest payments made to our finance lease vendors and our note holders. Our changes in cash provided by operating activities are primarily due to changes in our operating profit and changes in our interest payments. On the Closing Date, we entered into a TSA with the Seller, pursuant to which the Seller will provide to us, and we will provide to the Seller on an interim basis following the Closing Date, Transition Services to ensure an orderly transition following the separation of the Sprint Business from Sprint Communications. Amounts billed under the TSA are due 30 days from receipt of the related invoice. As of September 30, 2023, we owed $69.6 million to the Seller and the Seller owed $16.8 million to us under the TSA agreement resulting in an increase in cash provided by operating activities. During the nine months ended September 30, 2023 we were billed $218.0 million and paid $153.1 million under the TSA agreement.
Net Cash Provided by (Used in) Investing Activities. Our primary use of cash for investing activities is for purchases of property and equipment. Purchases of property and equipment were $86.0 million and $59.4 million for the nine months ended September 30, 2023 and 2022, respectively. The changes in purchases of property and equipment are primarily due to the timing and scope of our network expansion activities including geographic expansion, purchases in anticipation of the closing of our acquisition of the Sprint Business and adding buildings to our network. We paid $61.1 million, net of $47.1 million of cash acquired, for a net total of $14.0 million paid for our acquisition of the Sprint Business. On the Closing Date, we entered into the IP Transit Services Agreement pursuant to which TMUSA will pay us an aggregate of $700.0 million, consisting of (i) $350.0 million in equal monthly
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installments during the first year after the Closing Date and (ii) $350.0 million in equal monthly installments over the subsequent 42 months. During the nine months ended September 30, 2023 we were paid $116.7 million under the IP Transit Services Agreement.
Net Cash Used In Financing Activities. Our primary uses of cash for financing activities are for payments to redeem and extinguish our debt, dividend payments and principal payments under our finance lease obligations and for purchases of our common stock. During the nine months ended September 30, 2023 and 2022, we paid $135.4 million and $125.9 million, respectively, for our quarterly dividend payments. Our quarterly dividend payments have increased due to increases in our quarterly dividend per share amounts. Principal payments under our finance lease obligations were $58.5 million and $21.0 million for the nine months ended September 30, 2023 and 2022, respectively. The changes in our principal payments under our finance lease obligations are primarily due to the timing and extent of our network expansion activities including geographic expansion, purchases in anticipation of the closing of our acquisition of the Sprint Business and adding buildings to our network. There were no purchases of our common stock in the nine months ended September 30, 2023 and 2022.
Cash Position and Indebtedness
At September 30, 2023, our total indebtedness, at par, was $1.4 billion and our total cash, cash equivalents and restricted cash ($56.4 million) was $166.1 million. Our total indebtedness at September 30, 2023 includes $483.2 million of finance lease obligations for dark fiber under long-term IRU agreements.
Summarized Financial Information of Holdings
Holdings is not a restricted subsidiary as defined under the indentures governing our 2026 Notes and our 2027 Notes (the “Indentures”). Holdings is a guarantor under these notes. Under the Indentures, we are required to disclose financial information of Holdings including its assets, liabilities and its operating results (“Holdings Financial Information”). The Holdings Financial Information as of and for the nine months ended September 30, 2023 is detailed below (in thousands).
| September 30, 2023 | ||
(Unaudited) | |||
Cash and cash equivalents | $ | 1,185 | |
Accrued interest receivable |
| 4 | |
Total assets | $ | 1,189 | |
Investment from subsidiaries | $ | 559,311 | |
Common stock |
| 49 | |
Accumulated deficit |
| (558,171) | |
Total equity | $ | 1,189 | |
Nine Months | |||
Ended | |||
| September 30, 2023 | ||
(Unaudited) | |||
Equity‑based compensation expense | 22,644 | ||
Interest income |
| 551 | |
Net loss | $ | (22,093) | |
Common Stock Buyback Program
Our Board of Directors has approved purchases of shares of our common stock under a buyback program (the “Buyback Program”). There were no purchases of shares of our common stock in the three or nine months ended September 30, 2023 and 2022. As of September 30, 2023, there was a total of $30.4 million available under the Buyback Program that is authorized to continue through December 31, 2024.
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Dividends on Common Stock and Return of Capital Program
On November 1, 2023, our Board of Directors approved the payment of our quarterly dividend of $0.955 per common share. This estimated $45.1 million dividend payment is expected to be made on December 8, 2023.
The payment of any future dividends and any other returns of capital, including stock buybacks, will be at the discretion of our Board of Directors and may be reduced, eliminated or increased and will be dependent upon our financial position, results of operations, available cash, cash flow, capital requirements, limitations under our debt indentures and other factors deemed relevant by our Board of Directors. We are a Delaware corporation and under the General Corporation Law of the State of Delaware, distributions may be restricted including a restriction that distributions, including stock purchases and dividends, do not result in an impairment of a corporation’s capital, as defined under Delaware Law. The indentures governing our notes limit our ability to return cash to our stockholders. See Note 3 of our interim condensed consolidated financial statements for additional discussion of limitations on distributions.
Future Capital Requirements
We believe that our cash on hand and cash generated from our operating activities will be adequate to meet our working capital, capital expenditure, debt service, dividend payments and other cash requirements for the next twelve months if we execute our business plan.
Any future acquisitions or other significant unplanned costs or cash requirements in excess of amounts we currently hold may require that we raise additional funds through the issuance of debt or equity. Such financing may not be available on terms acceptable to our stockholders, or us or at all. Insufficient funds may require us to delay or scale back the number of buildings and markets that we add to our network, reduce our planned increase in our sales and marketing efforts, or require us to otherwise alter our business plan or take other actions that could have a material adverse effect on our business, results of operations and financial condition. If issuing equity securities raises additional funds, substantial dilution to existing stockholders may result.
We may need to, or elect to, refinance all or a portion of our indebtedness at or before maturity and we cannot provide assurances that we will be able to refinance any such indebtedness on commercially reasonable terms or at all. In addition, we may elect to secure additional capital in the future, at acceptable terms, to improve our liquidity or fund acquisitions or for general corporate purposes. In addition, in an effort to reduce future cash interest payments as well as future amounts due at maturity or to extend debt maturities, we may, from time to time, issue new debt, enter into debt for debt, or cash transactions to purchase our outstanding debt securities in the open market or through privately negotiated transactions. We will evaluate any such transactions in light of the existing market conditions. The amounts involved in any such transaction, individually or in the aggregate, may be material.
Off-Balance Sheet Arrangements
We do not have relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. In addition, we do not engage in trading activities involving non-exchange traded contracts. As such, we are not materially exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in these relationships.
Impact of COVID-19 on Our Liquidity and Operating Performance
As of September 30, 2023, we had cash, cash equivalents and restricted cash ($56.4 million) totaling $166.1 million. The COVID-19 pandemic and its lingering effects has not affected our credit rating to date, nor do we believe that it has materially changed our cost of capital. We believe we are able to timely service our debt obligations and will not require any concessions to do so. We believe we will have access to additional capital from a variety of sources and the public capital markets for debt and equity.
Beginning with and throughout the COVID-19 pandemic, we witnessed a deteriorating real estate market in and around the buildings we service in central business districts in North America. Because of the rising vacancy levels and falling lease initiations or renewals, we experienced a slowdown in new sales to our corporate customers, which negatively affected our legacy corporate revenue results. As the option to fully or partially work from home becomes permanently established at many companies, our
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corporate customers are integrating some of the new applications that became part of the remote work environment, which benefits our corporate business as these customers upgrade their Internet access infrastructure to higher capacity connections. Further, if and when companies eventually return to the buildings in which we operate, we believe it will present an opportunity for increased sales. While we are seeing a return to pre-pandemic leasing activity and a return to in-office work in a number of regions, the exact timing and path of these positive trends remains uncertain, and as the after effects of the COVID-19 pandemic linger, we may continue to see increased corporate customer turnover, fewer upgrades of existing corporate customer configurations and fewer new tenant opportunities, which would negatively affect our corporate revenue growth.
While worldwide capital markets have remained unstable or unpredictable since then, particularly for non-investment grade issuers, legislative bodies and reserve banks have taken various actions in response to the pandemic that have impacted the capital markets, and we expect that these efforts may continue. We cannot predict whether new COVID-19 variants will arise and spread widely, the impact of the spread of new COVID-19 variants on the global economy, how national and local governments may react to the spread of new variants nor predict the impact the variants and any measures taken in response may have on our operations, employee retention, revenue growth, cash flows and our profitability.
Critical Accounting Estimates
Management believes that as of September 30, 2023, there have been no material changes to our critical accounting policies and significant estimates from those listed in Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our annual report on Form 10-K for the year ended December 31, 2022, except as noted below.
Acquisition of Sprint Business
In connection with our acquisition of the Sprint Business we made the following significant changes to our critical accounting policies and significant estimates.
In connection with the Transaction, the identifiable assets acquired and liabilities assumed were recorded at their fair values as of the acquisition date. Assigning fair market values to the assets acquired and liabilities assumed at the date of an acquisition requires the use of significant judgment regarding estimates and assumptions. For the fair values of the assets acquired and liabilities assumed, we used the cost, income and market approaches, including market participant assumptions.
In connection with the Transaction, we acquired customer relationship intangible assets the value of which were determined using an income approach. This fair value measurement was based on significant inputs not observable in the market and, therefore, represents a Level 3 measurement. The key assumptions in applying the income approach include the discount rate, projected revenue from existing customers, customer attrition rate and projected capital and operating expenditures.
The Purchase Agreement includes an estimated payment from Seller to Buyer related to short-term lease obligations. This amount was recorded at its present value resulting in a discount. The interest rate used in determining the present value was derived considering rates on similar issued debt instruments with comparable durations, amongst other market factors. The determination of the discount rate requires some judgment.
On the Closing Date, we entered into the IP Transit Services Agreement. We evaluated what elements were part of the business combination and the consideration exchanged to complete the acquisition. We concluded that the payments to be made represent consideration received from T-Mobile to complete the acquisition of a distressed business. We concluded that T-Mobile did not represent a customer, the stated contract price did not represent consideration for services to be delivered, and the transaction did not satisfy the definition of revenue. We also considered whether the IP Transit Services Agreement would be considered separable from the business combination. We concluded that the cash consideration was not separately identifiable from the business combination and was therefore not meant to be in exchange for a distinct good or service. As a result, the IP Transit Services Agreement was recorded in connection with the Transaction at its discounted present value resulting in a discount. The interest rate used in determining the present value was derived considering rates on similar issued debt instruments with comparable durations, amongst other market factors. The determination of the discount rate and the conclusions reached related to the IP Transit Services Agreement required significant judgment.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Management believes that as of September 30, 2023, there have been no material changes to our exposures to market risk from those disclosed in Item 7A “Quantitative and Qualitative Disclosures About Market Risk” of our annual report on Form 10-K for the year ended December 31, 2022, except as disclosed below under Item 1A “Risk Factors”.
ITEM 4. CONTROLS AND PROCEDURES.
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
As required by SEC Rule 13a-15(b), an evaluation was performed under the supervision and with the participation of our management, including our principal executive officer and our principal financial officer, of the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this report. Based upon that evaluation, our management, including our principal executive officer and our principal financial officer, concluded that our disclosure controls and procedures were effective at the reasonable assurance level as of the end of the period covered by this report.
There has been no change in our internal control over financial reporting during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
SOX Exemption
In accordance with guidance issued by the Securities and Exchange Commission, registrants are permitted to exclude acquired businesses from management’s report on internal control over financial reporting for a period not to extend beyond one year from the date of acquisition or beyond more than one annual management report on internal control over financial reporting. The Company is in the process of assessing and integrating the internal control, compliance and operations over financial reporting of the Sprint Business. Given the significance of the Transaction and complexity of its systems and business processes, we intend to exclude the acquired business from our assessment and report on internal control over financial reporting for the year ending December 31, 2023.
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PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
We are involved in legal proceedings in the ordinary course of our business that we do not expect to have a material impact on our operations or results of operations. Note 4 of our interim condensed consolidated financial statements includes information on these proceedings.
ITEM 1A. RISK FACTORS
We may not realize the anticipated benefits of the acquisition of Sprint Communications, and the integration of the Sprint Business may disrupt our business and management.
The success of our acquisition of the Sprint Business of Sprint Communications, including the realization of anticipated benefits and cost savings, will depend, in part, on our ability to successfully combine our business and the Sprint Business. The integration may be more difficult, costly or time consuming than expected. The integration process involves numerous risks. These risks include:
● | inability to achieve the financial and strategic goals for the Sprint Business and the combined businesses; |
● | inability to achieve the projected cost savings for the Sprint Business and the combined businesses and the resulting impact on profitability; |
● | difficulty in, and the cost of, effectively integrating the operations, technologies, products or services, and personnel of the Sprint Business; |
● | entry into markets in which we have minimal prior experience and where competitors in such markets have stronger market positions; |
● | disruption of our ongoing business and distraction of our management and other employees from other opportunities and challenges; |
● | inability to retain key personnel of the Sprint Business; |
● | inability to retain key customers, vendors and other business partners of the Sprint Business or to migrate customers from legacy services; |
● | any non-occurrence of anticipated tax benefits or potential for adverse tax consequences; |
● | the effects of complex accounting requirements on our reported results; |
● | incurring acquisition-related costs or amortization costs for acquired intangible assets that could impact our operating results; |
● | elevated delinquency or bad debt write-offs related to receivables of the Sprint Business we assume; |
● | difficulty in maintaining internal controls, procedures and policies during the transition and integration; |
● | impairment of our relationships with employees, customers, partners, distributors or third-party providers of our technologies, products or services; |
● | failure of our due diligence processes to identify significant problems, liabilities or other challenges of the Sprint Business or technology; |
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● | exposure to litigation or other claims in connection with, or inheritance of claims or litigation risk as a result of, the Transaction, such as claims from terminated employees, customers, or other third parties; |
● | inability to conclude that our internal control over financial reporting is effective; |
● | delay in customer purchasing decisions due to uncertainty about the direction of our product and service offerings; |
● | Transition Services costs for longer than anticipated; |
● | increased accounts receivables collection times and working capital requirements associated with business models of the Sprint Business; and |
● | incompatibility of business cultures. |
If we experience difficulties during the integration process and are unable to integrate the Sprint Business successfully or in a timely manner, we may not realize the benefits of the Transaction to the extent anticipated. These integration matters could have an adverse effect on us during the transition period and on the combined company for an undetermined period after completion of the Transaction.
We maintain our cash and cash equivalents at financial institutions in amounts in excess of insured limits.
The Company maintains the majority of its cash and cash equivalents in accounts with U.S. and multi-national financial institutions, and our deposits at certain of these institutions, including the counterparty to our Swap Agreement, exceed insured limits. Market conditions can affect the viability of these institutions. In the event of failure of any of the financial institutions where we maintain our cash and cash equivalents, there can be no assurance that we would be able to access uninsured funds in a timely manner or at all. Any inability to access or delay in accessing these funds could adversely affect our business and financial position.
Management believes that as of September 30, 2023, except as set forth herein there have been no material changes to our risk factors from those disclosed in Item 1A “Risk Factors,” of our annual report on Form 10-K for the year ended December 31, 2022, except as disclosed in Item 1A - Risk Factors.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Our Board of Directors has authorized a plan to permit the repurchase of our common stock in negotiated and open market transactions through December 31, 2024. We may purchase shares from time to time depending on market, economic, and other factors. There were no purchases of shares of our common stock during the third quarter of 2023.
ITEM 5. OTHER INFORMATION
During the three months ended September 30, 2023, no director or officer of the Company adopted or terminated a “
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ITEM 6. EXHIBITS.
| (a) | Exhibits |
Exhibit Number |
| Description |
31.1 | ||
31.2 | ||
32.1 | Certification of Chief Executive Officer (furnished herewith) | |
32.2 | Certification of Chief Financial Officer (furnished herewith) | |
101.1 | The following materials from the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2023, formatted in Inline Extensible Business Reporting Language (XBRL), include: (i) the Condensed Consolidated Statements of Comprehensive Income (Loss), (ii) the Condensed Consolidated Balance Sheets, (iii) the Condensed Consolidated Statements of Cash Flows, and (iv) related notes (filed herewith). | |
104 | Cover Page Interactive Data File (the cover page XBRL tags are embedded within the iXBRL document). |
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Date: November 9, 2023 | COGENT COMMUNICATIONS HOLDINGS, INC. | ||
By: | /s/ David Schaeffer | ||
Name: | David Schaeffer | ||
Title: | Chief Executive Officer | ||
Date: November 9, 2023 | By: | /s/ Thaddeus G. Weed | |
Name: | Thaddeus G. Weed | ||
Title: | Chief Financial Officer and Treasurer | ||
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