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Good morning, ladies and gentlemen, welcome to TeraGo's Q3 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 risks set forth in the Risk Factors sections and each of the annual MD&A for the year ended December 31, 2019, and the Q3 2020 MD&A, which are available on www.sedar.com. Except as may be required by Canadian securities laws, the company does not undertake any obligation to update any forward-looking statement 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 will now turn the conference over to Mr. David Charron, Interim CEO and Chief Financial Officer at TeraGo. Please go ahead.
Well, thank you, and good morning, everyone, and thank you for joining TeraGo's Third Quarter 2020 Earnings Conference call. After the market closed yesterday, we issued a press release announcing our results for the third quarter ended September 30. And in that press release that financial statements and MD&A are currently available on SEDAR as well as our company's website, along with the slide deck that I will use for this call. Before I get into the financials, I want to provide an update with respect to our operations. First, I wanted to preface that every year around this time, the Board and the leadership team hold detailed strategic planning sessions, and one of the main topics this year, among other things, is the appointment of a permanent CEO. And given the importance of this decision, the Board has elected to continue their comprehensive review to first solidify the long-term strategy of the business and then align on the skill sets, qualifications and requirements for TeraGo's next CEO. Nevertheless, the Board has its full confidence in our current management team with me as interim CEO and the rest of the senior leadership team. I'm pleased to share that we have recently promoted our Chief Revenue Officer, Blake Wetzel, to the additional position of Chief Operating Officer. Blake's expanded mandate includes growing both TeraGo's top line revenue as well as leading the engineering and operations team in delivering best-in-class service to our customers. I'd also like to quickly touch on some Q3 operational highlights and KPIs. To begin, I'm pleased to share that we are exceeding my expectations as we continue to operate within this era of the COVID pandemic. As an essential service in Canada, we've been tracking our progress of bookings, cash collection, cash management and other internal metrics. And I'm very pleased with the results across these key stats. We have achieved year-over-year growth in our cloud and colocation business, stabilized customer churn and significantly grew our connectivity backlog, all of which I'll discuss further. Additionally, as I referenced in our previous earnings call, we received a Net Promoter Score of 70, which is well above the industry average and reflects a superior customer service and our ability to swiftly provision new services to customers. This accomplishment is certainly a testament to our resilient business model as well as our team's ability to adapt and execute. With that said, let's take a quick look at our key operating metrics for Q3. On Slide 5, starting first with our backlog monthly recurring revenue, or MRR, in our connectivity business. At September 30, backlog MRR increased to $113,200, driven by higher sales volumes from both the direct sales team and the channel. Cloud and colocation backlog MRR in Q3 grew to $31,900. The increase was due to strong bookings activity in the quarter that had yet to be provisioned. Taking a look at average revenue per customer, or ARPU. In our connectivity business, ARPU for the third quarter was -- of 2020 was relatively flat at $1,028 compared to $1,014 in Q3 of last year. However, our cloud and colocation ARPU for Q3 was $3,468, up 7%, from $3,248 in Q3 of last year. The increase is due to strong upgrade activity from existing customers, and we've seen increased demand from our CPU, storage and other offerings within our cloud and colocation portfolio. Looking at our third key operating metric churn. For the third quarter of 2020, churn in our connectivity business was 1.4%, down significantly from the 1.7% recorded last quarter. Churn in our cloud and colocation business decreased to 0.9% in the third quarter of 2020. Overall, the decrease in churn levels were a result of improved retention efforts and reflects the essential nature of our service to our customers' business. Turning now to the financial performance for the third quarter. On Slide 6, you can see that our total revenue in the third quarter declined 4% from the prior year period to $11.3 million compared to $11.8 million in Q3 of last year. Connectivity revenue in the quarter decreased 8% to $6.9 million compared to $7.5 million in Q3 of 2019. The decrease was attributable to churn exceeding customer provisioning. Cloud and colocation revenue for the third quarter of 2020 grew by 1.7% to $4.3 million in the quarter. Turning now to EBITDA. In the third quarter, our adjusted EBITDA decreased to $3.8 million compared to $4.4 million in Q3 of last year. The decrease was primarily due to the decrease in revenue as well as the investments we're making in our go-to-market team. Moving down the income statement, net loss for the third quarter of 2020 totaled $3.2 million compared to a net loss of $0.9 million in Q3 of last year. The increase in net loss was primarily driven by lower revenue and the severance charges recorded in the quarter. Turning to our cash flow on Slide 8. In the third quarter, we generated $3.7 million in cash from operating activities. While capital expenditures were $2 million or 18% of total revenue, driven primarily by strong success CapEx in the connectivity business. At quarter end, we had $7.6 million in cash, which was down from $8.7 million at the end of Q4 of 2019. Additionally, as we shared on the last call, we continue to have access to a revolving credit facility with RBC and TD Bank. Although this facility provides TeraGo with additional financial flexibility, we have no plans to draw from it in the near future. Instead, I intend to continue using cash on the balance sheet, and we expect that our growing bookings and provisioning activities will generate incremental cash flow from operations. I'd now like to review the current progress on executing our multipronged growth strategy, which we think of as 3 pillars on Slide 9. Starting with the first pillar of stabilizing our business and generating free cash flow. As I mentioned earlier, we saw excellent progress on churn returning to more normal rates as a result of our excellent customer retention efforts, which have certainly been encouraging. On the second pillar, we have significantly increased our overall backlog MRR. In particular, I'm pleased to see continued increases in our connectivity backlog, which validates the improvements we've seen in our sales efforts in our business across inside sales, direct sales and our channel teams. And finally, I'd like to provide an update on our 5G testing, which we continue to advance in our technical trials in the Greater Toronto area. We are optimistic of achieving even greater performance with higher power radios from Nokia and next-gen CPE devices from both Askey and INTEVO, which we now expect to receive in Q4. We're having meaningful discussions with partners and potential customers about promising 5G private network use cases in logistics, manufacturing, mining, education and transportation, to name a few. In the meantime, we continue to add innovative capabilities to our connectivity portfolio such as network managed services, which we plan to launch in 2021 in addition to our Internet 5010 and SDN solutions, which we recently announced. In conclusion, thanks to our diversified customer base, predictable recurring revenue, prudent approach to cash management, strong order backlog and outstanding customer service, I believe we are well-poised for both a successful turnaround as well as exciting future growth. That concludes my prepared remarks, and we can now open the call for questions.
[Operator Instructions] And our first question comes from Bentley Cross with TD Securities.
Dave, 2 questions, if I may. One, just a shorter term question on the backlog. When can we expect that to start trickling into revenues? And then a bigger strategic question, I think you know my thoughts on the value of the data center business to TeraGo going forward. But wondering if I might get your updated thoughts. And then as an extension to that, if you can help us connect the dots a little bit and talk about margins by segment, just to help us value that, that would be much appreciated.
Sure. Sure. Thanks, Bentley. Two good questions. So first, with regards to the backlog, our provisioning teams are working flat out right now to provision those backlog orders into revenue. What I can say is that we're starting to see -- you can tell from my prepared remarks, we're starting to see excellent execution in our go-to-market strategy. It feels like all of the elements are firing on all cylinders right now. And so we've got -- in the short term, we've got -- I'll call it, a good problem to have, and that's backlog growing and our provisioning teams being extremely busy right now. And as I look into the fourth quarter, we're seeing that level of activity increase and continue. And so again, a good problem to have, but we're going to have to really need to think about how we improve and increase our resources for provisioning to match the demand that we're seeing on the sales side. And so basically, coming back to your question here, Bentley, is indeed, we expect that to convert to revenue in the fourth quarter. And we're expecting continued activity into next year. As far as the data center business, most of our capital allocation, and you've seen the sales activity is around the -- what happens in our connectivity business. That being said, we're seeing very good demand on the sales side in our data center business. And so that business is chugging along nicely. It's been steady Eddy from a growth perspective. We don't feel the need of deploying additional capital to grow that business. But it is a very important cash flow business to TeraGo. And so one of the things that I get asked a lot, I think what you're asking, Bentley, and I get asked by investors all the time is how do the margins stack up. And so I think, while we don't disclose EBITDA margins for our lines of business, it's important to think about -- the 2 lines of business it's actually important to think about as 3 lines of business. The margins for the connectivity business are different than the margins for the cloud business and are different from the margins in the colocation business. And if I were to rank them in terms of profitability, our connectivity business, is the most profitable. Our cloud business is the next most profitable, and the colocation business is probably the least profitable of the 3 lines of business that we have. And I'll start with the colocation business, which primarily because we have excess capacity in our data centers. And as we continue to see our backlog increasing in cloud and colocation, as we start to fill up the data centers, I expect that those margins will increase. But as it stands today, that's the relative ranking of the 3 businesses.
And our next question comes from David McFadgen with Cormark Securities.
Just a couple of questions. I was just looking on Slide 8. You detailed your operating leverage, 3.15. Can you just remind us again what the covenant is? And I know you don't want to provide guidance, but do you expect that, say, in 6 months or 12 months from now, that your leverage would be down from where it is right now?
Thanks, David, great question. So our debt facility takes us to 3.5x leverage. And you're right, we're over 3. We're at 3.1 and change right now. And I do expect, and I will come out and say, David, I do expect that over the next couple of quarters, I expect that to come down. And the reasons are around the revenue that I expect to see increase, just given our backlog and given the sales momentum that we have over the next couple of quarters. As well, we've taken some actions, David, in the quarter to reduce expenses, and you'll see that in the severance charges that we've recorded. And so that happened mid-quarter. And so I expect that in the next couple of quarters, we'll see full quarter benefit from those changes. And so when we put those 2 things together as well as continuing to pay down the debt and not drawing any further on it, as I mentioned in my prepared remarks, I do expect a leveling off and a decline in that leverage over the next couple of quarters.
And so -- and then just another question. I was just looking at the churn rate. I mean, the churn rate is heading in the right direction, generally. It's flat or down. So it looks like COVID has -- and your small business – small/medium-sized businesses haven't really been hit by COVID. Is that a correct way to think about it?
That's indeed correct, David. We -- at the very beginning of the pandemic, we were cautiously optimistic that because of our diversified customer portfolio, we had customers in 34 industries. And so when we looked at our customer base and where they sat, we had very little exposure to customers and industries that are, I'll call it, directly impacted by COVID. We've been fortunate in that regard. And we've monitored our metrics very, very closely, and as I mentioned, bookings and cash collection and provisioning and so on. We've been very fortunate that because of the essential nature of our services, we haven't been adversely affected by COVID.
And our next question comes from Matthew Lee with Canaccord.
Just in terms of connectivity, I mean, I'm looking at the revenue number, and obviously, it's going back into the -- a larger decline than maybe we saw in Q2 and Q1. Can you maybe talk to why that is? I know you said it's churn, a greater amount of churn than provisioning. But maybe you can talk about -- is it a large client or a number of small clients? Or what's going on there?
Yes. Thanks, Matt. I'll provide some color there. So what we've been seeing in our connectivity business has been continued churn of the small business segment. And so it's those customers with, I'll call it, one location and there -- it's a combination of being very price sensitive. And some of them, frankly, have been hit by COVID, the small, small businesses. And so we've seen some declines there. But what we fully expect to see, as our backlog has increased and as you noticed, we're targeting our efforts to the mid-market to customers that require multiple locations, multiple sites across Canada. And so we've seen pickup from everything from lead generation to pipeline growth. And then now, we're seeing it in our backlog. And that is very encouraging in our connectivity business. We see that starting to happen. And I expect over the next couple of quarters, we'll start to see that inflection point where that growth will start to happen in the business that we've been waiting for, for quite a long time.
Yes. I think that was really my next question. Kind of when would you peg your revenues from positive? Is it an early Q2 '21 thing or late Q2 '21 -- or early fiscal '21 or late fiscal '21?
I think we'll start to see some improvements in early 2021. It all depends on timing of deals that we expect to close and then the provisioning of that. So when we speak again in February for our year-end, I'll provide more color on that. As we start to see, I'll have another quarter under my belt to actually observe that, the timing of orders and provisioning. But as it stands now, I would expect in early 21 to see that inflection point.
[Operator Instructions] And the next question comes from Jerome Dubreuil with Desjardins.
Can you maybe tell us what the Board is looking for primarily for the new CEO? Is it a cost-cutter? Strong [ wireless ] capabilities?
Jerome, thanks for your question. And so as I mentioned in my prepared remarks, we're going through, I'll call it a very detailed strategic planning review with our Board. And this is something that in the 30 years I've been doing this, it happens every year. You sort of sit back and you reflect on what you want to be when you grow up. This year, given the management change that we've made and given the great Board addition we've had with Ken Campbell joining our Board, we're actually doing a deeper dive than normal. And so as we're working through that, it's probably no surprise that a lot of what we're seeing is and what we're coming up with is excitement about the connectivity business, excitement about our assets that we have across Canada, 600 rooftops in almost all the business -- major business parks across Canada. And of course, our spectrum. And so as we think about how we're trying to position ourselves for growth in the upcoming 5G opportunity in front of us, it's probably no surprise that, that's where we're leaning. But until we work through that full strategic planning exercise -- and the Board is very happy what they're seeing right now with the current management team and the trajectory that we have and the progress that we're making. And so it's likely that what we're going to need is somebody to manage this growth and drive this growth. It's not going to be somebody who's going to be retrenching. We see great growth trajectory in front of us. And I think it's very fair to say that it's going to be a leader that can help us drive growth.
That's helpful. And maybe another quick one. Do you expect any CapEx impact in the fourth quarter from the additional equipment investment?
Yes. That's a good question, Jerome. Thanks. And I do expect the sort of continued CapEx spending at the rate that we've seen in the last couple of quarters, and it is driven by the growth that we're seeing in the connectivity business and our backlog. And so I would expect from a modeling perspective to see something similar in that respect.
And there are no further questions at this time. Mr. Charron, I'll turn the call back over to you.
Okay. Great. Thanks, everyone, for joining us on the call today. And on behalf of everyone at TeraGo, I want to thank you for your continued support, and I look forward to providing an update next quarter.
And thank you, ladies and gentlemen. This concludes today's conference call. Thank you for participating. You may now disconnect.