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TeraGo’s (TRAGF) CEO Antonio Ciciretto on Q2 2017 Results – Earnings Call Transcript

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TeraGo Inc. (OTC:TRAGF) Q2 2017 Earnings Conference Call August 10, 2017 9:00 AM ET

Executives

Antonio Ciciretto – President and CEO

Jeffrey Yim – VP, Corporate Development

Analysts

David McFadgen – Cormark Securities

Bentley Cross – TD Securities

Lee Matheson – Ewing Morris & Co.

Maher Yaghi – Desjardins Capital Markets

Operator

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the TeraGo Inc.’s Q2 2017 Financial Results Conference Call. At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session, and instructions will be provided at that time for you to queue up for questions. [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 and are intended to be forward-looking statements under applicable Canadian securities legislation.

By their nature, forward-looking statements are made based on assumptions and are subject to inherent risks and uncertainties. We caution participants on this conference not to place undue reliance on forward-looking statements, as a number of factors could cause actual future results, conditions, actions, or events to differ materially from the targets, expectations, estimates or intentions expressed with the forward-looking statements.

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 ended December 31, 2016, which is available on www.sedar.com, and consider other uncertainties and potential events in particular. If any of the risks materialize, expectations and predictions of the Company may need to be re-evaluated.

Consequently, any forward-looking statements made on this conference call are expressly qualified by this cautionary statement, and there can be no assurance that the actual results or developments anticipated by the Company will be realized. Except as maybe required by Canadian securities laws, the Company does not undertake any obligation to update any forward-looking statement as a result of new information, future events or otherwise.

I will now turn the conference over to Mr. Tony Ciciretto, President and Chief Executive Officer of TeraGo. Please go ahead.

Antonio Ciciretto

Thanks, Megan. Good morning, everyone, and thank you for joining us for the second quarter investors call. An overview of the second quarter financial results will be addressed by Jeffrey Yim, Vice President, Finance and Corporate Development, right after my opening remarks.

Before I speak about our progress executing our strategic growth plan, I would like to highlight our continued effort to strengthen key management and Board positions. We recently announced the appointment of a new Board chair, Matt Gerber, who has extensive operating and Board experience at several significant cloud computing businesses. He will definitely be an asset to our management team.

Also, I’m pleased to have announced that David Charron has been appointed TeraGo’s next Chief Financial Officer, who will join us on September 5. David brings more than 20 years of financial leadership experience to TeraGo and a wealth of knowledge and expertise in the IT services industry. These latest two appointments will help accelerate our strategic growth plan.

We also announced an amendment to our credit agreement this past quarter, extending that maturity date from June 30, 2018, to June 14, 2021. The total credit facilities will decrease from an aggregate amount of $85 million to $75 million, to reflect principal repayments made to our non-revolver term facility. The extension of our credit agreement allows us to continue to focus on growing the business, knowing that the financial support and flexibility is there to facilitate the execution of our strategic growth plan.

Let me begin by saying that we continue to diligently focus on executing our strategic plan, with the clear objective of achieving a sustainable, profitable growth. Important progress on many facets of our strategic plan was made in the last quarter, although we have experienced some minor challenges related to scaling, new personnel and processes. We’re focused on addressing the situation and taking corrective actions to ensure we get back on track.

An important tenet of our strategy is placing a greater focus on the colocation business. We have onboarded a number of seasoned colocation sales professionals, focused on maximizing our data centre utilization. As these resources start to be productive, we have seen growth in our colocation sales pipeline in the second quarter and expect it to translate in improved sales bookings in the third quarter.

Next, we continue to enhance and simplify our services portfolio by introducing a number of key service offerings. For example, to protect and store customer data, we’ve launched a fully managed disaster recovery-as-a-service and rounded out our security portfolio with the introduction of virtual firewall and anti-malware products.

Also, I’m pleased with our progress building our AWS practice. Although progress is lagging our initial expectations as the magnitude of the various facets of the program become clear, we have achieved 227 AWS business and technical accreditations to date, and six AWS-certified solutions architect associates with an additional six certifications in progress. With the number of certifications and other criteria in place, we will be in a position to achieve our standard tier requirement by the end of the summer.

Architecting, onboarding and migration of customers to AWS Cloud is an important component of establishing our AWS practice. We currently have 20 architectural design trained resources and additional five resources trained on customer migration. We have also concluded an agreement with Cloud Technology Partners, an AWS-certified migration partner, headquartered in Boston, to acquire system platform capabilities to migrate customer environments to AWS.

Next quarter we’ll see a ramp-up of go-to-market activities and the soft launch of initial AWS managed service offerings to beta clients, progressing towards our goal of achieving advanced partner tier status. We have also completed our billing proof of concept for AWS, billing and back-office software. Although AWS managed services will not be made available to sales until the beginning of the fourth quarter, on a selective basis we have already started to build the sales pipeline and we are actively engaged working on a number of sales opportunities.

In an effort to improve customer experience, we have rolled out a new Customer Lifecycle Management Framework to all employees at TeraGo. The framework will focus on enhancing processes and systems that will create a differentiated experience at every touch point with our customers, resulting in increased customer loyalty and revenue. We have also launched an improved interim Web-site, with a full new Web-site coming online later this summer, in parallel with the launch of our new CRM, making it easier for us to reach new customers, enabling us to build our brand.

In other matters, on June 5, Government of Canada’s Innovation, Science and Economic Development Canada, ISED, recently issued a consultation on releasing millimetre wave spectrum to support 5G. The consultation contemplates the release of spectrum in the 28 gigahertz, 37 to 40 gigahertz, and 64 to 71 gigahertz frequency bands. TeraGo is a major license holder and user of the 38-gigahertz spectrum, holding 25 of the 28 auctioned licenses. We are currently working on completing our submission that’s scheduled for early September.

In closing, a great deal has been accomplished in the past quarter. We will continue to make progress executing our strategic plan and I look forward to sharing our progress with you at the next quarterly Board Meeting – sorry, next quarterly investor call.

Next, I would like to turn it over to Jeff Yim to provide you an overview of our second quarter financial results. Jeff, over to you.

Jeffrey Yim

Thank you, Tony. I’ll start on Slide 7. Cloud and colocation revenue increased 6.3% or $281,000 in the quarter compared to the same period in 2016. The increase was driven by higher base monthly recurring revenues, offset slightly by lower usage revenues that we experienced in the quarter.

Connectivity revenue decreased 10.6% or $1.2 million compared to Q1 of 2016. The majority of this decrease was attributable to churn and the Company’s burstable Internet services, which are lower bandwidth services, slightly offset by higher revenues that we experienced from re-sale fiber.

Overall, total revenue decreased 6% to $13.9 million in the quarter, compared to $14.8 million in Q2 of 2016, as growth in the cloud and colocation revenue was not enough to offset the decline in connectivity revenue. In the quarter, cloud and colocation revenue accounted for 34% of our total revenue, up from 30% last year.

Adjusted EBITDA decreased $1.9 million in the quarter, driven by the decrease in revenue and higher SG&A expenses, as the Company continued to implement elements in each of our strategic growth imperatives Tony just took us through. As a result to this progress, in the quarter we incurred higher personnel cost and marketing expenses. We also saw higher one-time costs in the quarter related to our Web-site redesign and recruiting expenses related to our CFO search.

Turning to Slide 8, capital expenditures decreased slightly in Q2 by $137,000 compared to the prior year. The lower capital expenditures in the quarter were mainly driven by timing of projects. Leverage in the quarter increased to 2.43x compared to Q1 of 2017, as investments in the business decreased adjusted EBITDA. The ratio is still well below our covenant of 3.5x.

As Tony mentioned earlier, we completed a second amendment of our credit facilities, extending the maturity to June 2021 from 2018. I’d like to thank National Bank of Canada, TD Bank and RBC for their continued support of TeraGo. With our strong balance sheet and the extension of the credit facilities, we continue to have the financial flexibility to execute on our initiatives, with $8 million of cash and unutilized $10 million operating line, and a $25 million acquisition and Capex facility in place.

With that, I will now turn the call back over to Tony.

Antonio Ciciretto

Thank you, Jeff. Turning to the last slide to summarize, our result is guided by our three strategic principles: First, a clear focus on the execution of our six strategic imperatives. Next, invest in growth while achieving sustainable profitable growth. And lastly, deliver value to our customers while creating value for our shareholders.

I will now turn it over to the operator if there are any additional questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of David McFadgen with Cormark Securities. Your line is open.

David McFadgen

A couple of questions. So, first of all, when I look at your cloud and colocation revenue, it dipped a little bit sequentially from Q1 2017 to Q2 2017. Should we read anything into that? Is that a new trend or do you expect it to bounce back and continue to grow sequentially starting in Q3?

Antonio Ciciretto

I think it’s important to understand first that the recurring revenue for our cloud and colocation has actually gone up. What happened in the second quarter is that the usage revenue has gone down and that’s very dependent on the customer activity. So we don’t see that certainly as an ongoing trend. We certainly also saw one of our cloud customers that was with our channel partner that has looked to bring their cloud infrastructure in-house. So that was kind of the second one-time activity.

And then lastly, it’s really starting to, as most of our salespeople now within the second quarter started to – as the salespeople started to onboard, it does take about six to nine months of sales time to really become fully productive.

And lastly, we went through, as I mentioned in previous calls, we went through a significant sales restructure in the second quarter within our sales organization, again to be much more broadly focused around selling all our services for our salespeople as well as having more attention with existing customers and more focus on acquisition of customers within the mid-market.

So those are all one-time certainly events that we see that are not systemic and certainly does not account for a trend. And we see, and we envisage actually cloud and colocation revenues going up in the following quarters.

David McFadgen

Okay, that’s helpful. You also talked a little bit about your pipeline and how you expect to realize some of that starting in Q3. Could you just elaborate a bit on that?

Antonio Ciciretto

Again, it comes back to, over the past quarter, we really have brought on a number of new sales individuals, and our expectation certainly as these individuals start to be fully productive is that the sales pipeline will start to build. We are at a full complement of salespeople within our organization. And again, along with that, as the sales pipeline grows, we certainly envisage, just even maintaining current close rates, a better production in sales. So, I’ll leave it at that.

David McFadgen

Okay. And then just on the SG&A, you talked about how the adjusted EBITDA dipped a bit because you had higher sales and marketing expense. Should we expect that to continue to go up again into Q3 and beyond or have you sort of stopped building up the sales end?

Antonio Ciciretto

I will turn it over to Jeff for that.

Jeffrey Yim

So, yes, I would say that from an employee complement, we are fully staffed within the sales organization. So we wouldn’t expect the ongoing personnel cost to increase. In fact, given we had some one-time items in the quarter, we would expect that to look a bit better.

David McFadgen

Okay. And then just lastly on the spectrum that you talked about for 5G, so in the event that 37 gigahertz, 38 gigahertz band will be used for 5G, do you imagine that you could actually free up that spectrum and then repurpose it?

Antonio Ciciretto

As I mentioned earlier, I mean our focus really is in driving our key core business, and one of our strategic imperatives as you know is really unlocking hidden value of our assets. Spectrum is really one of these assets, obviously the others being connectivity and data centre infrastructure.

So, we’ll continue to use our spectrum to drive our business. We’ll certainly study the spectrum situation closely and determine how best to unlock the value that we see within that asset for our shareholders. And we will also be doing it in conjunction and looking how the playing field will start to be clarified with our submission of the consultation for ISED and their ultimate decision, which we would expect shortly afterwards.

David McFadgen

And when do you think ISED will actually render a decision on this?

Antonio Ciciretto

It’s hard to say, David. In past experience, I would think if I were to say potentially near the year-end or possibly early in 2018.

David McFadgen

Okay, all right. Thank you.

Operator

Your next question comes from the line of Bentley Cross with TD Securities. Your line is open.

Bentley Cross

First I want to ask about the legacy connectivity business. I mean, in some of our conversations recently, I was getting the impression that things are starting to turn here, but obviously that wasn’t quite the case in the quarter. Is there any sort of forward indicators that you can give us, whether it would be backlog or churn or any of those metrics that might give some investors some confidence?

Antonio Ciciretto

Bentley, as you know, we don’t report obviously on churn. But I think, certainly we haven’t seen a worsening of the revenue situations for connectivity, in that I think the market from a competitive standpoint has become and continues to be fairly disciplined. When we actually are looking at things like our lifecycle management processes and improving that within the Company, we will certainly continue to see improvements on how we actually are able to continue to serve our connectivity customers, and that should drive greater loyalty and greater revenue within that line of business.

Bentley Cross

Okay. And just to clarify, there were no big customer losses or one-offs of any nature in the quarter?

Antonio Ciciretto

No, there were no surprises at all, Bentley.

Bentley Cross

Okay. And just on the data side of business, you talked in your opening comments about the ramp for AWS. I know it’s hard and it’s still early days but can you kind of give us some color as to kind of how you expect that to ramp throughout the year from a revenue standpoint?

Antonio Ciciretto

I think it’s probably fair to say that – and I think we were very clear on the Q1 call that it will certainly take 9 to 12 months to really become fully productive in the AWS to get all the infrastructure to support our customers, to train our people. And so, I think it’s safe to say, you’re going to get relatively little revenue impacts in 2017. You’ll start to see, and we have started to see our pipeline grow. I think as the pipeline grows, majority of these migrations, the revenue will start to hit latter part of this year, but really primarily in 2018.

Bentley Cross

Okay, that’s it for me. Thanks.

Operator

Your next question comes from the line of Lee Matheson from Ewing Morris. Your line is open.

Lee Matheson

So you mentioned the submission to ISED on the spectrum, I’m just curious if you can give us some color in terms of the resources that the Board and management have put towards understanding the value of the spectrum and how best to monetize it. I mean because if you’re going ahead into the consultation phase, do you have some outside advisors on this, can you just provide some color on that?

Antonio Ciciretto

I think we closely monitor obviously the situation as it relates to the spectrum. We continue to look south of the border on some of the things that have happened. So, we obviously have talked to a number of different organizations to get I think an understanding of the value of assets.

And again, I think what’s going to be clear for us and certainly on how we approach this as a key data point is really what I said will come back as part of our response, which ultimately I think will – not I think, it will be public certainly for organizations and we continue to consult even with our competitors in the market, as we contribute to the consultation process.

Lee Matheson

And I guess there’s two things, I mean certainly the discussion around the 38-gig spectrum and 5G is focused on 5G wireless standards, I mean presumably mostly for mobile handheld devices, I’m wondering based on what’s going on south of the border where we’re seeing Verizon, we’re seeing AT&T, we’re seeing T-Mobile, everybody, [indiscernible] TELUS now in Vancouver talking about wireless to the premise as a replacement for fiber to the premise, which is sort of 180 from where people were talking about last mile delivery 18 months ago, I’m curious if from the spectrum that you hold, that there’s potentially then two complementary uses for this spectrum, I’m wondering if you’ve contemplated or your advisors have contemplated the use of that spectrum again not for wireless handheld but for wireless. I think Verizon is doing wireless to the home for residential connectivity in a few markets now.

Antonio Ciciretto

Yes, so we definitely are always looking and seeing how our spectrum could be better utilized. You mentioned about obviously handheld and just the fact of getting greater bandwidth at the wireless device, but there are other components. Obviously, vehicle automation is one. Second is around the one that you just brought out, is fixed wireless to the home, and Verizon has been doing a number of trials and proofs of concepts in this area. So, again, it’s a number of data points that we’re trying to bring together to formulate I think a very succinct way of us maximizing the value of our assets. But we are obviously very interested in those developments.

Lee Matheson

And so, I mean in theory, I think you spoke about maximizing value in terms of the, call it, three buckets of your business, connectivity, data centre, also data centre cloud, and then spectrum, I mean if the world is going the way of what TELUS and Verizon are purporting to do, is there really a – I mean does the connectivity and the spectrum business mod then – are they kind of – could they be considered one unit as opposed to separate units? I mean given the fact that you guys are a leader in fixed wireless, would it not make sense to keep the spectrum and the connectivity business together if people are starting to kind of contemplate that as a business model?

Antonio Ciciretto

Yes, certainly the spectrum really for us, it’s a core asset to drive our core business, and how best to actually deliver that and create value for our shareholders is certainly the most important. So, yes, we don’t divide the two into separate categories. Spectrum is a key delivery method for us for our core business.

Lee Matheson

Yes, okay. And last question on this is, in terms of the 28-gig spectrum, have you hired somebody to help lobby in terms of getting that spectrum included in the consultation process, and potentially putting a stake in the ground in terms of what that spectrum could be worth?

Antonio Ciciretto

So just to clarify, Lee, so the 28 which is being contemplated by ISED through the consultation process is different than the 24-gigahertz that we actually have.

Lee Matheson

Sorry, I meant to say 24, pardon me, 24.

Antonio Ciciretto

So the 24 certainly is, to us again is a key delivery vehicle for us to deliver our core services. We see this irrelevant of how and if ISED actually approves spectrum beyond the two or the three that I mentioned and entertains the 24, I think irrelevant of that, is that 24 gigahertz is still an important spectrum for us because it certainly is, other than probably fibre, it is probably the preferred backhaul method of any other millimeter wave spectrum. So, it’s still of significant value to us. And again, we’ll position it in a way that we believe is worthwhile for us in our response to ISED.

Lee Matheson

Good, okay. Thank you, gentlemen.

Operator

[Operator Instructions] Your next question comes from Maher Yaghi with Desjardins Capital Markets. Your line is open.

Maher Yaghi

Tony, you were asked a question earlier about the connectivity business decline. You mentioned that you are not at this point willing to let’s say give out the metrics on subscribers or ARPU, et cetera. But of the 11% decline that we’re seeing year-on-year in connectivity, how much let’s say the majority of that decline, is it related to the subscriber decline or ARPU decline?

Antonio Ciciretto

Again, I think the majority, it’s safe to say, is with small business and in a very low bandwidth area of our business. It’s probably an area where a small business customer can easily [indiscernible] to a more fibre-based service without the need for the reliability that we would offer. So, it’s almost best case service offerings. And so, we don’t anticipate – a lot of this churn in this area is really what we would consider low value customers and not contributing a significant amount to the bottom line.

Maher Yaghi

Okay. So, as you say, the majority of this is related to subscribers than ARPU price pressure?

Antonio Ciciretto

Let me clarify. The fact is that, yes, churn is one aspect of it. But as you know, we contract typically between two and three years for our customers. And so, after a three-year period, typically there will be a price reduction typically to re-sign. And we endeavor to actually bundle our services with either other components of connectivity offerings or more likely to some of our bundled offerings that we’ve actually put in the market to grow into security offerings as well as some data centre service offerings, so in order for us to mitigate that. But it’s safe to say that a good percentage is also priced after a three-year period where you’ve seen a lot of decline within the connectivity business price realm.

Maher Yaghi

Okay. I guess what we are all trying to figure out is, it’s still the majority of your revenue coming from that business line and we’re trying to figure out how we’ve seen the worst of the year-on-year declines, and not return to growth, but I mean it’s still weighing heavily on your consolidated revenue line. So, what can you provide us in terms of outlook that can either say, okay, we’ve seen the worst or close to seeing the worst and we should start to see retrenchment in that decline, or if you are not ready to say that, then what as management can do to remedy the situation on a consolidated basis for the whole organization?

Antonio Ciciretto

So the trend obviously that occurred last year, at the end of last year and into Q1, I mean we’re taking a significant number of measures in order to improve the way we serve our customers to increase the loyalty and increase the revenue from those customers. Those specific initiatives take time. It’s not just the way we serve them. It’s also the processes we use in order to better serve our customers.

We first of all have not seen a degradation in the reduction of our connectivity. So again, we see signs that certainly the worst of what we’ve seen in the past year is not going to occur, at least certainly from what we see at this point in time, and we’ll start to see better retention, better service of these customers, and hopefully get greater loyalty and revenue from these customers.

Jeffrey Yim

It’s Jeff here. Another thing I would just add is, so we did see some growth in our resale fibre, which I think is important because we believe that the customers who are taking fibre, one, they are staying on the TeraGo platform, and secondly, because they are using higher bandwidth services with fibre, we believe that there is a higher propensity for them to purchase additional services, specifically our cloud and colocation services. So, that’s the trend that’s emerging that might not completely stem the decline in connectivity, but we feel provides us a good base of customers to continue to sell our additional services into.

Maher Yaghi

Okay, okay. And in terms of many questions were asked about the ISED review on 5G and the spectrum’s allocations there, I’m more interested in understanding really what you as an organization would like the outcome of this consultation to lead to? What’s your best case scenario?

Antonio Ciciretto

We’re still at the point where we’re formulating those opinions, Maher, because we’re in the process of completing the response to the consultation. So, we’re not there. I think we’d be in a better position in the next quarter to give a view of what our response is. And right now, we’re in fact finding [indiscernible]. But ultimately, at the end of the day, we want to make sure that this is going to really help TeraGo with how we grow our business, and making sure that the principles of the playing field is conducive to that.

Maher Yaghi

Okay. And last question more related to CapEx, you mentioned that there was let’s say a momentary decline in the CapEx. Should we still continue to expect around 13% capital intensity for the business as a whole for 2017? Is that the goal?

Jeffrey Yim

Yes, so we’re still targeting to hit around the mid to low teens for 2017. As I mentioned, there were some timing of projects that contributed to a little bit lower CapEx. So, in the back half of the year, we’d see that, we would expect that to come up a little bit.

Maher Yaghi

Okay. And this one last question I have is on the 38 gigahertz. How much of that spectrum is actually used by TeraGo right now? I know that you use the 24 I guess to a large extent. What’s the 38 gigahertz usage right now?

Antonio Ciciretto

Again, we won’t – Maher, we can’t tell you exactly what our usage is based on the spectrum that we have, but we use our spectrum based on the customers that we serve and where we serve them. And so, we’ll use the spectrum based on that. It’s not something we’ll report or convey in a conference call.

Maher Yaghi

Okay, great. Thank you for taking my questions, guys.

Operator

And there are no further questions at this time. I’ll turn the call back over to the presenters.

Antonio Ciciretto

All right. Listen, everyone, thank you very much for attending this morning’s call. We look forward to sharing our results and performance on the Q3 call. So thank you very much. Have a great day.

Operator

This concludes today’s conference call. You may now disconnect.

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