TeraGo Inc Annual Report

Transcription

1 TeraGo Inc Annual Report INTERNET DATA NETWORKING VOICE

2 CONTENTS Letter to Shareholders 3 Management s Discussion and Analysis 6 Auditors Report 41 Consolidated Financial Statements Statement of Financial Position 42 Statements of Comprehensive Earnings (Loss) 43 Statements of Cash Flows 44 Statements of Changes in Equity 45 Notes to Financial Statements 46 Corporate Information 75

3 Letter to Shareholders April, 2012 Fellow shareholders, TeraGo s overall performance in 2011 underscores the strength of both our business and our strategic direction. We continued to effectively implement the growth strategy we introduced several years ago and were rewarded with record results and positive net income for the year. Two significant initiatives executed in the year, both enabled by our history of prudent fiscal management, allowed us to accelerate our growth. The first was the acquisition and subsequent successful integration of a major regional competitor; followed by a favourable debt restructuring. MetroBridge acquisition complete In May, we closed an asset purchase transaction to acquire the business customers, related network infrastructure and other selected assets of MetroBridge Networks International Inc., significantly strengthening our operations in the Greater Vancouver Market and eliminating a significant competitor. Following a recurring revenue calculation, the final purchase price was $5.7 million. The acquisition and integration of MetroBridge s network and customer base is now complete and it has proven to be as accretive as we anticipated, contributing seven months of revenue and EBITDA to our 2011 results. In the fourth quarter of 2011 we achieved our post integration objective of converting more than half the revenue from MetroBridge s customer base into EBITDA. Credit facilities improved Also in May, we established credit facilities totalling $19.0 million with the Royal Bank of Canada, essentially refinancing, at interest rates below 5%, a previous debt facility with the Business Development Bank of Canada. The RBC facilities added incremental financing for the MetroBridge asset purchase and makes funds available in pursuit of our continued growth. Record financial and operating results Our financial results in 2011 were outstanding. Revenue growth was strong but more important, as we did last year, we were able to convert a significant proportion into increased profitability. We achieved record revenue of $44.9 million in 2011, up 19% over 2010 as a result of both strong organic growth, the successful acquisition of the MetroBridge customer base, and Internet and data service upgrades by existing customers. The stability of our business model is illustrated by the fact that about 98% of our revenue continues to be service, or recurring in nature, and no single customer accounts for more than 6% of our revenues. 3

4 Combined with our gross margin, which was up two and a half percentage points over 2010 to 78.4%, this resulted in record EBITDA of $12.2 million, an increase of 82% from 2010 and reflecting the operating leverage of our business model. For the first time in TeraGo s history, we posted positive annual net earnings of $214,000 and annual earnings per share of 2 cents. We added 915 net new customer locations in 2011, 47.6% more than in Gross customer additions of 1,691 were also strong and included 588 from the MetroBridge acquisition. Our average monthly unit churn rate in 2011 was 1.08% compared with 0.99% in However, excluding former MetroBridge customer locations, the churn rate in 2011 was a comparable 1.01%, reflecting our satisfied customer base and quality network. Cellular backhaul In 2011 we experienced significant growth in the cellular backhaul segment of our business. We provided Ethernet-based wireless backhaul services to Public Mobile Inc. in the Greater Toronto and Montreal markets, and assisted with the launch of 3G data services. We also provided wireless backhaul services to Wind Mobile and Mobilicity for segments of their networks. We upgraded about 250 cellular backhaul sites during the last two quarters of 2011 and this will drive improvements in ARPU as well as overall revenue from this segment in TeraGo Voice TeraGo Voice TM is a first example of one of the pillars of our growth strategy -- introducing new revenue-generating services to our customers. During 2011, we launched voice services in Greater Vancouver and Winnipeg, and while it is still in the initial stages of market activation, TeraGo Voice TM is now available in major markets in Quebec, Ontario, Manitoba, Alberta and British Columbia. Strong financial position In addition to beneficially restructuring our financing agreements during 2011, we ended the year with cash, cash equivalents and short-term investments of $4.3 million as well as the $5.0 million undrawn portion of the RBC facilities. Our overall financial position is strong. We have the resources to meet our working capital and capital requirements for the foreseeable future and the capacity to continue our growth. In addition to financial strength, we have the core assets to facilitate future growth and increase the long term value of the company. TeraGo owns 76 spectrum licences in the 24 GHz and 38 GHz bands, covering Canadian markets with a population base of nearly 23 million. We use this spectrum to provide Ethernet-based broadband links for businesses, government and cellular backhaul, as part of our growth strategy. 4

5 Our strategy is paying off We continue to work towards our strategic objectives of increasing customer penetration in our existing markets, expanding the cellular backhaul segment of our business, introducing new revenue-generating services, and capitalizing on strategic growth opportunities through initiatives such as acquisitions. This strategy is clearly paying off. Since 2002, our annual revenue has increased at a compound annual growth rate of 28%. In 2011, TeraGo completed the transition of its financial reporting framework from Canadian GAAP (Generally Accepted Accounting Principles) to IFRS (International Financial Reporting Standards), as required by the Accounting Standards Board (AcSB) for publicly accountable enterprises. The rationale for the conversion is that the increased comparability of IFRS financial statements will improve accessibility to global capital markets and could reduce both the cost of capital and the cost of compliance for Canadian companies. During 2011 we were also fortunate enough to win two awards that reflect both the high regard in which we hold our employees and their importance to our success. We were named one of the Top Employers in the GTA and one of the 50 Most Engaged Workplaces in Canada. On behalf of the executive team, I wish to thank our employees for their dedication and commitment, the Board of Directors for their guidance, and our shareholders for their support. Building on our exceptional results in 2011, and with a proven and effective strategy, we are ideally positioned to deliver continued growth in 2012 and beyond. Bryan Boyd President and Chief Executive Officer 5

6 TERAGO INC. MANAGEMENT S DISCUSSION AND ANALYSIS OF FINANCIAL RESULTS FOR THE YEARS ENDED DECEMBER 31, 2011 AND 2010 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 27, 2012 and should be read in conjunction with our audited consolidated financial statements and accompanying notes. 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. See Forward-Looking Statements and Risk Factors. This MD&A also contains certain industry-related non-ifrs and additional GAAP measures that management uses to evaluate performance of the Company. These non-ifrs and additional GAAP measures are not standardized and the Company s calculation may differ from other issuers. See Definitions IFRS, Additional GAAP and Non-IFRS measures. FORWARD-LOOKING STATEMENTS This MD&A includes certain forward-looking statements that are made as of the date hereof 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. 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 set forth herein and other uncertainties and potential events. 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. 6

7 EXECUTIVE OVERVIEW 2011 Financial and Operations Highlights Total revenue for the year ended December 31, 2011 was $44.9 million compared to $37.8 million, an increase of 18.9% compared to the same period in 2010; Total revenue for the three months ended December 31, 2011 was $12.0 million compared to $9.9 million, an increase of 20.7% compared to the same period in 2010; Gross profit margin for the three months and year ended December 31, 2011 increased to 78.3% and 78.4%, respectively, compared to 77.9% and 75.9% for the same periods in 2010; EBITDA for the year ended December 31, 2011 was $12.2 million compared to $6.7 million for 2010, an increase of 82%; EBITDA for the three months ended December 31, 2011 was $3.8 million compared to $2.5 million for 2010, an increase of 53%; Net earnings for the three months and year ended December 31, 2011 were $0.8 million and $0.2 million, respectively, compared to a net loss of $(1.1) million and $(5.8) million, respectively; The Company achieved its first annual positive earnings per share of $0.02 compared to a loss per share of $(0.52) for the same period in For the three months ended December 31, 2011, earnings per share was $0.07 compared to a loss per share of $(0.09) in the same period in 2010; Average monthly unit churn rate for the year ended December 31, 2011 was 1.08% compared to 0.99% for the same period in 2010; Added 915 net customer locations in 2011, ending the period with 6,278 customer locations in service compared to 620 net customer locations added in the same period in 2010; Average revenue per customer location ( ARPU ) for the three months and year ended December 31, 2011 was $622 and $618, respectively, compared to $607 and $610, respectively, in the same periods in 2010; Ended the period with $4.3 million of cash, cash equivalents and short-term investments as at December 31, 2011; and As at December 31, 2011, $5.0 million of the $19.0 million credit facilitites remains undrawn and available for future use Key Developments The Company entered into an asset purchase agreement with MetroBridge Networks International Inc. ( MetroBridge ) to acquire substantially all of MetroBridge s customers, related network infrastructure, real estate leases, and other assets. MetroBridge's broadband fixed wireless network, which covers the Lower Mainland of British Columbia and Vancouver, added 588 business customer locations to TeraGo's customer base as at the May 31, 2011 closing date. The purchase price was $5.716 million and integration efforts are nearing completion as planned. TeraGo completed an agreement to establish credit facilities totaling $19.0 million with the Royal Bank of Canada ( RBC ). The new facilities essentially refinanced at interest rates below 5%, a previous $10.0 million facility with the Business Development Bank of Canada ( BDC ), added incremental financing for the MetroBridge asset purchase, and makes available funds for general working capital purposes and continued growth. The Company was awarded additional orders from Public Mobile Inc. to provide Ethernet-based wireless backhaul services in the Greater Toronto and Montreal markets. The Company assisted Wind Mobile and Mobilicity by providing Ethernet-based wireless backhaul services in certain segments of their cellular networks. Over 250 cellular backhaul sites were upgraded in the second half of 2011 which will drive future ARPU increases in this segment. The Company continued its entry into the local voice market by launching TeraGoVoice TM in the Greater Vancouver area and Winnipeg Manitoba. The Company added Oshawa to its market footprint complementing existing network coverage in Durham region. The Company completed the transition of financial reporting frameworks from Canadian GAAP to IFRS. TeraGo has earned a ranking as one of the top employers in the GTA in the Canada s Top Employers competition and ranked among Canada s top technology companies on the Branham 300 list for the fourth consecutive year. TeraGo was named one of the 50 Most Engaged Workplaces in Canada, an award recognizing top employers that display leadership and innovation towards engaging their employees. 7

8 Events Subsequent to December 31, 2011 On January 1, 2012, National Online Inc. was amalgamated with TeraGo Networks Inc. The Company received a final release from the vendor related to the acquisition of MetroBridge and the final payment of $1.516 million was made in January Company Overview TeraGo is a leading wireless broadband communications service provider to businesses in Canada. The Company owns and operates a carrier-grade Multi-Protocol Label Switching ( MPLS ) enabled, fixed wireless, Internet Protocol ( IP ) communications network in Canada, providing businesses with high performance, scalable, and secure Internet access and data connectivity services. The Company also serves an important and growing demand among enterprise businesses in Canada for network access diversity by offering wireless services that are redundant to their existing wireline broadband connections. In addition, the Company is a provider of facilities-based backhaul services to Canadian wireless carriers and local voice access services. Services offered by the Company are delivered on a wireless broadband IP network that has been designed to eliminate single points of failure. TeraGo backs its services by providing its customers with service level commitments including 99.9% service availability, industry leading mean time to repair, 24 x 7 telephone and access to technical support specialists, and an industry leading three-month satisfaction guarantee. TeraGo s next generation, carrier-class, broadband IP network has been built using a combination of licenced spectrum bands which the Company owns and leases, and licence-exempt spectrum. See Radio Spectrum. In each of our geographic markets, TeraGo owns and controls wireless networks that aggregate customer data traffic and interconnect with intercity leased fiber-optic facilities. The Company uses commercially available equipment for the delivery of our broadband wireless services. Since inception, TeraGo has experienced strong growth, in both the number of customers and locations serviced. The number of customer locations serviced has grown every quarter since commercial operations were launched in 2000 and revenue has grown at a compound annual growth rate of 28% from the year ended December 31, 2002 to the year ended December 31, We have successfully launched our wireless broadband network across major geographic markets in Canada, including the six largest Canadian cities. As at December 31, 2011, the Company offered its services in 46 geographic markets across Canada serving 6,278 business locations. Business Model TeraGo s subscription-based business model generates stable and predictable recurring revenue from internet, data and voice services. Our customers typically sign one, two or three year contracts, which include automatic renewal provisions for the initial term. In 2011, approximately 85% of our new customers signed contracts for three years or more. Services are billed monthly over the term of the contract. In addition, we typically charge a one-time installation fee per customer location. For the year ended December 31, 2011 approximately 98% of our total revenue was service revenue substantially all of which is recurring in nature. Once a customer is installed, we have an opportunity to generate incremental recurring revenue from a customer through the addition of new customer locations and increased service capacity supplied to existing locations and through the provisioning of additional value-added services. Company Strategy The Company intends to leverage its strategic strengths to become a leading network service alternative for business customers in Canada, enabling their businesses to connect to the world. Our growth strategy includes the following key components: Increase customer penetration in our existing markets; Expand and enhance our wireless broadband network; Leverage our IP enabled network infrastructure to service new categories of customers; Continue to expand our service offering to include value-added IP services that complement our current broadband Internet access and data connectivity services starting with local voice access service; and Pursue strategic initiatives including acquisitions on an opportunistic basis. 8

9 Our Network The Company has built and operates a next generation, carrier-grade, broadband IP network. It utilizes licensed and license-exempt spectrum that supports commercially available equipment for the delivery of broadband wireless services. The Company can quickly offer a range of diverse Ethernet-based services over a 128 bit encrypted secured wireless connection, to customer locations up to 20 kilometres from a hub, provided line of sight exists. 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, Calgary and Toronto although Internet access is also available in all regional markets for further redundancy. TeraGo has enabled end-to-end Quality of Service ( QoS ) capabilities in all of its major national markets to ensure the foundation to support voice traffic and other potential future applications. In each regional market, the Company s network is composed of three main components: a core hub, multiple hub sites and customer locations: Core Hub Sites - are the main point of interconnection of our regional wireless system and national MPLS fiber-optic facilities. They are equipped with redundant fiber-optic equipment, high performance MPLS routers, uninterruptible power supplies, and server equipment. Core hub sites are configured in MPLS ring architecture to avoid service disruption in the event of any single point of failure. The MPLS network has been equipped with QoS capabilities to improve network performance and traffic management. Hub Sites - are generally equipped with broadband wireless base stations, high performance Ethernet switches and routers, high capacity licensed backhaul radios and uninterruptible power supplies. Base stations are matched with broadband wireless radios deployed at the customer locations, and selected from the same supplier. Licensed backhaul radios are used to connect the Hub site to one or more adjacent hub sites. The benefits (mentioned above) of MPLS, QoS, and ring architectures have been extended to key high traffic hub sites. Customer Locations - are typically equipped with a broadband wireless radio and, depending upon the services deployed, can include a managed Ethernet switch, router, or voice demarcation device (which will be QoS-enabled). Broadband wireless radios are available from a variety of leading manufacturers and selected to match the performance requirements of the customer. The customer premise equipment is industry standard and sourced from leading manufacturers. The customer interface to our services is an industry standard RJ45 Ethernet or PRI jack. Radio Spectrum The Company owns a national spectrum portfolio of 24 GHz and 38 GHz wide-area spectrum licences, including 1,160 MHz in the top 6 Canadian cities. Our spectrum portfolio includes 76 licences in the 24 GHz and 38 GHz spectrum bands, and covers geographic regions in Canada with a population base of nearly 23 million. The Company utilizes its 24 GHz spectrum for point-to-point and point-to-multipoint deployments. In 1999, the Company acquired 70 licences in the 24 GHz and 38 GHz bands in Industry Canada s first spectrum auction for this spectrum. The licences range in bandwidth from 200 MHz to 600 MHz. In September, 2010, the Company completed the purchase of six 24 GHz licences for a gross purchase price of $5 million (subject to certain deductions). The purchased 24 GHz spectrum includes 240 MHz in each of Toronto, Montreal and Ottawa, as well as 80 MHz in each of Calgary, Vancouver and Edmonton. This transaction was subject to Industry Canada approval which the Company received on July 26,

10 The following table summarizes our ownership of 24 GHz and 38 GHz wide area licences: Tier Area Owned 24/38 GHz Spectrum (in MHz) Population (2006 Census) Abitibi ,761 Barrie ,962 Belleville ,723 Brandon ,054 Brockville ,243 Calgary 280 1,235,692 Chatham ,300 Cobourg ,477 Cornwall ,426 Edmonton 80 1,316,455 Huntsville ,020 Kingston ,774 Lethbridge ,665 Listowel/Goderich/Stratford ,845 London/Woodstock/St. Thomas ,331 Medicine Hat/Brooks ,253 Montreal 240 3,990,036 Nanaimo ,019 Niagara-St. Catharines ,063 Okanagan/Columbia ,028 Ottawa 240 1,334,081 Pembroke ,968 Peterborough ,182 Red Deer ,784 Strathroy ,442 Toronto 240 6,128,278 Vancouver 80 2,463,413 Victoria ,325 Windsor/Leamington ,102 Winnipeg ,059 Total 14,260 22,941,761 Using radios operating in 24 GHz and 38 GHz spectrum, we can deliver our broadband services to our customers at speeds of 10 to 1,000 Mbps. We use our licenced spectrum to connect our core hubs together to create a wireless backbone, often in a ring configuration, to avoid any points of failure. We also use our 24 GHz and 38 GHz licenced spectrum in the access network or last mile to deliver high capacity Ethernet-based broadband links for business, government and cellular backhaul. The Company has also applied for and received licences in the 38 GHz band which the Company uses for point-topoint deployments. These licences are issued on an as needed and user defined basis. Industry Canada uses the spectrum grid concept to define service areas, based on hexagonal grid cells, each with an area of 25 square kilometres. These licences are issued in paired frequency blocks, each with a bandwidth of 50 MHz. The following table summarizes the 38 GHz user defined licences that we currently hold: Area 38 GHz Spectrum (in MHz) Licenced Cells (#) Cell Coverage (sq/km) Abbotsford Calgary Edmonton Montreal Ottawa Toronto ,000 Vancouver ,000 Waterloo Total 1, ,275 10

11 In addition to our 24 GHz and 38 GHz wide-area licences, we also utilize point-to-point spectrum in the 11 and 18 GHz bands. The 11 GHz and 18 GHz spectrum is licensed to us by Industry Canada on a site-by-site basis. These spectrum resources are utilized by the Company to deploy point-to-point radio links. The Company currently holds over 283 point-to-point licences in the 11 and 18 GHz bands. In 2010, the Company applied for and received 16 licences in the 3.65 GHz band provided on a shared use basis. Each licence consists of 50 MHz of spectrum which is available for the entire serving area and enables the Company to provide services up to 10 Mbps using point-to-point and point-to-multipoint deployments. The following table summarizes our 3.65 GHz licence holdings: Our Services Tier 4 Area 3.65 GHz Spectrum (in MHz) Barrie 50 Calgary 50 Edmonton 50 Guelph/Kitchener 50 Kelowna 50 London/Woodstock/St. Thomas 50 Montreal 50 Niagara-St. Catharines 50 Ottawa 50 Red Deer 50 Steinbach 50 Toronto 50 Vancouver 50 Victoria 50 Windsor/Leamington 50 Winnipeg 50 Internet Services The Company s wireless broadband network provides Canadian businesses with high performance Internet access with upload and download speeds from 1.5 megabytes per second ( Mbps ) to 100 Mbps. To enhance the performance of TeraGo s service, we minimize the number of networks between our customers and their audience by connecting to the Internet through peering arrangements with multiple tier-one carriers. The table below lists the Internet access services that the Company offers. All of our services are symmetrical (allowing customers to experience the same high speed broadband performance when uploading or downloading) unlike DSL services offered by many of our competitors, which are asymmetrical. Service Speed (Mbps) TSL (Burstable) E (Burstable) E (Burstable) Dedicated Internet Access Benefits Symmetrical bandwidth with standard service level agreement Committed minimum symmetrical bandwidth with 5x on-demand scalability Premium service level agreement Committed symmetrical bandwidth Premium service level agreement Guaranteed symmetrical bandwidth Premium service level agreement Customer Profile Businesses looking for higher performance than DSL Businesses looking for an alternative to legacy T1 services and requiring additional speed on an as-needed basis Businesses and enterprise organizations that require higher dedicated bandwidth with the capability to burst on an asneeded basis Businesses and enterprise organizations that require dedicated bandwidth to support mission critical applications 11

12 Data Services The Company s data connectivity services provide businesses with the ability to connect their multiple sites within a city or across our geographic footprint through a Private Virtual Local Area Network ( VLAN ). Our VLAN services are available with speeds from 1.5 Mbps to 100 Mbps and are ideal for companies with multiple offices and large interoffice data requirements. Our data services are symmetrical, allowing communication between parties in both directions simultaneously, and include our premium service level agreement. The Company s data services run across our recently installed MPLS core network. TeraGo uses Ethernet over MPLS ( EoMPLS ) technology to enhance the performance of its VLAN services. The enhancement of this service enables TeraGo s VLAN customers to experience the higher reliability, easier provisioning, and improved performance of the MPLS network for the portion of their VLAN service that traverses either TeraGo s inter-city or Greater Toronto Area IP backbones. Cellular Backhaul The Company is a provider of facilities-based backhaul services to Canadian wireless carriers. Backhaul is the transport of voice and data traffic from a wireless carrier s cell sites to its mobile switching centre or other exchange point. The Company utilizes its spectrum assets to provide backhaul services through its national network architecture. Our wireless backhaul services allow wireless carriers to optimize their networks, offering a high capacity, scalable and cost competitive alternative to other backhaul options and providing a long-term solution to address the demand for backhaul capacity. Initial cellular backhaul sites are often upgraded periodically to accommodate increasing customer traffic. Voice Services The Company s voice access service provides businesses with a cost effective, flexible and high quality connection from their private branch exchange (PBX) to the public switched telephone network (PSTN). The service provides features and capabilities generally consistent with those provided by incumbent local exchange carriers (ILECs) while offering greater value for our customers. TeraGo received approval from the Canadian Radio-television and Telecommunications Commission ( CRTC ) to operate as a Type IV competitive local exchange carrier ( CLEC ) to offer voice services. 12

13 SELECTED ANNUAL INFORMATION The following table displays a summary of our Consolidated Statements of Operations for the three months ended December 31, 2011 and 2010 and the years ended December 31, 2011, 2010 and 2009 and a summary of select Balance Sheet data as at December 31, 2011, 2010 and Revenue Service Installation Expenses Operating expenses Salaries and related costs - Cost of services Salaries and related costs - Direct Other Operating items Stock-based compensation Amortization of intangibles Three months ended December 31 Years ended December (as recast) $ 11,677 $ 9,678 $ 43,841 $ 37,002 $ 33, , ,966 9,911 44,923 37,768 34,772 2,206 1,846 8,258 7,725 7, ,440 1,365 1,384 3,945 3,757 16,354 15,922 14,411 1,638 1,617 6,961 6,370 6, ,695 1, , Depreciation of network assets, property and equipment 2,060 2,668 7,486 10,507 9,041 10,967 10,813 43,535 43,385 40,843 Earnings (loss) from operating items Foreign exchange gain (loss) Finance costs Finance income Net earnings (loss) and comprehensive earnings (loss) Deficit, beginning of period Deficit, end of period 999 (902) 1,388 (5,617) (6,071) (26) (222) (185) (1,167) (306) (2) $ 811 $ (1,059) $ 214 $ (5,831) $ (5,786) (62,069) (60,413) (61,472) (55,641) (49,855) $ (61,258) $ (61,472) $ (61,258) $ (61,472) $ (55,641) Basic earnings (loss) per share Diluted earnings (loss) per share Basic weighted average number of shares outstanding Diluted weighted average number of shares outstanding $ 0.07 $ (0.09) $ 0.02 $ (0.52) $ (0.52) $ 0.06 $ (0.09) $ 0.02 $ (0.52) $ (0.52) 11,286 11,239 11,273 11,198 11,136 12,796 11,239 12,783 11,198 11,136 Selected Balance Sheet Data Years ended December (as recast) Cash and cash equivalents $ 3,224 $ 1,083 $ 1,074 Short term investments $ 1,096 $ 1,071 $ 7,121 Accounts receivable $ 3,318 $ 3,175 $ 2,491 Network assets, property and equipment $ 37,097 $ 33,545 $ 30,737 Total Assets $ 58,556 $ 48,600 $ 45,564 Accounts payable and accrued liabilities $ 6,991 $ 5,506 $ 5,805 Long-term debt $ 13,582 $ 6,817 $ - Other long-term liabilities $ 2,625 $ 1,622 $ 413 Shareholders'equity $ 33,383 $ 32,849 $ 38, data are in accordance with Canadian GAAP 13

14 RESULTS OF OPERATIONS Comparison of the three months and year ended December 31, 2011 and 2010 (in thousands of dollars, except with respect to gross profit margin, earnings (loss) per share and operating metrics) Three months ended December 31 Year ended December Financial Revenue $ 11,966 $ 9,911 $ 44,923 $ 37,768 Cost of Services (1) 2,593 2,191 9,698 9,090 Gross profit margin (1) 78.3% 77.9% 78.4% 75.9% EBITDA (1)(2) $ 3,833 $ 2,506 $ 12,234 $ 6,716 Earnings (loss) from operations (3) $ 999 $ (902) $ 1,388 $ (5,617) Net earnings (loss) $ 811 $ (1,059) $ 214 $ (5,831) Basic earnings (loss) per share $ 0.07 $ (0.09) $ 0.02 $ (0.52) Diluted earnings (loss) per share $ 0.06 $ (0.09) $ 0.02 $ (0.52) Operating Churn rate (1) 1.18% 1.13% 1.08% 0.99% Customer locations in service 6,278 5,363 6,278 5,363 ARPU (1) $ 622 $ 607 $ 618 $ 610 Number of employees (1) See "DEFINITIONS - IFRS, Additional GAAP and NON-IFRS Measures" for descriptions of Cost of Services, Gross profit margin %, EBITDA, Churn and ARPU. (2) See "EBITDA" for a reconciliation of net earnings (loss) to EBITDA. (3) Earnings (Loss) from operations is defined as earnings (loss) before interest and taxes. Refer to Definitions IFRS, Additional GAAP and Non-IFRS measures for a description of the components of relevant line items below. Revenue Total revenue increased 18.9% to $44.9 million for the year ended December 31, 2011 compared to $37.8 million for the same period in For the three months ended December 31, 2011, total revenue increased 20.7% to $12.0 million compared to $9.9 million for the same period in The increase in revenue was the result of a greater number of customer locations in service, including the acquisition of 588 new customer locations added in the second quarter of 2011 from the MetroBridge acquisition, and existing customers upgrading their Internet and data connections. For the three months and year ended December 31, 2011, the MetroBridge acquisition contributed incremental revenue of $1.0 million and $2.5 million, respectively. Service revenue increased by 18.5% to $43.8 million for the year ended December 31, 2011 compared to $37.0 million for the same period in For the three months ended December 31, 2011, service revenue increased 20.7% to $11.7 million compared to $9.7 million for the same period in The increase in service revenue was driven primarily by the addition of 915 net new customer locations in service during the year ended December 31, 2011, including 585 in the second quarter of 2011 from the acquisition of MetroBridge, and existing customers upgrading their internet and data connections. Total customer locations in service increased 17% to 6,278 as at December 31, 2011 compared to 5,363 as at December 31, For the year ended December 31, 2011, approximately 98% of our total revenue was service revenue. Installation revenue increased to $1.1 million for the year ended December 31, 2011 compared to the $0.8 million for the same period in For the three months ended December 31, 2011 installation revenue was $0.3 million compared to $0.2 million for the same period in This increase is primarily due to the recognition of revenue relating to installations that were completed in prior periods. ARPU increased to $618 for the year ended December 31, 2011 compared to $610 for the same period in ARPU increased to $622 for the three months ended December 31, 2011 compared to $607 for the same period in The increase in ARPU was driven primarily by existing customers upgrading the capacity of their services, an increase in the number of new customers requiring higher capacity services or voice services, early termination fees 14

15 and lower credits partially offset by lower usage revenue. The average monthly churn rate was 1.08% for the year ended December 31, 2011 compared to 0.99% for the same period in The average monthly churn rate was 1.18% for the three months ended December 31, 2011 compared to 1.13% for the same period in The average monthly churn rate increased in 2011 primarily due to the churn from customers acquired as part of the MetroBridge acquisition including the cancellation of low value DSL resale customer locations. Excluding former MetroBridge customer locations, the average monthly churn rate is 1.11% and 1.01% for the three months and year ended December 31, 2011, respectively, consistent with recent experience. Management continues to focus on network quality and customer service in addition to monitoring customer creditworthiness and churn levels. Gross profit margin For the year ended December 31, 2011, gross profit margin increased to 78.4% compared to 75.9% for the same period in For the three months ended December 31, 2011, gross profit margin increased to 78.3% compared to 77.9% for the same period in This increase is primarily due to savings from lower telecommunications and maintenance costs in addition to reduced spectrum lease payments as a result of the purchase of 24 GHz licences. Salaries and related costs-other and other operating items ( SG&A ) For the year ended December 31, 2011, SG&A expenses increased 4.6% to $23.3 million compared to $22.3 million for the same period in For the three months ended December 31, 2011, SG&A expenses increased 3.9% to $5.6 million compared to $5.4 million for the same period in The increase in 2011 was largely a result of increased marketing capacity building on investments made in 2010 in pursuit of our strategic growth objectives, increased travel costs and professional fees related to the MetroBridge acquisition and to a lesser extent additional operations personnel. As of December 31, 2011, the number of direct sales personnel was 33 compared to 34 as of December 31, EBITDA For the year ended December 31, 2011, EBITDA increased to $12.2 million compared to $6.7 million for the same period in For the three months ended December 31, 2011, EBITDA increased to $3.8 million compared to $2.5 million for the same period in The increase in EBITDA is in line with management s expectation as the Company continued to grow revenue while focusing on cost management. Consistent with prior years, EBITDA for the quarter ended March 31, 2012, is expected to decline by up to $0.5 million due to the seasonal nature of certain expenses. See Seasonality. For the three months and year ended December 31, 2010, the Company reclassified $77 thousand and $240 thousand, respectively, of Directors Fees paid by issuance of shares to Stock-Based Compensation previously included in SG&A. The table below reconciles net earnings (loss) to EBITDA for the three months and year ended December 31, 2011 and (in thousands of dollars) Three months ended December 31 Year ended December Net earnings (loss) for the period $ 811 $ (1,059) $ 214 $ (5,831) Foreign exchange loss (gain) (25) (21) 26 (60) Finance costs , Finance income (9) (7) (19) (32) Earnings (loss) from operations 999 (902) 1,388 (5,617) Add: Depreciation of network assets, property and equipment and amortization of intangibles 2,499 2,767 8,827 11,000 Loss on disposal of network assets Stock-based compensation ,695 1,003 EBITDA $ 3,833 $ 2,506 $ 12,234 $ 6,716 15

16 Depreciation and amortization For the year ended December 31, 2011, depreciation of network assets, property and equipment and amortization of intangibles decreased by 19.8% to $8.8 million compared to $11.0 million for the same period in For the three months ended December 31, 2011, depreciation of network assets, property and equipment and amortization of intangibles decreased by 9.7% to $2.5 million compared to $2.8 million for the same period in The decrease in depreciation expense relates primarily to the change in the useful life of network assets starting from January 1, 2011 from 4 and 7 years to 6 and 9 years based on actual experience. Deferred income taxes The Company reviewed and updated the assumptions and projections regarding future profitability as at December 31, Based on management s analysis, no additional deferred income taxes resulting from temporary tax differences were recognized in the three months and year ended December 31, Net earnings (loss) For the year ended December 31, 2011, net earnings were $0.2 million compared to a net loss of $(5.8) million for the same period in For the three months ended December 31, 2011, net earnings was $0.8 million compared to a net loss of $(1.1) million for the same period in Summary of Quarterly Results All financial results are in thousands, with the exception of earnings (loss) per share. Q4-11 Q3-11 Q2-11 Q1-11 Q4-10 Q3-10 Q2-10 Q1-10 Revenue $ 11,966 $ 11,858 $ 10,769 $ 10,330 $ 9,911 $ 9,699 $ 9,230 $ 8,928 Gross Profit Margin % 78.3% 78.3% 78.7% 78.3% 77.9% 76.2% 75.8% 73.6% EBITDA $ 3,833 $ 3,441 $ 2,721 $ 2,239 $ 2,506 $ 1,610 $ 1,344 $ 1,256 Net earnings (loss) $ 811 $ 131 $ (398) $ (330) $ (1,059) $ (1,455) $ (1,876) $ (1,441) Basic earnings (loss) per share $ 0.07 $ 0.01 $ (0.04) $ (0.03) $ (0.09) $ (0.13) $ (0.17) $ (0.13) Diluted earnings (loss) per share $ 0.06 $ 0.01 $ (0.04) $ (0.03) $ (0.09) $ (0.13) $ (0.17) $ (0.13) Basic weighted average number of shares oustanding 11,286 11,277 11,269 11,258 11,239 11,198 11,185 11,170 Diluted weighted average number of shares oustanding 12,796 12,795 11,269 11,258 11,239 11,198 11,185 11,170 Seasonality The Company s net customer growth is typically lower in the first quarter of the year primarily due to weather conditions. 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 in productive installation days. In addition, the Company s cash flow and earnings is typically impacted in the first quarter of the year due to several annual programs requiring payments in the first quarter, annual rate increases in the long-term contracts and the restart on January 1 st of payroll taxes and other levies related to employee compensation. 16

17 LIQUIDITY AND CAPITAL RESOURCES TeraGo has historically financed its growth and operations through the issuance of equity securities and long-term debt. The table below outlines selected balance sheet accounts, and a summary of cash inflows and outflows by activity. (in thousands of dollars, except with respect to Working capital ratio and Days sales outstanding) Three months ended December 31 Year ended December Statement of Cash Flows Summary Cash inflows and (outflows) by activity: Operating activites $ 4,991 $ 2,532 $ 12,108 $ 6,087 Investing activities (2,930) (3,210) (15,212) (12,493) Financing activities 433 1,233 5,245 6,415 Net cash inflows 2, ,141 9 Cash and cash equivalents, beginning of period ,083 1,074 Cash and cash equivalents, end of period $ 3,224 $ 1,083 $ 3,224 $ 1,083 Year ended December 31 Key Ratios Working Capital (deficiency) $ (3,622) $ 242 Working capital ratio Days sales outstanding Cash from Operations For the three months ended December 31, 2011, cash generated from operating activities was $5.0 million compared to $2.5 million for the same period in For the year ended December 31, 2011, cash generated from operating activities was $12.1 million compared to $6.1 million for the same period in The increase in cash generated from operating activities for the three months and year ended December 31, 2011 is principally from a decrease in net loss driven primarily by increased revenue and improved gross margin. It was also partially due to a decrease in working capital changes, in particular accounts receivable and accounts payable and accrued liabilities. Cash used in Investing Cash used in investing activities includes the acquisition of the MetroBridge assets described in further details below, purchase and installation of equipment related to our network build, upgrade and sparing activity, the purchase and installation of customer premise equipment, the purchase of property and equipment such as computer hardware and software, and the redemption of short-term investments. For the three months ended December 31, 2011, cash used for the purchase and installation of network assets, property and equipment was $2.6 million compared to $1.8 million for the same period in For the year ended December 31, 2011, cash used for the purchase and installation of network assets, property and equipment was $9.7 million compared to $13.7 million for the same period in For the three months ended December 31, 2011, cash used for the purchase of intangibles and other assets was $0.4 million compared to $1.5 million for the same period in For the year ended December 31, 2011, cash used for the purchase of intangibles and other assets was $1.3 million compared to $1.5 million for the same period in The capital expenditures in the year ended December 31, 2011 decreased compared to the same period in 2010 as the upgrade and testing of infrastructure including the implementation of QoS capabilities to support local voice access service was completed in

18 On May 31, 2011, the Company closed an asset purchase with MetroBridge and acquired substantially all of MetroBridge s customers, related network infrastructure, real estate leases, and other assets. MetroBridge provided small and medium-sized businesses with wireless broadband services. The acquisition further accelerated the Company s growth plan as it acquired network in the lower mainland of British Columbia and Vancouver and a customer base of 588 customer locations at closing. The final purchase price is comprised of $4.2 million paid on the closing date of May 31, 2011 and the remaining balance to be paid following a final recurring revenue calculation to be completed for the 180 day period following the closing date. The fair value of the contingent consideration was estimated on the date of acquisition using best estimates of discounted future cash flows and resulted in $1.498 million in contingent consideration being included as part of the purchase price for accounting purposes. The Company received a final release from the vendor and the final cash payment of $1.516 million for the contingent consideration was made in January The difference of $18 thousand from the initial fair value estimate of $1.498 million was recorded as finance costs with a corresponding credit to accounts payable and accrued liabilities as of December 31, The acquisition was accounted for using the acquisition method in accordance with IFRS 3 with the results of operations consolidated with those of the Company effective June 1, 2011 and has contributed incremental revenue of $2.5 million and net earnings of $0.5 million for the year ended December 31, Management estimates that if the acquisition had occurred on January 1, 2011, total consolidated revenue for the Company would have been $46.7 million and consolidated net earnings for the year would have been $0.6 million. The total acquisition related costs were $0.3 million of which $69 thousand was included in other operating items and the remaining amount was included in finance costs (Note 11). The fair values of the assets acquired in the acquisition are as follows (in thousands): Network assets, property and equipment $1,674 Customer relationships 3,330 Brand 254 Acquired real estate leases 173 Prepaid Expenses 21 Goodwill 246 $5,698 Fair value of consideration Cash consideration $4,200 Contingent consideration 1,498 $5,698 Contingent consideration Contingent consideration at closing $1,498 Subsequent adjustment recorded as finance costs 18 $1,516 Goodwill represents the expected operational synergies with the acquiree including intangible assets that do not qualify for separate recognition. Under the current income tax act, goodwill and other intangible assets are deductible for tax purposes to the extent of 75% of the cost incurred. For tax purposes, 75% of eligible capital expenditures are added to the cumulative eligible capital amount, which is deductible for tax purposes at the rate of 7% per year on a declining balance method. The customer relationships, brand and acquired real estate leases are recorded as Intangibles and other assets and are being amortized over a period of 5 years. The acquired assets, including other intangibles and goodwill, have been integrated into the Company s single CGU. For the three months ended December 31, 2011 and December 31, 2010, the Company had minimal transactions in short-term investments. For the year ended December 31, 2011, the Company had net purchase of $25 thousand in short-term investments compared to net redemption of $6.2 million for use in business operations for the same period in Cash from Financing For the three months and year ended December 31, 2011, cash generated from financing activities was primarily due to the net drawdown of $0.6 million and $6.3 million, respectively, of which $5.5 million was used to finance the MetroBridge asset purchase and the remainder was for repayment of the term debt facility and capital lease obligations. The final payment of $1.5 million for the MetroBridge asset purchase was completed in January

19 For the year ended December 31, 2010, cash generated from financing activities was primarily due to the drawdown of $6.5 million from the senior term-debt facility partially used to purchase the 24 GHz spectrum covering six of the largest markets in Canada and the repayment of capital lease obligations. Capital Resources As at December 31, 2011, the Company had cash and cash equivalents and short-term investments of $4.3 million and access to the $5.0 million undrawn portion of its $19.0 million credit facility. 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 and into strategic centres around existing markets. The Company expanded its product portfolio and also invested in its sales and marketing and support organizations as economic conditions improved. The Company entered into a new agreement in May 2011 with the Royal Bank of Canada that provides credit facilities totaling $19.0 million that are principally secured by a general security agreement over the Company s assets. The new facilities essentially refinanced, at lower interest rates, an existing $10.0 million facility with the BDC and added incremental financing for the asset purchase of MetroBridge. The agreement includes three new senior term debt facilities totalling $16.0 million and also includes a $3.0 million operating line of credit that replaced an existing $3.5 million operating line of credit on similar terms and bears interest at a floating rate of prime plus 1.65%. The outstanding long-term debt of $7.5 million with the BDC was repaid using proceeds from the new debt facility and the related deferred financing fees of $71 thousand were written off to finance costs. The additional $16.0 million in senior term debt is available to the Company in 3 facilities: $7.5 million to repay the drawn portion of TeraGo s senior term credit facility with BDC bearing interest at 4.74% and is repayable in monthly principal installments of $125 thousand starting October 2011 and matures September 2014; $5.5 million to finance the MetroBridge purchase of which $4.2 million bears interest at 4.61% and $1.3 million bears interest at 3.97% and is repayable in monthly principal installments of $92 thousand starting June 2011 and matures September As of December 31, 2011, this facility has been fully drawn; and $3.0 million available for general working capital purposes to fund continued growth bears interest at 4.31% and is repayable in monthly principal installments of $75 thousand starting April 2012 once fully drawn. As of December 31, 2011, $2.0 million of this facility remains undrawn. The Company incurred financing fees of $256 thousand in the second quarter of 2011 which are being amortized using the effective interest method over the term of the debt. 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, 2011 that are due in each of the next five years and thereafter. Less than 1 year 1-3 years 4-5 years After 5 years Long-term debt including financing fees $ 3,606 $ 5,913 $ 4,308 $ - $ 13,827 Finance leases Operating leases 6,264 7,249 5, ,809 Metrobridge contingent payment 1, ,516 Purchase Obligations 2, ,109 Stock-based compensation 1, ,304 Total $ 15,413 $ 13,869 $ 9,432 $ 172 $ 38,886 Off-Balance Sheet Arrangements As of December 31, 2011, the Company had no off-balance sheet arrangements. Total 19

20 Transactions with Related Parties The Company provides services to one customer whose Chairman of the Board of Directors is one of the Directors of the Company. Revenue from this customer for the years ended December 31, 2011 and 2010 was $41 thousand and $40 thousand, respectively. Accounts receivable from this customer both as at December 31, 2011 and 2010 was $1 thousand and $3 thousand, respectively. The Company provides services to one customer whose Chairman of the Board of Directors is the Chairman of the Board of Directors of the Company. Revenue from this customer for both the years ended December 31, 2011 and 2010 was $31 thousand. Accounts receivable from this customer as at December 31, 2011 and 2010 was $nil and $3 thousand, respectively. The terms governing these related party transactions reflect those negotiated at arm s length. Share Capital As of February 27, 2012, there were 7,662,148 Common Shares, 3,633,474 Class A Non-Voting Shares and two Class B Shares outstanding. Restricted Cash On June 18, 2007, two officers (one current and one former) exchanged 287,300 and 62,700 options respectively to purchase Common Shares, at an exercise price of $4 per share with options to purchase 189,496 and 41,355 Common Shares at $0 exercise price. The exchanged options had a value equal to the original options. On June 18, 2007, these options were exercised to facilitate Common Share ownership and as a result, the two officers received 189,496 and 41,355 Common Shares, respectively, pursuant to such exercise. The Company provided the officers with an indemnity with a combined maximum coverage of $1.0 million to cover any potential negative personal tax consequences that might arise as a result of the early exercise of these options. The indemnity period for the current officer expires in June The restricted cash is segregated for the period of the indemnity and is invested in a guaranteed investment certificate. The related accrued interest is included in short-term investments. During the third quarter of 2009, the Company received notice of a claim from the former officer against the restricted cash balance relating to the sale of the 41,355 Common Shares. The notice of claim was settled in the second quarter of 2010 for $0.2 million and an additional stock-based compensation expense of $50 thousand was recorded in that quarter. 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: (a) Financial assets at FVTPL are measured at fair value at the balance sheet date with any gain or loss recognized immediately in net earnings (loss). Interest and dividends earned from these assets are also included in net earnings (loss) for the period. (b) Loans and receivables are measured at amortized cost using the effective interest method. Any gains or losses are recognized in net earnings (loss) for the period. (c) Other financial liabilities are measured at amortized cost using the effective interest method. Any gains or losses are recognized in net earnings (loss) for the period. The following is a summary of the Company s significant categories of financial instruments as at December 31, 2011: 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, investments, trade and other receivables. Restricted cash is classified as loans and receivables. 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. 20

21 Short-Term Investments Short-term investments 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 investmentgrade fixed income securities, such as guaranteed investment certificates, bankers acceptance notes and investment savings accounts and these are in compliance with the Company s policy on investments. Short-term investments 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 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, bank overdrafts and accounts payable and accrued liabilities. Such liabilities are recognized initially at fair value plus 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. 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 - Level 2 - Level 3 - Unadjusted quoted prices in active markets for identical assets or liabilities; Inputs other than quoted prices included in Level 1, that are observable for the asset or liability, either directly or indirectly; and 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 balance sheets, 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 current market interest rate for similar debt with similar security. Credit risk The Company s cash and cash equivalents and short-term investments subject the Company to credit risk. The 21

22 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 s maximum exposure to credit risk is limited to the amount of cash and cash equivalents and short-term investments. 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. Interest rate risk The Company is subject to interest rate risk on its cash and cash equivalents, short-term investments and long-term debt. The Company believes that interest rate risk is low as its short term investments consists of low risk money market and fixed income securities with maturity dates of less than one year. It is exposed to interest rate risk on its long-term debt and 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, 2011 and 2010, the long-term debt facility balance is $13.1 million and $6.5 million, respectively. A 1% increase or decrease in interest rates would result in an increase or decrease of interest expense of $131 thousand per year. 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, 2011, the Company had cash and cash equivalents and short-term investments of $4.3 million and has access to the $5.0 million undrawn portion of its $19.0 million credit facility. 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 $9 thousand per year. CRITICAL ACCOUNTING ESTIMATES Management makes certain estimates and relies on certain assumptions relating to the reporting of our assets and liabilities as well as operating results in order to prepare the financial statements in conformity with IFRS. Such estimates and assumptions include the valuation of accounts receivable, recoverability of long-lived assets, the estimation of useful lives of the various classes of network assets, property and equipment, intangible assets and goodwill, stock-based compensation, decommissioning and restoration obligations, business combinations and the measurement of income tax valuation allowances. In determination of the valuation of accounts receivable, including the allowance for doubtful accounts, the Company relies on current customer information, payment history and trends as well as future business and economic conditions. The recoverability of long-lived assets is determined based on the future undiscounted cash flows expected to be generated from such assets. The fair value of stock options is based on certain estimates applied to the Black-Scholes option-pricing model as discussed below. The estimation of useful lives of our various classes of network assets, property and equipment and intangible assets and goodwill are based upon history and experience of the same within each class. The value of the decommissioning and restoration obligation is estimated based on the present value of the estimated future cash outflows discounted at the Company's credit-adjusted risk-free rate of interest. The measurement of the income tax valuation allowance is based upon estimates of future taxable income and the expected timing of reversals of temporary differences. Actual results may differ from our estimates and assumptions. Revenue recognition The Company s revenue is derived primarily from recurring revenue streams consisting of contractual monthly charges for the Internet access, data connectivity and voice-over-ip services provided and a one-time set-up fee per customer location for installation services. Revenue is recognized as the related services are provided to customers, if evidence of an arrangement exists and collection is deemed reasonably assured by management. The Company s monthly recurring service revenue is recognized ratably over the number of months in the contract term. Revenue from installation services is deferred and recognized over the initial term of the contract. Revenue for hardware and for communication, hosting, and data administration services are recognized when a contractual arrangement is in place, the fee is fixed and determinable, the products and services have been delivered to the customer, and collectability is reasonably assured. Usage revenue is recorded as service revenue recorded in the month the usage occurs. Amounts billed but not earned are recorded as deferred revenue. 22

23 Network assets, property and equipment Measurement of network assets, property and equipment involves the use of estimates for determining the expected useful lives of depreciable assets. Management s judgment is also required to determine depreciation methods and an asset s residual value, the rate of capitalization of internal labour costs and whether an asset is a qualifying asset for the purposes of capitalizing borrowing costs. Intangible assets and goodwill: The calculation of useful life involves significant estimates and assumptions, including those with respect to future cash flows, discount rates and asset lives. These significant estimates and judgments could impact the Company s future results if the current estimates of future performance and fair values change, and could affect the amount of amortization expense on intangible assets in future periods. Accounting for stock-based compensation The Company has equity-settled and cash-settled stock-based compensation plans. The grant date fair value of equity settled stock-based payment awards to employees and directors are recognized as compensation cost, with a corresponding increase to equity, over the vesting period of the award. For cash-settled awards, the awards are classified as a liability and are re-measured to fair value at each reporting date. The Company accounts for the effects of service and non-market performance conditions in measuring the fair value of the liability in cash-settled awards by adjusting the number of rights to receive cash that are expected to satisfy any service and non-market performance conditions on a best estimate basis. Awards with graded vesting are valued and recognized as compensation cost based on the respective vesting tranche. The amount of compensation cost recognized is adjusted to reflect the number of awards expected to vest based on continued employment vesting conditions, such that the amount ultimately recognized as compensation cost is based on the number of awards that vest. 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 and volatility of the underlying stock. Allowance for doubtful accounts The allowance for doubtful accounts is based on our assessment of the collectability of specific customer balances. If there is deterioration in a customer s creditworthiness or actual defaults are higher than our historical experience, our estimates of recoverability for the accounts receivable could be adversely affected. The evaluation of collectability of customer accounts is done on an individual account basis. If, based on an evaluation of accounts, we conclude that it is probable that a customer will not be able to pay all amounts due, we estimate the expected loss. In developing the estimates for an allowance, we consider general and industry economic and market conditions as well as credit information available for the customer. We only record recoveries of provisions when objective verifiable evidence supports the change in the original provision. Business Combinations The amount of goodwill initially recognized as a result of a business combination, the fair value estimate of the 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 on future cash flows expected to be derived from the assets. Income taxes The Company recognizes deferred tax assets to the extent it is probable that they will be realized. This requires significant estimates and assumptions regarding future earnings, and the ability to implement certain tax planning opportunities in order to assess the likelihood of realizing the benefit of deferred tax assets. Provisions Considerable judgment is required to assess the likelihood of an outflow of the economic benefits to settle contingencies, such as litigations, which may require a liability to be recognized. Significant judgments include assessing future cash flows, selection of discount rates and the probability of the occurrence of future events. a) Decommissioning and Restoration Obligations: Significant assumptions are required to measure decommissioning and restoration obligations, primarily related to the amount and timing of cash flows required to satisfy the Company's future legal obligation including labour costs based on current marketplace wages and the rate of inflation over expected years to settlement; the length of facility lease renewal periods and probability of such renewals; and the appropriate discount rate to present value the future cash flows. 23

24 Impairment of non-financial assets The Company monitors events and changes in circumstances that may require an assessment of the recoverability of its non-financial long-lived assets, which includes network assets, property and equipment and intangibles subject to amortization and depreciation. If there is any indication of impairment, the recoverable amount of the asset is estimated in order to determine the extent of the impairment, if any. When an impairment test is performed, the recoverable amount is assessed by reference to the higher of the net present value of the expected future cash flows (value in use) and 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. In performing the annual impairment test for the Company s single CGU, the Company measured the recoverable amount of the CGU based on the value in use calculation using certain key management assumptions. Cash flow projections, which were made over a three-year period was based on financial budgets approved by the Board. The Company discounted these estimates of future cash flows to their present value using a pre-tax discount rate of 8.9%. Based on the sensitivity analysis performed, the Company has concluded that no reasonably possible changes in the key assumptions on which the recoverable amount is based would cause the carrying amount of the CGU to exceed the recoverable amount. CHANGES IN ACCOUNTING POLICIES AND RECENT ACCOUNTING PRONOUNCEMENTS Changes in Accounting Policies See Reconciliation of Canadian GAAP to IFRS. Recent Accounting Pronouncements Certain new standards, interpretations, amendments and improvements to existing standards were issued by the IASB which becomes applicable at a future date. The standards impacted that may be applicable to the Company are as follows: Financial Instruments In October 2010, the IASB issued IFRS 9, Financial Instruments ("IFRS 9"). IFRS 9, which replaces IAS 39, Financial Instruments: Recognition and Measurement, establishes principles for the financial reporting of financial assets and financial liabilities that will present relevant and useful information to users of financial statements for their assessment of the amounts, timing and uncertainty of an entity's future cash flows. This new standard is effective for the Company s interim and annual consolidated financial statements commencing January 1, Transfer of Financial Assets In October 2010, the IASB issued amendments to IFRS 7, Transfer of Financial Assets ( IFRS 7 ). The amendments introduce new disclosure requirements about transfer of financial assets including disclosure for, financial assets that are not derecognized in their entirety and, financial assets that are derecognized in their entirety but for which the entity retains continuing involvement. These amendments are effective for annual periods beginning on or after July 1, Deferred Tax: Recovery of underlying assets In December 2010, the IASB issued amendments to IAS 12, Income Taxes ( IAS 12 ) as Deferred Tax: Recovery of Underlying Assets Amendments to IAS 12. The amendments provide an exception to the general principle in IAS 12 that the measurement of deferred tax assets and deferred tax liabilities should reflect the tax consequences that would follow from the manner in which the entity expects to recover the carrying amount of an asset. These amendments are effective for annual period beginning on or after January 1, Consolidated Financial Statements In May 2011, the IASB issued IFRS 10, Consolidated Financial Statements ( IFRS 10 ). IFRS 10, which replaces the consolidation requirements of SIC-12 Consolidation Special Purpose Entities and IAS 27 Consolidation and Separate Financial Statements and establishes principles for the presentation and preparation of consolidated financial statements when an entity controls one or more entities. This new standard is effective for the Company s interim and annual consolidated financial statements commencing January 1,

25 Disclosure of Interests in Other Entities In May 2011, the IASB issued IFRS 12, Disclosure of Interests in Other Entities ( IFRS 12 ). IFRS 12 is a new and comprehensive standard on disclosure requirements for all forms of interests in other entities, including subsidiaries, joint arrangements, associates and unconsolidated structured entities. This new standard is effective for the Company s interim and annual consolidated financial statements commencing January 1, Fair Value Measurement In May 2011, the IASB issued new guidance on IFRS 13, Fair Value Measurement ( IFRS 13 ). IFRS 13 aims to improve consistency and reduce complexity by providing precise definition of fair value and a single source of fair value measurement and disclosure requirements for use across IFRSs. This new guidance is effective for the Company s interim and annual consolidated financial statements commencing January 1, Separate Financial Statements In May 2011, the IASB issued amendments to IAS 27, Separate Financial Statements ( IAS 27 ). The amended version of IAS 27 now only deals with the requirements for separate financial statements, which have been carried largely unamended from IAS 27, Consolidated and Separate Financial Statements. Requirements for Consolidated financial statements are now contained in IFRS 10, Consolidated Financial Statements. The standard requires that when an entity prepares separate financial statements, investment in subsidiaries, associates, and jointly controlled entities are accounted for either at cost, or in accordance with IFRS 9, Financial Instruments. These amendments are effective for annual periods beginning on or after January 1, Other Comprehensive Income In June 2011, the IASB issued amendments to IAS 1, Presentation of Financial Statements ( IAS 1 ). The amendments require companies preparing financial statements in accordance with IFRSs to group together items within Other Comprehensive Income (OCI) that may be reclassified to the profit or loss section of the income statement. The amendments also reaffirm existing requirements that items in OCI and profit or loss should be presented as either a single statement or two consecutive statements. These amendments are effective for annual periods beginning on or after July 1, Offsetting Financial Assets and Financial Liabilities In December 2011, the IASB issued amendments to IAS 32, Financial Instruments: Presentation ( IAS 32 ). The amendments require entities to disclose gross amounts subject to rights of set-off, amounts set off in accordance with the accounting standards followed, and the related net credit exposure. This information will help investors understand the extent to which an entity has set off in its balance sheet and the effects of rights of set-off on the company s rights and obligations. These amendments are effective for annual periods beginning on or after January 1, 2014 and are required to be applied retrospectively. Disclosures - Offsetting Financial Assets and Financial Liabilities In December 2011, the IASB issued amendments to the disclosure requirements in IFRS 7, Financial Instruments: Disclosures ( IFRS 7 ). The amendments require information about all recognized financial instruments that are set off in accordance with paragraph 42 of IAS 32, Financial Instruments: Presentation ( IAS 32 ). The amendments also require disclosure of information about recognized financial instruments subject to enforceable master netting arrangements and similar agreements even if they are not set off under IAS 32. These amendments are effective for annual periods beginning on or after January 1, The Company is assessing the impact of these new standards on its consolidated financial statements. 25

26 RECONCILIATION OF CANADIAN GAAP TO IFRS In preparing the January 1, 2010 opening IFRS statement of financial position, the Company has adjusted amounts reported previously in financial statements prepared in accordance with Canadian GAAP. An explanation of how the transition from Canadian GAAP to IFRS has affected the Company s financial position and financial performance is set out in the accompanying tables. In addition to the changes required to adjust for the accounting policy differences described below, cash paid for interest and cash received for interest have been moved into the body of the statements of cash flows as an adjustment to operating activities, whereas they were previously disclosed as supplementary information. These are now shown as financing activities. There are no other material differences between the consolidated statements of cash flows presented under IFRS and those presented under previous Canadian GAAP.. (a) Stock-based Compensation IFRS 2 is effective for the Company as at January 1, 2010 and is applicable to: New grants of stock-based payments subsequent to January 1, 2010; Equity settled stock-based compensation awards granted subsequent to November 7, 2002 and that vest after January 1, 2010; Liabilities arising from cash-settled stock-based compensation awards that vest and will be settled after January 1, 2010; and Awards that are modified on or after January 1, 2010, even if the original grant of the award was not accounted for in accordance with IFRS 2 (i) Recognition of Expense Stock Options Canadian GAAP - The Company calculates the fair value of the stock-based compensation on all awards granted and recognizes the expense from the date of grant over the vesting period using the graded vesting methodology. The Company determines the fair value of stock options granted using the Black-Scholes option pricing model. IFRS Each tranche in an award with graded vesting is considered a separate grant with a different vesting date and fair value. Each grant is accounted for on that basis. (ii) Forfeitures Restricted Share Units ( RSUs ) Canadian GAAP - The Company measures cash-settled share-based payments based on the intrinsic value of the award and recognizes forfeitures for RSUs in the period when they occur. IFRS - The recognition of compensation cost for awards under IFRS 2 is generally based on the number of awards expected to vest, which is revised if subsequent information indicates that actual forfeitures are likely to differ from the estimate. It also requires the Company to measure payments at the award s fair value, both initially and at each reporting date. (b) Impairment of Long-lived Assets Canadian GAAP - Canadian GAAP generally uses a two-step approach to impairment testing: first comparing asset carrying values with undiscounted future cash flows to determine whether impairment exists, and then measuring impairment by comparing asset carrying values to their fair value (which is calculated using discounted cash flows). IFRS IAS 36 uses a one-step approach for testing and measuring impairment, with asset carrying values compared directly with the higher of fair value less costs to sell and value in use (which uses discounted cash flows). This may potentially result in write-downs where the carrying value of assets was previously supported under Canadian GAAP on an undiscounted cash flow basis. The Company assessed the carrying value of its assets in accordance with IAS 36 and found that no impairment was required to be recognized on January 1, 2010 as a result of the change in measurement methodology. 26

27 (c) Presentation Reclassifications (i) Reclassification of Accretion Expense Canadian GAAP - Accretion expense for decommissioning and restoration obligations ( DROs ) were classified within sales, general and administrative expenses. IFRS - Accretion expense for DROs are required to be included in finance costs. (ii) Reclassification of Direct Salaries included in Cost of Goods Sold Canadian GAAP - Direct salaries are included in costs of goods sold. IFRS - Direct Salaries are presented separately on the face of the statement of comprehensive loss in salaries and related costs. (iii) Reclassification of Deferred Revenue During 2011, the Company reclassified an amount of $289 at January 1, 2010 and $993 at December 31, 2010 from current deferred revenue to long-term deferred revenue as compared to previously reported under pre-changeover Canadian GAAP. The adjustment relates to deferred service and installation revenue that will be amortized into revenue more than one year from the balance sheet date based on the remaining term of the contract. The following are reconciliations previously presented under Canadian GAAP to those under IFRS: Reconciliation of Consolidated Statement of Financial Position as of January 1, 2010 (In thousands, except for per share amounts) Previous Canadian GAAP 1 Effect of Adjustment Assets Assets Cash and cash equivalents $ 1,074 $ $ 1,074 Cash and cash equivalents Short-term investments 7,121 7,121 Short-term investments Accounts receivable 2,491 2,491 Accounts receivable Prepaid expenses 1,773 1,773 Prepaid expenses Total current assets 12,459-12,459 Total current assets Network assets, property and equipment 30,737 30,737 Network assets, property and equipment Intangibles and other assets Intangibles and other assets Restricted cash 1,000 1,000 Restricted cash Goodwill Goodwill Total noncurrent assets 33,105-33,105 Total non-current assets Total Assets $ 45,564 $ - $ 45,564 Total Assets IFRS Liabilities and Shareholders'Equity Liabilities and Shareholders'Equity Accounts payable and accrued liabilities $ 5,805 $ $ 5,805 Accounts payable and accrued liabilities Current portion of deferred revenue Current portion of deferred revenue Current portion of finance lease obligation Current portion of other long-term liabilities Total current liabilities 6,624-6,624 Total current liabilities Asset retirement obligations Decommissioning and restoration obligations Deferred revenue Deferred revenue Other long-term liabilities 342 (22) 320 Other long-term liabilities Total noncurrent liabilities 777 (22) 755 Total non-current liabilities Total Liabilities $ 7,401 $ (22) $ 7,379 Total Liabilities Equity Equity Share capital 69,661-69,661 Share capital Contributed surplus 24, ,165 Contributed surplus Deficit (55,654) 13 (55,641) Deficit Total equity 38, ,185 Total equity Total Liabilities and Equity $ 45,564 $ - $ 45,564 Total Liabilities and Equity 1 See Reconciliation of Canadian GAAP to IFRS c) Presentation Reclassifications iii) Reclassification of Deferred Revenue 27

28 Reconciliation of Consolidated Statement of Financial Position as of December 31, 2010 (In thousands, except for per share amounts) Previous Canadian GAAP 1 Effect of Adjustment Assets Assets Cash and cash equivalents $ 1,083 $ $ 1,083 Cash and cash equivalents Short-term investments 1,071 1,071 Short-term investments Accounts receivable 3,175 3,175 Accounts receivable Prepaid expenses 2,085 2,085 Prepaid expenses Total current assets 7,414-7,414 Total current assets Network assets, property and equipment 33,545 33,545 Network assets, property and equipment Intangibles and other assets 6,205 6,205 Intangibles and other assets Restricted cash Restricted cash Goodwill Goodwill Total non-current assets 41,186-41,186 Total non-current assets Total Assets $ 48,600 $ - $ 48,600 Total Assets IFRS Liabilities and Shareholders'Equity Liabilities and Shareholders'Equity Accounts payable and accrued liabilities $ 5,506 $ $ 5,506 Accounts payable and accrued liabilities Current portion of deferred revenue Current portion of deferred revenue Current portion of long-term debt Current portion of long-term debt Current portion of other long-term liabilities Current portion of other long-term liabilities Total current liabilities 7,172-7,172 Total current liabilities Asset retirement obligations Decommissioning and restoration obligations Deferred revenue Deferred revenue Long-term debt 6,273 6,273 Long-term debt Long-term liabilities 1,220 (73) 1,147 Other Long-term liabilities Total non-current liabilities 8,652 (73) 8,579 Total non-current liabilities Total Liabilities $ 15,824 $ (73) $ 15,751 Total Liabilities Equity Equity Share capital 70,141-70,141 Share capital Contributed surplus 24, ,180 Contributed surplus Deficit (61,529) 57 (61,472) Deficit Total equity 32, ,849 Total equity Total Liabilities and Equity $ 48,600 $ - $ 48,600 Total Liabilities and Equity 1 See Reconciliation of Canadian GAAP to IFRS c) Presentation Reclassifications iii) Reclassification of Deferred Revenue 28

29 Reconciliation of Consolidated Statement of Comprehensive Loss for the three months ended December 31, 2010 (In thousands, except for per share amounts) Canadian GAAP accounts Effect of Transition to IFRS Previous Canadian GAAP Adjustment Reclassification IFRS IFRS accounts Revenue Revenue Service $ 9,678 $ $ $ 9,678 Service Installation Installation 9, ,911 Revenue Cost of services 2,191 (2,191) - Gross Margin 7,720-2,191 9,911 Expenses Expenses - 1,846 1,846 Operating expenses Salaries and related costs - Cost of services - 3,757 3,757 Salaries and related costs - Other Sales, general and administrative 5,380 (3,763) 1,617 Other operating items Stock-based compensation 513 (32) 481 Stock-based compensation Amortization of intangibles Amortization of intangibles Amortization of network assets, Depreciation of network assets, property and equipment 2,668 2,668 property and equipment 8,660 (32) 2,185 10,813 Loss before undernoted items (940) 32 6 (902) Earnings (loss) from operating items Foreign exchange gain Foreign exchange gain Interest on long-term debt (179) (6) (185) Finance costs Investment income 7 7 Finance income Net loss and comprehensive loss $ (1,091) $ 32 $ - $ (1,059) Net loss and comprehensive loss Deficit, beginning of period (60,438) 25 - (60,413) Deficit, beginning of period Deficit, end of period $ (61,529) $ 57 $ - $ (61,472) Deficit, end of period Reconciliation of Consolidated Statement of Comprehensive Loss for year ended December 31, 2010 (In thousands, except for per share amounts) Canadian GAAP accounts Effect of Transition to IFRS Previous Canadian GAAP Adjustment Reclassification IFRS IFRS accounts Revenue Revenue Service $ 37,002 $ $ $ 37,002 Service Installation Installation 37, ,768 Revenue Cost of services 9,090 (9,090) - Gross Margin 28,678-9,090 37,768 Expenses Expenses 7,725 7,725 Operating expenses 1,365 1,365 Salaries and related costs - Cost of services 15,922 15,922 Salaries and related costs - Other Sales, general and administrative 22,312 (15,942) 6,370 Other operating items Stock-based compensation 1,047 (44) 1,003 Stock-based compensation Amortization of intangibles Amortization of intangibles Amortization of network assets, Depreciation of network assets, property and equipment 10,507 10,507 property and equipment 34,359 (44) 9,070 43,385 Loss before undernoted items (5,681) (5,617) Earnings (loss) from operating items Foreign exchange gain Foreign exchange gain Interest on long-term debt (286) (20) (306) Finance costs Investment income Finance income Net loss and comprehensive loss $ (5,875) $ 44 $ - $ (5,831) Net loss and comprehensive loss Deficit, beginning of year (55,654) 13 - (55,641) Deficit, beginning of year Deficit, end of year $ (61,529) $ 57 $ - $ (61,472) Deficit, end of year 29

30 CONTROLS AND PROCEDURES The conversion to IFRS from Canadian GAAP impacts the way the Company presents its financial results. Our management, under the supervision and with the participation of our CEO and CFO, has evaluated the impact of the conversion on its accounting and financial reporting systems and has updated the requisite systems to enable the reporting of historical Canadian GAAP information related to its initial IFRS adoption and for future periods to be reported under IFRS. The Company s internal and disclosure control processes have not required significant modification as a result of its adoption of IFRS. Our management has evaluated, under the supervision and with the participation of our Chief Executive Officer ( CEO ) and Chief Financial Officer ( CFO ), the design and effectiveness of the Company s disclosure controls and procedures as at the year ended December 31, Management has concluded that these disclosure controls and procedures, as defined in National Instrument Certification of Disclosure in Issuers Annual and Interim Filings ( NI ), are adequate and effective and that material information relating to the Company was made known to them and was recorded, processed, summarized and reported within the time periods specified under applicable securities legislation. Our management, under the supervision and with the participation of our CEO and CFO, has designed and evaluated the effectiveness of the Company s internal controls over financial reporting ( ICFR ) to provide reasonable assurance that our financial reporting is reliable and that our consolidated financial statements were prepared in accordance with IFRS. Management has concluded that ICFR, as defined in NI and using the Committee of Sponsoring Organization of the Treadway Commission ( COSO ) Framework are effective as at the year ended December 31, SIGNIFICANT REGULATORY DEVELOPMENTS CLEC Status On May 12, 2010, TeraGo received approval from the CRTC to operate as a CLEC in certain Canadian markets. The Company has met all of the Type IV CLEC obligations set out in Telecom Decision 97-8, Local Competition, as amended from time to time, and has subsequently launched local voice services in such markets. Usage-Based Billing for Gateway Access Services and Third-Party Internet Access Services On January 25, 2011, the CRTC approved the implementation of usage-based billing (UBB) for wholesale services provided to Internet service providers (ISPs) that allows such ISPs to provide retail Internet services to their own customers. The CRTC determined that UBB rates for an incumbent telephone carrier s wholesale residential gateway access services or equivalent services, and for an incumbent cable carrier s third-party Internet access services, are to be established at a discount rate of 15% from the carrier s comparable UBB billing rates for its retail Internet services. In February 2011, the CRTC initiated a review of billing practices for wholesale residential high-speed access. On November 15, 2011, the CRTC issued a new decision approving two billing models, a flat-rate model in which the third party internet access rate includes access and usage and a capacity-based model in which access and capacity usage are billed separately. As a facilities-based provider of broadband and data services, TeraGo is not directly impacted by this regulatory development. We own and operate a carrier-grade, fixed wireless, IP communications network in Canada targeting Canadian businesses that require broadband connectivity services. Our business model is primarily focused on direct sales to end business customers and our bandwidth packages include both variable and fixed rate usage plans. TeraGo will continue to monitor developments regarding this regulatory matter. Canada Digital Economy Strategy On May 10, 2010, in response to the 2010 Speech from the Throne and federal budget, the Government of Canada released a consultation paper on creating a digital economy strategy for Canada entitled Improving Canada s Digital Divide. TeraGo submitted a formal response paper advocating the need for Canada to build a world class digital infrastructure for all Canadians, including Canadian businesses and public sector organizations. 30

31 Foreign Ownership Restrictions On June 11, 2010, Industry Canada initiated a public consultation on foreign investment restrictions in the telecommunications sector. The Consultation outlines the current restrictions, describes how Canada compares with other member countries of the Organization for Economic Co-operation and Development (OECD) and presents the following three options for consideration: (i) increase the limit on direct foreign investment in broadcasting and telecommunications common carriers to 49 percent; (ii) lift restrictions on telecommunications common carriers with a 10 percent market share or less, by revenue; or (iii) remove telecommunications restrictions completely. TeraGo is subject to the foreign ownership restrictions imposed by the Telecommunication Acts and the Radiocommunication Act. TeraGo submitted a formal response supporting the relaxation of foreign ownership restrictions and we await Industry Canada s final decision on this matter. Non-Canadian Investors TeraGo is required, as a radiocommunication carrier pursuant to the Radiocommunication Act (Canada) and a telecommunications common carrier pursuant to the Telecommunications Act (Canada), as well as by conditions of spectrum licences issued to it, to comply with Canadian ownership and control provisions (the Canadian Rules ). The Canadian Telecommunications Common Carrier Ownership and Control Regulations under the Telecommunications Act (the Regulations ) contain provisions that enable TeraGo to respond to situations where non-canadians own and control more voting shares than permitted under the Canadian Rules. Having regard to the Canadian Rules, the Regulations and the number of common shares (the Purchased Shares ) purchased by a US-based investor (the Investor ), as set out in the report under National Instrument filed by the Investor on May 7, 2010, TeraGo informed the Investor of its intention to take appropriate steps under the Regulations to ensure compliance with the Canadian Rules. As a result, pursuant to a letter agreement dated June 10, 2010 entered into between the Company and the Investor, the voting rights attached to all of the Purchased Shares were suspended immediately and continuing until (i) the repeal or relaxation of the Canadian Rules permitting the reinstatement of the voting rights attached to some or all of the Purchased Shares, but only to the extent of such repeal or relaxation, (ii) the Investor sells or otherwise disposes of some or all of the Purchased Shares to Canadians, at which time the suspension of voting rights shall be rescinded for those Purchased Shares so sold or disposed of, or (iii) the non-canadian ownership of TeraGo declines to the extent that the voting rights of some or all of the Purchased Shares can be reinstated without TeraGo violating the Canadian ownership and control provisions of the Canadian Rules. In the letter agreement, the Investor acknowledged and agreed that TeraGo has not waived or compromised any of its rights in law, including, without limitation, under (a) the Regulations, (b) TeraGo s articles of incorporation, including without limitation, the constrained class restrictions included therein, and (c) the Canada Business Corporations Act. EXECUTIVE MANAGEMENT CHANGES The Vice President of Marketing left the Company in August 2011 and received a severance payment of $0.2 million which was recorded in the third quarter of RISK FACTORS We have a history of operating losses and we could continue to realize net losses for the foreseeable future. We have recorded a net loss in each reporting period since our inception except for Our net loss for the years ended December 31, 2010 and 2009 was $5.8 million and $5.8 million, respectively. For the year ended December 31, 2011, we recorded net earnings of $0.2 million and our accumulated deficit at December 31, 2011 was $61.3 million. We cannot anticipate with certainty what our earnings, if any, will be in any future period. However, we could incur further net losses as we continue to expand our network into new and existing markets, offer new services and pursue our business strategy. We intend to invest significantly in our business before we expect cash flow from operations to be adequate to cover our anticipated expenses. In addition, at this stage of our development, we are subject to the following risks: our results of operations may fluctuate significantly, which may adversely affect the value of an investment in our Common Shares; we may be unable to further expand our network, offer new services, meet the objectives we have established for our business strategy or grow our business profitably, if at all; it may be difficult to predict accurately our key operating and performance metrics because of our relatively limited operating history; and 31

32 our network and related technologies may fail or the quality and number of services we are able to offer may decline if our network operates at maximum capacity for an extended period of time. If we are unable to execute our business strategy and grow our business, either as a result of the risks identified in this section or for any other reason, our business, prospects, financial condition and results of operations will be materially and adversely affected. Our 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: competitive conditions in the industry, including strategic initiatives by us or our competitors, new services, service announcements and changes in pricing policy by us or our competitors; market acceptance of our services; timing and contractual terms of orders for our services, which may delay the recognition of revenue; the discretionary nature of purchase and budget cycles of our customers and changes in their budgets for, and timing of, services orders; strategic decisions by us or our competitors, such as acquisitions, divestitures, spin-offs, joint ventures, strategic investments or changes in business strategy; general weakening of the economy resulting in a decrease in the overall demand for telecommunications services or otherwise affecting the capital investment levels of medium-sized and enterprise businesses; timing of the development of new service offerings; and the length and variability of the sales cycles for our services. Delays, reductions in the amount or cancellations of customers orders would adversely affect our business, results of operations and financial condition. Excessive customer churn may adversely affect our financial performance by slowing customer growth, increasing costs and reducing revenue. 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 GAAP and NON-GAAP MEASURES CHURN for a description of how we determine churn. Customer churn could increase as a result of: billing errors and/or reduction in the quality of our customer service; interruptions to the delivery of services to customers over our network; the availability of competing technology and other emerging technologies, some of which may, from time to time, be less expensive or technologically superior to those offered by us; and competitive conditions in the industry, including strategic initiatives by us or our competitors, new services, service announcements and changes in pricing policy by us or our competitors. 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. See Executive Overview Comment on Current Economic Conditions. Our business may require additional capital for continued growth, and our growth may be slowed if we do not have sufficient 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 or private offerings, potentially at a price lower than the market price at the time of such issuance. Similarly, we may seek debt financing and we may be forced to incur significant interest expense. If we cannot secure sufficient funding, an increasing challenge given current economic conditions, we may be forced to forego strategic opportunities or delay, scale back or eliminate network deployments, operations, acquisitions, spectrum acquisitions and other investments. 32

33 Our Credit Facilities contain restrictive debt covenants. Covenants in our Credit Facilities with our lender impose operating and financial restrictions on us. A breach of any of these covenants could result in a default under our Credit Facilities. These restrictions may limit our ability to obtain additional financing, withstand downturns in our business and take advantage of business opportunities. Moreover, we may be required to seek additional debt financing on terms that include more restrictive covenants, may require repayment on an accelerated schedule or may impose other obligations that limit our ability to grow our business, acquire needed assets, or take other actions we might otherwise consider appropriate or desirable. Many of our competitors are better established and have significantly greater resources than we have, which may make it difficult to attract and retain customers. The market for broadband Internet access and data connectivity services is highly competitive and we compete with several other companies within each of our markets. Many of our competitors are better established or have greater financial resources than we have. Our competitors include: ILECs and CLECs providing DSL services over their existing wide, metropolitan and local area networks; Utelcos offering or planning to offer broadband Internet connectivity over power lines; cable operators offering high-speed Internet connectivity services and voice communications; internet service providers offering dial-up Internet connectivity; wireless Internet service providers using licenced or licence-exempt spectrum; satellite and fixed wireless service providers offering or developing broadband Internet connectivity and VoIP; and resellers providing wireless Internet or other wireless services using infrastructure developed and operated by others. Many of our competitors are well established with larger and better developed networks and support systems, longer standing relationships with customers and suppliers, greater name recognition and greater financial, technical and marketing resources than we have. Our competitors may subsidize competing services with revenue from other sources and, thus, may offer their products and services at prices lower than ours. Our competitors may also reduce the prices of their services significantly or may offer broadband connectivity packaged with other products or services. We may not be able to reduce our prices or otherwise combine our services with other services, which may make it more difficult to attract and retain customers. We expect other existing and prospective competitors to adopt technologies and/or business plans similar to ours, or seek other means to develop services competitive with ours, particularly if our services prove to be attractive in our target markets. In addition, other operators may deploy their network faster or more broadly than we do, thereby obtaining a time to market advantage over us. Acquisitions and other strategic transactions could result in operating difficulties, dilution and distractions from our core business. We have entered, and may in the future enter, into strategic transactions, including strategic acquisitions of other assets and businesses. Any such transactions can be risky, may require a disproportionate amount of our management and financial resources and may create unforeseen operating difficulties or expenditures, including: difficulties in integrating acquired businesses and assets into our business while maintaining uniform standards, controls, policies and procedures; obligations imposed on us by counterparties in such transactions that limit our ability to obtain additional financing, our ability to compete in geographic areas or specific lines of business or other aspects of our operational flexibility; increasing cost and complexity of assuring the implementation and maintenance of adequate internal control and disclosure controls and procedures; difficulties in consolidating and preparing our financial statements due to poor accounting records, weak financial controls and, in some cases, procedures at acquired entities not based on IFRS, particularly those entities in which we lack control; and inability to predict or anticipate market developments and capital commitments relating to the acquired company, business or assets. If we do not successfully address these risks or any other problems encountered in connection with an acquisition, the acquisition could have a material adverse effect on our business, results of operations and 33

34 financial condition. Problems with an acquired business could have a material adverse effect on our performance or its business as a whole. In addition, if we proceed with an acquisition, our available cash may be used to complete the transaction, diminishing our liquidity and capital resources, or additional equity may be issued which could cause significant dilution to existing shareholders. We rely on certain technologies and standards to deploy our services and may be affected by changes relating to these technologies and standards. Our industry is characterized by rapidly changing technology, evolving industry standards and increasingly sophisticated customer requirements. The introduction of new or alternative technology and the emergence of new industry standards may render our existing network obsolete and our services unmarketable and may exert price pressures on existing services. It is critical to our success that we be able to anticipate changes in technology or in industry standards and ensure that we can leverage such new technologies and standards to remain competitive from a service and cost perspective. Investments in development of new technologies, products and services may not yield expected benefits. The Company has and will continue to make significant investments in the development and introduction of new products and services that make use of the Company s network. There is no assurance that the Company will be successful in implementing and marketing these new products and services in a reasonable time, or that they will gain market acceptance. Development could be delayed for reasons beyond our control. Alternatively, we may fail to anticipate or satisfy the demand for certain products or services, or may not be able to offer or market these new products or services successfully to subscribers. The failure to attract customers to new products or services, or failure to keep pace with changing consumer preferences for products or services, would slow revenue growth and could have a materially adverse effect on our business, results of operations and financial condition. We may experience difficulties in expanding, upgrading and maintaining our network, which could adversely affect customer satisfaction, increase churn and reduce our revenue. We expect to expend significant resources in expanding, maintaining and improving our network. Additionally, as the number of our customer locations increase, as the usage habits of our customers change and as we increase our service offerings, we may need to upgrade our network to maintain or improve the quality of our services. If we do not successfully implement upgrades to our network, the quality of our services may decline and our churn rate may increase. We may experience quality deficiencies, cost overruns and delays with the expansion, maintenance and upgrade of our network including the portions of those projects not within our control. Expansion of our network may require permits and approvals from governmental bodies and third parties. Failure to receive approvals in a timely fashion can delay expansion of our network. In addition, we typically are required to obtain rights from land, building and tower owners to install the antennas and other equipment that provide our service to our customers. We may not be able to obtain, on terms acceptable to us or at all, the rights necessary to expand our network. We also may face challenges in managing and operating our network. These challenges include ensuring the availability of customer equipment that is compatible with our network and managing sales, advertising, customer support, and billing and collection functions of our business while providing reliable network service that meets our customers expectations. Our failure in any of these areas could adversely affect customer satisfaction, increase churn, increase our costs, decrease our revenue and otherwise have a material adverse effect on our business, prospects, financial condition and results of operations. We rely on third party suppliers that supply our network equipment. If such suppliers fail to deliver equipment that we need to expand, maintain and improve our networks, we may be unable to execute our business strategy or operate our business. We rely on third-party suppliers, in some cases sole suppliers or limited groups of suppliers, to provide us with components necessary for the operation of our network. If we are unable to obtain sufficient allocations of components, our network expansion will be delayed, we may lose customers and our profitability will be affected. Reliance on suppliers also reduces our control over costs, delivery schedules, reliability and quality of components. Any inability to obtain timely deliveries of quality components, or any other circumstances that would require us to seek alternative suppliers, could adversely affect our ability to expand and maintain our network. 34

35 We are subject to extensive regulation that could limit or restrict our activities and adversely affect our ability to achieve our business objectives. If we fail to comply with these regulations, we may be subject to penalties, including fines and suspensions, which may adversely affect our financial condition and results of operations. We are subject to the laws of Canada and the regulation of regulatory authorities of the Canadian government, primarily the CRTC and Industry Canada. Regulatory authorities may adopt new laws, policies or regulations, or change their interpretation of existing laws, policies or regulations, that could cause our existing authorizations to be changed or cancelled, require us to incur additional costs, or otherwise adversely affect our operations, revenue or cost of capital. Any currently held regulatory approvals may be subject to rescission and renewal and may not remain sufficient. Additional approvals may be necessary that we may not be able to obtain on a timely basis or on terms that are not unduly burdensome. Further, if we fail to obtain or maintain particular approvals on acceptable terms, such failure could delay or prevent us from continuing to offer some or all of our current or new services, or offer new services, and adversely affect our results of operations, business prospects and financial condition. Even if we were able to obtain the necessary approvals, the licences or other approvals we obtain may impose significant operational restrictions. The acquisition, lease, maintenance and use of spectrum are extensively regulated in Canada. These regulations and their application are subject to continual change as new legislation, regulations or amendments to existing regulations are adopted from time to time by governmental or regulatory authorities, including as a result of judicial interpretations of such laws and regulations. Current regulations directly affect the breadth of services we are able to offer and may impact the rates, terms and conditions of our services. Regulation of companies that offer competing services, such as incumbent telecommunications carriers and cable and DSL providers, also affects our business indirectly. The breach of a licence or applicable law, even if inadvertent, can result in the revocation, suspension, cancellation or reduction in the term of a licence or the imposition of fines. In addition, regulatory authorities may grant new licences to third parties, resulting in greater competition in markets where we already have rights to licenced spectrum. In order to promote competition, licences may also require that third parties be granted access to our bandwidth, frequency capacity, facilities or services. We may not be able to obtain or retain any required licence, and we may not be able to renew our licences on favourable terms, or at all. Our wireless broadband services may become subject to greater regulation in the future. If we become subject to proceedings before the CRTC or Industry Canada with respect to our compliance with the relevant legislation and regulations relating to restrictions on foreign ownership and control, we could be materially adversely affected, even if it were ultimately successful in such a proceeding. In addition, these Canadian ownership restrictions may limit the Company s ability to raise equity capital outside of Canada in the future. There can be no assurance that a future CRTC or Industry Canada determination or events beyond our control will not result in our ceasing to comply with the relevant legislation or regulations. If this occurs, our ability to operate as a Canadian carrier under the Telecommunications Act or to hold, renew or secure licences under the Radiocommunication Act could be jeopardized and our business, operating results and financial condition could be materially adversely affected. If we do not obtain and maintain rights to use licenced spectrum in one or more markets, we may be unable to operate in these markets, which could adversely affect our ability to execute our business strategy. To offer our services using licenced spectrum in Canada, we depend on our ability to acquire and maintain sufficient rights to use spectrum through ownership or long-term leases in each of the markets in which we operate or intend to operate. Obtaining the necessary amount of licenced spectrum can be a long and difficult process that can be costly and require a disproportionate amount of our resources. We may not be able to acquire, lease or maintain the spectrum necessary to execute our business strategy. In addition, we may spend significant resources to acquire spectrum licences, even if the amount of spectrum actually acquired in certain markets is not adequate to deploy our network on a commercial basis in all such markets. Using licenced spectrum, whether owned or leased, poses additional risks to us, including: inability to satisfy build-out or service deployment or research and development requirements upon which our spectrum licences or leases are, or may be, conditioned; adverse changes to regulations or licence conditions governing our spectrum rights; inability to use the spectrum we have acquired or leased due to interference from licenced or licenceexempt operators in our band or in adjacent bands; 35

36 refusal by Industry Canada to recognize our acquisition or lease of spectrum licences from others or our investments in other licence holders; inability to offer new services or to expand existing services to take advantage of new capabilities of our network resulting from advancements in technology due to regulations governing our spectrum rights; inability to control leased spectrum due to contractual disputes with, or the bankruptcy or other reorganization of, the licence holders; failure of Industry Canada to renew our spectrum licences as they expire and our failure to obtain extensions or renewals of spectrum leases before they expire; imposition by Industry Canada of new or amended conditions of licence, or licence fees, upon the renewal of our spectrum licences or in other circumstances; potentially significant increases in spectrum prices, because of increased competition for the limited supply of licenced spectrum in Canada; and invalidation of our authorization to use all or a significant portion of our spectrum, resulting in, among other things, impairment charges related to assets recorded for such spectrum. We expect Industry Canada to make additional spectrum available from time to time. Additionally, other companies hold spectrum rights that could be made available for lease or sale. The availability of additional spectrum in the marketplace could change the market value of spectrum rights generally and, as a result, may adversely affect the value of our spectrum assets. We also use radio equipment under individual radio licences issued by Industry Canada, and subject to annual renewal. We may not be able to obtain the licences we require thereby jeopardizing our ability to reliably deliver our services. Industry Canada may decline to renew our licences, or may impose higher fees upon renewal, or impose other conditions that adversely affect us. Industry Canada may decide to reassign the spectrum in the bands we use to other purposes, and may require that we discontinue our use of radio equipment in such bands. We utilize licence-exempt spectrum, which is subject to intense competition, low barriers to entry and slowdowns due to multiple simultaneous users. We presently utilize licence-exempt spectrum in connection with a majority of our customers. Licence-exempt or free spectrum is available to multiple simultaneous users and may suffer bandwidth limitations, interference and slowdowns if the number of users exceeds traffic capacity. The availability of licence-exempt spectrum is not unlimited and others do not need to obtain permits or licences to utilize the same licence-exempt spectrum that we currently or may in the future utilize, threatening our ability to reliably deliver or expand our services. Moreover, the prevalence of licence-exempt spectrum creates low barriers to entry in our business, creating the potential for heightened competition. A change in foreign ownership legislation could increase competition which could reduce our market share or decrease our revenue. We could face increased competition if there is a removal or relaxation of the limits on foreign ownership and control of radiocommunication carriers and telecommunication common carriers. Legislative or executive action to remove or relax these limits could result in foreign telecommunication companies entering the Canadian wireless communications market, including the fixed broadband market, through the acquisition of either wireless licences or of a holder of wireless licences. The entry into the market of such companies with significantly greater capital resources than us could reduce our market share and cause revenue to decrease. It is uncertain as to whether the Internet will remain unregulated and to the extent that it does not, our business could be affected. Regulation of the Internet and the content transmitted through that medium is a topic that receives considerable political discussion from time to time, from both a pro-regulation and an anti-regulation perspective, including discussions on whether all Internet traffic should be delivered equally. It is unclear as to what impact decisions made on either side of this issue by various political and governing bodies could have on us and our business or on the ability of our customers to utilize our services. Interruption or failure of our information technology and communications systems could impair our ability to provide our services, which could damage our reputation and harm our operating results. We have experienced service interruptions in some markets in the past and may experience service interruptions or system failures in the future. Any service interruption adversely affects our ability to operate our business and could result in an immediate loss of revenue. If we experience frequent or persistent system or network failures, our reputation and brand could be permanently harmed. We may make significant capital 36

37 expenditures to increase the reliability of our systems, but these capital expenditures may not achieve the results we expect. Our services depend on the continuing operation of our information technology and communications systems. Any damage to or failure of these systems could result in interruptions in our service. Interruptions in our service could reduce our revenue and profit, and our brand could be damaged if people believe our network is unreliable. Our systems are vulnerable to damage or interruption from earthquakes, terrorist attacks, floods, fires, power loss, telecommunications failures, computer viruses, computer denial of service attacks or other attempts to harm our systems, and similar events. Some of our systems are not fully redundant, and our disaster recovery planning may not be adequate. The occurrence of a natural disaster or unanticipated problems at our network centers could result in lengthy interruptions in our service and adversely affect our operating results. The industries in which we operate are continually evolving, which makes it difficult to evaluate our future prospects and increases the risk of your investment. Our services may become obsolete and we may not be able to develop competitive services or services on a timely basis or at all. Our business is characterized by rapid technological change, competitive pricing, frequent new service introductions, evolving industry standards and changing regulatory requirements. Each of these development efforts faces a number of continuing technological and operational challenges. We believe that our success depends on our ability to anticipate and adapt to these and other challenges and to offer competitive services on a timely basis. We face a number of difficulties and uncertainties associated with our reliance on future technological development, such as: existing service providers may use more traditional and commercially proven means to deliver similar or alternative services; new service providers may use more efficient, less expensive technologies, including services not yet invented or developed; consumers may not subscribe to our services; we may not be able to realize economies of scale; we may be unable to respond successfully to advances in competing technologies in a timely and costeffective manner; and existing, proposed or undeveloped technologies may render our existing or planned services less profitable or obsolete. As our services and those offered by our competitors develop, businesses and other consumers may not accept our services as an attractive alternative to other means of receiving wireless broadband services. We rely on highly skilled executives and other personnel. If we cannot retain and motivate key personnel, we may be unable to implement our business strategy. We depend on the services of key technical, sales, marketing and management personnel. The loss of any of these key persons could have a material adverse effect on our business, results of operations and financial condition. Our success is also highly dependent on our continuing ability to identify, hire, train, motivate and retain highly qualified technical, sales, marketing and management personnel. Competition for such personnel can be intense, and we cannot provide assurance that we will be able to attract or retain highly qualified technical, sales, marketing and management personnel in the future. Our inability to attract and retain the necessary technical, sales, marketing and management personnel may adversely affect our future growth and profitability. It may be necessary for us to increase the level of compensation paid to existing or new employees to a degree that our operating expenses could be materially increased. If we cannot hire, train and retain motivated and well-qualified individuals, we may face difficulties in attracting, recruiting and retaining various sales and support personnel in the markets we serve, which may lead to difficulties in growing our subscriber base. We could be subject to claims that we have infringed on the proprietary rights of others, which claims would likely be costly to defend, could require us to pay damages and could limit our ability to use necessary technologies in the future. Competitors or other persons may independently develop or patent technologies that are substantially equivalent or superior to those we currently use or plan to use or that are necessary to permit us to deploy and operate our network. Some of these patents may grant very broad protection to the owners of the patents. We cannot determine with certainty whether any existing third party patents or the issuance of any third party 37

38 patents would require us to alter technology we use, obtain licences or cease certain activities. Defending against infringement claims, even meritless ones, would be time consuming, distracting and costly. If we are found to be infringing the proprietary rights of a third party, we could be enjoined from using such third party s rights, may be required to pay substantial royalties and damages, and may no longer be able to use the intellectual property subject to such rights on acceptable terms or at all. Failure to obtain licences to intellectual property held by third parties on reasonable terms, or at all, could delay or prevent us from providing services to customers and could cause us to expend significant resources to acquire technology which includes noninfringing intellectual property. If we have to negotiate with third parties to establish licence arrangements, or to renew existing licences, it may not be successful and we may not be able to obtain or renew a licence on satisfactory terms or at all. If required licences cannot be obtained, or if existing licences are not renewed, litigation could result. If our data security measures are breached, customers may perceive our network and services as not secure. Our network security and the authentication of our customer credentials are designed to protect unauthorized access to data on our network. 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, regardless of our responsibility, 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. Economic and geopolitical uncertainty may negatively affect our business. The market for our services depends on economic and geopolitical conditions affecting the broader market. Economic conditions globally are beyond our control. In addition, acts of terrorism and the outbreak of hostilities and armed conflicts between countries can create geopolitical uncertainties that may affect the global economy. Downturns in the economy or geopolitical uncertainties may cause customers to delay or cancel projects, reduce their overall capital or operating budgets or reduce or cancel orders for our services, which could have a material adverse effect on our business, results of operations and financial condition. 38

39 DEFINITIONS IFRS, Additional GAAP and Non-IFRS Measures EBITDA The term EBITDA refers to earnings before deducting interest, taxes, depreciation and amortization. EBITDA is a term commonly used to evaluate operating results. The Company believes that EBITDA is useful additional information as it provides an indication of the operational results generated by its business activities prior to taking into consideration how those activities are financed and taxed and also prior to taking into consideration asset depreciation and amortization. The Company also excludes foreign exchange gain or loss, finance costs, finance income, gain or loss on disposal of network assets, property and equipment and stock-based compensation from its calculation of EBITDA. Investors are cautioned that EBITDA should not be construed as an alternative to operating earnings or net earnings determined in accordance with IFRS as an indicator of our financial performance or as a measure of our liquidity and cash flows. EBITDA does not take into account the impact of working capital changes, capital expenditures, debt principal reductions and other sources and uses of cash, which are disclosed in the consolidated statements of cash flows. TeraGo s method of calculating EBITDA may differ from other issuers and, accordingly, EBITDA may not be comparable to similar measures presented by other issuers. See Results of Operations - EBITDA for reconciliation of net earnings (loss) to EBITDA. ARPU The term ARPU refers to the Company s average revenue per customer location. The Company believes that ARPU is useful supplemental information as it provides an indication of our revenue from an individual customer location on a per month basis. ARPU is not a recognized measure under IFRS and, accordingly, investors are cautioned that ARPU should not be construed as an alternative to revenue determined in accordance with IFRS as an indicator of our financial performance. The Company calculates ARPU by dividing our service revenue by the average number of customer locations in service during the period and we express ARPU as a rate per month. TeraGo s method of calculating ARPU may differ from other issuers and, accordingly, ARPU may not be comparable to similar measures presented by other issuers. Churn The term churn or churn rate is a measure, expressed as a percentage, of customer locations terminated in a particular month. Churn represents the number of customer locations disconnected per month as a percentage of total number of customer locations in service during the month. The Company calculates churn by dividing the number of customer locations disconnected during a period by the total number of customer locations in service during the period. Churn and churn rate are not recognized measures under IFRS and, accordingly, investors are cautioned in using it. TeraGo s method of calculating churn and churn rate may differ from other issuers and, accordingly, churn may not be comparable to similar measures presented by other issuers. Service revenue Service revenue is generated from Internet access and data connectivity services that are sold on a subscription basis. This revenue is recurring and contracted with terms from one to three years and these contracts are typically renewable automatically unless notice of non-renewal is received 60 days prior to expiry. Installation revenue Customers are also charged a one-time set-up fee for installation services. The installation fee charged to customers typically decreases with longer-term contracts. Gross profit margin % Gross profit margin % consists of Gross profit margin divided by Revenue where Gross profit margin is Revenue less Cost of Services. Operating expenses Operating expenses consists of expenses related to delivering service to customers and servicing the operations of our networks. These expenses include costs for the lease of intercity facilities to connect our cities, Internet transit and peering costs paid to other carriers, network real estate lease expense, spectrum lease expenses and network maintenance expenses. Cost of Services Cost of services consists of Operating expenses and Salaries and related costs cost of services. Other operating items Other operating items includes sales commission expense, advertising and marketing expenses, travel expenses, administrative expenses including insurance and professional fees, communication expenses and rent expenses for office facilities. 39

40 Earnings (loss) from operating items Earnings (loss) from operating items exclude foreign exchange gain (loss), income taxes, finance costs and finance income. Foreign exchange gain (loss) Foreign exchange gain (loss) relates to the translation of monetary assets and liabilities into Canadian dollars using the exchange rate in effect at that date. The resulting foreign exchange gains and losses are included in net income in the period. Finance costs Finance costs consist of interest charged on our short- and long-term debt, deferred financing costs including expenses associated with closing our long-term debt facility and DRO accretion expense. The deferred financing costs are amortized using the effective interest method over the term of the loan. Finance income Finance income consists of interest earned on our cash and cash equivalent and short-term investment balances. 40

41 !" #$%& '"( Independent Auditor s Report To the Shareholders of TeraGo Inc. We have audited the accompanying consolidated financial statements of TeraGo Inc., which comprise the consolidated balance sheets as at December 31, 2011, December 31, 2010 and January 1, 2010, and the consolidated statements of operations, comprehensive earnings (loss) and deficit, cash flows and changes in equity for the years then ended, and a summary of significant accounting policies and other explanatory information. Management's Responsibility for the Consolidated Financial Statements Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with International Financial Reporting Standards and for such internal control as management determines is necessary to enable the preparation of consolidated financial statements that are free from material misstatement, whether due to fraud or error. Auditor s Responsibility Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with Canadian generally accepted auditing standards. Those standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on the auditor's judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity's preparation and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity's internal control. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion. Opinion In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of TeraGo Inc. as at December 31, 2011, December 31, 2010 and January 1, 2010, and its results of operations and its cash flows for the years then ended in accordance with International Financial Reporting Standards. Chartered Accountants, Licensed Public Accountants Markham, Ontario February 27,

42 TERAGO INC. Consolidated Statements of Financial Position (In thousands) December 31 December 31 January Assets Cash and cash equivalents (Note 5) $ 3,224 $ 1,083 $ 1,074 Short-term investments (Note 5) 1,096 1,071 7,121 Accounts receivable (Note 5) 3,318 3,175 2,491 Prepaid expenses 2,219 2,085 1,773 Total current assets 9,857 7,414 12,459 Network assets, property and equipment (Note 7) 37,097 33,545 30,737 Intangibles and other assets (Note 8) 9,920 6, Restricted cash (Notes 5 and 9) ,000 Goodwill (Note 6) Total non-current assets 48,699 41,186 33,105 Total Assets $ 58,556 $ 48,600 $ 45,564 Liabilities Accounts payable and accrued liabilities $ 6,991 $ 5,506 $ 5,805 Current portion of deferred revenue 1, Current portion of long-term debt (Note 5 and 11) 3, Current portion of other long-term liabilities (Note 12) 1, Total current liabilities 13,479 7,172 6,913 Decommissioning and restoration obligations (Note 13) Deferred revenue Long-term debt (Note 5 and 11) 10,025 6,273 - Other long-term liabilities (Note 12) 695 1, Total non-current liabilities 11,694 8, Total Liabilities 25,173 15,751 7,379 Equity Share capital (Note 15) 70,453 70,141 69,661 Contributed surplus 24,188 24,180 24,165 Deficit (61,258) (61,472) (55,641) Total equity 33,383 32,849 38,185 Total Liabilities and Equity $ 58,556 $ 48,600 $ 45,564 Commitments and contingencies and subsequent events (Notes 10 and 23) On behalf of the Board: Charles Allen Director Grant Ballantyne Director The accompanying notes are an integral part of these financial statements. 42

43 TERAGO INC. Consolidated Statements of Comprehensive Earnings (Loss) (In thousands, except per share amounts) Years ended December Service Installation Revenue $ 43,841 $ 37,002 1, ,923 37,768 Expenses Operating expenses Salaries and related costs - Cost of services Salaries and related costs - Other Other operating items Stock-based compensation (Note 16) Amortization of intangibles 8,258 7,725 1,440 1,365 16,354 15,922 6,961 6,370 1,695 1,003 1, Depreciation of network assets, property and equipment (Note 3c) 7,486 10,507 43,535 43,385 Earnings (loss) from operating items Foreign exchange gain (loss) Finance costs Finance income Net earnings (loss) and comprehensive earnings (loss) Deficit, beginning of year Deficit, end of year 1,388 (5,617) (26) 60 (1,167) (306) $ 214 $ (5,831) (61,472) (55,641) $ (61,258) $ (61,472) Basic earnings (loss) per share Diluted earnings (loss) per share $ 0.02 $ (0.52) $ 0.02 $ (0.52) Basic weighted average number of shares outstanding Diluted weighted average number of shares outstanding (Note 17) 11,273 11,198 12,783 11,198 The accompanying notes are an integral part of these financial statements. 43

44 TERAGO INC. Consolidated Statements of Cash Flows (In thousands) Years ended December Cash provided by (used in) Operating Activities Net earnings (loss) $ 214 $ (5,831) Adjustments to reconcile net earnings (loss) to net cash provided by (used in) operating activities: Depreciation of network assets, property and equipment and amortization of intangibles 8,827 11,000 Stock-based compensation 1, Finance costs 1, Finance income (19) (32) Loss on disposal of network assets Decommissioning and restoration obligations accretion Changes in non-cash working capital items: Accounts receivable (143) (684) Prepaid expenses (113) (312) Accounts payable and accrued liabilities (13) (299) Deferred revenue Other long-term liabilities - 11 Cash from Operating Activities 12,108 6,087 Investing Activities Acquisition of MetroBridge (Note 6) (4,200) - Proceeds from disposal of network assets Purchase of network assets, property and equipment (9,710) (13,666) Purchase of intangibles and other assets (1,299) (1,456) Purchase of spectrum license - (4,488) Purchase of short-term investments (1,413) (3,560) Sale of short-term investments 1,388 9,968 Decrease in restricted cash - (179) Cash used in Investing Activities (15,212) (12,493) Financing Activities Proceeds from issuance of share capital Finance costs (1,167) (306) Finance income Proceeds from long-term debt 15,675 6,879 Repayment of long-term debt (8,910) (62) Repayment of finance lease obligation (425) (306) Cash from Financing Activities 5,245 6,415 Net change in cash and cash equivalents, during the year 2,141 9 Cash and cash equivalents, beginning of year 1,083 1,074 Cash and cash equivalents, end of year $ 3,224 $ 1,083 The accompanying notes are an integral part of these financial statements. 44

45 TERAGO INC. Consolidated Statements of Changes in Equity (In thousands) Share Capital 1 Contributed Number Amount Surplus Deficit Total Balance, January 1, ,169 $ 69,661 $ 24,165 $ (55,641) $ 38,185 Issuance of shares upon exercise of options (24) Stock-based compensation Issuance of shares for Directors'Fees Issuance of shares on conversion of warrants 5 38 (38) - - Net loss and comprehensive loss (5,831) (5,831) Balance, December 31, ,256 $ 70,141 $ 24,180 $ (61,472) $ 32,849 Issuance of shares upon exercise of options Stock-based compensation Issuance of shares for Directors'Fees Net earnings and comprehensive earnings Balance, December 31, ,295 $ 70,453 $ 24,188 $ (61,258) $ 33,383 1 See Note 15 Share Capital for classes of shares The accompanying notes are an integral part of these financial statements. 45

46 TERAGO INC. Notes to Consolidated Financial Statements (In thousands, except for per share amounts) 1. Reporting Entity TeraGo Inc. (the Company) is a leading wireless broadband communications service provider to businesses in Canada. The Company is located in Canada and the address of its registered office is Suite Commerce Valley Drive West, Thornhill, Ontario. The Company was incorporated under the Canada Business Corporations Act on December 21, 2000 and owns and operates a carrier-grade, fixed wireless, IP communications network in Canada targeting small to medium-sized businesses that require broadband Internet, data connectivity and voice services. The Company s common shares are listed on the Toronto Stock Exchange under the symbol TGO. 2. Basis of Preparation (a) Statement of Compliance These consolidated financial statements have been prepared in accordance with International Financial Reporting Standards ( IFRS ) as issued by the International Accounting Standards Board ("IASB"). These are the Company's first annual consolidated financial statements prepared using International Financial Reporting Standards ("IFRS"), and the Company has elected January 1, 2010 as the date of transition to IFRS (the 'Transition Date '). IFRS 1, First-time Adoption of IFRS ("IFRS 1"), has been applied. An explanation of how the transition to IFRS has affected the consolidated financial statements is included in notes 21 and 22. In preparing these financial statements, management has amended certain accounting, valuation and consolidation methods previously applied in the Canadian GAAP financial statements to comply with IFRS. The comparative figures for 2010 were restated to reflect these adjustments. Certain information relating to these adjustments is provided along with reconciliations and descriptions of the effect of the transition from Canadian GAAP to IFRS on equity, earnings and comprehensive income and cash flows. The consolidated financial statements were authorized for issue by the Board of Directors on February 27, (b) Basis of Measurement The consolidated financial statements have been prepared on a historical cost basis except for the following material items in the statement of financial position: financial instruments at fair value through profit (loss) ( FVTPL ) are measured at fair value through income or loss liabilities for cash-settled stock-based payment arrangements are measured at fair value (c) Functional and Presentation Currency These consolidated financial statements are presented in Canadian dollars, which is the Company s functional currency. (d) Use of Estimates and Judgments 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. Information about critical judgments in applying accounting policies that have the most significant effect on amounts recognized in the consolidated financial statements is included in the following areas: (i) (ii) Estimates of useful lives of network assets, property and equipment: Management's judgment involves the use of estimates for 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. Estimates of useful lives of intangible assets and goodwill: The calculation of useful life involves significant estimates and assumptions, including those with respect to future cash flows, discount rates and asset lives. These significant estimates and judgments could impact the Company s future results if the current estimates of future performance and fair values change, and could affect the amount of amortization expense on intangible assets in future periods. (iii) Impairment of non-financial assets: The process to calculate impairment of non-financial assets requires use of valuation methods such as the discounted cash flow method which uses assumptions to estimate cash flows. The recoverable amount depends significantly on the discount rate used in the cash flow model, as well as the expected future cash 46

47 TERAGO INC. Notes to Consolidated Financial Statements (In thousands, except for per share amounts) flows and the expected growth rates used. (iv) Allowance for doubtful accounts: In developing the estimates for an allowance, 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. (v) 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 and volatility of the underlying stock. (vi) Business Combination: The amount of goodwill initially recognized as a result of a business combination, the fair value estimate of the 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 on future cash flows expected to be derived from the assets. (vii) Income taxes: The Company recognizes deferred tax assets to the extent it is probable that they will be realized. This requires significant estimates and assumptions regarding future earnings, and the ability to implement certain tax planning opportunities in order to assess the likelihood of realizing the benefit of deferred tax assets. (viii) Provisions: Considerable judgment is required to assess the likelihood of an outflow of the economic benefits to settle contingencies, such as litigations, which may require a liability to be recognized. Significant judgments include assessing future cash flow, selection of discount rates and the probability of the occurrence of future events. a. Decommissioning and Restoration Obligations: Significant assumptions are required to measure decommissioning and restoration obligations, primarily related to the amount and timing of cash flows required to satisfy the Company's future legal obligations including labour costs based on current marketplace wages and the rate of inflation over expected years to settlement; the length of facility lease renewal periods and probability of such renewals; and the appropriate discount rate to present value the future cash flows. 3. Significant Accounting Policies (a) Basis of Consolidation The consolidated financial statements include the accounts of TeraGo Inc. and its wholly-owned subsidiaries, TeraGo Networks Inc., National Online Inc., Onsite Access (Canada) Inc. and Ontario Inc. (collectively, the Company). A subsidiary is an entity that is controlled by another entity, known as the parent. Control is the power to govern the financial and operating policies of an entity so as to obtain benefits from its activities. All intercompany transactions between subsidiaries are eliminated in consolidation. Onsite Access (Canada) Inc. was dissolved on December 20, National Online Inc. was amalgamated with TeraGo Networks Inc. on January 1, (b) 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: (d) Financial assets at FVTPL are measured at fair value at the balance sheet date with any gain or loss recognized immediately in net earnings (loss). Interest and dividends earned from these assets are also included in net earnings (loss) for the period. 47

48 TERAGO INC. Notes to Consolidated Financial Statements (In thousands, except for per share amounts) (e) (f) Loans and receivables are measured at amortized cost using the effective interest method. Any gains or losses are recognized in net earnings (loss) for the period. Other financial liabilities are measured at amortized cost using the effective interest method. Any gains or losses are recognized in net earnings (loss) for the period. The following is a summary of the Company s significant categories of financial instruments as at December 31, 2011: 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, investments, trade and other receivables. Restricted cash is classified as loans and receivables. 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. Short-Term Investments Short-term investments 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, bankers acceptance notes and investment savings accounts and these are in compliance with the Company s policy on investments. Short-term investments 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 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, bank overdrafts 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. 48

49 TERAGO INC. Notes to Consolidated Financial Statements (In thousands, except for per share amounts) (c) Network Assets, Property and Equipment Network assets, property and equipment are recorded at cost less accumulated depreciation and impairment charges, if any. Cost includes expenditures directly attributable to the acquisition of the asset. The cost of self-constructed network assets includes the cost of materials and direct labour and any other costs directly attributable to bringing the assets to a working condition for their intended purpose. This includes direct costs to design, acquire and build the asset and include directly attributable internally and externally generated engineering and construction costs, and equipment on-hand. Cost also includes the cost of dismantling and removing items and restoring the site on which they are located and specifically attributable borrowing costs on qualifying assets. Subsequent costs are included in the asset s carrying amount or recognized as a separate asset only when it is probable that future economic benefits associated with the item will flow to the Company and the costs of the item can be reliably measured. All other expenditures are charged to operating expenses as incurred. When major components of an item of network assets and property and equipment have different useful lives, they are accounted for as separate items. Depreciation of network assets and property and equipment is based on the estimated useful life of the assets as follows: Estimated useful life/ Asset depreciation method Network assets 4 to 9 years straight line Computer equipment 3 years straight line Office furniture and equipment 5 years straight line Leasehold improvements over the term of lease Vehicles 30% declining balance As of January 1, 2011, the estimated useful life for network assets was extended by two years to reflect actual usage experience based on historical data. This change in useful life resulted in a $1,107 and $3,965 decrease in depreciation of network assets for the three months and year ended December 31, Depreciation methods, useful lives and residual values are reviewed at least annually. Adjustments, if necessary, are recognized prospectively. (d) Intangibles and Other Assets Intangibles and other assets include the following: Radio Spectrum Licenses Radio spectrum licenses were recorded at cost less accumulated amortization and amortized on a straight-line basis over 10 years, which was the estimated useful life of the licenses. In March 2009, Industry Canada issued a decision granting a five-year extension to the initial term of the radio spectrum licenses held by the Company. As of June 2010, radio spectrum licenses are classified as indefinite life assets and are not amortized but are tested for impairment on an annual basis. The licenses are granted with an auto-renewal policy and non-renewal of licenses by the regulatory body is considered remote unless contract conditions are breached and it is noted that it is common industry practice for established telecommunications companies to treat these licenses as indefinite life. Computer Software Computer software is recorded at cost less accumulated amortization and amortized on a straight-line basis over 3 years. Customer Relationships, Brand and Acquired Real Estate Leases Customer relationships, brand and vendor s real estate leases are recorded at cost less accumulated amortization, initially measured at fair value on the acquisition date if acquired in a business combination. Customer relationships and brand are amortized on a straight-line basis over 5 years and acquired real estate leases are amortized over the term of the lease. Amortization methods, useful lives and residual values are reviewed at least annually. Adjustments, if necessary, are recognized prospectively. 49

50 TERAGO INC. Notes to Consolidated Financial Statements (In thousands, except for per share amounts) (e) Goodwill Goodwill is the amount that results when the fair value of consideration transferred for an acquired business exceeds the net fair value of the identifiable assets, liabilities and contingent liabilities recognized. When the Company enters into a business combination, the acquisition method of accounting is used. Goodwill is assigned, as of the date of the business combination, to cash generating units that are expected to benefit from the business combination. Each cash generating unit represents the lowest level at which goodwill is monitored for internal management purposes and it is never larger than an operating segment. During 2011, $246 was added to goodwill as a result of the acquisition of the assets of MetroBridge Networks International Inc. ( MetroBridge ) - see Note 6. During 2010, no amounts were added to goodwill. (f) Subscriber acquisition costs Subscriber acquisition costs are expensed as incurred. (g) Business Combinations Acquisitions of businesses are accounted for using the acquisition method. The consideration for each acquisition is measured at the aggregate of the fair values (at the date of exchange) of assets given, liabilities incurred or assumed, and equity instruments issued by the Company in exchange for control of the acquiree. Acquisition-related costs are recognized in earnings (loss) as incurred. Where applicable, the consideration for the acquisition includes any asset or liability resulting from a contingent consideration arrangement, measured at its acquisition-date fair value. Subsequent changes in such fair values are adjusted against the cost of acquisition where they qualify as measurement period adjustments (see below). All other subsequent changes in the fair value of contingent consideration classified as an asset or liability are accounted for in accordance with relevant IFRS sections. Changes in the fair value of contingent consideration classified as equity are not recognized. Where a business combination is achieved in stages, the Company s previously held interests in the acquired entity are remeasured to fair value at the acquisition date (i.e. the date the Company attains control) and the resulting gain or loss, if any, is recognized in profit or loss. Amounts arising from interests in the acquiree prior to the acquisition date that have previously been recognized in other comprehensive income are reclassified to profit or loss, where such treatment would be appropriate if that interest were disposed of. The acquiree s identifiable assets, liabilities and contingent liabilities that meet the conditions for recognition under IFRS 3 are recognized at their fair value at the acquisition date. If the initial accounting for a business combination is incomplete by the end of the reporting period in which the combination occurs, the Company reports provisional amounts for the items for which the accounting is incomplete. Those provisional amounts are adjusted during the measurement period (see below) or additional assets or liabilities are recognized, to reflect new information obtained about facts and circumstances that existed as of the acquisition date that, if known, would have affected the amounts recognized as of that date. The measurement period is the period from the date of acquisition to the date the Company obtains complete information about facts and circumstances that existed as of the acquisition date and is subject to a maximum period of one year. (h) Leases Leases entered into by the Company as lessee that transfer substantially all the benefits and risks of ownership to the Company are recorded as finance leases and are included in property and equipment and obligations under finance leases. Obligations under finance leases are reduced by lease payments net of imputed interest. All other leases are classified as operating leases under which lease payments are expensed on a straight-line basis over the term of the lease. Lease incentives received are recognized as an integral part of the total lease cost, over the term of the lease. Contingent lease payments are accounted for in the period incurred. (i) Impairment of non-financial assets The Company monitors events and changes in circumstances that may require an assessment of the recoverability of its non-financial long-lived assets, which includes network assets, property and equipment and intangibles subject to amortization and depreciation. If there is any indication of impairment, the recoverable amount of the asset is estimated in order to determine the extent of the impairment, if any. When an impairment test is performed, the recoverable amount is assessed by reference to the higher of the net present value of the expected future cash flows (value in use) and the fair 50

51 TERAGO INC. Notes to Consolidated Financial Statements (In thousands, except for per share amounts) 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. In performing the annual impairment test for the Company s single CGU, the Company measured the recoverable amount of the CGU based on the value in use calculation using certain key management assumptions. Cash flow projections, which were made over a three-year period was based on financial budgets approved by the Board. The Company discounted these estimates of future cash flows to their present value using a pre-tax discount rate of 8.9%. Based on the sensitivity analysis performed, the Company has concluded that no reasonably possible changes in the key assumptions on which the recoverable amount is based would cause the carrying amount of the CGU to exceed the recoverable amount. (j) Provisions A provision is recognized if, as a result of a past event, the Company has a present legal or constructive obligation that can be estimated reliably, and it is probable that an outflow of economic benefits will be required to settle the obligation. Where the impact is significant, provisions are determined by discounting the expected future cash flows at a pre-tax rate that reflects the current market assessments of the time value of money and the risk specific to the liability. The unwinding of the discount is recognized as a finance cost. a. Decommissioning and Restoration Obligations: In the course of the Company's operations, network and other assets are utilized on leased premises. Often costs are expected to be incurred associated with decommissioning these assets and restoring the location where these assets are situated upon ceasing their use on those premises. These decommissioning and restoration provisions are calculated on the basis of the identified costs for the current financial year, extrapolated into the future based on management's best estimates of future trends in prices, inflation, and other factors, and are discounted to present value at a risk-adjusted rate specifically applicable to the liability. Forecasts of estimated future provisions are reviewed periodically in light of future changes in business conditions or technological requirements. The Company records these decommissioning and restoration costs as Network Assets, Property and Equipment, and subsequently allocates them to expense using a systematic and rational method over the asset's useful life. The Company records the accretion of the liability (unwinding of the discount) as a charge to finance costs. (k) Foreign Currency Translation Foreign currency accounts are translated into Canadian dollars as follows: At the transaction date, each asset, liability, revenue, and expense is translated into Canadian dollars using the exchange rate in effect at that date. At the year-end date, monetary assets and liabilities are translated into Canadian dollars by using the exchange rate in effect at that date. The resulting foreign exchange gains and losses are included in net earnings in the current period. (l) Finance income and finance costs Finance income comprises interest income on funds invested, dividend income, gains on sale of available-for-sale financial assets, and changes in fair value of financial assets at FVTPL. Finance costs comprise interest expense on borrowings, accretion of discounts on provisions, and changes in fair value of financial assets at FVTPL. Borrowing costs that are not directly attributable to the acquisition or construction of a qualifying asset are recognized in earnings and loss using the effective interest method. (m) Income Taxes Income taxes on earnings and loss include current and deferred taxes. Income taxes are recognized in earnings and loss except to the extent that it relates to business combinations, or items recognized directly in equity or in other comprehensive income. Current tax is the expected tax payable or receivable on the taxable income or loss for the period, 51

52 TERAGO INC. Notes to Consolidated Financial Statements (In thousands, except for per share amounts) using tax rates enacted or substantively enacted at the reporting date, and any adjustment to tax payable in respect of previous years. Deferred tax is generally recognized in respect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for taxation purposes. Deferred tax assets and liabilities are measured, on an undiscounted basis, at the tax rates that are expected to be applied to temporary differences when they reverse, based on the laws that have been enacted or substantively enacted by the reporting date. Deferred tax assets and liabilities are recognized where the carrying amount of an asset or liability in the consolidated statement of financial position differs from its tax base, except for differences arising on: the initial recognition of goodwill; the initial recognition of an asset or liability in a transaction which is not a business combination and at the time of the transaction affects neither accounting or taxable profit; and investments in subsidiaries, branches and associates, and interests in joint ventures where the Company is able to control the timing of the reversal of the difference and it is probable that the difference will not reverse in the foreseeable future. A deferred tax asset is recognized to the extent it is probable that it will be realized. Deferred tax assets are reviewed at each reporting date and are reduced to the extent it is no longer probable the related tax benefit will be realized. (n) Government incentives The Company applies for government incentive programs such as investment tax credits. Government incentives are recognized when there is reasonable assurance of realization and reflected as a reduction of the expenditure to which the incentive relates. In the event the investment tax credits received differs from the amount claimed, the difference will be reflected in operations in the period in which it is determined. (o) Revenue Recognition The Company earns revenue by providing Internet access, data connectivity and voice services. Revenue is measured at the fair value of the consideration received or receivable for services, net of discounts and sales taxes. Revenue is recognized as the related services are provided to customers, if evidence of an arrangement exists, collection is deemed probable by management, and revenue and costs are reliably measurable. The principal sources of revenue to the Company and recognition of these revenues are as follows: (i) Monthly recurring revenue from Internet access and data connectivity services are recognized as service revenue ratably over the number of months in the contract term and as related services are provided to the customer. (ii) Revenue from installation services that do not have standalone value from the ongoing service is deferred and recognized over the initial term of the contract. (iii) Usage revenue is recorded as service revenue in the month the usage occurs. Billings or payments received from customers in advance of revenue recognition are recorded in deferred revenue on the consolidated statement of financial position. (p) Stock-based Compensation Plans The Company has equity-settled and cash-settled stock-based compensation plans. The grant date fair value of equity settled stock-based payment awards to employees and directors are recognized as compensation cost, with a corresponding increase to equity, over the vesting period of the award. For cash-settled awards, the awards are classified as a liability and are re-measured to fair value at each reporting date. The Company accounts for the effects of service and non-market performance conditions in measuring the fair value of the liability in cash-settled awards by adjusting the number of rights to receive cash that are expected to satisfy any service and nonmarket performance conditions on a best estimate basis. Awards with graded vesting are valued and recognized as compensation cost based on the respective vesting tranche. The amount of compensation cost recognized is adjusted to reflect the number of awards expected to vest based on continued employment vesting conditions, such that the amount ultimately recognized as compensation cost is based on the number of awards that vest. The Employee share purchase plan allows employees to voluntarily participate in a share purchase plan. Under the terms 52

53 TERAGO INC. Notes to Consolidated Financial Statements (In thousands, except for per share amounts) of the plan, employees can contribute a specified percentage of their regular earnings through payroll deductions and the Company makes a contribution match which is recorded as compensation expense. (q) Operating Segments Management has determined that the Company operates in a single reportable operating segment. The Company offers its Internet, data connectivity and voice services exclusively in Canada. All of the Company's identifiable assets as at December 31, 2011 and 2010 and January 1, 2010 were located in Canada. (r) Earnings (Loss) Per Share The basic earnings or loss per share has been computed by dividing the net earnings or loss for the period by the weighted average number of Common and Class A Non-Voting shares outstanding during the period. Diluted earnings or loss per share is computed by adjusting the net earnings or loss attributable to common shareholders for the period and the weighted average number of Common and Class A Non-Voting shares outstanding for the period for the effects of all potentially dilutive common shares including shares subject to the exercise of stock options and warrants, where dilutive. The Company uses the treasury stock method for calculating diluted earnings per share. 4. Recent Accounting Pronouncements (i) Changes in Accounting Policies See Notes 21 and 22 for Transition to IFRS. (ii) Recent Accounting Pronouncements Certain new standards, interpretations, amendments and improvements to existing standards were issued by the IASB which becomes applicable at a future date. The standards impacted that may be applicable to the Company are as follows: Financial Instruments In October 2010, the IASB issued IFRS 9, Financial Instruments ("IFRS 9"). IFRS 9, which replaces IAS 39, Financial Instruments: Recognition and Measurement, establishes principles for the financial reporting of financial assets and financial liabilities that will present relevant and useful information to users of financial statements for their assessment of the amounts, timing and uncertainty of an entity's future cash flows. This new standard is effective for the Company s interim and annual consolidated financial statements commencing January 1, Transfer of Financial Assets In October 2010, the IASB issued amendments to IFRS 7, Transfer of Financial Assets ( IFRS 7 ). The amendments introduce new disclosure requirements about transfer of financial assets including disclosure for, financial assets that are not derecognized in their entirety and, financial assets that are derecognized in their entirety but for which the entity retains continuing involvement. These amendments are effective for annual periods beginning on or after July 1, Deferred Tax: Recovery of underlying assets In December 2010, the IASB issued amendments to IAS 12, Income Taxes ( IAS 12 ) as Deferred Tax: Recovery of Underlying Assets Amendments to IAS 12. The amendments provide an exception to the general principle in IAS 12 that the measurement of deferred tax assets and deferred tax liabilities should reflect the tax consequences that would follow from the manner in which the entity expects to recover the carrying amount of an asset. These amendments are effective for annual period beginning on or after January 1, Consolidated Financial Statements In May 2011, the IASB issued IFRS 10, Consolidated Financial Statements ( IFRS 10 ). IFRS 10, which replaces the consolidation requirements of SIC-12 Consolidation Special Purpose Entities and IAS 27 Consolidation and Separate Financial Statements and establishes principles for the presentation and preparation of consolidated financial statements when an entity controls one or more entities. This new standard is effective for the Company s interim and annual consolidated financial statements commencing January 1, Disclosure of Interests in Other Entities In May 2011, the IASB issued IFRS 12, Disclosure of Interests in Other Entities ( IFRS 12 ). IFRS 12 is a new and comprehensive standard on disclosure requirements for all forms of interests in other entities, including subsidiaries, joint arrangements, associates and unconsolidated structured entities. This new standard is effective for the Company s interim and annual consolidated financial statements commencing January 1,

54 TERAGO INC. Notes to Consolidated Financial Statements (In thousands, except for per share amounts) Fair Value Measurement In May 2011, the IASB issued new guidance on IFRS 13, Fair Value Measurement ( IFRS 13 ). IFRS 13 aims to improve consistency and reduce complexity by providing precise definition of fair value and a single source of fair value measurement and disclosure requirements for use across IFRSs. This new guidance is effective for the Company s interim and annual consolidated financial statements commencing January 1, Separate Financial Statements In May 2011, the IASB issued amendments to IAS 27, Separate Financial Statements ( IAS 27 ). The amended version of IAS 27 now only deals with the requirements for separate financial statements, which have been carried largely unamended from IAS 27, Consolidated and Separate Financial Statements. Requirements for Consolidated financial statements are now contained in IFRS 10, Consolidated Financial Statements. The standard requires that when an entity prepares separate financial statements, investment in subsidiaries, associates, and jointly controlled entities are accounted for either at cost, or in accordance with IFRS 9, Financial Instruments. These amendments are effective for annual periods beginning on or after January 1, Other Comprehensive Income In June 2011, the IASB issued amendments to IAS 1, Presentation of Financial Statements ( IAS 1 ). The amendments require companies preparing financial statements in accordance with IFRSs to group together items within Other Comprehensive Income (OCI) that may be reclassified to the profit or loss section of the income statement. The amendments also reaffirm existing requirements that items in OCI and profit or loss should be presented as either a single statement or two consecutive statements. These amendments are effective for annual periods beginning on or after July 1, Offsetting Financial Assets and Financial Liabilities In December 2011, the IASB issued amendments to IAS 32, Financial Instruments: Presentation ( IAS 32 ). The amendments require entities to disclose gross amounts subject to rights of set-off, amounts set off in accordance with the accounting standards followed, and the related net credit exposure. This information will help investors understand the extent to which an entity has set off in its balance sheet and the effects of rights of set-off on the company s rights and obligations. These amendments are effective for annual periods beginning on or after January 1, 2014 and are required to be applied retrospectively. Disclosures - Offsetting Financial Assets and Financial Liabilities In December 2011, the IASB issued amendments to the disclosure requirements in IFRS 7, Financial Instruments: Disclosures ( IFRS 7 ). The amendments require information about all recognized financial instruments that are set off in accordance with paragraph 42 of IAS 32, Financial Instruments: Presentation ( IAS 32 ). The amendments also require disclosure of information about recognized financial instruments subject to enforceable master netting arrangements and similar agreements even if they are not set off under IAS 32. These amendments are effective for annual periods beginning on or after January 1, The Company is assessing the impact of these new standards on its consolidated financial statements. 54

55 TERAGO INC. Notes to Consolidated Financial Statements (In thousands, except for per share amounts) 5. Financial Instruments (i) The Company has classified its financial instruments as follows: December 31 December 31 January Financial assets: Loans and receivables, measured at amortized cost Cash and cash equivalents $ 3,224 $ 1,083 $ 1,074 Short-term investments 1,096 1,071 7,121 Accounts receivable 3,318 3,175 2,491 Restricted cash ,000 Financial liabilities, measured at amortized cost: Accounts payable and accrued liabilities 6,991 5,506 5,805 Long-term debt 13,582 6,817 - (ii) Cash and cash equivalents The Company s cash and cash equivalents are comprised of bank balances at major Canadian financial institutions. (iii) Short-term investments The Company s short-term investments are as follows: December 31 December 31 January Guaranteed Investment Certificates (maturity dates of 1 year with interest rates of 1.50% to 1.85%) $ 1,096 $ 1,071 $ 7,121 Interest earned on short-term investments is included in finance income. (iv) Accounts receivable The Company s accounts receivable is comprised of the following: December 31 December 31 January Trade receivables $ 3,223 $ 3,094 $ 2,524 Allowance for doubtful accounts (82) (27) (125) Other $ 3,318 $ 3,175 $ 2,491 The Company s summary of activity related to allowance for doubtful accounts is as follows: December 31 December 31 January Opening Balance $ (27) $ (125) $ (176) Additions (251) (127) (187) Write-offs Ending Balance $ (82) $ (27) $ (125) (v) Restricted cash Restricted cash is comprised of cash restricted from current use in operations (see Note 9). 55

56 TERAGO INC. Notes to Consolidated Financial Statements (In thousands, except for per share amounts) (vi) 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 - Level 2 - Level 3 - Unadjusted quoted prices in active markets for identical assets or liabilities; Inputs other than quoted prices included in Level 1, that are observable for the asset or liability, either directly or indirectly; and 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 balance sheets, 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. Credit risk The Company s cash and cash equivalents and short-term investments 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 s maximum exposure to credit risk is limited to the amount of cash and cash equivalents and short-term investments. 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, 2011 and 2010, the Company had no material past due trade accounts receivable. The following table provides the aging of the trade accounts receivable: December 31 December 31 January Current $ 2,356 $ 2,255 $ 1, to 60 days to 90 days over 90 days $ 3,223 $ 3,094 $ 2,524 Interest rate risk The Company is subject to interest rate risk on its cash and cash equivalents, short-term investments and long-term debt. The Company believes that interest rate risk is low as its short term investments consists of low risk money market and fixed income securities with maturity dates of less than one year. It is exposed to interest rate risk on its long-term debt and 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, 2011 and 2010, the long-term debt facility balance is $13,108 and $6,500, respectively (Note 11). A 1% increase or decrease in interest rates would result in an increase or decrease of interest expense of $131 per year. 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, 2011, the Company had cash and cash equivalents and short-term investments of $4,320. The Company has access to the $5,000 undrawn portion of its $19,000 credit facilities. 56

57 TERAGO INC. Notes to Consolidated Financial Statements (In thousands, except for per share amounts) The Company s liabilities that have contractual maturities are summarized below: Less than 1 year 1-3 years 4-5 years After 5 years Long-term debt including financing fees $ 3,606 $ 5,913 $ 4,308 $ - $ 13,827 Finance leases Operating leases 6,264 7,249 5, ,809 Metrobridge contingent payment (Note 6) 1, ,516 Purchase Obligations 2, ,109 Stock-based compensation 1, ,304 Total $ 15,413 $ 13,869 $ 9,432 $ 172 $ 38,886 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 $9 per year. Balances denominated in foreign currencies that are considered financial instruments are as follows: Total December 31 December 31 January 1 Currency Cash and cash equivalents USD $ 1 $ - $ 1 Accounts payable and accrued liabilities USD The exchange rates used were as follows: USD $ $ $ MetroBridge Acquisition On May 31, 2011, the Company closed an asset purchase with MetroBridge and acquired substantially all of MetroBridge s customers, related network infrastructure, real estate leases, and other assets. MetroBridge provided small and medium-sized businesses with wireless broadband services. The acquisition further accelerated the Company s growth plan as it acquired network in the lower mainland of British Columbia and Vancouver and a customer base of 588 customer locations at closing. The final purchase price is comprised of $4,200 paid on the closing date of May 31, 2011 and the remaining balance to be paid following a final recurring revenue calculation to be completed for the 180 day period following the closing date. The fair value of the contingent consideration was estimated on the date of acquisition using best estimates of discounted future cash flows and resulted in $1,498 in contingent consideration being included as part of the purchase price for accounting purposes. The Company received a final release from the vendor and the final cash payment of $1,516 for the contingent consideration was made in January The difference of $18 from the initial fair value estimate of $1,498 was recorded as finance costs with a corresponding credit to accounts payable and accrued liabilities as of December 31, The acquisition was accounted for using the acquisition method in accordance with IFRS 3 with the results of operations consolidated with those of the Company effective June 1, 2011 and has contributed incremental revenue of $2,507 and net earnings of $538 for the year ended December 31, Management estimates that if the acquisition had occurred on January 1, 2011, total consolidated revenue of the Company would have been $46,713 and consolidated net earnings for the year would have been $598. The total acquisition related costs were $325 of which $69 was included in other operating items and the remaining amount was included in finance costs (Note 11). 57

58 TERAGO INC. Notes to Consolidated Financial Statements (In thousands, except for per share amounts) The fair values of the assets acquired in the acquisition are as follows: Network assets, property and equipment $1,674 Customer relationships 3,330 Brand 254 Acquired real estate leases 173 Prepaid Expenses 21 Goodwill 246 $5,698 Fair value of consideration Cash consideration $4,200 Contingent consideration 1,498 $5,698 Contingent consideration Contingent consideration at closing $1,498 Subsequent adjustment recorded as finance costs 18 $1,516 Goodwill represents the expected operational synergies with the acquiree including intangible assets that do not qualify for separate recognition. Under the current income tax act, goodwill and other intangible assets are deductible for tax purposes to the extent of 75% of the cost incurred. For tax purposes, 75% of eligible capital expenditures are added to the cumulative eligible capital amount, which is deductible for tax purposes at the rate of 7% per year on a declining balance method. The customer relationships, brand and acquired real estate leases are recorded as Intangibles and other assets. Customer relationships and brand are being amortized over a period of 5 years and acquired real estate leases are being amortized over the term of the lease. The acquired assets, including other intangibles and goodwill, have been integrated into the Company s single CGU. 7. Network Assets, Property and Equipment Cost Network assets Computer equipment Office furniture and equipment Leasehold improvements Vehicles Total Balance, January 1, 2011 $ 72,989 $ 1,632 $ 2,347 $ 709 $ 46 $ 77,723 Additions/ reclassifications 1 11, (21) 1-11,362 Disposals (1,572) (1,572) Balance, December 31, 2011 $ 82,647 $ 1,784 $ 2,326 $ 710 $ 46 $ 87,513 Accumulated Depreciation Balance, January 1, 2011 $ 40,616 $ 1,271 $ 1,852 $ 425 $ 14 $ 44,178 Depreciation for the year 6, ,486 Disposals (1,224) - (24) - - (1,248) Balance, December 31, 2011 $ 46,346 $ 1,480 $ 2,050 $ 517 $ 23 $ 50,416 Net Book Value, December 31, 2011 $ 36,301 $ 304 $ 276 $ 193 $ 23 $ 37,097 58

59 TERAGO INC. Notes to Consolidated Financial Statements (In thousands, except for per share amounts) Cost Network assets Computer equipment Office furniture and equipment Leasehold improvements Vehicles Total Balance, January 1, 2010 $ 60,788 $ 1,353 $ 2,296 $ 571 $ 4 $ 65,012 Additions/ reclassifications 13, ,666 Disposals (946) (9) (955) Balance, December 31, 2010 $ 72,989 $ 1,632 $ 2,347 $ 709 $ 46 $ 77,723 Accumulated Depreciation Balance, January 1, 2010 $ 30,852 $ 1,143 $ 1,773 $ 505 $ 2 $ 34,275 Depreciation for the year 2 10, (69) 12 10,507 Disposals (587) (6) - (11) - (604) Balance, December 31, 2010 $ 40,616 $ 1,271 $ 1,852 $ 425 $ 14 $ 44,178 Net Book Value, December 31, 2010 $ 32,373 $ 361 $ 495 $ 284 $ 32 $ 33,545 1 Of the total addition, $1,674 were acquired through the acquisition of MetroBridge (Note 6) 2 Depreciation for the year includes reclassifications between various asset classes as part of the reconciliation of the subledger. This had no impact on total depreciation. As at December 31, 2011, the Company has included assets under finance lease of $1,028 (December 31, $1,034, January 1, $167) with accumulated depreciation of $285 (December 31, $147, January 1, $2) in network assets and $86 (December 31, $56, January 1, $24) with accumulated depreciation of $46 (December 31, $20, January 1, $12) in office furniture and equipment. Purchases of assets under finance lease are considered a non-cash investing and financing activity and are excluded from additions to network assets, property and equipment in the consolidated statement of cash flows. For the years ended December 31, 2011 and 2010, the Company has included capitalized wages of $3,354 and $3,702, respectively, in network assets. During 2011, the Company wrote off assets with a net book value of $346 (Cost of $1,238 less accumulated depreciation of $892) to reflect physical inventory count results. This corresponding loss on disposal of network assets of $324 was included in Other operating items. During 2010, the Company wrote off network assets with a net book value of $369 (Cost of $979 less accumulated depreciation of $610) to reflect physical inventory count results. This corresponding loss on disposal of network assets of $330 was included in Other operating items. 8. Intangibles and Other Assets Cost Radio spectrum licenses Computer Software Customer relationships Brand and acquired real estate leases Balance, January 1, 2011 $ 7,041 $ 3,160 $ - $ - $ 10,201 Additions (Note 6) - 1,299 3, ,056 Balance, December 31, 2011 $ 7,041 $ 4,459 $ 3,330 $ 427 $ 15,257 Accumulated Amortization Balance, January 1, 2011 $ 2,371 $ 1,625 $ - $ - $ 3,996 Amortization for the period ,341 Balance, December 31, 2011 $ 2,371 $ 2,523 $ 393 $ 50 $ 5,337 Net Book Value, December 31, 2011 $ 4,670 $ 1,936 $ 2,937 $ 377 $ 9,920 Total 59

60 TERAGO INC. Notes to Consolidated Financial Statements (In thousands, except for per share amounts) Cost Radio spectrum licenses Computer Software Customer relationships Brand and acquired real estate leases Balance, January 1, 2010 $ 2,553 $ 1,704 $ - $ - $ 4,257 Additions 4,488 1, ,944 Balance, December 31, 2010 $ 7,041 $ 3,160 $ - $ - $ 10,201 Accumulated Amortization Balance, January 1, 2010 $ 2,344 $ 1,159 $ - $ - $ 3,503 Amortization for the year Balance, December 31, 2010 $ 2,371 $ 1,625 $ - $ - $ 3,996 Net Book Value, December 31, 2010 $ 4,670 $ 1,535 $ - $ - $ 6,205 On March 1, 2007, the Company entered into a 5 year operating lease agreement (with a 5 year extension) to use a range of wireless spectrum. The lease contained an option which allowed the Company to purchase the above mentioned spectrum range. On June 23, 2010, the Company exercised its option to purchase licenses for 24GHz spectrum covering six of the largest markets in Canada for a gross purchase price of $5,000 less certain deductions. Industry Canada approval was received in July Restricted Cash On June 18, 2007, two officers (one current and one former) exchanged 287 and 63 options respectively to purchase Common Shares, at an exercise price of $4 per share with options to purchase 189 and 41 Common Shares at $0 exercise price. The exchanged options had a value equal to the original options. On June 18, 2007, these options were exercised to facilitate Common Share ownership and as a result, the two officers received 189 and 41 Common Shares, respectively, pursuant to such exercise. The Company provided the officers with an indemnity with a combined maximum coverage of $1,000 to cover any potential negative personal tax consequences that might arise as a result of the early exercise of these options. The indemnity period for the current officer expires in June The restricted cash is segregated for the period of the indemnity and is invested in a guaranteed investment certificate. The related accrued interest is included in short-term investments. During the third quarter of 2009, the Company received notice of a claim from the former officer against the restricted cash balance relating to the sale of the 41 Common Shares. The notice of claim was settled in the second quarter of 2010 for $179 and an additional stock-based compensation expense of $50 was recorded in that quarter. There were no changes to restricted cash in Commitments The Company is committed to leases for premises, office equipment, network real estate access, automobiles, telecommunication facilities and radio spectrum licenses. Annual minimum payments over the next five years and thereafter are as follows: Amount 2012 $ 6, , , , ,890 Thereafter 172 $ 18,809 It is common practice for the company to re-negotiate network real estate access lease arrangements as they become due for renewal. Included in the amounts above are estimates for the renewal of leases that are currently due for renewal or are due for renewal in Total 60

61 TERAGO INC. Notes to Consolidated Financial Statements (In thousands, except for per share amounts) Per the conditions established by Industry Canada for the 24/38 GHz licenses, the Company is required to invest, as a minimum, two percent of its adjusted gross revenues (as defined by Industry Canada) resulting from the Company s operations in respect of its licenses from Industry Canada in the 24/38 GHz frequency bands, averaged over the term of such licenses, in research and development related to telecommunications. As at December 31, 2011, management believes they are in compliance with this condition to that date and the Company has made the required research and development expenditures. The Company is required to pay, under a CRTC-administered regime, a percentage (currently 0.66%, %) of its adjusted Canadian telecommunications service revenue (as defined by CRTC and excluding retail Internet revenue) into a fund administered by CRTC. 11. Long-term Debt December 31 December Long-term debt facility $ 13,108 $ 6,500 Equipment loan less: financing fees (245) (162) 13,582 6,817 less: current portion (3,557) (544) $ 10,025 $ 6,273 The Company entered into a new agreement in May 2011 with the Royal Bank of Canada that provides credit facilities totaling $19,000 that are principally secured by a general security agreement over the Company s assets. The new facilities essentially refinanced, at lower interest rates, an existing $10,000 facility with the Business Development Bank of Canada ( BDC ) and added incremental financing for the asset purchase of MetroBridge. The agreement includes three new senior term debt facilities totalling $16,000 and also includes a $3,000 operating line of credit that replaced an existing $3,500 operating line of credit on similar terms and bears interest at a floating rate of prime plus 1.65%. The outstanding long-term debt of $7,500 with the BDC was repaid using proceeds from the new debt facility and the related deferred financing fees of $71 ($88 less amortization of $17) were written off to finance costs. The additional $16,000 in senior term debt is available to the Company in 3 facilities: $7,500 to repay the drawn portion of TeraGo s senior term credit facility with BDC bears interest at the rate of 4.74% and is repayable in monthly principal installments of $125 starting October 2011 and matures September 2014; $5,500 to finance the MetroBridge purchase of which $4,200 bears interest at 4.61% and $1,300 bears interest at 3.97% is repayable in monthly principal installments of $92 starting June 2011 and matures September This facility has been fully drawn as of December 31, 2011; and $3,000 available for general working capital purposes to fund continued growth bears interest at 4.31% and is repayable in monthly principal installments of $75 starting April 2012 once fully drawn. $2,000 of this facility remains undrawn as of December 31, In May 2011, the Company incurred financing fees of $256 related to this transaction which are being amortized using the effective interest method over the term of the debt. The Company entered into equipment loans for $507 in October 2010 and $500 in March 2011 that are secured by the equipment. The debt facility is repayable in monthly installments of $16 and $16, respectively, and bears interest at a fixed rate of 7.69% and 7.30%, respectively, for 3 years. 12. Other Long-Term Liabilities 61 December 31 December 31 January Restricted Share Units (Note 16) $ 1,713 $ 796 $ 240 Performance-based Share Units (Note 16) Finance lease obligations ,625 1, less: current portion of finance lease obligations and RSUs (1,930) (475) (93) $ 695 $ 1,147 $ 320

62 TERAGO INC. Notes to Consolidated Financial Statements (In thousands, except for per share amounts) The Company has entered into finance leases for certain network assets and office equipment. The leases expire on various dates. Minimum lease payments for finance leases in aggregate are as follows: 2012 $ Total minimum lease payments 342 Interest included in minimum lease payments at rates between 6.90% and 9.01% (21) Total finance lease obligations $ Decommissioning and Restoration Obligations The Company s hub sites are established in leased premises. As part of the leasing arrangements with the landlords, the Company is liable for all restoration costs to ensure that the space is returned to its original state upon termination of the lease. The asset retirement obligation relates to future site restoration costs related to these leased facilities. The decommissioning and restoration obligations were determined using a discount rate of 15% over a range of periods from 2025 to As at December 31, 2011 and 2010, the amount of undiscounted cash flows required to settle this liability were $5,649 and $5,335, respectively. The following table presents the reconciliation of the beginning and ending aggregate carrying amount of the decommissioning and restoration obligations associated with the retirement of network assets: December 31 December 31 January Obligation, beginning of year $ 166 $ 146 $ 146 Accretion expense Obligation, end of year $ 186 $ 166 $ Income Taxes December 31 December Loss before Income taxes (recovery) $ 214 $ (5,831) Income tax expense (recovery) at statutory rates $ $ (1,808) (31.0) Expenses (revenue) deducted (included) in the accounts that have no corresponding deduction (inclusion) for income taxes Change in unrecognized deferred tax assets (246) (115.0) 1, Difference in effective tax rates (71) (33.2) Expiry of loss carryforwards (66) (1.1) Other (180) (84.2) Tax expense $ - - $

63 TERAGO INC. Notes to Consolidated Financial Statements (In thousands, except for per share amounts) Deferred tax assets have not been recognized for the following: December 31 December 31 January Excess UCC over NBV $ 10,952 $ 11,321 $ 9,969 SR&ED Non-capital tax loss carry forwards 1,891 1,691 1,653 Finance costs Other differences ,852 14,123 13,211 Valuation allowance (13,852) (14,123) (13,211) $ - $ - $ - The non-capital tax losses carried forward are available to reduce future taxable income and expire as follows: 2012 $ , , $ 7, Share Capital Authorized Unlimited Unlimited Two Dividends Common Shares Class A Non-voting Shares, convertible into Common Shares on a share for share basis if the holder meets certain regulatory requirements. Class B Shares, non-transferable unless approved by the Board, non-participating and redeemable. Holder of Class B shares are entitled to nominate and elect one director for each Class B Share held. Dividends are payable in an equal amount on each Common Share and each Class A Non-Voting Share. Issued Common Shares Number of Class A Non-Voting Shares Balance, January 1, ,536 3,633 11,169 Issuance of Common Shares on exercise of Options Issuance of Common Shares on conversion of Warrants 5-5 Issuance of Common Shares for Directors'Fees Balance, December 31, ,623 3,633 11,256 Issuance of Common Shares on exercise of Options Issuance of Common Shares for Directors'Fees Balance, December 31, ,662 3,633 11,295 Total 63

64 TERAGO INC. Notes to Consolidated Financial Statements (In thousands, except for per share amounts) Issued Common Shares In $ Class A Non-Voting Shares Share Issue Costs Balance, January 1, ,130 14,187 (5,656) 69,661 Issuance of Common Shares on exercise of Options Issuance of Common Shares on conversion of Warrants Issuance of Common Shares for Directors'Fees Balance, December 31, ,610 14,187 (5,656) 70,141 Issuance of Common Shares on exercise of Options Issuance of Common Shares for Directors'Fees Balance, December 31, ,922 14,187 (5,656) 70,453 Total 16. Stock-Based Compensation i. Options There are 1,429 Common Shares reserved for issuance under the Company s stock option plan. Upon closing of our initial public offering on June 26, 2007, 799 options granted under the Company s original option plan (the Old Plan ) fully vested. Options granted under the Old Plan expire 10 years from date of vesting and as at December 31, 2011, there are 596 Common Shares reserved for issuance under the Old Plan with a weighted average exercise price of $4.00. On June 18, 2007, at a meeting of the Board of Directors, the Company adopted a new option plan (the 2007 Option Plan ) which is available to our directors, officers, employees and other persons approved by the Board from time to time. On Closing of our initial public offering, 833 Common Shares were reserved for issuance under the 2007 Option Plan. As at December 31, 2011, 569 options to purchase Common Shares have been granted under the 2007 Option Plan. The options granted under the 2007 Option Plan expire 10 years from the date of grant and vest on a quarterly basis in 12 equal amounts over three years. All options under the 2007 Option Plan will vest immediately on a change of control of the Company. During the year ended December 31, 2011, the Company recorded stock-based compensation of $8 with a corresponding credit to contributed surplus related to stock options granted to director, officers and employees of the Company. During year ended December 31, 2010, the Company recorded stock-based compensation of $77. A summary of the status of the Company s stock option plan as at December 31, 2011 and 2010 is presented below Number of Options Weighted Average Exercise Price Number of Options Weighted Average Exercise Price Outstanding - January 1, ,200 $6.90 1,274 $6.85 Exercised (13) $4.00 (42) $4.16 Forfeited / Expired (22) $10.21 (32) $8.84 Outstanding - December 31, ,165 $6.87 1,200 $6.90 Exercisable 1,165 $6.87 1,171 $6.96 The Company estimated the fair value of all options issued using the Black-Scholes option-pricing model. The weighted average share price at the date of exercise for options exercised in 2011 was $10.42 ( $5.64). 64

65 TERAGO INC. Notes to Consolidated Financial Statements (In thousands, except for per share amounts) ii. Restricted Share Units (RSUs) On March 12, 2009, the Company established a RSU Plan which is available to our directors, officers, and full-time employees approved by the Board from time to time. In the first quarter of 2009, the Company granted 203 RSUs. The share price at the date of grant was $3.15 and is re-measured to fair value on a quarterly basis. The value of one RSU is equal to the value of one Common Share. Plan participants are granted a specific number of RSUs for a given period based on their position and level of contribution. At the end of the three-year vesting period, the RSUs vest if the plan participant is employed by the Company. Vested RSUs are expected to be paid in cash or Common Shares purchased on the open market, or a combination of both, as the Company chooses. All RSUs under this Plan will vest immediately on a change of control of the Company. The fair value of restricted share units is determined based on the market price of the underlying common share of the Company. For the years ended December 31, 2011 and 2010, the Company recorded stock-based compensation of $917 and $556, respectively, related to the RSUs granted. As at December 31, 2011, a liability of $1,713 related to the RSUs granted is included in the current portion of Other long-term liabilities (Note 12). The following table is a summary of the number of outstanding RSUs as at: December 31 December 31 January Opening Balance Granted Forfeited - (17) (8) Ending Balance iii. Performance-based Share Units (PSUs) On August 10, 2010, the Company granted 99 PSUs to certain key executives. The share price at the date of grant was $5.93 and will be re-measured to fair value each reporting period. On March 2, 2011, the Company granted 70 PSUs to certain key executives. The share price at the date of grant was $9.84 and is re-measured to fair value each reporting period. The value of one PSU is equal to the value of one Common Share. Plan participants are granted a specific number of PSUs for a given period based on their position and level of contribution. At the end of the three-year vesting period, the PSUs vest if the plan participant is employed by the Company and certain non-market performance criteria are met. Vested PSUs are expected to be paid in cash or Common Shares purchased on the open market, or a combination of both, as the Company chooses. All PSUs under this Plan will vest immediately on a change of control of the Company. For the years ended December 31, 2011 and 2010, the Company recorded stock-based compensation of $511 and $80, respectively, related to the PSUs granted. As at December 31, 2011, a liability of $591 related to the PSUs granted is included in Other long-term liabilities (Note 12). The following table is a summary of the number of outstanding PSUs as at: December 31 December Opening Balance 99 - Granted Forfeited (2) - Ending Balance iv. Employee Share Purchase Plan In May 2011, the Company started a plan that allows employees to voluntarily participate in a share purchase plan to purchase the Company s common shares through payroll deductions. Under the terms of the plan, employees may elect to contribute 1% to 5% of their regular gross earnings. The Company makes a contribution of 25% of the employee s contribution to the Plan for the benefit of the employee which is recorded as compensation expense. The designated administrator of the plan then purchases the shares on the open market on behalf of the participants. For the year ended December 31, 2011, the Company recorded compensation expense of $15 related to the employee share purchase plan. 65

66 TERAGO INC. Notes to Consolidated Financial Statements (In thousands, except for per share amounts) v. Stock-Based Compensation Summary The following table is a summary of the stock-based compensation: Year ended December Stock options $ 8 $ 127 Restricted share units Performance-based share units Directors'Fees paid in shares Earnings (loss) Per Share $ 1,695 $ 1,003 The following table sets forth the calculation of basic and diluted earnings (loss) per share. Numerator for basic and diluted earnings (loss) per share: Net earnings (loss) for the year Denominator for basic and diluted earnings (loss) per share: Basic weighted average number of shares outstanding Effect of stock options, RSU and PSU Diluted weighted average number of shares outstanding Earnings (loss) per share: Basic Diluted Year ended December $ 214 $ (5,831) 11,273 11,198 1,510-12,783 11,198 $ 0.02 $ (0.52) $ 0.02 $ (0.52) For the year ended December 31, 2010, the effect of stock options, RSU and PSU of 1,477 were excluded in the calculation of diluted earnings (loss) per share because they were antidilutive. 18. Key Management Personnel Compensation Key management personnel are those persons having authority and responsibility for planning, directing and controlling the activities of the Company, including the directors of the Company. Key management personnel compensation, including directors, is as follows: 66 Year ended December Short-term employee benefits $ 2,301 $ 1,911 Termination benefits Share-based payments 1, $ 4,193 $ 2, Management of Capital The Company s objectives when managing capital are: i. to ensure that the Company will continue as a going concern so that it can continue to provide services to its customers and offer a return on investment to its shareholders; ii. to maintain a capital structure which optimizes the cost of capital while providing flexibility and diversity of funding sources and timing of debt maturities along with adequate anticipated liquidity for future growth; and iii. to comply with debt covenants.

67 TERAGO INC. Notes to Consolidated Financial Statements (In thousands, except for per share amounts) The Company defines capital that it manages as the aggregate of its cash and cash equivalents, short-term investments, debt facilities including finance leases and equity comprising of share capital, contributed surplus and deficit. 67 December 31 December 31 January Cash and cash equivalents $ (3,224) $ (1,083) $ (1,074) Short-term investments (1,096) (1,071) (7,121) Long term debt facilites and finance lease obligations 13,903 7, Share capital 70,453 70,141 69,661 Contributed surplus 24,188 24,180 24,165 Deficit (61,258) (61,472) (55,641) $ 42,966 $ 38,258 $ 30,163 The Company manages its capital structure and makes adjustments to it in light of economic conditions. The Company, upon approval from its Board of Directors, will make changes to its capital structure as deemed appropriate under the specific circumstances. The Company s investment policy is to invest only in investment grade, highly liquid money market and fixed income securities with less than one year maturity. The Company s term debt facilities and operating line of credit are subject to covenants which include maintaining minimum or maximum financial ratios. As of December 31, 2011, the Company is in compliance with these covenants and based on current business plans and economic conditions, the Company is not aware of any conditions or event that would give rise to non-compliance with the covenants. The Company s overall strategy with respect to management of capital remains unchanged from the prior year. 20. Related Party Transactions The Company provides services to one customer whose Chairman of the Board of Directors is one of the Directors of the Company. Revenue from this customer for the years ended December 31, 2011 and 2010 was $41 and $40, respectively. Accounts receivable from this customer as at December 31, 2011 and 2010 was $1 and $3, respectively. The Company provides services to one customer whose Chairman of the Board of Directors is the Chairman of the Board of Directors of the Company. Revenue from this customer for both the years ended December 31, 2011 and 2010 was $31. Accounts receivable from this customer as at December 31, 2011 and 2010 was $nil and $3, respectively. The terms governing these related party transactions are consistent with those negotiated on an arm s length basis with non-related parties. 21. Transition to IFRS As stated in Note 2, the Company s opening statement of financial position as at January 1, 2010 reflects the initial adoption of IFRS. The accounting policies set out in Note 3 and the application of IFRS 1 have been applied in preparing the audited consolidated financial statements for the year December 31, 2011, the comparative information presented in these audited consolidated financial statements for the year ended December 31, 2010 and in preparation of an opening IFRS statement of financial position on the Transition Date and statements of financial position at December 31, IFRS 1 requires an entity to adopt IFRS in its first annual financial statements prepared under IFRS by making an explicit and unreserved statement in those financial statements of compliance with IFRS. IFRS 1 requires first-time adopters to retrospectively apply all effective IFRS standards as of the reporting date, which for the Company is December 31, However, it also provides for certain optional and mandatory exemptions for first time IFRS adopters. Initial elections upon adoption Below are the IFRS 1 applicable exemptions applied in the conversion from Canadian GAAP to IFRS. IFRS Optional Exemption Options i. Business combinations IFRS 1 provides the option to apply IFRS 3 (revised), Business Combinations

68 TERAGO INC. Notes to Consolidated Financial Statements (In thousands, except for per share amounts) retrospectively or prospectively from the Transition Date. The retrospective basis would require restatement of all business combinations that occurred prior to the Transition Date. The Company elected not to retrospectively apply IFRS 3 to business combinations prior to its Transition Date and such business combinations have not been restated. Any goodwill arising on such business combinations before the Transition Date has not been adjusted from the carrying value previously determined under Canadian GAAP as a result of applying these exemptions. The Company adopted IFRS 3 on the Transition Date. Goodwill was tested for impairment on the Transition Date and no impairment was indicated. ii. iii. Share-based payment transactions IFRS 1 provides the option to retrospectively apply IFRS 2, Share-based Payments ( IFRS 2 ), to equity instruments and equity instruments expected to be settled in cash granted on or before November 7, 2002 ( Nov 7 Transition Date ). The Company has elected not to retrospectively apply IFRS 2 to equity instruments that were granted and had vested before the Nov 7 Transition Date. As a result of applying this exemption, the Company will apply the provisions of IFRS 2 only to all outstanding equity instruments that are unvested as at the Transition Date. Measurement of network assets, property and equipment at fair value IFRS 1 provides the option to use fair value or revaluation as deemed cost of an item of property, plant and equipment on the Transition Date. The Company elected not to utilize the exemption provided under IFRS 1 and has opted to measure network assets and property and equipment at depreciated historical cost in accordance with IAS 16, Property, Plant and Equipment on the Transition Date. iv. Borrowing Costs IFRS 1 provides an election that permits the Company to apply the requirements of IAS 23, Borrowing Costs ( IAS 23 ) prospectively from the Transition Date. IAS 23 requires the capitalization of borrowing costs directly attributable to the acquisition, construction or production of a qualifying asset as part of the cost of that asset. The Company elected to utilize this exemption provided by IFRS 1, therefore, the Company did not have an adjustment on its opening IFRS balance sheet. v. Decommissioning and restoration liabilities IFRIC 1, Changes in Decommissioning, Restoration and Similar Liabilities requires specified changes in decommissioning, restoration or similar liability to be added to or deducted from the cost of the asset to which it relates; the adjusted depreciable amount of the asset then is depreciated prospectively over its remaining useful life. IFRS 1 provides an election that permits the Company to not comply with the requirements for changes in such liabilities that occurred before the date of transition to IFRS. The Company elected to utilize this exemption provided by IFRS 1 therefore, the Company did not have an adjustment on its opening IFRS balance sheet. IFRS Mandatory Exemption vi. vii. Estimates - The estimates previously made by the Company under previous Canadian GAAP were not revised for the application of IFRS except where necessary to reflect any difference in accounting policy or where there was objective evidence that those estimates were in error. As a result the Company has not used hindsight to revise estimates. De-recognition of financial assets and liabilities - The Company has applied the de-recognition requirements in IAS 39, Financial Instruments: Recognition and Measurement, prospectively from the date of transition to IFRS. As a result any non-derivative financial assets or non-derivative financial liabilities derecognized prior to the date of transition to IFRS in accordance with previous Canadian GAAP have not been reviewed for compliance with IAS 39 de-recognition requirements. 68

69 TERAGO INC. Notes to Consolidated Financial Statements (In thousands, except for per share amounts) 22. Reconciliation of Canadian GAAP to IFRS In preparing the opening IFRS statement of financial position, the Company has adjusted amounts reported previously in financial statements prepared in accordance with Canadian GAAP. An explanation of how the transition from Canadian GAAP to IFRS has affected the Company s financial position and financial performance is set out in the accompanying tables. In addition to the changes required to adjust for the accounting policy differences described below, cash paid for interest and cash received for interest have been moved into the body of the statements of cash flows as an adjustment to operating activities, whereas they were previously disclosed as supplementary information. These are now shown as financing activities. There are no other material differences between the consolidated statements of cash flows presented under IFRS and those presented under previous Canadian GAAP. (a) Stock-based Compensation IFRS 2 is effective for the Company as at January 1, 2010 and is applicable to: New grants of stock-based payments subsequent to January 1, 2010; Equity settled stock-based compensation awards granted subsequent to November 7, 2002 and that vest after January 1, 2010; Liabilities arising from cash-settled stock-based compensation awards that vest and will be settled after January 1, 2010; and Awards that are modified on or after January 1, 2010, even if the original grant of the award was not accounted for in accordance with IFRS 2 (i) Recognition of Expense Stock Options Canadian GAAP - The Company calculated the fair value of the stock-based compensation on all awards granted and recognizes the expense from the date of grant over the vesting period using the graded vesting methodology. The Company determined the fair value of stock options granted using the Black-Scholes option pricing model. IFRS Each tranche in an award with graded vesting is considered a separate grant with a different vesting date and fair value. Each grant is accounted for on that basis. (ii) Forfeitures Restricted Share Units ( RSUs ) Canadian GAAP - The Company measures cash-settled stock-based payments based on the intrinsic value of the award and recognizes forfeitures for RSUs in the period when they occur. IFRS - The recognition of compensation cost for awards under IFRS 2 is generally based on the number of awards expected to vest, which is revised if subsequent information indicates that actual forfeitures are likely to differ from the estimate. It also requires the Company to measure cash-settled stock-based payments at the award s fair value, both initially and at each reporting date. (b) Impairment of Long-lived Assets Canadian GAAP - Canadian GAAP generally uses a two-step approach to impairment testing: first comparing asset carrying values with undiscounted future cash flows to determine whether impairment exists, and then measuring impairment by comparing asset carrying values to their fair value (which is calculated using discounted cash flows). IFRS IAS 36 uses a one-step approach for testing and measuring impairment, with asset carrying values compared directly with the higher of fair value less costs to sell and value in use (which uses discounted cash flows). This may potentially result in write-downs where the carrying value of assets was previously supported under Canadian GAAP on an undiscounted cash flow basis. The Company assessed the carrying value of its assets in accordance with IAS 36 and 69

70 TERAGO INC. Notes to Consolidated Financial Statements (In thousands, except for per share amounts) found that no impairment was required to be recognized on January 1, 2010 as a result of the change in measurement methodology. (c) Presentation Reclassifications i. Reclassification of Accretion Expense Canadian GAAP Accretion expense for decommissioning and restoration obligations were classified within sales, general and administrative expenses. IFRS - Accretion expense for decommissioning and restoration obligations are required to be included in finance costs. ii. Reclassification of Direct Salaries included in Cost of Goods Sold Canadian GAAP Direct salaries are included in costs of goods sold. IFRS Direct Salaries are presented separately on the face of the income statement in salaries and related costs. iii. Reclassification of Deferred Revenue During 2011, the Company reclassified an amount of $289 at January 1, 2010 and $993 at December 31, 2010 from current deferred revenue to long-term deferred revenue as compared to previously reported under prechangeover Canadian GAAP. The adjustment relates to deferred service and installation revenue that will be amortized into revenue more than one year from the balance sheet date based on the remaining term of the contract. 70

71 TERAGO INC. Reconciliation of Consolidated Statement of Financial Position as of January 1, 2010 (In thousands, except for per share amounts) Previous Canadian GAAP 1 Effect of Adjustment Assets Assets Cash and cash equivalents $ 1,074 $ $ 1,074 Cash and cash equivalents Short-term investments 7,121 7,121 Short-term investments Accounts receivable 2,491 2,491 Accounts receivable Prepaid expenses 1,773 1,773 Prepaid expenses Total current assets 12,459-12,459 Total current assets Network assets, property and equipment 30,737 30,737 Network assets, property and equipment Intangibles and other assets Intangibles and other assets Restricted cash 1,000 1,000 Restricted cash Goodwill Goodwill Total noncurrent assets 33,105-33,105 Total non-current assets Total Assets $ 45,564 $ - $ 45,564 Total Assets IFRS Liabilities and Shareholders'Equity Liabilities and Shareholders'Equity Accounts payable and accrued liabilities $ 5,805 $ $ 5,805 Accounts payable and accrued liabilities Current portion of deferred revenue Current portion of deferred revenue Current portion of finance lease obligation Current portion of other long-term liabilities Total current liabilities 6,624-6,624 Total current liabilities Asset retirement obligations Decommissioning and restoration obligations Deferred revenue Deferred revenue Other long-term liabilities 342 (22) 320 Other long-term liabilities Total noncurrent liabilities 777 (22) 755 Total non-current liabilities Total Liabilities $ 7,401 $ (22) $ 7,379 Total Liabilities Equity Equity Share capital 69,661-69,661 Share capital Contributed surplus 24, ,165 Contributed surplus Deficit (55,654) 13 (55,641) Deficit Total equity 38, ,185 Total equity Total Liabilities and Equity $ 45,564 $ - $ 45,564 Total Liabilities and Equity 1 See note 22(c)(iii) Reclassification of Deferred Revenue 71

72 TERAGO INC. Reconciliation of Consolidated Statement of Financial Position as of December 31, 2010 (In thousands, except for per share amounts) Previous Canadian GAAP 1 Effect of Adjustment Assets Assets Cash and cash equivalents $ 1,083 $ $ 1,083 Cash and cash equivalents Short-term investments 1,071 1,071 Short-term investments Accounts receivable 3,175 3,175 Accounts receivable Prepaid expenses 2,085 2,085 Prepaid expenses Total current assets 7,414-7,414 Total current assets Network assets, property and equipment 33,545 33,545 Network assets, property and equipment Intangibles and other assets 6,205 6,205 Intangibles and other assets Restricted cash Restricted cash Goodwill Goodwill Total non-current assets 41,186-41,186 Total non-current assets Total Assets $ 48,600 $ - $ 48,600 Total Assets IFRS Liabilities and Shareholders'Equity Liabilities and Shareholders'Equity Accounts payable and accrued liabilities $ 5,506 $ $ 5,506 Accounts payable and accrued liabilities Current portion of deferred revenue Current portion of deferred revenue Current portion of long-term debt Current portion of long-term debt Current portion of other long-term liabilities Current portion of other long-term liabilities Total current liabilities 7,172-7,172 Total current liabilities Asset retirement obligations Decommissioning and restoration obligations Deferred revenue Deferred revenue Long-term debt 6,273 6,273 Long-term debt Long-term liabilities 1,220 (73) 1,147 Other Long-term liabilities Total non-current liabilities 8,652 (73) 8,579 Total non-current liabilities Total Liabilities $ 15,824 $ (73) $ 15,751 Total Liabilities Equity Equity Share capital 70,141-70,141 Share capital Contributed surplus 24, ,180 Contributed surplus Deficit (61,529) 57 (61,472) Deficit Total equity 32, ,849 Total equity Total Liabilities and Equity $ 48,600 $ - $ 48,600 Total Liabilities and Equity 1 See note 22(c)(iii) Reclassification of Deferred Revenue 72

73 TERAGO INC. Reconciliation of Consolidated Statement of Comprehensive Loss for year ended December 31, 2010 (In thousands, except for per share amounts) Canadian GAAP accounts Effect of Transition to IFRS Previous Canadian GAAP Adjustment Reclassification IFRS IFRS accounts Revenue Revenue Service $ 37,002 $ $ $ 37,002 Service Installation Installation 37, ,768 Revenue Cost of services 9,090 (9,090) - Gross Margin 28,678-9,090 37,768 Expenses Expenses 7,725 7,725 Operating expenses 1,365 1,365 Salaries and related costs - Cost of services 15,922 15,922 Salaries and related costs - Other Sales, general and administrative 22,312 (15,942) 6,370 Other operating items Stock-based compensation 1,047 (44) 1,003 Stock-based compensation Amortization of intangibles Amortization of intangibles Amortization of network assets, Depreciation of network assets, property and equipment 10,507 10,507 property and equipment 34,359 (44) 9,070 43,385 Loss before undernoted items (5,681) (5,617) Earnings (loss) from operating items Foreign exchange gain Foreign exchange gain Interest on long-term debt (286) (20) (306) Finance costs Investment income Finance income Net loss and comprehensive loss $ (5,875) $ 44 $ - $ (5,831) Net loss and comprehensive loss Deficit, beginning of year (55,654) 13 - (55,641) Deficit, beginning of year Deficit, end of year $ (61,529) $ 57 $ - $ (61,472) Deficit, end of year 73

74 23. Subsequent Events On January 1, 2012, National Online Inc. was amalgamated with TeraGo Networks Inc. The Company received a final release from the vendor related to the acquisition of MetroBridge and the final payment of $1,516 was made in January (Note 6) 74

75 CORPORATE INFORMATION DIRECTORS Charles Allen Chairman, TeraGo Inc. Grant Ballantyne Chairman, Canlan Ice Sports Corp. Bryan Boyd President & CEO, TeraGo Inc. Richard Brekka Managing Partner, Dolphin Equity Partners Jerry S. Grafstein, Q.C. Counsel, Minden Gross LLP James McDonald Corporate Director Dennis O Connell Partner, Dolphin Equity Partners EXECUTIVE MANAGEMENT Bryan Boyd President & Chief Executive Officer Scott Browne Chief Financial Officer Jim Nikopoulos Vice President, Corporate Development and General Counsel Allan Laudersmith Vice President, Sales Kevin Hickey Vice President, Engineering & Operations CORPORATE HEAD OFFICE 55 Commerce Valley Drive West, #500 Thornhill, Ontario L3T 7V TeraGo.1 ( ) EXCHANGE LISTING Toronto STOCK SYMBOL TGO INVESTOR RELATIONS CONTACT Scott Browne TeraGo Inc. Phone: Fax: (905) [email protected] WEBSITE YEAR END December 31 AUDITORS BDO Canada LLP Markham, Ontario, Canada LEGAL COUNSEL McCarthy Tétrault LLP Toronto, Ontario, Canada TRANSFER AGENT Computershare Investor Services Inc. Toronto, Ontario, Canada ANNUAL MEETING NOTICE The Annual Meeting of Shareholders will be held at 10:00am on June 5, 2012, at Minden Gross LLP, Main Boardroom, 145 King St. W, Ste 2200, Toronto, ON M5H 4G2 Certain trademarks used in this annual report, such as TeraGo, TeraGo Networks, TeraGo Networks Design and are trademarks owned by TeraGo or our subsidiaries. Other trademarks or service marks appearing in this annual report are trademarks or service marks of the person who owns them.

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