TeraGo Inc. (TGO) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen. And welcome to the TeraGo's 2019 Year-End Financial Results Conference Call. [Operator Instructions] I would like to remind everyone that this conference is being recorded. TeraGo would like to remind listeners that the company's remarks and answers to your questions today may contain forward-looking statements that are based upon management's current expectations. All such statements are made pursuant of the safe harbor provisions of and are intended to be forward-looking statements under applicable Canadian security legislation. When relying on forward-looking statements, to make decisions with respect to the company, you should carefully consider the risks set forth in the Risk Factors section in the annual MD&A for the year-end December 31, 2019, which is available on www.sedar.com, and also consider other uncertainties and potential events. Except as may be required by Canadian security laws, the company does not undertake any obligation to update any forward-looking statements as a result of new information. We would like to remind the listeners that TeraGo uses certain non-GAAP financial measures to arrive at adjusted results to assess its business and to measure overall performance. TeraGo believes that these financial measures provide readers with a better understanding of how management views the company's overall performance. I would now like to turn the conference over to Mr. Tony Ciciretto, President and Chief Executive Officer of TeraGo. Please go ahead.

Thank you, Marcela. Good morning, everyone. And thank you for joining TeraGo's Fourth Quarter and Full Year 2019 Earnings Conference Call. With me today is our CFO, Dave Charron. After the market closed yesterday, we issued a press release announcing our results for the fourth quarter and full year ended December 31, 2019. Our press release, financial statements and MD&A are currently available on SEDAR and our company website along with a slide presentation accompanying this call. The fourth quarter marked a strong finish to a pivotal year in TeraGo's growth strategy. As our financial and operational results for 2019 demonstrate, we executed on our plan to effectively manage costs and generate strong adjusted EBITDA and cash flow, while realizing key milestones on our next-generation 5G fixed wireless growth strategy. We solidified our balance sheet through the bought deal we completed last July, we gave us -- which gave us the financial resources to judiciously invest in our 5G initiatives. We are also assembled -- we have also assembled a dedicated team of experienced executives to build a global channel partnership ecosystem and develop strategic partnerships with leading industry players. In step with this, we also enhanced our sales effectiveness, broadened our sales footprint as well as expanded our sales pipeline. These accomplishments have helped to improve the stability of our overall business, and position TeraGo for improving performance in the years ahead. Now let's look at our key operating metrics for Q4 and the full year in more detail. On Slide 5 of your presentation, you can see that our sales and customer success initiatives are helping to stabilize and improve our key operating metrics. Starting first with backlog monthly recurring revenue or MRR in our connectivity business. At December 31, 2019, backlog MRR increased 42% to $92,096 from $64,659 in the comparable period last year, driven by higher sales volume. In fact, this is the highest level of connectivity backlog MRR in several quarters, which is a testament to our higher close rate and larger number of multi-site deals signed in the year. Cloud and colocation backlog MRR at December 31, 2019, was $18,615, down from $31,742 in the comparable period last year. The decrease was due to lower sales volume. It's important though to note that cloud deals typically take less than a quarter to provision, especially if it's an upgrade for an existing customer, which is why we don't anticipate large backlogs in the cloud and colocation line of business, unless it's a larger colocation deal. Shifting now to average revenue per user or ARPU. In our connectivity business, ARPU for the fourth quarter of 2019 was $1,019 compared to $1,054 in Q4 of last year. For 2019, connectivity ARPU was $1,022, down slightly from $1,053 in 2018. The decrease in ARPU for both periods was due to provisioning and renewals at lower rates. However, you'll note that we did achieve sequential quarter-over-quarter growth of connectivity ARPU in Q4 2019 when compared to Q3 2019. As we have mentioned on our prior calls, we expect connectivity ARPU to trend upwards over time as we secure large multi-site deals and as we gain traction with new products. Our cloud and colocation ARPU for Q4 2019 was $3,393, up from $3,138 in Q4 of last year. For the full year, cloud and colocation ARPU increased to $3,262 from $3,147 in 2018. The increase for both periods was due to upgrades from existing customers and churn of lower ARPU customers. Now let's look at our third key operating metric, churn. For the fourth quarter of 2019, churn in our connectivity business was 1.4%, which was essentially flat compared to Q4 of last year. For the full year, connectivity churn was 1.4%, down slightly from 1.5% in 2018. Churn in our cloud and colocation business decreased to 0.9% in the fourth quarter of 2019 from 1.3% in Q4 of last year. For the full year, cloud and colocation churn was 1.3%, which was an improvement from 1.9% in 2018. The improvement in churn levels in both of our lines of businesses reflects the customer-focused initiatives we implemented in late 2018. These implementations include proactive customer-orientated processes to ensure our direct sales team and channel partners are working closely with customers, leading up to contract renewals as well as listening to customer needs and looking for product upsell opportunities. Altogether, we believe these initiatives will help to further improve churn levels into 2020, which is consistent with our two-pronged strategy of reducing churn, while increasing bookings, which ultimately would drive top line revenue growth. Before I provide an update on our growth strategy, I'm going to turn the call over to our CFO, Dave Charron, to walk you through the financial details for the quarter and year. David?

Thanks, Tony, and good morning, everyone. Moving on to Slide 7, you can see that our total revenue in the fourth quarter declined 7% from the prior year period to $12 million compared to $12.9 million in Q4 of last year. Connectivity revenue in the quarter decreased 13% to $7.3 million compared to $8.4 million in Q4 of 2018. The decrease in connectivity revenue was primarily due to customer churn as well as certain customers renewing long-term contracts at lower market rates. In contrast, cloud and colocation revenue for the fourth quarter of 2019 increased 4% to $4.7 million compared to $4.5 million of Q4 of last year, which partially offset the decrease in connectivity revenue. The increase in cloud and colocation revenue was primarily due to a onetime nonrecurring customer termination fee that we recognized in the quarter, and that amount was approximately $350,000. On Slide 8, you'll see that total revenue for the full year decreased 11% to $48.4 million compared to $54.3 million in 2018. Connectivity revenue for 2019 decreased 13% to $30.4 million compared to $35 million in 2018. The decrease in connectivity revenue was primarily due to customer churn and certain customers renewing long-term contracts at lower market rates. Cloud and colocation revenue for 2019 decreased 6% to $18.1 million compared to $19.3 million in 2018. And the decrease in cloud and colocation revenue was primarily due to customer churn in the second half of 2018, resulting in lower revenue entering 2019. As the improvements we've made in our sales and channel groups take hold, we are optimistic that we'll see top line revenue stabilize and grow throughout 2020 and beyond. Turning now to EBITDA. In the fourth quarter of 2019, our adjusted EBITDA increased 29% to $4 million compared to $3.1 million in Q4 of last year. For the full year period, adjusted EBITDA increased 35% to $17.5 million compared to $13 million in 2018. However, excluding the impact of IFRS 16, our adjusted EBITDA in the fourth quarter would have been $2.4 million compared to $3.1 million in Q4 of 2018. And for 2019, adjusted EBITDA, excluding the impact of IFRS 16, would have been $11 million compared to $13 million in 2018. And this is primarily due to the reduction in revenue, partially offset by our continued focus on cost management. Moving down the income statement, net loss for the fourth quarter of 2019 totaled $2.1 million compared to net loss of $2 million in Q4 of 2018. And for the full year, net loss totaled $7 million compared to a net loss of $4.8 million in 2018. The increased net loss for both periods were in part due to the adoption of IFRS 16. As I've talked about on prior calls, with the adoption of IFRS 16, we now recognize all leases on our balance sheet as a right-of-use asset and a corresponding lease liability. This resulted in higher depreciation and finance costs that exceed the beneficial impact of lower cost of sales and operating costs for previously recognized operating leases. The net result was a higher net loss in the fourth quarter and full year of 2019, the impact being about $1.3 million for the full year. Turning to our cash flow on Slide 11. In the fourth quarter, we generated $4 million in cash from operating activities and incurred $1.7 million in lease payments. Capital expenditures were $1.6 million or 14% of total revenue in Q4. For the full year, we generated $15.4 million in cash flow from operating activities and incurred $7 million in lease payments. Capital expenditures for the full year were $6.7 million or 14% of total revenue. Turning to the balance sheet. At year-end, we had $8.7 million in cash, which is down slightly from $9.1 million last quarter, but up from $3.9 million at the end of 2018. We also have an undrawn $10 million operating line and a $25 million acquisition and CapEx facility that will allow us to invest in growth initiatives. We believe we have sufficient capital resources to meet our working capital and capital expenditure requirements, including funding our 5G technical and customer trials, which we expect to be approximately $500,000 in 2020. And finally, our leverage ratio at the end of the quarter was 2.7x adjusted EBITDA, excluding the impact of IFRS 16, which is well below our debt covenant of 3.5x. And that concludes my prepared remarks. I'll turn the call back to Tony to provide an operational update on our growth strategy for 2020. Tony?

Thank you, Dave. I'd like to now review our progress executing on our growth strategy, which we think of as 3 pillars, which are depicted on Slide 13. The first pillar of our strategy is to stabilize our business and generate positive cash flow. The cost optimization measures we began implementing toward the end of 2018, helped to improve cash flow in the fourth quarter and full year. As Dave mentioned, we generated net $2.3 million of operating cash flow in Q4 and $15.4 million for the full year. We believe our optimized cost structure will allow us to continue to generate strong cash flow going forward. The second pillar of our strategy is building a premier channel and alliance program. Since we launched the program in early 2019, we have added new global channel partners at a consistent pace and ended the year with more than 20 new channel partners. Importantly, these programs have enhanced TeraGo's overall sales effectiveness, expanded our pipeline and broadened our sales footprint. In fact, our enhanced direct and indirect sales initiatives have allowed us to more than double our sales pipeline compared to Q4 of last year. Looking specifically at our connectivity business, we continue to see abundant opportunities to target multinational and U.S. companies that have operations in Canada. We're encouraged by the number of large multi-site sales opportunities in the sales pipeline. It's this type of traction that confirms the significant opportunity TeraGo has to leverage its existing fixed wireless footprint and bundled service offerings. However, we're not resting on our laurels, and we continue to selectively invest in new innovative products to meet customer needs and increase ARPU. One such product is the TeraGo Internet 50/10 product, which is also a fiber-like fixed wireless solution that delivers flexible and reliable internet connectivity to Canadian business customers with less than a handful of sites. With business grade service level agreements and features such as 24/7 technical support, TeraGo Internet 50/10 provides a comprehensive nationwide wireless alternative to cable or DSL-based internet connections. In addition to TeraGo's Internet 50/10 product, last week, we launched the TeraGo-managed SD-WAN in partnership with NetFortris, which is a new and advanced networking solution that brings next-generation technology to business customers across Canada. SD-WAN is critical in supporting network agility, simplicity and performance while allowing us to advance our capabilities to deliver best-in-class customer experience. We believe that SD-WAN solutions are one of the leading technologies addressing business network requirements, and we're excited to be one of the few national service providers adding this service to our connectivity portfolio. It's product launches like Internet 50/10 and SD-WAN that demonstrates TeraGo's continued commitment to provide the best-in-class next-generation networking solutions for our customers across Canada and globally. Now shifting to our cloud and colocation business. We are seeing a pickup in colocation deals in our sales pipeline that have the potential to utilize a significant amount of our excess capacity. In 2019, TeraGo was recognized in the major players category by IDC for Canadian data center operations. This recognition adds even more credibility to our direct and indirect sales efforts and positions us well to capitalize on the continued market demand for managed cloud and colocation services. Our third pillar and primary growth driver for TeraGo is 5G. As Canada's largest holder of 24- and 38-gigahertz licensed millimeter wave spectrum, we are in a prime position to capitalize on the growing number of used cases of the Canadian business market as they transition to 5G. We will be commencing our technical trials shortly at our headquarters in Thornhill, utilizing 5G fixed wireless network equipment from Nokia and customer premise equipment from ASCII. Initial testing will be conducted using the 38-gigahertz frequency band, followed by the testing of their 24-gigahertz radios, which we expect to start in the second half of the year. However, business customer trials will begin midyear following our technical trials. We continue to take a very prudent approach in evaluating our near- and long-term opportunities with the objective of securing strategic partnerships to expand our markets, minimize initial capital outlay and reduce operational risk. We remain laser-focused on monetizing the value of our 24- and 38-gigahertz spectrum assets, and I believe we have a significant time to market advantage to be the first Canadian -- one of the first Canadian carriers to launch fixed 5G fixed wireless services nationally. In summary, we enter 2020 with significant operating momentum across our businesses. We believe our strengthened channel partner network, building sales pipeline and new products will help to drive top line growth in 2020. In step with this, we're confident that our strong balance sheet and capital resources give us the flexibility to invest in our 5G initiatives, which we believe will lay the foundation for growth in the years ahead. Now that concludes our prepared remarks, and we're now ready to open the call for questions. Operator?

[Operator Instructions] Your first question comes from the line of Vince Valentini from TD Securities.

Clarify a couple of things in the numbers, first. The -- a pretty big increase in the backlog on the connectivity side. Is there anything that needs to be called out there as unusual? Or any sort of low-margin revenue coming through? Or is that all just normal, high-quality recurring revenue?

Well, Vince, thanks very much for the question. Essentially, what it is, is our execution strategy really taking hold. As I mentioned out at the -- in my remarks, one of our key tenant is to bring on channel partners from the U.S. that have customers with operations in Canada. And as I mentioned, we have over 20 new channel partners that we brought in 2019. And that, along with our sales, just our sales productivity improvement, I think, is contributing to the connectivity backlog.

Okay. And in terms of the outlook for 2020, you said you expect revenue growth to turn positive. If I can -- just trying to make sure I understand that fully. Is that in both segments? Or just on a consolidated basis? And do you expect that improvement to start to show up in Q1? Or is it more of a back-end loaded?

I think that's going to be back-end loaded, Vince. It's Dave here. As we start to take some of that backlog and convert it to revenue throughout the first half of the year and then continue to drive increased orders and backlog, that should manifest itself in the second half.

And would you expect both the connectivity side and the cloud side to have positive revenue growth for the full year?

That's correct.

Great. And switching to CapEx and free cash flow, it's -- you've been trending just a bit below 14% in terms of capital intensity. Is your expectation that the core business sort of stays in that similar range next year, and then you add $500,000 for the fixed wireless trials?

Yes. That's just about correct, Vince. I think the other element to it in what we said, I think, last quarter, is there is a small investment we're making in our core network to get that to be 5G-ready. So in addition, there was some additional spending, maybe about $250 million a quarter type of thing to model going forward.

Okay. And putting that together with the revenue and then margin outlook, is this free cash flow you generated in 2019 a reasonable indicator of what the run rate can be? Or do you think you can do another $4 million-or-so in 2020?

Yes, absolutely.

Okay. And then lastly, is there anything updated in terms of strategic thoughts on the spectrum? I know you're pushing ahead with the trials, but if there's anything new you can update us on, on what you think the wireless carriers are doing, given the hearing going on right now? And the 3.5-gigahertz spectrum auctions still not still not set in stone, but theoretically coming later this year, if you get a sense that anybody is looking at millimeter wave spectrum yet? Or are there -- are the incumbent carriers in Canada all just sort of sitting and waiting to see what happens with the CRTC and the 3.5 gig before they even consider strategic options on millimeter wave?

Yes. Well, thanks for the question, Vince. And I think the play in Canada, quite frankly, I think, is you won't start to hear a lot of millimeter wave discussions until the 3.5-gigahertz spectrum auction has taken place at the end of this year. That being said, I think, globally, you've seen a real groundswell of millimeter wave activity. So for example, certainly in the U.S., they've conducted all their auctions in the 24, the 28 and the 38, 39, which is just about completed. That gives us certainly confidence that the U.S. carriers are going to be very much -- they're certainly betting a lot on millimeter wave, and has a significant role to play along with the other spectrum assets. So we're very encouraged. That, along with now the Qualcomm chipsets, are going to be included. As it relates to millimeter wave, I think we're going to be something that after the auction of 3.5, you're going to see a lot more activity.

Your next question comes from the line of Matthew Lee from Canaccord Genuity.

Can you maybe just discuss the nature of magnitude of the onetime costs in the quarter for Q4? It was in the MD&A.

Yes. And it was also in, I think, Note 13, probably somewhat buried in that, but we did disclose that we took a provision for a contingency of about $500,000. So that amount wasn't disclosed, albeit somewhat buried.

All right. Great. And then on the colocation side, you obviously benefited from the onetime termination fee. Is it fair to say that, that's excluded from the way you calculate ARPU?

I think that's correct. I would have to double check that, but I think that's the correct assumption.

Right. So if that's the case, and I mean, ARPU growth was really strong for the quarter, is that -- you guys have sort of talked in the past about how you kind of pruned your customer base to get rid of some of the lower-end customers. And given the fact that your churn is down, ARPU is up, can we assume that you're comfortable with your customer base as it is? And that kind of pruning has been completed?

I'd say, by and large, we -- I think that statement is correct, Matthew. I think the fact is, though, we're spending a lot of focus, particularly last year and this year on really moving more products to market. You saw the 50/10 announcement that we have announced. That really will be aimed at retaining some of those customers. As well, I think you're going to see that moving forward, as we start to focus more on our existing customer base, and we have a very rich customer base as we start to cross-sell our data center customers with our connectivity and vice versa. I think we're doing a much better job at getting greater ARPU from our existing customers, and I think you're going to see that continue in 2020.

Your next question comes from the line of David McFadgen from Cormark.

So I was just looking at Slide 14 of your presentation. I was just looking at the various breakdown of the millimeter wave spectrum. Correct me if I'm wrong, but I think the 24-gigahertz spectrum still hasn't been designated for anything other than fixed wireless use. Is that still correct?

Yes, that's correct, David. I think a couple of notable points, though, is that WRC-19 was just a -- it was a global standard. They set global standards for spectrum. The 5G component of that presentation this past year, actually had both the 38 and the 24 as designated 5G spectrum globally. And how -- what we -- and I think that's very encouraging for a company like TeraGo where I think ISED certainly was looking for some direction globally. And I think, I would not be surprised if certainly they're revisiting their priority level of 24 over the next few months.