All improvement: TeraGo's CEO Discusses Q4 2013 Results

Executives

Carolyn Capaccio – IR

Stewart Lyons – President & CEO

Joe Prodan – Chief Financial Officer

Bosco Chan – Vice President of Finance

Analysts

Dvai Ghose – Genuity Capital Markets

Vince Valentini – TD Newcrest

Pardeep Sangha – PI Financial

Maher Yaghi – Desjardins Securities

TeraGo Inc. (OTC:TRAGF) Q4 2013 Earnings Conference Call February 26, 2014 9:00 AM ET

Operator

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the TeraGo Inc. Fiscal 2013 Fourth Quarter 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 on February 26, 2014. I would now like to turn the meeting to Ms. Carolyn Capaccio. Please go ahead Ms. Capaccio.

Carolyn Capaccio

Thank you, operator and good morning everyone. This is Carolyn Capaccio from LHA. With me on the call today from TeraGo are Stewart Lyons, the company’s President & Chief Executive Officer; Joe Prodan, Chief Financial Officer; and Bosco Chan, Vice President of Finance.

For those of you joining the call today by phone, please note that there is an accompanying slide presentation that you can view on the live webcast section of TeraGo’s website www.terago.ca. TeraGo likes 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.

Several assumptions were made by the company in preparing these forward-looking statements and there are risks that actual results will differ materially from those contemplated by the forward-looking statements. For additional information on such assumptions and risks, please refer to TeraGo’s 2013 MD&A and 2013 annual information form that were issued this morning. 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, future events or otherwise.

I will now turn the conference call over to Stewart Lyons, President and Chief Executive Officer of TeraGo Networks. Stewart.

Stewart Lyons

Thanks Carolyn, and thanks to everyone for joining TeraGo’s fourth quarter call, my first as the company’s CEO. I have spoken with many of you on the phone and many of our analysts and investors, and I look forward to getting to know the rest of you as we move ahead.

Overall the focus for 2014 is this is a year of transition. I want to be very clear about that. We will be leveraging our assets to transform the company from a single product broadband provider to a multi-product data and IT services company, including platform as a service and infrastructure as a service applications. These may be offered directly or indirectly by TeraGo. This transition, which is expected to take the bulk of 2014 at least will put TeraGo in a strong position as these multiple products will not only create demand for existing access and data centre products, but [Indiscernible] customers and faster revenue growth.

You will know we are making good progress down this path already, given the previous and most recent data centre acquisition and related fibre acquisition in downtown Vancouver. Additionally we are making progress rounding out the management team with the addition of our CFO, whom I worked with in the past and I know to be a strong performer.

With respect to Q4 performance, we experienced reasonable revenue and EBITDA growth, especially considering the company’s internal challenges around departures and confusion on the strategic process.

Moving on to the next slide, 2014 is a year of transition. It is a year that transformed TeraGo by expanding the foothold already established in the data centre business through an opportunistic buy and build strategy, and through our service offerings, juxtaposing the introduction of faster growth services alongside the colo strategy to create a fully integrated data and IT services provider.

We are actively working on building out our new strategy, focusing on the when, where and how of our IT services, which ones we will consider offering directly, and which indirectly and to what customers. As this strategy unfolds further, we will be presenting to you a formal detailed overview of the plan in the coming quarters. However, in the meantime, we will continue to put the constituent elements in place across the country, some of which is discussed on the next slide.

Additionally, we are also very focused on improving the results of the existing access business, particularly around aspects such as retention/churn management, and we feel very confident that we can improve, for example, churn fairly quickly as I have implemented programs like these before in a much more competitive consumer environment, and there are obvious areas of opportunity that we can address very quickly.

Moving on to Slide 6, data centre acquisition. This slide shows our progress on data centre M&A. We recently acquired a facility at the end of Q4. We established a presence in a key underserved market, namely the downturn core of Vancouver, which does not have its own data centre facility space. It is a great space that we acquired, up to 7000 square feet of area and it is efficient use of capital with zero cash impact – cash flow impact. And we also retained the existing customer base and there is significant room for additional customers as well.

And just last week we announced a small acquisition of fibre, which effectively connects that Vancouver data centre facility to the [Indiscernible] at 555 West Hastings to deliver the best possible service into the data centre. So this positions TeraGo very well to sell competitively to existing and new SMB and enterprise customers.

With respect to data centres Canada and Toronto, the monitoring and entry integration work is complete, and we are starting to actively add new customers to the facility. We are still pursuing future datacenter growth, and we are actively in the market reviewing multiple small, and I would say these are 15,000 square feet and under data centre opportunities across the country and most of the major markets in which we operate. Thankfully there is a fairly robust pipeline that we are looking at.

Slide 7 will summarize the overview. The strategy is in place to modernize TeraGo’s products and services to fit today’s customers needs. Key assets are in place to form an excellent foundation for this. So obviously we have a very strong and very top tier list of SMB customers that is part of our [secret sword] so to speak to push the company into the future, and we are trying to transform business from sort of a 1990s perspective on access only, from a 2010 perspective on co-location only, to a 2014 perspective on the full gamut of IT services.

2014 will be a year of transition and transformation. We will begin to see tangible results in the second half of the year, and we are already moving quickly in and making rapid progress.

Now I want to introduce Joe Prodan, TeraGo’s new CFO, who joined the company on February 4. I’m very pleased to bring Joe to the company. We worked together for the past four years. He is an extremely capable financial executive with the skill set to match TeraGo’s precise needs, and we also want to take this opportunity to thank Bosco Chan, who performed very admirably on an interim basis, and of course, remains with the company.

Now I will turn the call over to Joe.

Joe Prodan

Thanks for the introduction. I personally believe it is an exciting time for TeraGo. Prior to joining a few weeks ago I had the opportunity to review the strategy Stewart just spoke of, the recurring revenue base from our existing active customers, combined with the product suite in the data centre segment is a winning strategy for revitalizing growth.

We can improve customer retention by creating stickier customers through encouraging multiple product purchases and providing access to new high-growth data products. I have just begun to dig into the operations, but I would like to share some early observations. Speaking with employees, I notice that many refer to the entity and the drive they experienced early on in their career. As someone familiar with start-ups, I would suggest that for 2014, TeraGo resume start-up mode as an IT services company in its early formation, reestablishing a culture of getting it done, whether that is the integration in newly acquired data centres or the launch of new products will be a key component to our success.

As we continue in our transformation, we will be strengthening our internal metrics and modifying them to be suitable for the new IT services company we are creating. For example, we intend to focus on internal reporting for a diversified product suite, [rate card] reviews, margin analysis and reviewing commission structures for new products.

There are some clear priorities already on my radar. The company has a reasonable existing bank facility, however, we will be revisiting just to see how well is it aligned with our current strategy and to ensure that we have the ability to finance new acquisitions that we will be exploring.

I like to look at establishing a process for success-based review of new investment. If we are going to stimulate additional growth, we will need to look at investments outside of the core budget and pursue them if they make economic sense. This comes back to the financing point I made above.

We also have a number of existing investments that I want to ensure we exploit it, such as the fibre purchase in Vancouver. We can exploit with minimal further investment. Both Stewart and I are committed to ongoing dialogue with you at the next chapter the TeraGo story unfolds.

I will now turn it over to Bosco to discuss the results.

Bosco Chan

Thank you, Joe. First the highlights, our revenue continued to grow in the fourth quarter and was at $12.9 million, up 3% from Q4 of 2012. Q4 EBITDA was at $3 million, which was lower than last year at the same period. However, EBITDA was suppressed due to costs related to due diligence work and the departing executive in Q4. Excluding those costs, the EBITDA would have been higher by $1.3 million.

Q4 net loss of $0.7 million and a basic loss per share of $0.06 compared to net earnings of $3.2 million, [our basic] EPS up $0.29 in Q4 2012. The net loss was due to the reason mentioned above, while Q4 2012 had a benefit of a deferred tax recovery of $2.5 million for Q4. ARPU for Q4 2013 was $621 compared to $625 in Q4 2012. Usage discount and other retention incentive contributed to the lower ARPU during the quarter, but contributed to high -- to customer retention effort.

Net access customer locations decreased by 80 in Q4 2013 compared to an increase of 73 last year in – last year’s Q4. A large multi-site customer cancellation contributed to the spike in customer location decline in Q4. Average monthly churn rate for access customer locations in full-year 2013 was 1.28 compared to 1.05 in 2012 for the reason mentioned above.

At December 31, 2013 the company had $2.6 million of cash or cash equivalents and $19.6 million of credit facilities remaining undrawn, and available for future use. Now let us look at various specific measures. First to revenue, our revenue continued to grow in the fourth quarter, and was $12.9 million, up 3% from Q4 2012 largely as a result of the revenue from the data centre, as well as existing customers upgrading their Internet and data connections.

About 98% of our revenue continues to be service or recurring revenue. On the average revenue per customer location, average monthly revenue per customer location for 2013 increased to $625 from $622 in 2012, primarily due to existing customers upgrading their capacity, and increase in number of new customers requiring higher capacity of voice services.

The Q4 ARPU decreases is due to usage discount and other retention incentives in a quarter but had helped customer retention effort. Now onto the customer relations, we had [215] new access customer additions in the fourth quarter, down from 243 in Q4 last year, primarily due to the increased competitive environment.

The churn rate for the fourth quarter was 1.5% up from 0.86% in Q4 2012, primarily due to the increased competitive environment related to high capacity services. In addition, a large multisite customer with low ARPU cancelled during Q4 contributing to the churn result. Management continues to strive for lower churn rate by offering retention incentives, and focusing on new network quality and customer services.

On the capital expenditures, the fourth quarter capital expenditure of $3.9 million were up from $2.5 million in the same period in 2012, primarily as a result of acquiring the Vancouver data centre asset of $0.6 million, the fiberoptic construction in Western Canada, and network improvement in Toronto’s data centre improvement projects.

On our financial strength, we ended the fourth quarter with $2.6 million of cash, cash equivalent and short-term investments, as well as access to $19.6 million undrawn portion of the company’s $41.8 million total credit facility. We have a stable and predictable revenue stream and strong EBITDA margin. We effectively manage our capital expenditure to improve our cash flow. We have the ability to shelter about $9.9 million in future income taxes.

I will now turn the call back to Stewart.

Stewart Lyons

Thanks Bosco. I’m on Slide 18, a summary. Thanks Bosco. We are moving the company into 2014 and beyond. It is a big shift, and there maybe bumps and bruises along the way, but we are moving ahead aggressively with the strategy in hand that is aligned with our customer’s immediate and future needs, and recognizes where the market is going [Indiscernible] in the future. We are able to move very fast because this is a small and nimble company.

We are uniquely positioned to succeed in the IT services space given – particularly in the SMB space, given our base business and customer relationship. We believe we are uniquely positioned among facilities base providers in this respect. We are also looking forward to reporting to you on our progress on the next call.

And now I will turn it back to the operator to begin the Q&A.

Question-and-Answer Session

Operator

Thank you. (Operator instructions) Our first question is from Dvai Ghose with Canaccord Genuity. Please go ahead.

Dvai Ghose - Genuity Capital Markets

Yes, thanks very much. Good morning Stewart and Joe. Welcome to the company. You have come at an interesting time. A couple of questions on the income statement growth, and a couple of questions on the balance sheet if I may, so I see that the -- what I would consider now legacy fixed wireless connectivity revenues were down 2%, both year-over-year and sequentially, do you think this business can ever grow again, or is it basically maxed out?

Stewart Lyons

I do think it can grow Dvai, and the reason why I say that is, you know, look the company started from an interesting place where, you know, in the early part of 2005 to say 2010 or 2011 period, they effectively put up fixed wireless product in an area where it was a low competitive environment, and they let the customers come to them.

And now this is the – sorry, the environment in which the company operated for many years. Now the world has changed. Now the world is more competitive, and there is new techniques and new strategies to deal with that that I would argue this company is yet to deploy. That is from a sales perspective and a retention perspective.

So I do think there is some juice left in the orange so to speak, and it hasn’t been fully squeezed. So yes, I think there is still growth in the business. And yes, I think it needs some cleanup from a sales perspective and a retention perspective, but the tools are there and the customer base is there.

Dvai Ghose - Genuity Capital Markets

That is great, now on the data centre side, you know, [Indiscernible] is still small, but it looks like about 6% sequential revenue growth, which is pretty positive if you could confirm that of what it actually was, and, you know, what sort of growth rates do you think we should expect going forward?

Stewart Lyons

You know, I will take it. And in reality from a growth rate perspective, so Dvai, you know, the company went from a – it is a big transition for the company. Obviously it went from we are in the access business to let us get into the colo business to what does the colo business mean in 2014, because the colo business as you and I know is a business that was kind of really exciting in 2010 and remains exciting today, but from a different perspective.

So, you know, we are really into a mode of redesigning what the colo business means and how to really generate the high-growth numbers in colo, which is really due to the provision of providing a whole bunch of other IT services around it. So from a growth perspective, I think the growth is really going to explode starting in the latter half of this year.

Dvai Ghose - Genuity Capital Markets

Okay, great. And then the last one for Joe or for Bosco or for yourself, Stewart is on the – on the balance sheet and the covenants, so obviously you have been pretty realistic I think in portraying this year as a turnaround year and it will take a little bit of time, but do you think that you can continue to generate positive net income, adjusted net income at least, as well as free cash flow during this period, and as far as the covenants, you know, about 20 million of your liquidity is undrawn bank lines, are there any issues that you are concerned about, or is it nearly a positive in terms of trying to get some more flexibility by looking at alternatives?

Stewart Lyons

There is no issues on the covenants that we have right now. So when I mentioned the financing relooking at it, it is a combination of both the existing facility, but slicing and dicing it a little bit differently, to allow monies to be spent on perhaps more data centres, less fibres and secondly, we are also going to look at in terms of a quantum and what that number should be given the M&A opportunities that exist for us.

Dvai Ghose - Genuity Capital Markets

But do you think that during the period ex-M&A you are going to continue to generate positive net income and free cash, in which case, you only really need the lines to finance incremental growth through acquisitions or do you see potential dip there into negatives?

Joe Prodan

So, I think – I think Stewart mentioned sort of as he called it the bumps in the road. I think the next couple of quarters we may have some challenges as we transform and revisit some of the prior processes and strategies that occurred in the latter part of the year, but from a longer term picture, we don’t foresee any issue.

Dvai Ghose - Genuity Capital Markets

Okay, that is very realistic. Thank you very much and I look forward to your progress during the year.

Operator

Thank you. Our next question is from Vince Valentini with TD Securities. Please go ahead.

Vince Valentini - TD Newcrest

Yes, thanks very much. First the multisite customer you lost, and then the other one that gave you notice in February, I’m assuming these are the wireless new entrants, I don’t know if you can confirm that. I know you said it was for February, but I’m assuming that it was the case in Q4 as well, with my understanding that the contract there included some cancellations, and if you did lose those contracts, you did at least get reimbursed for the money you put into install those networks, and there will be a little bit of upfront revenue to offset the loss of the customer. It certainly doesn’t look that way when I look at your ARPU and your revenue results in the fourth quarter, so I’m wondering if those amounts are still coming or did the customer negotiate to get out of those payments?

Stewart Lyons

Yes and yes is the answer to your question, sorry the first part of your question. For the second part, no, there is no – so, you know, the TeraGo did business – does business with all three of the new entrants including [my former shop]. This obviously didn’t relate to [my former shop] and the company that we are talking about that is getting out of directly needing TeraGo’s services. It was acquired though. The acquirer will be paying those amounts in due course.

Vince Valentini - TD Newcrest

So, any idea how long it takes to get those, and will those show up as revenue or --

Stewart Lyons

They are not due yet to be honest with you, but I anticipate no concerns.

Vince Valentini - TD Newcrest

Okay. And question on data centres, it is a growing area and you guys have gone through initial traction there, but it is certainly on the North American scale of business where there is giant players getting involved, putting in huge amounts of capital and they have massive scalability advantages over what TeraGo could ever do, is this an area where you think there are little niches you can compete and where you can flush out little bit more how a little company like TeraGo competes with the huge players out there?

Stewart Lyons

It is a great question and the answer is yes, and that is exactly what we are doing. So you have to remember where we compete. We compete in the SMB space, which is admittedly for the big guys a space they don’t serve all that well. So we are competing already in this business from our access, legacy access business, and our data centre acquisitions, the ones we have done already and the ones we are looking at reflect that.

So these aren’t the ones the big guys are pursuing. They don’t want 5000, 10,000, even 15,000 square foot data centres, they want 40,000, 50,000, 100,000 square feet. So we’re not on -- we are talking about acquisitions which are below their radar, so you’re talking about different multiples, different conversations in different levels of investment. While it is not necessarily talking about tier 3 ultra secure Fort Knox style data centres that the RBC would require, or sorry in your case, [Indiscernible] would require for their data centre needs. We’re talking about the needs of the SMB customer, which of course reflected at lower cost Capex expenditures, most data centres suitable for their needs.

So, all that is wrapped up to tell you that yes, we are talking about a niche play here. No, I am not concerned because the big guys don’t compete in that space.

Vince Valentini - TD Newcrest

Okay, and last question, I mean as you go through this somewhat painful transition and transformation, investors are obviously going to be a bit left in the dark as to what – what the future holds, do you plan to come out at some point once you get your head wrapped around the strategy with some sort of targets you can set so that we know you are too down the road, whether your transition has been successful or not, because you have set goals ahead of time, and then we can benchmark you against those goals like some sort of ball park guidance, or you are just going to leave it sort of flapping in the wind?

Stewart Lyons

Well that is a bit of a leading question, because I am not – we will not leave you flapping in the wind obviously. We are hesitant to give obviously guidance. The company never gave guidance in the past. I’m not a [Indiscernible] believer necessarily in giving guidance for a whole bunch of reasons, but I do think there should be benchmarks. I do think the plan needs to be fully, you know, presented in a fulsome way to everyone, so all the stakeholders, including all the analysts and this is the first phase of it.

So including what we are doing here Vince, is we are putting the physical pieces in place. We have the access business. We’re putting the data centre pieces in place, and that is not stopping. However, I guess the overall component though is how these pieces come together, which is what is still work in progress. We know where we want to be, we want to be a fully functional IT services company.

We offer a whole bunch of infrastructure as a service and platform as a service, all the high-growth type services, storage, compute, you name it, all that stuff on offer, you know, office 365, share point, the list goes on and on. Those are the services that people buy in 2014, people want to see in 2014. We are going to offer hopefully all of them.

Whether we offer them directly or indirectly is kind of the pose that we aren’t taking right now. So that is where we are going to get to. We will give you more details in the coming quarters, and yes, I think you should be able to [Indiscernible] and say, okay, he said he is offering all these services, these cloud services, because they are offering a whole bunch of those and you know, the revenue shows it, it looks like, you know, we are on track.

And by the way, the point is, all those services with the advantages of being a facilities-based provider, all those Cloud services, what do they require? They require data centre space, co-location space, and access, few things we also provide. So that is the – sort of the virtue of cycle here we are getting into when we talk about why we are providing all these services.

Vince Valentini - TD Newcrest

Okay, thanks.

Operator

Thank you. Our next question is from Pardeep Sangha with PI Financial. Please go ahead.

Pardeep Sangha - PI Financial

Hi, good morning. [Indiscernible] so a little clarity on that, what size is that and then could you give us a sense of what is your combined utilization, if it includes the BCC and the Vancouver facility, and also [Indiscernible]?

Stewart Lyons

So, I will answer the first one. The second one I will give you a bit of a condensed one. But anyways, so the data centre facility in Vancouver came with 5,000 square feet built out, the racks are sitting there, the last few thousand which effectively require the racks.

I have actually toured the facility myself and I have seen, you know, the space and it is a very good space. It is literally in a bank vault, so it is about as secure as it could possibly be. it has got a 4 foot door to get into the thing. So, four foot deep doors, so I would say it is a very secure, very, very well built, very interesting facility that would really give attribution to the company, and that space is great.

You know, overall in terms of capacity, I would say that space is, well, you know, less than a quarter built – used up, and on the space in Toronto, it is probably between half and two thirds filled up. So, you know, we are in good shape. We have not really yet even begun to really promote either space in terms of getting customers in there because, as I said we are flushing out the strategy of doing that, merging sales teams together and all those kinds of things, but even before we actually put a real effort into it, we have inbound calls, particularly for Vancouver.

People are asking for space, we’re not even working out hard to get people in the door. So it is a pretty good indicator of where we are going to go when we actually put our noses to the grindstone and actually start driving some of that space utilization.

Pardeep Sangha - PI Financial

And I think in the sense, the call the Vancouver definitely a sort of, you know, top tier sort of data centre facilities of downtown core, but – so that overall when I look at the – you’re looking at combining utilization about 50%, if you include the Vancouver and Toronto data centre space, I think that is kind of what I am looking at when you add the two together?

Stewart Lyons

Yes, something like that.

Pardeep Sangha - PI Financial

Yes, so then, on the acquisition strategy, I mean, you have been in the Vancouver facility and have sort of I guess is [Indiscernible], I mean what kind of rate should we be looking at, I mean, you guys going to need to digest the Vancouver thing moving here, or do you think you will be pretty fast turnaround to start looking at doing some more here?

Stewart Lyons

I have – I have half dozen other ones in the pipeline right now that I am actively looking at. And that includes in Vancouver, more in Toronto, and more in other places across the country.

Pardeep Sangha - PI Financial

Okay. [Indiscernible] update sort of your sales and marketing kind of strategy, I mean, data centre sales is a different type of sales and broadband access type of sale, how can you sort of -- what do you think you are doing for combining your sales teams and adding to your sales team, or what is guiding [Indiscernible] just give us a high level on that?

Stewart Lyons

It is a great question Pardeep, and you are absolutely right. It is a very different sales process. And we’re still getting the [Indiscernible] of the sort of secret sauce competitive stuff. I will tell you that you are bang on, selling access is a very direct sales approach. Selling co-location is oftentimes an indirect sales approach, meaning that there could be a third party involved in the middle.

The good news is TeraGo has very, very strong relationships with a lot of the larger players that serve the SMB community, those integrators, those hosting folks, what I call value added service providers, and those are the folks that will become more and more important to TeraGo as we move into the IT services space, those are the folks that offer the battery of services we are talking about and those are the folks that effectively buy colocation space.

So, you are right, we are moving from a direct sales model into more of a indirect sales model, but thankfully both Joe and myself have a lot of experience in that world. And we built a distributor sales force in Mobilicity at several hundred locations in just a few months. And we know how complicated it can be, and we know the ups and downs of having a third party sales processes but we are pretty confident it is going to go well given the fact that TeraGo already has strong relationships in that area.

Pardeep Sangha - PI Financial

Thanks very much and good luck.

Stewart Lyons

Thank you.

Operator

Thank you. Our next question is from [Indiscernible]. Please go ahead.

Unidentified Analyst

Hi, just first off, just a couple of clarifications, so in the fourth quarter, last public mobiles, private tariff and then did you say there was another large customer but a low ARPU that was cancelled in the fourth quarter as well?

Stewart Lyons

In Q4 the large multisite customer that I was referring to was in the public sector of the economy.

Unidentified Analyst

Okay. I’m just wondering what the underlying business performance was if you exclude public mobile and then a public sector, can you give us any color on that in terms of changing customer locations churn?

Stewart Lyons

I did not mention anything about public mobile churn in Q4.

Unidentified Analyst

Okay.

Stewart Lyons

Multisite customers I was referring to the public sector customer.

Unidentified Analyst

Okay. If we exclude that customer can you give us an idea of what the underlying business, how the underlying business perform in terms of customer locations and churn?

Stewart Lyons

I don’t think we had it broken out just off hand, but we can probably get back to you offline and give you some more color on that.

Unidentified Analyst

Okay, that’s it from me, thanks.

Operator

Thank you. (Operator Instructions) Our next question is from Maher Yaghi with Desjardins, please go ahead.