Terago Inc. (OTCPK:TRAGF) Q3 2016 Results Earnings Conference Call November 11, 2016 9:00 AM ET
Executives
Tony Ciciretto - President & CEO
Joe Prodan - CFO
Analysts
David McFadden - Cormark Securities
Bentley Cross - TD Securities
Maher Yaghi - Desjardins Capital Markets
Operator
Good morning ladies and gentlemen. Thank you for standing by. Welcome to TeraGo Inc.’s Q3 2016 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 of 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 annual MD&A for the year ended December 31, 2015, which is available on www.sedar.com, and consider other uncertainties and potential events.
In particular, if any of the risks materialize, the expectations and the predictions based on them 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 may be required by Canadian securities laws, the company does not undertake any obligations to update 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.
Tony Ciciretto
Well, thank you, Scott. Good morning everyone and thank you for joining us this morning. TeraGo delivered mix third quarter results as we continue to execute our strategy of transforming TeraGo into a national cloud and data center service provider underpinned by excellence in customer service.
In a few moments I'll had Joe Prodan, our CFO, review the latest financial results, but before I do, let me provide you with some highlights for the third quarter. First our cloud and data center revenues grew by a $0.5 million or 10.9% over the same period last under a backdrop of continued competitive pressure in our network and voice business.
As a result our business continues to reduce its reliance on the network and voice segment with data center and cloud services now comprising 31% of our total revenues.
Moreover, despite the highly competitive network and voice segments positive churn trends in the last quarter carried forward to the third quarter. However, we see continue competitive pressure particularly in Western Canada where we had start to see more aggressive pricing.
Lastly, with the integration of RackForce, Box Fabric and AirVM assets behind us, our team is diligently focus on accelerating growth by improving the performance of our existing assets while enhancing our service offerings in the market and refining our go-to-market approach.
I'll now turn the call over to Joe to review the financial results. Joe?
Joe Prodan
Thanks, Tony. Total revenue decreased 3.2% to $14.8 million for the three months ended September 30, 2016 compared to $15.3 million for the same period in 2015. A decrease in revenue was primarily driven by lower network and voice revenue partially offset by growth in cloud and data center revenue.
Network and voice revenue impacted by a variety of factors including regional economic impacts, consciously allowing low value customers to churn, selected discounting for long-term renewals, and lower usage revenues as certain customers moved to unlimited usage plan. For the three months ended September 30, 2016, cloud and data center revenue increased 10.9% to $4.6 million compared to $4.2 million for the same period in 2015.
The increase was driven by greater adoption of cloud services from new and existing customers as well as from the acquisitions of BoxFabric and Hosting Business. For the nine months ended September 30, 2016, cloud and data center revenue increased 51.1% to $13.5 million compared to $8.9 million for the same period in 2015.
The increase was driven by the factors described above, as well as the acquisition of RackForce in March 2015. Total revenue increased 4.4% to $44.5 million for the nine months ended September 30, 2016 compared to $42.6 million for the same period in 2015. In Q3 of 2016, 31% of total revenues now come from cloud and data center services.
Adjusted EBITDA decreased 15.7% to $4.5 million for the three months ended September 30, 2016 compared to $5.3 million for the same period in 2015. The decrease was primarily driven by the reduction of network and voice revenue, an increase in marketing costs related to TeraGo’s re-branding and an increase in personnel costs, partially offset by the growth of cloud and data centre revenue. For the nine months ended September 30, 2016, Adjusted EBITDA increased 3.8% to $14.1 million compared to $13.5 million for the same period in 2015.
Turning to slide seven. We continue to use a very methodical approach to investing capital and capitalizing on economies of scale with much of our upfront capital investments a readymade. Capital expenditures were flat in Q3 of 2016 compared to Q3 of 2015 and predominantly success based at $1.6 million or 11% of revenue in the quarter.
We continue to improve financial flexibility within the organization. We have a strong deleveraging profile and debt to adjusted EBITDA ratio has dropped to 2.29 in Q3 of 2016 from 2.94 in Q2 of 2015. We have capital in place to execute on our organic growth plan with over $10 million in cash and $10 million in an undrawn operating line.
I will now turn the call back over to Tony.
Tony Ciciretto
Thank you, Joe. I'd like to take this opportunity to highlight four key objectives and priorities that the TeraGo team will be keenly focused on. The first strategic priority is to continue sales momentum in our data centre and cloud segment by concerted effort on increasing the capacity utilization of our Mississauga and Kelowna state-of-the-art data centers by targeting large enterprise co-location customers.
Next, we will be surgically focused on realizing the full benefits of the current network and data center infrastructure while being more opportunistic from an acquisition perspective.
Further, we will enhance our service offerings and refine our go-to-market approach by simplifying our product portfolio and bundled value-added services to create a greatest stickiness with our current and potential customers.
And lastly, we will achieve economies of scale as the current cost structure is able to drive growth with only success base, customer related investment, while optimizing the deployment of capital so that we can maintain positive free cash flow generation.
Scott, at this I'd like to turn the call back to you, so you can coordinate the Q&A.
Question-and-Answer Session
Operator
[Operator Instructions] Your first question comes from the line of David McFadden from Cormark Securities. Your line is open.
David McFadden
Hi. Couple of questions. So when you talked about Western Canada, is more aggressive on the pricing for the legacy business. Can you give us a little more detail how much more competitive it has gotten, say, since your last conference call?
Tony Ciciretto
Well, I think its - I won't get into the actual pricing magnitude, but I think its fair to say that both cable coaxial and telecom companies at West had been putting their much more aggressive packages that have certainly gotten the attention of the customers in the west and so we're taking a look at our product portfolio to ensure that we're competitive as possible in the market there.
David McFadden
Okay. And now, that you are the CEO what are you planning to do, differently than the previous CEO was doing?
Tony Ciciretto
Well, I think as I mentioned in the strategic priorities, I think certainly some of the things that we're trying to do is again continue to focus on improving the benefits of the existing assets that we've actually have acquired over the past two years. I think that's very important and that I believe we have the assets that will enable us to grow the company as we expect.
The other area of opportunity for us is around simplifying our product portfolio in the market so that we can actually be able to bundle many more of our products and services. I think there's an opportunity to leverage the cloud and data center services that we have acquired over the past two years and have a stronger bundle with our access services that will not only hopefully grow revenues but also to protect our churn.
David McFadden
Okay. So, I think previously management was holding back on taking some or filling in some capacity on the data centers just because they wanted the higher pricing. Are you prepared to lower pricing just to get more capacity sales in those networks - in those data centers, sorry?
Tony Ciciretto
Well, again, I think the focus for us is making sure that we're competitive in the market. The good thing is that we have - we have the capital already spend in our data centers. The fact of the future spending of capital will really be around success based. We certainly have the capacity, but we are not going to certainly lower our prices just to fill it up. We are looking at both competitive pricing and ensuring profitable service - profitable deals for our customers and ourselves.
David McFadden
Okay. And I saw on the filings that I think it was the Chief Marketing Officer, who has also - has also left the company and have you replaced that person or what’s the plan there?
Tony Ciciretto
We have someone at the moment that has come in on a temporary basis to fill in behind him so that we didn’t lose any type of momentum. We continue to do a search and we feel that at this point, we haven’t lost any momentum around the product side.
David McFadden
Okay. Are there going to be any changes with respect to the total number of sales people or that’s going to stay the same?
Tony Ciciretto
We are currently - we want to make sure certainly that we are in a position to realize the full benefits of the improvement in our product - simplifying our product portfolio. We would certainly look to put as many resources available to ensure the growth that we are expecting for the year to come.
David McFadden
Okay. All right. Thanks. That’s it for me. Thanks.
Tony Ciciretto
Okay. Thanks, David.
Operator
[Operator Instructions] Your next question comes from the line of Bentley Cross from TD securities. Your line is open.
Bentley Cross
Good morning, gentlemen.
Tony Ciciretto
Good morning, Ben.
Bentley Cross
First, I want to just dive a little bit deeper on the last question. Maybe it’s a function of pricing out west, but we’ve seen accelerating declines in the access business for four, five quarters. Wondering if that’s a function of churn, of pricing or any color you are willing to divulge?
Tony Ciciretto
I’m not sure it would be anything different than what we had already said. I mean the decline was from Q1 to Q2, let’s call it $150k and so from Q2 to 3 was $200k, which is actually lower than the decline that we had from Q4 to Q1. So, I think it’s going to be choppy but I wouldn’t say for example what’s occurred in the last two quarters is something that at this point we see as a trend. I think it’s going to be up and down depending on timing of our contracts coming up for renewal and a variety of external factors.
Bentley Cross
Okay. And maybe just for our own benefit as investors and analysts, is there any chance that we could go back and get a little bit more disclosure? I mean historically, before Stewart came in we used to get ARPU or customers, is there any chance, Tony, you might reintroduce those customers, I mean those metrics to us?
Tony Ciciretto
What, Ben, we will take that back and we will certainly communicate that back to the investment community. But let’s take that back and see what we can do.
Bentley Cross
All right. And then a few other questions. The first one being, I assume Wales and Missouri assets you guys were using are a function of the AirVM acquisition. So, any chance that capacity could be in-sourced into your own facilities to maybe save some money there?
Tony Ciciretto
Yes. So, I guess to answer your first question, yes, they were part of the AirVM asset acquisition. As we continually look at our data centre footprint and maximizing I think the profitability of our data centres, certainly we will look at any potential ways to maximize our current infrastructure. So, I would say that that would be something that we would be considering.
Bentley Cross
Great. And then just one last one for me. Tony, you talked a lot about maximizing and using the capacity you already have, I’m hoping that means that we can expect CapEx to come down, is that a fair assessment?
Tony Ciciretto
Well, I think the CapEx as we have today I think is fairly considerably lower than industry that what industry would normally see. I would suspect that some of that lower CapEx is related to some of the timing. We certainly will continue to make sure that our data centres and infrastructure are aware that we can actually support and operate or support our customers. But I would certainly say that if we are obviously successful in our growth for the company that we will see probably a demand-based capital increasing but certainly not and most likely below industry standards.
Bentley Cross
Okay. Thank you.
Tony Ciciretto
Okay.
Operator
Your next question comes from the line of Maher Yaghi from Desjardins Capital Markets. Your line is open.
Maher Yaghi
Yes. Thank you. I wanted to ask you, Tony about the M&A strategy or the M&A path that TeraGo has been on and what’s your view on M&A, what are the assets that you would look at filling in through acquisition and what kind of metrics are you looking at when you are looking at acquisitions?
Tony Ciciretto
Okay. So, I will let - for this part I will turn over to Joe on the metrics. But the view right now is that we have, as you know gone on a fairly significant acquisition path over the past two years. We need to take a breath and absorb these assets and need to extract, I believe not only the cost-benefit which we, I think by and large have but also the revenue synergies that we believe that we can drive as part of these assets.
So, from an M&A perspective where it will be more opportunistic, potential some tuck-in positions as it relates to potential gaps in our product portfolio. But our focus certainly in the near-term is to extract and realize the full benefits of the acquisitions that we’ve made. Joe, on the metric side?
Joe Prodan
I think the only thing I would add is previously, we were focused on acquisitions that met the stability requirements, brought us customers or increased the product portfolios. So, I think the focus that Tony has been discussing is probably the latter part, is the only one that we would focus if there is a product, a gap in our product portfolio as we continue to evaluate the market that would drive an acquisition as opposed to anything from a facility perspective. We’ve got a lot in place right now and I think we’ve got a great customer base, B2B customer base to capitalize on right now.
Maher Yaghi
Okay. Can you talk about pricing in the co-location business in Canada? We’ve seen companies in your space having difficulties. Even larger companies you might be familiar with Tony, having difficulties in the U.S. and the U.K. How’s the market in Canada? Are we seeing a lot of pricing pressure from the large companies on the market and what’s the long-term growth outlook in industry in your view?
Tony Ciciretto
Well, I think the - let me just say that from a growth perspective, the co-location market and depending on the studies that you would look at, still I think provide a good growth for organizations certainly into the low single-digits to about 10%. I think the fact that there is still growth, I think the organizations today, customers, they are still at a point where the majority of their infrastructure and I think a great deal of customers still continue to have on-premise equipment. And you still see the trend of the equipment being put out to other organizations such as ourselves that they can either, use as a business continuity or disaster recovery sites or in fact as primary sites. You still see that trend happening.
As far as the market itself, I think you always get a cyclical view of the market. There’s always a balance between supply and demand. Sometimes as supply goes down, you’ll see a lot of - sorry, as demand goes out you’ll see a lot of supply come down and then you’ll start to see a ramp up in builds. And I think that’s where we are today, is more in a ramp up of builds to accommodate the growth that I think everyone is expecting.
Maher Yaghi
Okay. So in your view the current pricing environment is not on the downside?
Tony Ciciretto
Yes.
Maher Yaghi
It’s not.
Tony Ciciretto
Yes. Maybe I can - I didn't mention that as well. I certainly haven’t seen over - certainly in the past 12 months I haven’t seen any major erosion of pricing in the co-location market certainly from evidence that we have.
Maher Yaghi
Okay. And then one last question about just your geographical presence and the environments you are in, economically, are we seeing any kind of stabilization from the recent weakness we had earlier this year out west?
Tony Ciciretto
Well, I think it has stabilized that certainly over the - we’ve seen certainly over the last two quarters a stabilization in particularly out west. But as I alluded to in my earlier comments that we have seen an uptick with much more aggressive pricing certainly for access, network and access services out west.
Maher Yaghi
Great. Okay. Thank you very much.
Tony Ciciretto
Okay. Thank you.
Operator
There are no further questions in the queue at this time. Mr. Ciciretto, I will turn the call back over to you.
Tony Ciciretto
All right. Well, thanks everyone for joining us today. We look forward to the next quarter results. Have a great day. We will talk to you soon.
Operator
This concludes today’s conference call. You may now disconnect.
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