TeraGo Inc. (TGO) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen. Welcome to TeraGo's Q1 2020 Financial Results Conference Call. [Operator Instructions] I would like to remind everyone that this conference call 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 to the safe harbor provisions of and are intended to be forward-looking statements under applicable Canadian securities legislation. When relying on forward-looking statements to make decisions with respect to the company, you should carefully consider the risk set forth in the risk factors section in each of the annual MD&A for the year ended December 31st, 2019, and the Q1 2020 MD&A which are available on www.sedar.com. 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 also like to remind 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 turn the conference over to Mr. Tony Ciciretto, President and Chief Executive Officer of TeraGo. Please go ahead.

Thank you, Sherrill. Good morning everyone, and thank you for joining TeraGo's First Quarter 2020 Earnings Conference Call. With me on today's call is our CFO Dave Charron. After the market closed yesterday, we issued a press release announcing our results for the first quarter ended March 31st, 2020. 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. What an extraordinary time we're living through as we undergo a global transition in how we all work. The COVID-19 health crisis requires remarkable efforts from people, communities, organizations and governments to safeguard our health and safety. We're thankful for the frontline workers and healthcare providers who are continuing to provide essential services to us, all during this challenging and unprecedented time. It also goes without saying that the crisis has impacted companies and people all over the world, and our thoughts go out to all those affected. Like most companies, we were impacted by the COVID-19 outbreak as it spread through Canada. By quickly implementing our Pandemic Response Plan, we were able to fully maintain business operations while ensuring employee safety. We continued to provision and maintain services for our customers, even with the unprecedented global business closures, and slowdown caused by the pandemic event. Our network, data centers and critical facilities are all up and running and we're supporting customers 24/7 despite having our non-essential employees working remotely. Maintaining our business operations will allow us to help our customers meet the increasing demands and challenges of today's dynamic remote work environment, and in turn help restore some normalcy to their day-to-day lives. As anticipated, overall online usage, network volume and demand for virtual collaboration continues to increase. The crisis has made it even more apparent that broadband connectivity is crucial to their business success. TeraGo delivers networking and infrastructure solutions that our customers rely on for critical services such as virtual collaboration, telehealth, distance education and remote applications. It's also worth noting that our customer base is diverse, both in terms of numbers and industries represented. As I mentioned, we remain focused internally on employee safety. And our team is delivering on our valuation proposition to our partners and customers, thereby ensuring the long-term health and viability of our business. I continue to be impressed daily by our team's resilience and productivity, navigating these uncharted waters. Our uninterrupted operational execution in the first quarter is a testament to their unwavering commitment to helping our customers and partners in a time of increased need. This includes accommodating customer requests for additional bandwidth, and enhanced storage and server capacity among other things. Recognizing the ongoing uncertainty from the global pandemic, and its downstream effects on the business and the economy, we believe it was prudent to enact precautionary measures to ensure our business remains secure and our long-term viability remains intact. To that end, we have implemented certain cost measures and reduced discretionary CapEx spending. The goal of these programs is to maintain the long-term economic health of our business, and to ensure that we have the financial flexibility needed to withstand potential downturns should they arise. To be clear, we remain confident in the state of our business over a long-term horizon. These actions are being taken as a protective measure, and we believe TeraGo will ultimately come out in a better position than we entered. So with that context, let's look at our key operating metrics for Q1 in more detail. On Slide 5, 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 March 31, 2020, backlog MRR increased 25% to $89,296 from $71,624 in the comparable period last year, driven by higher volumes than in the prior period. Cloud and colocation backlog MRR at March 31, 2020, was $18,225, down from $37,094 in the comparable period last year. The decrease was primarily due to the timing of customer provisioning activity. And as I mentioned on our last call, cloud deals typically take less than a quarter to provision, especially if it's an upgrade, which is why we don't anticipate a large backlog in our Cloud and colocation line of business, unless it's a larger colocation or cloud infrastructure deal. Now shifting to average revenue per user, or ARPU. In our connectivity business, ARPU for the first quarter of 2020 was $1,033, which was unchanged from Q1 of last year as we continued to focus on acquiring and retaining mid-market business customers. Our Cloud and colocation ARPU for Q1 2020 was $3,240, up from $3,221 in Q1 of last year. In the first quarter of 2020, Cloud and colocation ARPU was negatively impacted by an increase in customer count as we contracted directly with 28 customers that were previously contracted through a wholesale partner. Normalizing for this increase in customer count, Cloud and colocation ARPU for the 3 months ended March 31, 2020, would have been $3,450, an increase of 7% compared to Q1 last year. The increase was due to upgrades from existing customers and churn of lower ARPU customers. Looking at our third key operating metric, churn. For the first quarter of 2020, churn in our Connectivity business was 1.5%, which was flat compared to Q1 of last year. Churn in our Cloud and colocation business slightly decreased to 1% in the first quarter of 2020 from 1.1% in Q1 of last year, due to increased retention efforts. So far in Q2, we have not seen a material change in churn, but that could change depending on the length and severity of the health crisis. Longer term, we continue to believe that our proactive customer-oriented process will help to further improve churn levels. I'll now turn the call over to our CFO Dave Charron to walk you through the financial details for the quarter. Then I'll return to provide an update on our growth strategy and outlook. David?

Thanks, Tony, and good morning, everyone. Moving on to Slide 7, you can see that our total revenue in the first quarter declined 6.5% from the prior year period to $11.6 million compared to $12.4 million in Q1 of last year. Connectivity revenue in the quarter decreased 7.6% to $7.3 million compared to $7.9 million in Q1 of 2019. The decrease in Connectivity revenue was primarily due to churn exceeding provisioning. I would also like to highlight here that we experienced quarter-over-quarter revenue growth in Connectivity in Q1, the first time since Q3 of 2018. Cloud and colocation revenue for the first quarter of 2020 decreased 4.4% to $4.3 million compared to $4.5 million in Q1 of last year. The decrease in Cloud and colocation revenue was primarily driven by the churn we experienced in 2019. Now turning to EBITDA, in the first quarter of 2020, our adjusted EBITDA decreased 22% to $3.6 million compared to $4.6 million in Q1 of last year. The decrease was primarily due to the impact of lower revenues, higher costs of cloud services sold and an increase in some corporate selling costs in the quarter. Moving down the income statement, net loss for the first quarter of 2020 totaled $2.2 million compared to a net loss of $1.2 million in Q1 of 2019. The higher net loss was primarily due to the impact of lower revenues and the higher costs described earlier. Turning to our cash flow on Slide 9, in the first quarter we generated $2.6 million in cash from operations, while capital expenditures were $2.2 million, or 19% of total revenue in Q1 of 2020. The increase in capital spending when compared to last quarter was driven primarily by success capital required for the Connectivity business. Turning to the balance sheet, at quarter end we had $7.5 million in cash, which was down from $8.7 million last quarter, but up from $3.1 million at the end of Q1 in 2019. This includes $1.4 million drawn on our debt facility as at March 31st. As such, our leverage ratio at the end of the quarter now stands at 3.05x adjusted EBITDA, which is well below our debt covenant of 3.5x. I would like to expand briefly on the cost reduction measures and the discretionary CapEx spending controls that Tony mentioned earlier. We've identified savings of approximately $250,000 per quarter in OpEx and savings of another $250,000 per quarter on discretionary CapEx. These measures will help improve our cash flow generation and provide us with sufficient cushion on our leverage ratio to fund our growth strategy, including our 5G trials. We believe our diversified customer base, predictable recurring revenue and prudent approach to cash management will help ensure we successfully navigate these uncertain times. That concludes my prepared remarks. I'll turn the call back to Tony. Tony?

Thank you, David. I'd like to now review our progress executing on our growth strategy, which we think of as 3 pillars which are on Slide 13. The first pillar of our [Technical Difficulty] stabilize our business and generate positive cash flow. As I talked about on our Q4 call at the end of February, the optimization measures we employed over the prior 12 months made our organization more lean, efficient and effective. This created a solid foundation to not only drive our business forward, but also position us well to weather any unexpected storms. The $2.6 million we generated of operating cash flow in the first quarter illustrates this resiliency. The recent cost measures we've taken at the additional -- the additional levers we can pull along with our stable recurring revenue base gives us confidence we can maintain a positive cash flow trajectory through the health crisis and beyond. Building a premier channel and alliance program is the second pillar of our strategy. We have added new global channel partners at a consistent pace since last year and ended Q1 with more than a dozen new channel partners. Leveraging these channel partners has continually expanded our reach, minimized incremental investment and reduced overall operational risk. We began the year with increasing sales momentum on both the direct and indirect side of our go-to-market motions. We had a strong start to the first quarter. However, in mid-March through early April sales activity tapered off as COVID-19 really took hold, and many of our partners pivoted to work from home enablement tasks. Then since mid-April, we've seen our pipeline creation pick up to pre-COVID levels. As said, we remain cautiously optimistic what that means for going forward to the new business trend. Our third pillar and primary growth driver for TeraGo is 5G. As we announced last week, we commenced our 5G technical trials in the Greater Toronto Area at our Thornhill head office location, which are expected to be carried out over the next several weeks. We're seeing the continued evolution of 5G network technology and our ongoing interoperability testing of network and customer premise equipment with our partners in real world environments. It is a critical step in enabling this transition. Although COVID-19 has shifted the timeline a bit, we currently expect customer trials to begin in the second half of 2020. Well, no one can say how long the current situation will persist. The leadership team and I have navigated through turbulent markets and recessionary times before, and we believe that an experienced steady hand will be essential to win in this environment. We're confident that given our flexibility and resilience our organization will be able to respond to whatever challenges the future may hold. We've taken some necessary actions to ensure the long-term viability of our business and the safety of our people. All things considered, I'm very proud of how our team have stepped up and quickly adapted to our new working environments. The proactive measures we've taken in the near-term will help us to drive our business forward today. But the resiliency in our business model and the accelerated secular growth drivers behind broadband connectivity and 5G will ensure that our business is positioned for tomorrow. Our success today will better position TeraGo in a post-COVID-19 environment and enable the realization of our vision to be one of the first operators to launch commercial 5G fixed wireless services in Canada. That concludes our prepared remarks. We're now ready to open the call for questions. Sherrill?

[Operator Instructions] Your first question is from the line of Bentley Cross with TD Securities.

Sorry, I was a little slow getting on the call. So I apologize if I missed it. But after giving I'd say loose guidance last quarter on revenue outlook, just wondering your updated thoughts on where you're going to trend for the balance of the year on -- in both segments?

Yes, maybe I'll start here, Bentley. Given that we're entering this sort of COVID-19 environment, we expect our revenue -- we had originally expected revenue to reach an inflection point and start trending upwards in the second half of 2020. I think that might be pushed out a quarter or two, just given the uncertainty. We're encouraged about what we're seeing in the pipeline and some of the sales activity, but I think it's reasonable to expect to be pushed out a quarter or two.

Okay. And then an extension of that. I mean a bunch of quarters ago, you guys outlined a kind of a target operating model that contemplated cloud and colo growth of 10% to 15% and pre-IFRS 16 EBITDA margins in the 30% to 35% range. Is that still how you're thinking about the business longer term? I know there's a lot of moving pieces between now and then, but...

Yes. That is indeed our thinking about it longer term, but again, we need to get through this hopefully short-term environment and then see where that takes us.

Okay. Very fair. And then quickly on kind of a COVID-related impacts, first and foremost, is the outlook still for this same CapEx extra savings that you outlined previously kind of baseline of I think 13.5 plus a couple of 5G initiatives that are going to add to that?

Yes, I think we're -- what you're seeing that is us to pull back on the CapEx spending. In addition to what I mentioned, I think that on the 5G side that will be taken -- we've taken possession of the 5G equipment. And as you've seen, we started our technical trial. So I don't expect to be much more in the way of expenditure on 5G in 2020, perhaps maybe towards the end of the year. And I think we're just going to be very cautious in any discretionary CapEx spending right now. We are in an industry that does require capital spending. And so we'll continue to service our customers as required, but I think you'll see we'll be very, very cautious in the next quarter or two. Yes.

I think the only thing I would add to that is the fact that most of the CapEx, Bentley, will be demand-based -- driven by demand-based CapEx, so new opportunities in driving CapEx that way.

Okay. And last for me before I pass the line, just with all the uncertainty, do you have any plans to refinance your line? And when can we kind of expect that to happen?

Yes. No, a good question, Bentley. And that is coming up for renewal. So I'm in discussions with our current lenders, and I expect to announce something shortly on that.

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

So maybe you can give me some additional color on the higher costs in the quarter and lower margin. I mean, is that cloud and sales cost elevated, or is that something that's going to persist going forward?

That particular item will persist going forward. We've had some increased costs on some of our cloud services. But I think more importantly, Matt, the worse than onetime costs that came through in Q1, that won't be repeated. Typically in Q1, there are some sort of seasonal costs that impact our EBITDA, and those include things like the reset, payroll taxes, Canadian-based. And there are some other projects that occurred in Q1 that won't repeat going forward. So there was a probably I'll call it $200,000-$250,000 of stuff that happened in the quarter that won't repeat going forward. And then there'll be additional measures that I've mentioned, which I would categorize or characterize rather as more belt-tightening for the next few quarters.

Okay. That's fair. And when you say that in April sales have picked back up, do you mean clients have become more receptive to sales calls? Or are you actually adding new customers and signing contracts?

So, Matt, I think it's both. I think we saw that right as the pandemic started to take hold, we have -- we saw customers kind of almost withdraw from really a lot of the conversations only because they had to get to battening down the hatches for their own organizations and making sure that they were positioning more for a remote work environment and make sure that their infrastructures were properly provisioned that way. So once that happened, we started to see again more conversations happening with customers. And we have seen not only the pipeline grow, but certainly we have seen more opportunities for new business. I think this whole COVID event, I think has spurred, I think, one, the value of both broadband and infrastructure to customers' environments. And I think it's safe to say that post-COVID, whatever that's going to look like, well, certainly, there's going to be a lot more need for digital requirements by customers using -- either using digital channels or putting more of their applications on through cloud or colocation environments. And so it's certainly I think encouraging for us and we've started to see some of that planning turn out as far as how we've seen the pipeline grow certainly over the past probably 3 weeks. So again we're cautiously optimistic, but I think obviously our services and data center assets are going to be critical to delivery of these services going forward and that will drive more opportunities.

Okay. And just a last one for me. I mean, have you started to see any increase in involuntary churn from clients or maybe looking for reprieve on payment? And then on the other hand are you seeing a lot of demand upgrade? I mean, given the amount of…

Yes.

Network needs that's the largest [indiscernible] probably have, I assume that you [indiscernible] upgrades on the other side?

Yes. Well, I think that's one of the interesting parts is that as soon as the -- as I mentioned to you, as customers were starting to focus on their own environment just to make sure that their organizations were able to work in a COVID environment, we received a number of upgrades for services both from an access broadband perspective up in their bandwidth requirements to accommodate the additional traffic for them. And also server and storage capacity in our data centers. So we were able to accommodate many of those requests because I think being a company like us, very agile, flexible organizations, we were able to accommodate those requests in a very timely fashion. And I think customers really appreciated. We actually have seen quite frankly our, as you probably notice in our MD&A we started to report net promoter score. And our net promoter score, in fact, has actually improved throughout this environment. We're right now at an NPS score of 71, which in our business is extremely, extremely high and best in class. Again, that shows I think what a competitive advantage service has for customers. Maybe I'll let David talk a little bit about some of the requests that we have had from some customers. And again --

Yes.

-- I think that also demonstrates the flexibility of working with an organization like TeraGo. David?

Yes. That's right, Tony. And so we have had some customers reach out requesting some deferrals of paying their bills. As you know, our services are essential to their operation, but in this environment some customers have been forced to close and they reached out. The number of customers and the amount of revenue on cash that that represents is very, very small. But as Tony said, we've been trying to be as flexible and as accommodating as we can, especially to the small, the very small customers that we have or the one-site shops and so on. And so again we'll -- we're keeping an eye on it. We're looking at this on a case-by-case basis, but the requests have been very, very small.

And I just think the additional question you had, Matt, was around churn. And again we've actually seen -- we haven't seen any increase in churn over the past while. It's actually quite well. We -- I think customers are much more intent on again making sure that their environments are up and running. And so we will continue I think to see and we have continued to see certainly in the subsequent weeks after the quarter a continued improvement in churn. So we see that continuing.

Your next question comes from the line David McFadgen with Cormark Securities.

A couple of questions. So just on the 5G trials, are you going to be testing 5G equipment on both the 24 gig and the 38 gig spectrum brands? Or it's just one that you're going to try on?

Yes. So, David, thank you very much for the question. So we -- our initial trial will be on the 38 gigahertz simply because of the availability of the equipment. We'll be looking at the interoperability between the Nokia gear and the partnership we have with them and various CPE providers, specifically ASCII to start. And we'll be testing interoperability, as I mentioned, between the CPE and the radios as well as the bandwidth throughput, the speeds and the latency requirements. So that's starting. We certainly see that we'll be testing the 24 as the equipment become available, which right now it appears in the second half of 2020. And I think one of the other things that we did mention, David, is that we had thought that we would be getting to customer testing in the second quarter. Obviously with the COVID impact that actually has been deferred to the second half of the year. However, we also see that customers, we've actually had some very good conversations with customers to date about being flagship pilot customers on 5G trials. So we've been very encouraged with those conversations with a number of flagship Canadian companies.

Okay. And then can you remind us how TeraGo fared during the last recession? I'm just wondering if this is just a very short-term recession or becomes really drawn out, and you start to see some small and medium-sized businesses shutting down, I mean I'm just wondering what the impact might be to TeraGo. If you can give us any learnings that you have from your last economic downturn?

Yes. Well, to be honest with you, David, I have -- I wasn't here at the time. So I don't recall. What I can tell you though is that a lot of the measures that we've taken over the past couple of years to move away from the small business market segment I think has helped in moving forward. We have predominantly most of our customers today, about 70% of our customers are within the mid-market to enterprise customers. And so that I think has protected us to a number of -- to a various degree. I think the other strength that we can talk to is the fact that our customer diversity by industry and size has also helped. For example, the hardest hit industries certainly with COVID-19 has been the retail, the travel and the leisure, hospitality and energy, those are kind of the key verticals. And these only compromise about 14% of our revenues, which is fairly low. So we believe that the diversity we have in our customers and moving away from the small and SOHO market I think has really helped us weather -- will help us weather this temporary crisis.

Yes, maybe Tony, I'll just -- I'd also add that within that 14% of customers across the various industries that we serve, within those, if you look at it, if you sort of peel it back and look, includes, for example, the retail market, but we've got some very big-named customers in the retail space. So it's not to say that 14% of our revenue is at risk. It's just at a very high level 14% of our revenue from customers. Our industries that may be directly impacted, but we're certainly not seeing that impact to date. I hope that helps.

Yes, no, that's very helpful. Okay.

Your next question is from the line of Maher Yaghi with Desjardins.

I wanted to ask you go back to maybe the question about payment from customers. I noticed your accounts receivable jumped quite a bit in the quarter. Can you just help me understand why? What's the -- is that what you're talking about as a small increase, but it's still 400, 500 that I'm seeing here. So is that the jump that you're talking about here on customers delaying payment?

Yes. Hi, Maher, and thanks for the question. It's a good one. So yes, we have seen -- at the end of the quarter, we have seen some of our customers delay their payments. Typically our DSOs were in the 20 to 21 day range. And I think what we've seen with that increase in accounts receivable the impact of COVID-19 to an increase of about call it 24 days, which is still quite good. Subsequently in April, we've had very good collections from customers. I would characterize it more, yes, there are some smaller customers that are probably holding on to the cash a little bit longer than they normally would, but we're in direct contact and having conversations with them. Payment or collection flow is very good although there are some customers that were directly impacted that have asked for some deferrals that we've accommodated. I would expect -- maybe just to come full circle here, Maher, I would expect that our DSOs would probably remain at around the 24 or 25 day mark going through the COVID-19 crisis. But again, that's very manageable from our perspective.

Okay. Okay. That's good to hear. And how about -- do you account for any kind of credit loss on some accounts in your normal way of doing business and you think that's going to pick up here?

So another good question. And so, yes, we've disclosed in our financial statements and MD&A an allowance, and typically that allowance has been $30,000, $40,000. We've announced this last quarter of $50,000 an allowance for doubtful accounts. So it's in the ballpark. I don't expect it to go much higher. But again we're just being very cautious here. We're tracking this literally on a daily basis in conversations with customers. And we'll keep -- we're all watching to see how long this pandemic will last and how long businesses will be forced to be closed. And it's encouraging to see there's some start to opening up the economy and we'll keep very close tabs on it. But we do this, Maher, on a case-by-case basis, bottom up, very detailed, and we've allowed for $50,000 in Q1.

Okay. Okay, great. And so I wanted just to big picture. I tried to understand on your cloud and data services business, certainly after this is all, I mean, we get back to normal business, clouds -- cloud utilization is going to be on the -- is going to increase. I'm hearing that from many parts of the tech sectors that I cover. And so when you look at your business, how do you try to gain foothold a bigger market share advantage on cloud services and that kind of -- do you have to hire more salespeople to potentially grab market share there? Or your focus now is really on 5G and cloud is just you're maintaining it at these level here?

Yes. So thanks for that, Maher. I think right now, certainly I think we are -- our data center utilization is about 60 -- mid-60s right now. We have seen that the whole COVID event, particularly over the last 3 to 4 weeks as customers start to -- or at least start to think about more longer term after they've really made sure that their environments are protected, we started to see certainly a lot more activity as you put it in the Cloud and colocation side, potentially moving applications to the cloud or to colo environments, off premises. And I think this has spurred that activity, and I think we're seeing certainly acceleration of that and certainly our pipeline is certainly demonstrating that -- those encouraging results. I think the fact of focus on 5G versus data centers, I think it's safe to say that majority of our data center investments happened 3-4 years ago. And quite frankly, to bring in new customers into our data centers doesn't require a lot of incremental capital. But as we pointed out before, 5G is really where more of our strategic focus is going to be and where we're going to invest our strategic capital, particularly once we get over and understand what the post-COVID environment is going to be. But I think it's safe to say that all of our assets are going to be -- demonstrated, I think that most of our assets are going to be a need for customers going forward even more so than when it was pre-COVID.

Okay, great. And my last question is more on 5G. And I'm not sure how I -- we should be looking at the situation. We've seen if we -- we've seen some negative press in the past about 5G. And in Europe, we've seen some demonstrations against deployment of 5G. But recently -- which has never really crossed the pond over here. But more recently we've seen incidents, more recent in the last couple of days where you had antennas and arrays being burned in Canada. How do you view this? How do you look -- what's your view on -- is that something we should be worried about? Or it's just going to fizzle out as the pandemic go back to and recede?

Yes. Again, I think it's important to know that we certainly have seen some of the press. I think that for 5G it's -- most of our -- well, all of our environments are on our rooftops. So we don't see that that is a major issue for us. So it's rooftop to rooftop. And certainly, that doesn't change and certainly I don't see as an industry by and large change in that thinking. Even more specifically, as you may know, Maher, the WRC, which is the global standard for millimeter wave has standardized, particularly in the 24 gigahertz globally as the standard for 5G, which is obviously our spectrum. And so I think that bodes well with the type of rollout you're going to see certainly in Canada and how I said it's going to look at it. But certainly we don't see that that is a major impact. We're carefully obviously looking at all and relevant information. But this -- at this point in time, we don't see that as being an issue for us.

Okay, great.

I will now turn the call back over to Mr. Ciciretto for his closing remarks.

All right. Well, thanks everyone for joining us on the call today. I'd like to thank you for your support, certainly of our vision and certainly confidence in our ability to achieve it. We wish you all the best in these difficult times. So, operator, back to you.

Ladies and gentlemen, this concludes today's teleconference. You may now disconnect.