TORONTO, ONTARIO — (Marketwired) — 02/24/15 — TeraGo Inc. (“TeraGo” or the “Company”) (TSX: TGO) () today announced financial and operating results for the year ended December 31, 2014.
Stewart Lyons, President and CEO of TeraGo commented, “Our transition to a multi-product IT services company focused on securely managing our customers– data flow continues to proceed smoothly and is ahead of expectations. We will continue to focus on increasing our revenue trajectory in the coming quarters, as well as increase the pace by which we seek to close meaningful acquisitions that will enable TeraGo to gain valuable customers, insight and expertise, cutting edge products, and valuable infrastructure.”
Mr. Lyons added, “We were pleased to achieve continued increases in core customer revenue (net of the loss of Public Mobile) and ARPU(1) for the quarter, and again we were able to further gain customer loyalty as evidenced by our ability to keep customer churn at historically low levels, and our industry leading Net Promoter Score results, which are significantly ahead of the larger providers.”
2014 Key Developments
Financial Highlights
(1) Non-IFRS Measures
This press release contains references to “EBITDA”, “Churn Rate” and “ARPU” which are not measures prescribed by International Financial Reporting Standards (IFRS). The term “EBITDA” refers to earnings before deducting interest, taxes, depreciation and amortization. The Company calculates EBITDA as earnings before deducting interest, taxes, depreciation and amortization, foreign exchange gain or loss, finance costs, finance income, gain or loss on disposal of network assets, property and equipment and stock-based compensation, and excludes restructuring, acquisition-related and integration costs. The Company believes that EBITDA is useful additional information to management, the Board and investors as it excludes items that could affect the comparability of our operational results and could potentially alter the trends analysis in business performance. Excluding certain items such as restructuring, acquisition-related and integration costs does not imply they are non-recurring. A reconciliation of net earnings (loss) to EBITDA is found in the MD&A for the year ended December 31, 2014. The term “Churn Rate” represents the number of customer cancellations per month as a percentage of total number of customers during the month. The Company calculates churn by dividing the number of customer cancellations during a period by the total number of customers during the period. The Company believes that the Churn Rate is a useful indicator for retention efforts, marketing, customer satisfaction and successful sales. EBITDA and Churn Rate, as presented, may not be comparable to similar measures presented by other companies. The term “ARPU” refers to the Company–s average revenue per customer. The Company believes that ARPU is useful supplemental information as it provides an indication of its revenue from an individual customer on a per month basis. The Company calculates ARPU by dividing service revenue by the average number of customers in service during the period and express ARPU as a rate per month. TeraGo–s method of calculating ARPU may differ from other companies and, accordingly, ARPU may not be comparable to similar measures presented by other companies.
Conference Call and Webcast
Management will host a conference call tomorrow, Wednesday, February 25, 2015, at 9:00 am ET to discuss these results.
To access the conference call, please dial 647-788-4919 or 1-877-291-4570. The audited financial statements for the year ended December 31, 2014 and Management–s Discussion & Analysis for the same period have been filed on SEDAR at . Alternatively, these documents along with a presentation in connection with the conference call can be accessed online at .
An archived recording of the conference call will be available until March 11, 2015. To listen to the recording, call 416-621-4642 or 1-800-585-8367 and enter passcode 85866400.
About TeraGo
TeraGo, through its wholly owned subsidiary TeraGo Networks Inc., provides businesses across Canada with data and voice communications services, data center colocation and hosting services as well as cloud Infrastructure as a Service (“IaaS”) computing and storage solutions. The national service provider owns and manages its IP network servicing approximately 4,100 business customers in 46 major markets across Canada including Toronto, Montreal, Calgary, Edmonton, Vancouver and Winnipeg, as well as data centers in the Greater Toronto Area and the Greater Vancouver Area. TeraGo Networks is a Competitive Local Exchange Carrier (CLEC).
For more information about TeraGo, please visit .
Forward-Looking Statements
This press release includes certain forward-looking statements that are made as of the date hereof. Such forward-looking statements may include, but are not limited to, statements relating to the transition and transformation of the Company to a multi-product IT services company, increasing the Company–s revenue trajectory in the coming quarters and increasing the pace by which the Company seeks to close meaningful acquisitions. All such statements are made pursuant to the –safe harbour– provisions of, and are intended to be forward-looking statements under, applicable Canadian securities laws. Any statements contained herein that are not statements of historical facts may be deemed to be forward-looking statements. The forward-looking statements reflect the Company–s views with respect to future events and is subject to risks, uncertainties and assumptions, including the risk that there may be future delays in the transition process of the Company to a multi-product IT services company, the risk that revenue will not increase at the rate projected by management and those risks set forth in the “Risk Factors” section in the annual MD&A of the Company for the year ended December 31, 2014 available on . Statements relating to the Company–s transition and transformation assume that the Company can execute on its strategy effectively and that there are acquisition or expansion opportunities available to the Company at favourable terms. Accordingly, readers should not 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. Except as may be required by applicable Canadian securities laws, TeraGo does not intend, and disclaims any obligation, to update or revise any forward-looking statements whether in words, oral or written as a result of new information, future events or otherwise.
TERAGO INC.
MANAGEMENT–S DISCUSSION AND ANALYSIS OF FINANCIAL RESULTS FOR THE YEARS ENDED DECEMBER 31, 2014 AND 2013
The following Management–s Discussion and Analysis (“MD&A”) is intended to help the reader understand the results of operations and financial condition of TeraGo Inc. All references in this MD&A to “TeraGo”, the “Company”, “we”, “us”, “our” and “our company” refer to TeraGo Inc. and its subsidiaries, unless the context requires otherwise. This MD&A is dated February 24, 2015 and should be read in conjunction with our audited consolidated financial statements for the year ended December 31, 2014 and the notes thereto. Additional information relating to TeraGo, including our most recently filed Annual Information Form (“AIF”), can be found on SEDAR at and our website at . For greater certainty, the information contained on our website is not incorporated by reference or otherwise into this MD&A. All dollar amounts included in this MD&A are in Canadian dollars unless otherwise indicated.
Certain information included herein is forward-looking and based upon assumptions and anticipated results that are subject to uncertainties. Should one or more of these uncertainties materialize or should the underlying assumptions prove incorrect, actual results may vary significantly from those expected. For a description of material factors that could cause our actual results to differ materially, see the “Forward-Looking Statements” section and the “Risk Factors” section in this MD&A. This MD&A also contains certain industry-related non-GAAP and additional GAAP measures that management uses to evaluate performance of the Company. These non-GAAP and additional GAAP measures are not standardized and the Company–s calculation may differ from other issuers. See “Definitions – IFRS, Additional GAAP and Non-GAAP measures”.
FORWARD-LOOKING STATEMENTS
This MD&A includes certain forward-looking statements that are made as of the date hereof only and based upon current expectations, which involve risks and uncertainties associated with our business and the economic environment in which the business operates. All such statements are made pursuant to the –safe harbour– provisions of, and are intended to be forward-looking statements under, applicable Canadian securities laws. Any statements contained herein that are not statements of historical facts may be deemed to be forward-looking statements. For example, the words anticipate, believe, plan, estimate, expect, intend, should, may, could, objective and similar expressions are intended to identify forward-looking statements. This MD&A includes, but is not limited to, forward looking statements regarding TeraGo–s growth strategy, cloud services, retention campaign and initiatives, additional capital expenditures, investments in data centers and other IT services. By their nature, forward-looking statements require us to make assumptions and are subject to inherent risks and uncertainties. We caution readers of this document not to place undue reliance on our 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, uncertainties and assumptions, including the risk that TeraGo–s growth strategy will not generate the result intended by management, cross-selling of TeraGo–s cloud services may not succeed, retention efforts decreasing profit margins, opportunities for expansion and acquisition not being available or at unfavourable terms and those risks set forth in the “Risk Factors” section of this MD&A and 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, all of the forward-looking statements in this MD&A are expressly qualified by these cautionary statements and other cautionary statements or factors contained herein, and there can be no assurance that the actual results or developments anticipated by the Company will be realized or, even if substantially realized, that they will have the expected consequences for the Company.
Except as may be required by applicable Canadian securities laws, we do not intend, and disclaim any obligation, to update or revise any forward-looking statements whether in words, oral or written as a result of new information, future events or otherwise.
OVERVIEW
Financial Highlights
Key Developments
TERAGO OVERVIEW
TeraGo provides communications, data center and cloud services through its national network and data centers.
Strategy
TeraGo leverages its strategic strengths as a facilities-based information technology (“IT”) and data center and cloud services provider for small and medium-sized business (“SMB”) customers in Canada, enabling their businesses to connect to the world and securing their critical information assets by providing superior customer service, performance and availability as key differentiators.
TeraGo employs a growth strategy that consists of the following key components:
TERAGO–S BUSINESS MODEL
TeraGo–s subscription-based business model generates stable and predictable recurring revenue from Internet, data, voice services, data center services and cloud services.
Communications Services
TeraGo–s communications services customers typically sign one, two or three-year contracts. In 2014, approximately 80% of our new customers signed contracts for three years or more. Services are billed monthly or quarterly over the term of the contract.
Data center services
Hosting and colocation revenue is derived from set-up fees for new installations and monthly recurring charges based on the number of cabinets and/or the quantity of cage space, power requirements, managed services provided and Internet/data bandwidth requirements.
Cloud services
TeraGo–s focus is to provide these services to communications and data center services customers; though certain customers have purchased cloud-based services independent of TeraGo–s other services. Cloud services revenue is derived from monthly recurring charges based on usage.
As at December 31, 2014, the Company offered its services in 46 geographic markets across Canada serving over 4,000 customers. Once a customer is obtained, we work to capitalize on opportunities to generate incremental recurring revenue from that customer by adding new customer locations and increasing service capacity supplied to existing locations, by increasing data center cabinet space and by providing additional services.
ACCESS SERVICES
TeraGo owns and operates a carrier-grade Multi-Protocol Label Switching (“MPLS”) enabled wireline and fixed wireless, Internet Protocol (“IP”) communications network in Canada, providing businesses with high performance, scalable, and secure access and data connectivity services.
TeraGo–s carrier grade IP communication network serves an important and growing demand among Canadian businesses for network access diversity by offering wireless services that are redundant to their existing wireline broadband connections.
TeraGo–s IP network has been designed to eliminate single points of failure and the Company backs its services with customer service level commitments, including 99.9% service availability, industry leading mean time to repair, 24 x 7 telephone and e-mail access to technical support specialists.
TeraGo offers Canadian businesses high performance unlimited and usage-based dedicated Internet access with upload and download speeds from 5 megabits per second (“Mbps”) up to 1 gigabit per second (“Gbps”). Unlike asymmetrical DSL services offered by many of our competitors, TeraGo provides services that are symmetrical, hence customers can have the same high speed broadband performance whether uploading or downloading. TeraGo enhances service performance by minimizing the number of networks between our customers and their audiences, using peering arrangements with multiple tier-one carriers to connect to the Internet.
DATA SERVICES
TeraGo offers data connectivity services that allow businesses to connect their multiple sites within a city or across TeraGo–s geographic footprint through a Private Virtual Local Area Network (“VLAN”). With speeds from 3 Mbps to 1 Gbps, TeraGo–s VLAN services are ideal for companies with multiple offices and large interoffice data requirements. Campus VLAN services between two customer locations are available at speeds up to 1 Gbps. TeraGo–s data services, which run across our MPLS core network, are symmetrical, allowing communication between parties in both directions simultaneously. TeraGo–s use of Ethernet over MPLS (“EoMPLS”) technology enhances its VLAN performance and enables VLAN customers to experience higher reliability and easier provisioning.
VOICE SERVICES
TeraGo is approved by the Canadian Radio-television and Telecommunications Commission (“CRTC”) to offer voice services as a Type IV competitive local exchange carrier (“CLEC”). TeraGo provides businesses with a cost effective, flexible and high quality connection from their private branch exchange (PBX) to the public switched telephone network (PSTN). TeraGo–s service provides features and capabilities generally consistent with those provided by incumbent local exchange carriers (“ILECs”), while offering greater value for our customers.
NETWORK
To deliver its services, the Company has built and operates a carrier-grade, IP network, using licensed and license-exempt spectrum and fibre-optic wireline infrastructure that supports commercially available equipment.
The Company owns and controls a national MPLS distribution network from Vancouver to Montreal that aggregates customer voice and data traffic and interconnects when necessary with carrier diverse leased fiber optic facilities. Major Internet peering and core locations are centralized in Vancouver, Toronto, Seattle and Los Angeles although Internet access is also available in all regional markets for further redundancy.
TeraGo offers a range of diverse Ethernet-based services over a secured wireless connection to customer locations up to 20 kilometres from a hub (provided line of sight or wireline networks exist) or through a fibre optic connection.
Quality of Service Capabilities
TeraGo–s MPLS network, including key high traffic hub sites, is equipped with Quality of Service (“QoS”) capabilities to improve performance and traffic management. All of TeraGo–s major national markets are end-to-end QoS enabled providing the foundation to support voice traffic and other potential future applications.
Radio Spectrum
24-GHz and 38-GHz Wide-area Licences
The Company owns a national spectrum portfolio of 24-GHz and 38-GHz wide-area spectrum licences which covers regions across Canada, including 1,160 MHz in Canada–s 6 largest cities. This spectrum is used for: point-to-point and point-to-multipoint microwave radio deployments; connecting core hubs together to create a wireless backbone where appropriate (often in a ring configuration to avoid points of failure); and in the access network or “last mile” to deliver high capacity (speeds of 10 to 1,000 Mbps) Ethernet-based links for business, government and cellular backhaul.
For further details on licensed spectrums, please refer to the Company–s 2014 AIF.
DATA CENTER AND MANAGED SERVICES
TeraGo provides data center services that protect and connect our customers– valuable information assets. Customers can provision computing equipment within shared partial cabinets or full, private cabinets, as well as customized caged space designed for their specific needs. TeraGo provides connectivity on redundant routes in and out of the facilities.
TeraGo also offers a variety of managed hosting solutions, which may require us to manage various aspects of a customer–s hardware, software or operating systems in public or privately accessible environment. TeraGo offers disaster recovery services on a custom basis. This includes back-up office facilities that can be used in case of disaster. These facilities can be provisioned at the data center location and provide customers with the capability to restore office functionality with direct access to their information located in the data center.
Our network can provide these customers Internet and/or secure private virtual LAN connections between the data center facility and the customer–s office location(s).
Data center services customers typically include national government agencies, financial services companies, cloud and data storage service providers, content and network service providers, and small and medium businesses which rely on TeraGo to store and manage their critical IT equipment and provide the ability to directly connect to the networks that enable our information-driven economy.
Data Center Facilities
TeraGo–s data centers provide data center solutions, including colocation and disaster recovery, to a roster of small and medium-sized businesses, enterprises, public sector and technology service providers. As of December 31, 2014, TeraGo has approximately 40,000 square feet of data center capacity in four facilities across Canada:
Vaughan, Ontario
TeraGo operates a 16,000 square foot SSAE 16 SOC1 Type 2 data center facility in Vaughan, Ontario, serving the Greater Toronto Area. This data center and its operations were purchased in May 2013 when the Company acquired Data Centers Canada Inc.
Mississauga, Ontario
In October, 2014, TeraGo acquired a 10,000 square foot tier 3-ready data center facility in Mississauga, Ontario that was previously managed by BlackBerry Limited. This facility is expected to be ready in March, 2015 and will predominantly serve the Greater Toronto Area.
Vancouver, British Columbia
TeraGo operates two data center facilities in downtown Vancouver. Its first facility, acquired in December 2013, is 5,000 square feet and is expandable to 7,000 square feet. The facility has redundant fibre facilities between the data center and the –telco hotel–, 555 West Hastings, in downtown Vancouver. The second facility which was acquired in April 2014 is 7,000 square feet and is served by TeraGo–s fiber optic line. Both facilities are used to service the Greater Vancouver Area.
CLOUD SERVICES
TeraGo provides cloud services that seek to meet the complex and evolving IT needs of our customers. TeraGo provides Infrastructure as a Service (“IaaS”) cloud computing solutions and data archiving or cloud storage and other offerings either on a direct or indirect basis. These solutions allow the Company to compete in the cloud services, Platform as a Service (“PaaS”) and IaaS markets.
With its entry into data center services and cloud services, TeraGo is building an operating platform to service the IT solutions sector. Cross selling opportunities to the customer base, while leveraging the Company–s carrier grade network is expected to augment and diversify the Company–s revenue base.
SELECTED ANNUAL INFORMATION
The following table displays a summary of our Consolidated Statements of Comprehensive Earnings (Loss) for the three months ended December 31, 2014 and 2013 and the years ended December 31, 2014, 2013 and 2012 and a summary of select Balance Sheet data as at December 31, 2014, 2013 and 2012.
RESULTS OF OPERATIONS
Comparison of the three months and year ended December 31, 2014 and 2013
(in thousands of dollars, except with respect to gross profit margin, earnings per share and operating metrics)
Refer to “Definitions – IFRS, Additional GAAP and Non-GAAP Measures” for a description of the components of relevant line items below.
Revenue
Total revenue decreased 2.2% to $12.6 million for the three months ended December 31, 2014, compared to $12.9 million for the same period in 2013. Excluding revenues related to the loss of a new wireless entrant customer, total ongoing revenue increased 2.1% for the quarter compared to the same period in 2013 with service revenues from ongoing operations steadily increasing quarter over quarter during 2014 (Q1 = $12.0 million, Q2 = $12.0 million, Q3 = $12.1 million, Q4 = $12.3 million).
For the year ended December 31, 2014, total revenue decreased 0.4% to $51.2 million compared to $51.4 million for the same period in 2013. Excluding revenues related to the loss of a new wireless entrant customer, total ongoing revenue increased 1.5% for the year ended December 31, 2014 compared to the same period in 2013.
The Company believes the current retention campaign launched for customers coming to the end of the contract term will help long-term revenue growth by maintaining and growing a large base of customers to cross-sell complementary services such as data center and cloud services.
ARPU
ARPU or revenue per customer decreased 2.7% to $1,006 for the three months ended December 31, 2014 compared to $1,034 for the same period in 2013. Excluding the impact of the loss of a new wireless entrant customer, ARPU increased 2.2% to $1,006 for the three months ended December 31, 2014 compared to $984 for the same period in 2013. This change was primarily due to a decrease in revenue contribution from the internet access business offset by an increase in the data center services as discussed in the revenue section above.
For the year ended December 31, 2014 ARPU decreased 2.7% to $1,009 compared to $1,037 the same period in 2013. Excluding the impact of the loss of a new wireless entrant customer, ARPU increased to $988 for the year ended December 31, 2014 compared to $986 for the same period in 2013.
Churn
The average monthly churn rate improved to 1.02% for the three months ended December 31, 2014 compared to 1.18% for the same period in 2013. For the year ended December 31 average monthly churn rate improved to 0.99% compared to 1.18% the same period in 2013. The improvement is primarily as a result of the enhanced retention focus now in place. Management continues to focus on retention initiatives and offerings, customer service, focused on the needs of SMB customers and renewed sales activity with competitive product offerings in addition to monitoring customer creditworthiness and churn levels.
Cost of services
Cost of services remained relatively stable at $3.1 million for the three months ended December 31, 2014 and 2013. For the year ended December 31, 2014, cost of services increased to $12.0 million compared to $11.7 million for the same period in 2013. The increase is primarily due to higher utility costs associated with the data centres being operational for the full year in 2014 vs. partial year in 2013.
Salaries and related costs and other operating items (“SG&A”)
SG&A expenses remained relatively stable at $6.9 million for the three months ended December 31, 2014 and 2013. For the year ended December 31, 2014, SG&A expenses increased to $27.8 million compared to $23.3 million for the same period in 2013. The increase was due to increased rental expenses associated with DC acquisitions, higher marketing costs related to new marketing programs and product launches, higher restructuring costs related to the ongoing alignment of the Company–s strategy and integration costs partially offset by savings in salary and benefits due to reductions in the number of employees.
EBITDA
EBITDA was $4.0 million for the three months ended December 31, 2014 compared to $4.3 million for the same period in 2013, a decrease of 8.2%. EBITDA for the year ended December 31, 2014 was $16.2 million compared to $18.4 million for the same period in 2013, a decrease of 12.0%. The decrease in both periods is driven by the revenue, cost of services and SG&A movements described above.
The table below reconciles net earnings (loss) to EBITDA for the three months and year ended December 31, 2014 and 2013.
Finance costs
Finance costs increased $0.03 million for the three months ended December 31, 2014 compared to the same period in 2013 due to $0.1 million expense related to the mark to market of the Company–s interest rate swap contract offset by benefits on interest rates from refinancing the debt in Q2 2014. For the year ended December 31, 2014, finance costs increased to $2.0 million compared to $1.1 million for the same period in 2013. The increase in finance costs for year ended December 31, 2014 compared to 2013 is primarily due to fees and charges related to the set-up of the new Credit Facilities and the extinguishment of the old facility, expense related to the mark to market of the Company–s interest rate swap contract and an increase in interest expense as TeraGo–s debt level increased due to acquisitions at the end of the second quarter in 2013.
Depreciation and amortization
Depreciation of network assets, property and equipment and amortization of intangibles increased by 2.7% to $3.3 million for the three months ended December 31, 2014 compared to $3.2 million for the same period in 2013. For the year ended December 31 2014 depreciation of network assets, property and equipment and amortization of intangibles increased by 8.0% to $13.3 million compared to $12.3 million for the same period in 2013. The increase in depreciation and amortization relates to increased investment in fibre optic network, wireless network assets and customer premise equipment as well as the amortization of new intangible assets acquired in the purchase of DCC on May 31, 2013.
Income tax
The Company reviewed and updated the assumptions and projections regarding future profitability as at December 31, 2014. Based on management–s analysis, no change in deferred income tax asset resulting from temporary tax differences were recognized in the three months and year end December 31, 2014. For the year ended December 31, 2013, the Company recognized a tax benefit of $1.3 million associated with previously unrecognized tax losses as management considered it probable that future taxable profits would be available against which they can be utilized.
Net earnings (loss)
Net loss was $1.1 million for the three months ended December 31, 2014, compared to net loss of $0.7 million for the same period in 2013. For the year ended December 31, 2014, net loss was $3.9 million compared to net earnings of $4.3 million for the same period in 2013. For the three months ended December 31, 2014 net loss was impacted by lower access revenue and higher stock based compensation expenses compared to the same period in 2013. For the year ended December 31, 2014, earnings were also negatively impacted by higher finance costs associated with the new credit facility, higher depreciation costs related to the new data center locations and restructuring costs incurred related to the ongoing alignment of the Company–s strategy compared to the same period in 2013. In addition, the year ended December 31, 2013 included a tax benefit of $1.3 million associated with previously unrecognized tax losses.
Summary of Quarterly Results
All financial results are in thousands, with the exception of earnings per share.
Seasonality
The Company–s net customer growth is typically impacted adversely by weather conditions as the majority of new customer locations require the installation of rooftop equipment. Typically, harsher weather in the first quarter of the year results in a reduction of productive installation days.
The Company–s cash flow and earnings are typically impacted in the first quarter of the year due to several annual agreements requiring payments in the first quarter including annual spectrum payments, annual rate increases in long-term contracts and the restart on January 1st of payroll taxes and other levies related to employee compensation.
LIQUIDITY AND CAPITAL RESOURCES
TeraGo has historically financed its growth and operations through cash generated by operations, the issuance of equity securities and long-term debt.
The table below is a summary of cash inflows and outflows by activity.
Operating Activities
For the three months ended December 31, 2014, cash generated from operating activities was $3.9 million compared to $4.5 million for the same period in 2013. For the year ended December 31, 2014, cash generated from operating activities was $13.6 million compared to $15.8 million for the same period in 2013. The decrease in cash from operating activities for the year ended December 31, 2014 is principally from a net loss mainly driven by an increase of expenses associated with the full year impact of data center operational costs (eg. rent, utilities), higher marketing costs related to new marketing programs and product launches and higher restructuring costs offset by savings in salary and benefit.
Investing Activities
Cash used in investing activities was $2.5 million and $11.6 million for the three months and year ended December 31, 2014 and $2.5 million and $20.6 million, respectively, for the same periods in 2013.
For the three and year ended December 31, 2014, additions to fibre optic and wireless network assets, property and equipment, excluding amounts related to changes in non-cash working capital, was $2.3 million and $11.9 million, respectively, compared to $2.9 million and $11.1 million, respectively, for the same periods in 2013. For the three months and year ended December 31, 2014, the capital spending is primarily attributable to data center improvements, upgrading intercity core network, new equipment related to new customer installs.
For the year ended December 31, 2013, cash used in investing included the payment of $9.5 million, net of cash acquired, for the acquisition of DCC.
For the three months ended December 31, 2014, the Company had redeemed net $0.1 million short-term investments. For the year ended December 31, 2014 the Company had redeemed net $0.5 million of short-term investments compared to a net redemption of $0.7 million for the same period in 2013.
Financing Activities
Cash used in financing activities was $1.8 million and $1.3 million, respectively, for the three months and year ended December 31, 2014 compared to cash used from financing activities of $0.8 million for the three months ended December 31, 2013 and cash provided from financing activities of $5.5 million for the year ended December 31, 2013.
For the three months and year ended December 31, 2014, cash used in financing activities was primarily due to the principal repayment of the new Credit Facility and related interest obligations. For the three months ended December 31, 2013, the $0.8 million cash used was mainly due to principal repayment of the Company–s previous debt facilities with RBC and related financing cost and interest obligations.
For the year ended December 31, 2014, cash used from financing activities was primarily due to repayment of the Company–s previous debt facilities with RBC and related finance costs mainly offset by draw from the new Credit Facilities. For the year ended December 31, 2013, cash generated from financing activities was primarily due to the draw of $12.1 million from the previous RBC facility to finance the DCC acquisition offset by repayment of the term debt facility and capital lease obligations, finance costs and interest obligations.
Capital Resources
As at December 31, 2014, the Company had cash and cash equivalents of $2.9 million and access to the $29.3 million undrawn portion of its $50.0 million Credit Facilities.
The Company anticipates incurring additional capital expenditures for the purchase and installation of network assets and customer premise equipment. As economic conditions warrant, the Company may expand its network coverage into new Canadian markets using wireless or fibre optics and making additional investments in data centers and other IT services through acquisitions or expansion.
In June 2014, TeraGo entered into an agreement with a syndicate led by the National Bank of Canada (“NBC”) that provides a $50.0 million credit facility that is principally secured by a general security agreement over the Company–s assets.
The total $50.0 million facility, which matures June 6, 2017, is made up of the following:
The Company incurred financing fees of $0.4 million which have been deferred and amortized using the effective interest method over the term of the debt. The NBC facility is subject to certain financial and non-financial covenants which the Company is in compliance with at December 31, 2014. Under this facility, the Company is also subject to a cash flow sweep that could accelerate principal repayments based on a detailed calculation outlined by NBC not later than 120 days after the end of each fiscal year commencing with the year ending December 31, 2014. At December 31, 2014, no accelerated principal repayments were required.
As at December 31, 2013, the Company had a credit facility agreement with the Royal Bank of Canada (“RBC”) that consisted of an operating line of credit and certain term facilities, of which $18.5 million was drawn at December 31, 2013. The RBC facility was repaid in 2014 with the proceeds received from the NBC facility. The Company recorded an expense of $0.6 million related to the write-off of unamortized deferred finance costs and unwinding fees which are included in finance costs in the consolidated statement of comprehensive earnings (loss).
Management believes the Company–s current cash, short-term investments, anticipated cash from operations, access to the undrawn portion of debt facilities and its access to additional financing in the form of debt or equity will be sufficient to meet its working capital and capital expenditure requirements for the foreseeable future.
Contractual Obligations
The following table is a summary of our contractual obligations at December 31, 2014 that are due in the next five years and thereafter.
Off-Balance Sheet Arrangements
As of December 31, 2014, the Company had no off-balance sheet arrangements apart from operating leases noted above.
Transactions with Related Parties
The Company provides services to one customer whose Chairman and Director of the Board of Directors are both Directors of the Company. Revenue from this customer for the years ended December 31, 2014 and 2013 was $68 and $58, respectively. Accounts receivable from this customer as at December 31, 2014 and 2013 was $5 and $5.
The terms governing these related party transactions are consistent with those negotiated on an arm–s length basis with non-related parties.
Share Capital
TeraGo–s authorized share capital consists of an unlimited number of Common Shares, an unlimited number of Class A Non-Voting Shares and two Class B Shares. A detailed description of the rights, privileges, restrictions and conditions attached to the authorized shares is included in the Company–s 2014 Annual Information Form, a copy of which can be found on SEDAR at .
As of February 23, 2015, there were 11,714 Common Shares issued and outstanding and 2 Class B Shares issued and outstanding. In addition, as of February 23, 2015, there were 1,301 Common Shares issuable upon exercise of TeraGo stock options.
Restricted Cash
The restricted cash is segregated for the period of a tax indemnity to a former officer in connection with the Company–s initial public offering on June 18, 2007, and is invested in a guaranteed investment certificate. The related accrued interest is included in short-term investments. The indemnity is described in note 8 of the Company–s 2014 Consolidated Financial Statements and the indemnity period expires in June, 2015. In 2014, the Company received a notice of a claim against the tax indemnity from the former officer relating to the sale of 189 Common Shares. The Company estimated the cost of the indemnity to be paid from the $0.8 million maximum allocated to the former officer and recorded stock-based compensation expense of $0.6 million related to this claim in the first quarter of 2014. The Company is awaiting a final settlement of claim with the former officer. The balance of $0.8 million is held as restricted cash and $0.6 million is recorded in accounts payable and accrued liabilities as at December 31, 2014.
Financial Instruments
The Company initially measures financial instruments at fair value. Transaction costs that are directly attributable to the issuance of financial assets or liabilities are accounted for as part of the carrying value at inception (except for transaction costs related to financial instruments related to FVTPL financial assets which are expensed as incurred), and are recognized over the term of the assets or liabilities using the effective interest method.
Subsequent measurement and treatment of any gain or loss is recorded as follows:
The following is a summary of the Company–s significant categories of financial instruments as at December 31, 2014:
Loans and receivables
Loans and receivables are financial assets with fixed or determinable payments that are not quoted in an active market. Such assets currently are comprised of cash and cash equivalents, short-term investments, accounts receivable and restricted cash.
Cash and Cash Equivalents
Cash and cash equivalents consists of bank balances, cash on hand, demand deposits that can be withdrawn without penalty and short-term, highly liquid securities such as debt securities with an initial maturity date of not more than three months from the date of acquisition, that can readily be converted into known amounts of cash and are subject to an insignificant risk of change in value. Bank overdrafts that are repayable upon demand and form an integral part of the Company–s cash management are included as a component of cash and cash equivalents. Cash and cash equivalents are carried at amortized cost.
Restricted Cash
Restricted cash consist of highly liquid marketable investments and short-term debt securities with an initial maturity from the date of acquisition of between three months and one year. These primarily consist of investment-grade fixed income securities, such as guaranteed investment certificates and investment savings accounts and these are in compliance with the Company–s policy on investments. Restricted cash are carried at amortized cost.
Accounts Receivable
Accounts receivable are measured at the amount the item is initially recognized. The allowance for doubtful accounts is based on the Company–s assessment of the collectability of outstanding trade receivables. The evaluation of collectability of customer accounts is done on an individual account basis. If, based on an evaluation of accounts, it is concluded that it is probable that a customer will not be able to pay all amounts due, an expected impairment loss is recognized. Recoveries are only recorded when objective verifiable evidence supports the change in the original allowance. Changes in the carrying amount of the allowance account are recognized in net earnings (loss) for the period.
Impairment of Financial Assets
A financial asset carried at amortized cost is considered impaired if objective evidence indicates that one or more events have had a negative effect on the estimated future cash flow of that asset that can be estimated reliably. An impairment loss is calculated as the difference between its carrying amount and the present value of the estimated future cash flows discounted at the asset–s original effective interest rate.
In assessing impairment, the Company uses historical trends of the probability of default, timing of recoveries and the amount of loss incurred, adjusted for management–s judgment as to whether current economic and credit conditions are such that the actual losses are likely to be greater or less than suggested by historical trends. Losses are recognized in the consolidated statements of earnings (loss) and reflected in an allowance account against the financial asset.
Other non-derivative financial liabilities
The Company recognizes debt securities issues and subordinated liabilities on the date that they originated. All other financial liabilities are recognized initially on the date that the Company becomes a party to the contractual provisions. The Company has the following non-derivative financial liabilities: current and long-term debt and accounts payable and accrued liabilities.
Such liabilities are recognized initially at fair value less any directly attributable transaction costs. Subsequent to initial recognition these financial liabilities are measured at amortized cost using the effective interest method.
Interest on loans and borrowings is expensed as incurred unless capitalized for qualifying assets in accordance with IAS 23, Borrowing Costs. Loans and borrowings are classified as a current liability unless the Company has an unconditional right to defer settlement for at least 12 months after the end of the reporting period.
Derivative instruments
The Company uses an interest rate swap contract to manage the risk associated with the fluctuations of interest rates on long-term debt. Management does not apply hedge accounting on the interest rate swap contract. As a result, the interest rate swap contract is marked to market each period, resulting in a gain or loss in the consolidated statement of comprehensive earnings (loss). The interest rate swap contract is valued based on broker quotes.
Financial Instrument Risks
Fair value of financial instruments
The Company has determined the estimated fair values of its financial instruments based on appropriate valuation methodologies. Where quoted market values are not readily available, the Company may use considerable judgment to develop estimates of fair value. Accordingly, any estimated values are not necessarily indicative of the amounts the Company could realize in a current market exchange and could be materially affected by the use of different assumptions or methodologies. The Company classifies its fair value measurements within a fair value hierarchy, which reflects the significance of the inputs used in making the measurements as defined in IFRS 7 – Financial Instruments – Disclosures.
Level 1 – Unadjusted quoted prices in active markets for identical assets or liabilities;
Level 2 – Inputs other than quoted prices included in Level 1, that are observable for the asset or liability, either directly or indirectly; and
Level 3 – Unobservable inputs for the asset or liability which are supported by little or no market activity
The fair values of cash and cash equivalents, short-term investments and restricted cash, which are primarily money market and fixed income securities, are based on quoted market values. The fair values of short-term financial assets and liabilities, including accounts receivable, accounts payable and accrued liabilities, as presented in the consolidated statements of financial position, approximate their carrying amounts due to their short-term maturities. The fair value of long-term debt approximates its carrying value because management believes the interest rates approximate the market interest rate for similar debt with similar security. The fair value of our interest rate swap contract is based on broker quotes and therefore, these contracts are measured using Level 2 inputs. Similar contracts are traded in an active market and the quotes reflect the actual transactions in similar instruments.
Credit risk
The Company–s cash and cash equivalents, short-term investments and restricted cash subject the Company to credit risk. The Company holds low risk money market and fixed income securities, as per its practice of protecting its capital rather than maximizing investment yield. The Company maintains cash and investment balances at Tier 1 Canadian financial institutions. The Company–s maximum exposure to credit risk is limited to the amount of cash and cash equivalents and short-term investments.
Credit risk related to our interest rate swap contract arises from the possibility that the counter party to the agreement may default on their obligation. The Company assesses the creditworthiness of the counterparty to minimize the risk of counterparty default. The interest rate swap is held by a financial institution with a Standard & Poor–s rating of A.
The Company, in the normal course of business, is exposed to credit risk from its customers and the accounts receivable are subject to normal industry risks. The Company attempts to manage these risks by dealing with credit worthy customers. If available, the Company reviews credit bureau ratings, bank accounts and industry references for all new customers. Customers that do not have this information available are typically placed on a pre-authorized payment plan for service or provide deposits to the Company. This risk is minimized as the Company has a diverse customer base located across various provinces in Canada.
As at December 31, 2014 and 2013, the Company had no material past due trade accounts receivable.
Interest rate risk
The Company is subject to interest rate risk on its cash and cash equivalents and long-term debt. The Company is exposed to interest rate risk on its operating line of credit since the interest rates applicable are variable and is, therefore, exposed to cash flow risks resulting from interest rate fluctuations. As at December 31, 2014, the operating line of credit balance was $nil. On September 30, 2014, the Company entered into an interest rate swap contract to fix the interest rate on the Banker–s Acceptance portion of the term facility at 3.79%. At December 31, 2014, $18.4 million of the $18.5 million drawn term facility was subject to the fixed 3.79% interest rate. The remaining $0.1 million under this facility bears interest for the period at prime rate plus a margin.
Liquidity risk
The Company believes that its current cash and cash equivalents, short-term investments and anticipated cash from operations will be sufficient to meet its working capital and capital expenditure requirements for the foreseeable future. As at December 31, 2014, the Company had cash and cash equivalents and short-term investments of $2.9 million. The Company has access to the $29.3 million undrawn portion of its $50.0 million credit facilities after consideration of outstanding letters of credit.
Currency risk
The Company has suppliers that are not based in Canada which gives rise to a risk that earnings and cash flows may be adversely affected by fluctuations in foreign currency exchange rates. The Company is primarily exposed to the fluctuations in the US dollar. The Company believes this risk is minimal and does not use financial instruments to hedge these risks. A one cent variation in the U.S. dollar would result in an impact of $33 thousand per year.
SIGNIFICANT ACCOUNTING ESTIMATES
The preparation of financial statements in conformity with IFRS requires management to make judgments, estimates and assumptions that affect the application of accounting policies and the reported amounts of assets, liabilities, income and expenses. Actual results may differ from these estimates. Estimates and assumptions are reviewed on an ongoing basis. Revisions to accounting estimates are recognized in the period in which the estimates are revised and in any future periods affected.
Key areas of estimation and information about critical judgments in applying accounting policies that have the most significant effect on amounts recognized in the consolidated financial statements are:
Estimates of useful lives of network assets, property and equipment and intangible assets:
Management–s judgment involves consideration of intended use, industry trends and other factors in determining the expected useful lives of depreciable assets, to determine depreciation methods, the asset–s residual value and whether an asset is a qualifying asset for the purposes of capitalizing borrowing costs.
Capitalization of costs:
Judgments and estimates are used in assessing the direct labour and other costs capitalized to network assets, property and equipment.
Cash generating units:
Judgment is required to assess the Company–s determination of cash generating units for the purpose of impairment testing.
Impairment of non-financial assets:
The process to calculate the recoverable amount of our cash generating unit requires use of valuation methods such as the discounted cash flow method which uses assumptions of key variables including future cash flows, discount rate and terminal growth rates.
The Company monitors events and changes in circumstances that may require an assessment of the recoverability of its non-financial long-lived assets. When an impairment test is performed, the recoverable amount is assessed by reference to the higher of i) the net present value of the expected future cash flows (value-in-use) and ii) the fair value less cost to sell. If the recoverable amount is estimated to be less than the carrying amount, the carrying amount of the asset is reduced to its recoverable amount and an impairment loss is charged to operations in the period in which the impairment is identified. For the purposes of assessing impairment, assets are grouped at the lowest levels for which there are separately identifiable cash flows (“cash generating units” or “CGUs”).
The carrying values of identifiable intangible assets with indefinite lives and goodwill are tested at minimum annually for impairment. Goodwill and indefinite life intangible assets are allocated to CGUs for the purpose of impairment testing based on the level at which management monitors it, which is not higher than an operating segment. The allocation is made to those CGUs that are expected to benefit from the business combination in which the goodwill arose. The Company currently has assessed that it has a single CGU.
The carrying values of non-financial assets with finite useful lives, such as network assets, property and equipment and intangible and other assets subject to amortization, are assessed for impairment whenever events or changes in circumstances indicate that their carrying amounts may not be recoverable. If any such indication exists, the recoverable amount of the asset must be determined. Such assets are impaired if their recoverable amount is lower than their carrying amount. If it is not possible to estimate the recoverable amount of an individual asset, the recoverable amount of the CGU to which the asset belongs is tested for impairment.
The recoverable amount is the higher of (i) an asset–s or CGU–s fair value less costs to sell and (ii) its value-in-use. In performing the annual impairment test for the Company–s single CGU, the Company measured the value-in-use of the CGU using certain key management assumptions. Cash flow projections, which were made over a five-year period, were based primarily on the 3 year financial budget reviewed by the Board plus a terminal value using a 2% terminal growth rate. The Company discounted these estimates of future cash flows to their present value using an after-tax discount rate of 10.5%. The fair value less costs to sell, primarily based on the Company–s market capitalization as at December 31, 2014, also significantly exceeded the carrying amount of the CGU.
Allowance for doubtful accounts:
In developing the estimates for an allowance against existing receivables, the Company considers general and industry economic and market conditions as well as credit information available for the customer and the aging of the account. Changes in the carrying amount due to changes in economic and market conditions could significantly affect the earnings for the period.
Stock-based compensation:
Estimating fair value for stock-based payments requires determining the most appropriate valuation model for a grant, which is dependent on the terms and conditions of the grant. In valuing stock options, the Company uses the Black-Scholes option pricing model. Several assumptions are used in the underlying calculation of fair values of the Company–s stock options using the Black-Scholes option pricing model including the expected life of the option, risk-free interest rate and volatility of the underlying stock.
Business combination:
The amount of goodwill initially recognized as a result of a business combination, the fair value estimate of any contingent consideration and the determination of the fair value of the identifiable assets acquired and the liabilities assumed is based, to a considerable extent, on management–s judgment of future cash flows expected to be derived from the assets acquired.
Income taxes:
A deferred tax asset is recognized for unused losses, tax credits and deductible temporary differences to the extent that it is probable that future taxable income will be available against which they can be utilized. Significant estimates are required in evaluating the recoverability of deferred tax assets. The Company–s assessment is based on existing tax laws, estimates of future profitability and tax planning strategies.
Provisions:
Judgment is required to assess the likelihood of an outflow of the economic benefits to settle contingencies, such as litigations or decommissioning and restoration obligations, which may require a liability to be recognized. Significant judgments include assessing estimates of future cash flows, selection of discount rates and the probability of the occurrence of future events.
SIGNIFICANT REGULATORY DEVELOPMENTS
In December, 2014, Industry Canada announced a new framework for the licensing and renewal of licenses in the 24, 28 and 38 GHz bands. The new framework permits the renewal of all auctioned licenses for a subsequent 10-year term by their holders if such holders have met the prescribed conditions of these licenses. The Company is currently working on the renewal of its spectrum licenses and expects that the spectrum licenses which it currently holds and needs to operate its internet access business will be eligible for renewal. In addition, under the new framework, Industry Canada has changed the fee structure for new licences, but has “grandfathered” the previous fee structure for existing licenses.
RISK FACTORS
TeraGo is exposed to a number of risks and uncertainties that are common to other companies engaged in the same or similar businesses. The following is a summary of the material risks that could significantly affect the financial condition, operating results or business of TeraGo.
Revenues and Operating Results Can Fluctuate
Our revenue in past periods may not be indicative of future performance from quarter to quarter or year to year. In addition, our operating results may not follow any past trends. The factors affecting our revenue and results, many of which are outside of our control, include:
Transition of the Company to a Multi-Product IT Services Company
In the past, the core business of the Company was to provide internet access services. The Company is currently transitioning to a multi-product IT services company focused on the management of its customer–s data flow. In doing so, TeraGo has begun to offer colocation services through its data centers and is offering cloud storage and cloud computing services. If TeraGo is unable to execute on its new business strategy and to grow the business, either as a result of the risks identified in this section or for any other reason, the business, prospects, financial condition and results of operations will be materially and adversely affected. There is no assurance that such objectives can be obtained and there could be a risk that there may be future delays in the transition process of the Company to a multi-product IT services company that is profitable.
Price Sensitive Market
The competitive market in which the Company conducts its business could require the Company to reduce its prices. If competitors offer discounts on certain products or services in an effort to recapture or gain market share or to sell other products, the Company may be required to lower prices or offer other favourable terms to compete successfully. Any such changes would likely reduce the Company–s margins and could adversely affect operating results. Some of the Company–s competitors may bundle services that compete with the Company for promotional purposes or as a long-term pricing strategy or provide guarantees of prices and product implementations. These practices could, over time, limit the prices that the Company can charge for its products. If the Company cannot offset price reductions with a corresponding increase in volume, bundling of services or with lower spending, then the reduced revenues resulting from lower prices would adversely affect the Company–s margins and operating results.
Market Demand for Available Capacity
The Company currently has available capacity in its data centers and intends to expand its footprint in the co-location market. There can be no assurance that the existing or future market demand will be sufficient to fill this capacity. Should the demand for the Company–s data center services decline or fail to increase, this may negatively affect the Company–s ability to capitalize on its high operating leverage and may adversely affect the Company–s future financial performance.
Reductions in the amount or cancellations of customers– orders would adversely affect our business, results of operations and financial condition.
Security Risk
Our network security, data center security and the authentication of our customer credentials are designed to protect unauthorized access to data on our network and to our data center premises. Because techniques used to obtain unauthorized access to or to sabotage networks change frequently and may not be recognized until launched against a target, we may be unable to anticipate or implement adequate preventive measures against unauthorized access or sabotage. Consequently, unauthorized parties may overcome our network security and obtain access to data on our network, including on a device connected to our network. In addition, because we own and operate our network, unauthorized access or sabotage of our network could result in damage to our network and to the computers or other devices used by our customer. An actual or perceived breach of network security or data center security could harm public perception of the effectiveness of our security measures, adversely affect our ability to attract and retain customers, expose us to significant liability and adversely affect our business prospects.
Placing Newly Acquired Data Centers into Operation
The Company–s recently acquired data center in Mississauga is currently being evaluated and prepared for operation. Placement into operation of the data center is expected to occur in March 2015. If there are any delays or setbacks in the work that is required prior to servicing customers, the results of the business may be adversely affected.
Excessive Customer Churn
The successful implementation of our business strategy depends upon controlling customer churn. Customer churn is a measure of customers who stop using our services. See “DEFINITIONS – KEY PERFORMANCE INDICATORS, IFRS, ADDITIONAL GAAP AND NON-GAAP MEASURES” for a description of how we determine churn. Customer churn could increase as a result of:
An increase in customer churn can lead to slower customer growth, increased costs and a reduction in revenue. Given the current economic environment, there is risk that churn levels could increase in the future.
Insufficient Capital
The continued growth and operation of our business may require additional funding for working capital, debt service, the enhancement and upgrade of our network, the build-out of infrastructure to expand the coverage area of our services, possible acquisitions and possible bids to acquire spectrum licences. We may be unable to secure such funding when needed in adequate amounts or on acceptable terms, if at all.
To execute our business strategy, we may issue additional equity securities in public
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