Terago Inc

TSX:TGO

Earnings Call Transcript

[Operator]

Good morning, ladies and gentlemen. Welcome to TeraGo's Third Quarter 2021 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 application -- 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 section in the annual MD&A for the quarter ended September 30, 2021, which is available on www.sedar.com and also consider other uncertainties and potential events. Except as may be required by Canadian securities 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 will now turn the conference over to Terago's Chief Executive Officer, Matthew Gerber. Sir, please proceed.

[Matthew F. Gerber, CEO & Director]

Thanks, Patricia. Good morning, everybody. I hope your day is off to a great start, and thanks for joining our Q3 2021 earnings call. Before I get started, I want to let you know that joining me on this call is Andy Ramsey, our VP of Finance and Interim CFO; and Blake Wetzel, our CRO and COO. Andy will take you through the financial summary after I do the introduction, and Blake is on to help -- to possibly help me answer some of the questions you may have later on. After the market closed yesterday, we issued a press release announcing our results for the third quarter ended September 30, 2021. The press release, financial statements and MD&A are currently available on SEDAR as well as on our company website, along with the slide deck that we'll use for this call. We're really excited about what we can share with you today, especially the progress we're making towards launching our millimeter wave 5G private network services. Our operating results for the quarter were, for the most part, on par with what we expected. During the quarter, we continued to see a shift in our client base towards mid-market and small enterprise customers. As for the shift in our focus, we continue to see churn in our legacy connectivity small customer base while we grew overall sales to the mid-market, small enterprise customers, including expanding sales of multiple products into our targeted base of customers. As we focus on the mid-market and small enterprise, we remain intensely committed to competing on our ability to provide exceptional service levels to our customers. As we mentioned on prior calls, our ability to provide an unparalleled level of service in this industry is one of the primary reasons our mid-market and small enterprise customers do business with us and continue to expand relationships. The best evidence of our capabilities to provide this exceptional service level continues to be our Net Promoter Score or NPS. Our NPS for the past quarter was 66, and it's averaged 71 over the past 12 months. This compares to our competition that sees NPS scores in the single digits and, in some cases, in the negatives. Credit for these achievements in customer service goes to our amazing team, the TeraGo employees who are the lifeblood of this company. That said, we made some fundamental changes to our executive team this past quarter. We now have new faces at our senior leadership team table for our connectivity and cloud and colocation business lines, along with new faces for our finance, legal and human resource functions. With these changes come to new thinking and a first perspective on how we can continue to improve our organization and services capabilities. Andy Ramsey, our VP of Finance and General CFO, who will you hear from in a bit, is a prime example of these recent changes that are going to benefit all of us. Lastly, we're also reaping the benefits of strengthening our balance sheet earlier this year as the new capital provided us with the funds necessary to advance our millimeter wave 5G private networking strategy. I know that this is something that many of our shareholders are looking for an update on, so I'll be sharing more details around this after Andy gives you an update on our financial performance for the quarter. With that, I will pass the floor over to Andy for a review of how the financials look for Q3. Andy, over to you.

[Andrew Ramsey, VP of Finance & Interim CFO]

Thanks, Matt. I'll start on Slide 5 with a look at our KPIs for the quarter. Backlog monthly recurring revenue or MRR in our connectivity business for Q3 2021 decreased to $103,000 from $113,000 in Q3 last year. The decrease was driven by lower sales volume compared to the prior year period. Cloud and colocation backlog MRR in Q3 2021 increased to $39,000 from $32,000 in the same period last year. The increase was driven by the timing of sales bookings and provisioning activities. Taking a look at our average revenue per customer or ARPU. In our connectivity business, ARPU for the third quarter of 2021 decreased slightly to $1,026 compared to $1,056 in the same period last year. The decrease was due to customer contract renewals at lower rates. Our cloud and colocation ARPU in Q3 2021 increased 14% to $3,785 from $3,323 in the same period last year. The increase was due to customer upgrades and cross-selling activities as well as the churn of lower ARPU customers. Now looking at our third key operating metric, churn. For the third quarter of 2021, churn in our connectivity business was 0.9%, which compared to 1.4% in Q3 of last year. The decrease in churn was driven by a focused effort on improving our account management framework and offering compelling renewal options to our customers. Churn in our cloud and colocation business was 1.1% compared to 0.9% for the same period in 2020. The slight increase was due to the timing of customer contract renewals. Moving on to revenues on Slide 6. You can see that our total revenue in the third quarter was consistent with the prior quarter at $10.9 million but declined 3.5% from $11.3 million in Q3 last year. The year-over-year decrease was driven by lower revenues in our connectivity business. Connectivity revenue in the quarter decreased to $6.5 million from $6.6 million in the prior quarter and decreased 8.5% from $7.1 million in the same period last year. The decrease in both periods was driven by churn exceeding customer provisioning. Cloud and colocation revenue increased to $4.4 million compared to $4.3 million in the prior quarter and grew 4.8% from $4.2 million last year. The growth in both periods was driven by new customer acquisition and upgrades from our existing customers. Turning now to EBITDA on Slide 7. In the third quarter of 2021, our adjusted EBITDA decreased to $3.1 million from $3.8 million in the prior year period. The decrease was driven by a decline in revenue and higher cost of services due to the mix of services sold. Moving down the income statement, net loss for the third quarter of 2021 decreased to $2.3 million compared to $3.2 million in the same period last year. The decrease was driven by lower SG&A expenses due to executive restructuring costs incurred in the prior year and lower stock-based compensation in the current period. Turning to our cash flow on Slide 8. In the third quarter, we generated $2.6 million in cash from operating activities, while capital expenditures were $1.5 million or 13.7% of our total revenue. CapEx was driven by customer provisioning activities and network infrastructure upgrades. Turning to the balance sheet. We ended Q3 2021 with $6.7 million in cash, which was down from $7.6 million in the same period last year. With that said, I'd like to turn the call back over to Matt, who will provide an update on the encouraging trends we're seeing in the business. Matt?

[Matthew F. Gerber, CEO & Director]

Thanks, Andy. So as I mentioned in the opening remarks, we continue to see the benefits of focusing on our business customers in the mid-market and small enterprise segments. Well, with this focus comes leverage as we were able to narrow our product line offerings, the products that are most in demand by these customers, and also layer value-added services such as software-defined wide area networking or SD-WAN, manage both data storage and manage network services on top of our core connectivity, cloud and colocation product lines. We're also providing products and services tailored to the mid-market and small enterprise. And these customers partnering with us that deploy more of our products and services, we're becoming more integral to our customers' operations, which is creating very sticky and productive relationships. We found that a broader but targeted portfolio of offerings, coupled with our exceptional service, has been a recipe for success for us. As I mentioned earlier, while we've seen our total customer count decline as small customers churn off and purchase commodity connectivity services, our overall ARPU across our business lines continues to grow. More importantly, our overall revenues from the smaller group of customers also continues to expand as they partner with us to deploy more of our products and services. As an example of this shift, we're seeing our legacy low-speed connectivity products churn off at only a slightly higher rate than we're seeing our mid-market and small enterprise customers add higher-speed connectivity products. A typical example of a mid-market customer that continues to expand their relationship with us is one of our customers in the financial services space. When they initially started doing business with us a couple of years ago, we were tasked to provide them with basic cloud infrastructure. Fast forward 2 years, not only have they added on incremental cloud infrastructure, but they've also added backup services, disaster recovery services, data storage and additional networking to connect their cloud and backup environment. The same customer is now also working with us on integrating the cloud for an acquisition they're doing and evaluating TeraGo managing their national endpoint connectivity network via our SD-WAN platform. We think this is a prime example of how we see ourselves becoming more integral and further ingrained within our customers' operations as we cross-sell additional capabilities. While this transition is certainly positive for TeraGo in the long term, we are seeing the financial impact as our mix shift, as Andy mentioned, as our mix shift with selling more services and third-party services. While these services are things that our targeted customers highly value, they do come with gross margins that are more typical for services and, as Andy mentioned earlier, had a dilutive effect on our overall gross margins. Next, I'm personally excited about the new team of leaders that I mentioned earlier that we now have at the company, and I think our entire team shares that same sentiment. With a mix of promotions from within and hiring new talent, we now have a senior leadership team that's positioned to take us forward. As I mentioned earlier, we have new leaders at the table for our business lines, our finance, human resources and legal functions. I really could not be more honored to work with such a committed and talented group of individuals who inspire each other and our customers each and every day. So the last thing I want to cover in some detail is our progress towards our goal of becoming Canada's leading provider of millimeter wave 5G private networks. I know this is what many of our shareholders have been waiting for and why some have invested in our company. It's hard to convey to you how excited we are about what's happening in the 5G world and how we feel about the unique opportunity TeraGo has to capitalize on this developing market. It's almost daily now that we've seen and hear about 5G applications. Whether it's a discussion about advancing mobile phone capabilities or what 5G can do for improving capabilities in a manufacturing facility, the telecommunications world is buzzing, and that's a pun very much intended with the talk of 5G. This has also changed the conversations that we're having with partners and customers as they recognize that TeraGo is a potential partner in the quest to take advantage of the staggering improvements in bandwidth and latency that millimeter wave 5G has to offer. So as a result, we're now talking to many of the top-tier consultants, systems integrators, incumbent telco providers, software firms, IoT firms and our enterprise customers about how millimeter wave 5G can help with their next generation of business transformation efforts. Now at some point, the amount of interest and requests for engagement we're seeing becomes overwhelming. There's just so much of it, so we also realize that we need to focus our efforts in specific areas as we plan to launch and grow this part of our business. The area where we feel our millimeter wave spectrum has the most to offer and best fit for the markets in Canada for 5G private networks including applications -- include applications for manufacturing, distribution and mining. So those 3 use cases are the ones we feel have the best fit at this point, and these are the areas that TeraGo plans to focus on over the next couple of years and where you're going to see us gain early traction. A significant step we took towards further developing these markets and applications was announced earlier this week. If you didn't see the announcement, we jointly issued a press release with McMaster University on building the first millimeter wave 5G private network on the McMaster campus. Our team is honored to have the opportunity to partner with one of the most renowned research institutions in the world as we look to jointly bring 5G millimeter wave private networking technologies and capabilities to Canadian businesses. The combination of our 5G millimeter wave private network and the enthusiasm, creativity and expertise of McMaster's research team is going to result in a portfolio of technological solutions that are just real-world problems for Canadian businesses. So really, really super excited about that announcement. This past quarter, we continued to make significant progress in getting ourselves ready for 5G deployment. One of the keys for us in getting ready is to upgrade our core network and the connections to our hub sites to handle the increased traffic demands that 5G applications are going to place on our network. As of today, we're nearing the completion of an extensive list of projects that included over 50 high-speed upgrades to core network components and hub site connections we wanted to do this year. We also continue to test millimeter wave 5G equipment from various vendors for speed, latency and distance and are seeing incredibly good performance for all 3 of those key performance attributes. In addition to the insulation at McMaster University, we continue to work with several other entities on other pilot applications, and we'll be announcing those as we formalize our relationships and plans over the next couple of months. As you can tell from what I just took you through, our management team has put a heavy emphasis in getting us ready for millimeter wave 5G private network in this past quarter. We plan to continue this emphasis going forward and are extremely excited about the opportunity in front of us and our unique position in the marketplace. So all in all, we're encouraged by our accomplishments year-to-date. Our team continues to focus on the customer segments in the market that want the type of products and services we can deliver. We've once again delivered on our services promise and consistently garnered very high NPS scores. Additionally, we saw a slight uptick in recurring revenues and made significant progress towards our 5G deployment. Our management team remains laser-focused on executing our near- and long-term initiatives, and we're confident in our ability to establish TeraGo as one of the first operators to launch commercial millimeter wave 5G fixed wireless and private networking services in Canada. So that concludes the prepared remarks. I think we can now open up the call for questions. So Patricia, over to you to open us up for questions.

[Operator]

[Operator Instructions] Your first question comes from the line of Matthew Lee from Canaccord.

[Matthew James Lee, Associate Analyst of Telecom and Media]

Just taking a look at the connectivity business here, still seeing some revenue declines largely due to the combination of slightly lower subs and maybe a little of decline in ARPU. Can you maybe help us understand how that segment gets back to revenue growth over the near to medium term and whatever timing you're expecting on that front?

[Matthew F. Gerber, CEO & Director]

Matt, yes, yes. So I think consistent with what I mentioned earlier, we are seeing churn in our low-speed small customer base, and that churn still exceeds the rate at which we're replacing those revenues with the mid-market and small enterprise customers. We've aggressively gone after retaining our mid-market customers and small enterprise customers in the connectivity segment and also are aggressively pursuing growth in that area of the business. And our goal, clearly, and we don't give forward guidance on it, but our goal clearly is we've built a funnel of significant deals of significant size with that base of customers, and we intend to pursue those customers. And that's where we feel we have an opportunity to grow in that segment, along with, obviously, in the longer term the 5G private networking piece of the business.

[Matthew James Lee, Associate Analyst of Telecom and Media]

Right. So then between the subscribers and the ARPU, we should probably see ARPU improve first given that you're basically becoming more higher-value customers?

[Matthew F. Gerber, CEO & Director]

Again, without giving you guidance on it, that is the goal. And if we can drive what we are implementing right now, that should be the result.

[Matthew James Lee, Associate Analyst of Telecom and Media]

Great. And then maybe just another one for me. In terms of the 5G rollout and the CapEx associated with that, I mean, again, I know you guys don't give forward guidance, but should we be expecting a tick-up of CapEx going into 2022 or you should roll out the 5G network?

[Matthew F. Gerber, CEO & Director]

Yes, I think it's a great question. And we've been fairly consistent in saying that our business in general, I think everybody knows the connectivity business is a CapEx-intensive business, and so we are looking now at how aggressive -- various cases and how aggressive we could or should be at bolstering the network and driving specific network improvements around 5G market penetration. And so we're going through that analysis now, but we have been consistent in saying we will need capital to do that, and we may be looking at raising additional capital sometime next year to do that.

[Operator]

[Operator Instructions] Your next question will come from the line of David McFadgen from Cormark Securities.

[David John McFadgen, Director of Institutional Equity Research]

Just a couple of questions. So just on your 5G millimeter wave private network, is that network going to only run on the millimeter wave spectrum? Or do you encompass that it would also be some 3.5?

[Matthew F. Gerber, CEO & Director]

David, hope you're doing well. So it's a great question. When we look at the applications that we're pursuing or the use cases we're pursuing, so let's say manufacturing or transportation, we're envisioning those use cases demanding the higher speeds and the lower latencies that millimeter wave can deliver. And we're also looking at the possibility of hybrids where we may have some mid-band components. I think most folks know that we don't hold any spectrum in the mid-band. So we're talking to various folks about potential partnerships that would give us access to mid-band and also give them access to millimeter wave, which they don't have. So I think it's a -- we're exploring it, but stay tuned. Nothing really firm to share with you at this point.

[David John McFadgen, Director of Institutional Equity Research]

Okay. So McMaster, that's going to be the first millimeter wave private network that you guys are building, correct? That's the first one?

[Matthew F. Gerber, CEO & Director]

That will be the first one, yes.

[David John McFadgen, Director of Institutional Equity Research]

Yes. And so do you envision announcing something, say, within the next 6 months with a customer or a commercial application where you'd also be building another millimeter wave private network?

[Matthew F. Gerber, CEO & Director]

So we've got a couple of prospective partners we're working with. And yes, our goal is to get another few announcements out within the next 6 months on next steps there.

[David John McFadgen, Director of Institutional Equity Research]

Okay. And just talking about how your customer base is transitioning or moving more towards the mid-market. Do you guys have sort of a time line in place or a target where you think that will then start to be accretive and you've churned through all the negative impact from these lower value customers?

[Matthew F. Gerber, CEO & Director]

Great question. I mean as you're probably guessing, that's kind of one of the core questions we keep asking ourselves because we're right in the midst of the transition, and obviously, timing on that is key. And our sense is if things continue to go the way they're going, we've seen that we're stabilizing the base. Churn is coming down. We're all waiting to see if that is sustainable. We're certainly driving our efforts to try and make that sustainable. Our thinking is if we see sustainability in those efforts, and as we mentioned to Matt earlier, I mentioned that earlier, if we can sort of turn the corner on success with some of the larger deals, I think sometime in the first half of next year is what we're targeting from turning the corner standpoint there.

[David John McFadgen, Director of Institutional Equity Research]

Okay. I mean you talk about envisioning raising some additional capital next year sometime June. I don't know if you can, but can you give us an idea on the magnitude of the capital you would be looking for?

[Matthew F. Gerber, CEO & Director]

Too early to tell at this point because we're looking at a couple of different cases in terms of how aggressive we want to be on our builds. And I've said this publicly before, we're not a company that is going to do the field of dreams thing and build it, hoping they will come. We're going to be very surgical and targeted about how we make our investments and where we make our investments. So we're looking at a couple of cases and trying to get a sense of how quickly we can see a real adoption in the marketplace, and that will drive the CapEx planning. It's just -- we don't have -- we haven't settled on where on those various curves we want to be at this point.

[Operator]

At this time, this concludes our question-and-answer session. I'd now like to turn the call back over to Mr. Gerber for closing remarks.

[Matthew F. Gerber, CEO & Director]

Okay. Well, again, thanks, everybody, for joining our call today. And as we've said before, if anybody has any questions, whether in the analyst community or a shareholder, please reach out to us. Our e-mail and phones are always open. I enjoy taking the questions and giving you the answers.

[Operator]

Thank you for joining us today for TeraGo's Third Quarter 2021 Earnings Call. You may now disconnect.