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June 27, 2017

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Pareteum June Chairman Letter

Dear Fellow Shareholder,

As we pass the midpoint of the year, I wanted to again write to you as part of our commitment to improving transparency into the business and our efforts to communicate outside of traditional cycle of press announcements and quarterly conference calls.

I will start by repeating a message you have previously heard about the significant transformation we are now completing. I see truly remarkable progress the team has made in turning a nearly insolvent, unsustainable business, into one that is now stabilized and prepared for growth. This growth is being driven by the unprecedented changes brought about by the increasingly connected world where everyone, and everything, is wirelessly connected to each other. It’s a world that will be built on the ability to seamlessly manage and support the needs of millions of users and literally billions of devices on a global scale…this is our vision and we are working each day to make this opportunity a reality.

I hold firm to the view that at no point in Pareteum’s relatively short operating history has the organization been this well positioned to capitalize on the opportunities ahead of it. Having completed substantially all the required restructuring work by the end of 2016, we now move forward with a platform ready for growth and I’m pleased to say that the momentum behind our business is accelerating. This is evidenced in a string of new customer announcements made since the beginning of the year, highlighted by a substantial seven-year Mobile Virtual Network Enabler (MVNE) contract signed in Brazil. In fact, in the last six months, our team has successfully secured more new contracts than the Company has produced over the past four years. These successes are energizing the team as our progress in the marketplace continues. We realize, however, that there remain shareholders who question when our new contracts will contribute meaningfully to our financial results and there are those who are overlooking the value we have already built. I believe one of the key issues here is that investors have yet to take into consideration the scale of our contracted revenue backlog which has grown from $44 million discussed with you back in April, to its current level of nearly $60 million today, an achievement nearly unheard of for a Company of our size. Therefore, in this update we though you would like to know and better understand our “Pathway to Revenue” and how and when it is recorded. This will give you a better appreciation for our recent achievements and the untapped value of our business.

Commercial and Operational Update

As we previously communicated, we had outlined a number of performance expectations in regard to continued progress in stabilizing the business and our efforts to grow our top line through new customer additions. On these fronts, I’m pleased to report that we are delivering against those expectations:

  • We reported improved operational results for the first quarter of 2017. In addition to adding senior talent to the Company’s executive team and sales organization, notable improvements were recorded in our financial results. Offsetting the divestiture of ValidSoft and the impact of seasonal subscriber churn at our customers which contributed to slightly reduced revenue, results of operations showed significant improvement. Foremost amongst these were an increase in gross margins from 66% to 70%; a 37% decrease in operating expenses; and a 53% improvement in the loss from operations to ($1.9) million compared to ($4.3) million in 2016. Net Loss per weighted common share of ($0.14) for the quarter marked a 79% improvement from a ($0.66) in 2016. Furthermore, Adjusted EBITDA in the quarter was ($198,000), reflecting a 91% improvement from the negative Adjusted EBITDA of ($2.1) million reported last year. Revenue per employee was $186,330. Thanks to the successful execution of our restructuring activities, we have now greatly stabilized the business and believe that the first quarter of 2017 reflects a more normalized base from which to judge future operating performance.
  • Further adding to our stability, we secured additional positive revisions to the Amended & Restated Credit Agreement with Atalaya, our senior secured lender. Notable amendments include reduced quarterly principal amortization payment amounts and a confirmed extended maturity date of December 31, 2018. These amendments were made possible by the Company’s ability to satisfy the terms of its outstanding principal pay down schedule including a payment of $1.5 million in the first quarter of 2017. The revised schedule reduces the principal repayments significantly, improving cashflow by reducing the cash required for debt servicing by approximately $1.5 million through 2017. Collectively, these amendments provide the Company with important new cash flow flexibility including the ability to invest further in product development and sales activities and reaffirms Atalaya’s growing confidence in our plan and in our team.
  • We said that by the end of the year, on the customer side, we expect to have signed long-term contracts with one or more additional major MVNE customers, which we believe will add significant, material, additional deferred contract revenues. With our Brazil contract, we are well on our way to meeting those expectations.
  • Through our agreement with THYNGS, a provider of IoT services to taxi fleets in Las Vegas, New York and other global markets signed in April, we are now onboarding new subscribers onto our growing Global Mobility Cloud and we further expect a number of additional customers to be secured during the remaining two quarters of 2017.

The Path to Revenue – GAAP Accounting and the Software-as-a-Service Model

Certainly, these achievements are all positive measures of the progress we are making every day. As a team, we recognize the vast potential still lies ahead of us. The first step towards improving the understanding of our business model will be to more fully explain our “Path to Revenue” and the metrics and milestones that we expect to report on regularly.

“You announce new contracts, but when will revenues increase?”

This is a question we get quite frequently and the answer lies in the fact that Pareteum’s business model is built around on Monthly Recurring Revenue (MRR) under the Software-as-a-Service (SaaS) model.

In our business, we have three subscription-based offerings:

(1) the Managed Services Platform (i.e., serving customers such as Vodafone, Zain and the new customer in Brazil);
(2) the Global Mobility Cloud Services Platform (i.e., serving customers such as THYNGS); and,
(3) the App Exchange and Development Platform (i.e., serving customers such as Pronto Telecom)

For GAAP accounting purposes, revenue is earned when services are delivered, regardless of when cash is received. Therefore, it’s critical to understand the timing involved in the various steps of our business – the signing of an agreement; the implementation and delivery when service is established, and finally, billing which generates revenue. This is a multi-stage process that typically takes 90 days to complete and up to six months or more for very large Managed Services implementations as illustrated below:

Furthermore, in terms of inherent value and market multiples, these contracts also include a variety of customer commitments which generate a backlog of stable, predictable and guaranteed revenue for the Company. As of today, our contracted backlog currently stands at approximately $60 million, however, with a capitalization that is just 1/10th of our contracted backlog, it’s clear that our Company is not being fully valued by the market. This a disconnect that must and will change, as we begin to deliver the sequential revenue growth we expect to report over the remainder of 2017 and throughout 2018.

Total Contract Value is Only Part of the Story

In our MVNE model, the total contract value (TCV) is one way to measure a SaaS contract under GAAP. TCV is simply the sum of two elements – the upfront service implementation fee and the guaranteed minimum monthly recurring fees from managing individual devices. This, however, is only part of the story as our contracts contain additional important structures which can and do create significant “layers” of revenue for the Company.

Utilizing our Brazilian contract as an example, let me now answer some of the questions on our process from contract award to billing:

  • Our Company has been contracted for a seven-year MVNE services agreement. This agreement includes a service establishment fee valued at approximately $300,000 which is used to offset upfront costs including any hardware, software or service provisioning that may be required. This fee is recognized over the course of the implementation period which can take between three and six months based on the customer.
  • The terms of this agreement also include a guaranteed “monthly minimum” flat rate fee which is recorded as MRR until the agreed per subscriber/device monthly support charges exceed specified levels. This layer of revenue is called the “ramping period” of the contract and begins immediately upon the onboarding of the first subscriber or device.
  • Beyond the calculated TCV, the revenue potential of the Brazilian deal is also impacted by a “protective” scaled per subscriber/device fee schedule. This schedule includes pre-defined fee increases should the customer not reach their own projections. This is one of the contractual elements present in each of our MVNE services contracts that generates the sizable backlog I referenced earlier.

For reporting purposes, the combination of paid-in-advance fees and guaranteed minimum MRR delivers a minimum total contract value of approximately $2 million over the term of the contract. In this case, our customer-supplied business forecast projects a minimum of 3 million subscribers and supported connected devices within a three-year period. We closely monitor and will report on this “rolling 36-month view” of revenue since in our opinion, this timeframe best captures the essence of our SaaS business model. Based upon the terms of our per subscriber/device fee schedule, this would generate annual run-rate revenue in the 8-figures range (i.e., > $10,000,000) by the end of the third year of service. As you can see, the impact of this additional revenue layered onto our current revenue base is significant, and given expectations that our margin structure will increase from its current 70% level, this contract will drive meaningful bottom-line growth as well.

While newer contracts like Brazil reflects the general base structure of our MVNE SaaS contracts, it is important to note that established customers such as Vodafone have already surpassed their contract minimums, meaning they are generating MRR which we call “run rate revenue” and are contributing to our backlog. This contracted backlog has value not only because of its present value, but because of its stability and predictably as defined by a tiered per subscriber/device fee schedule.

To recap, there are four key drivers of revenue: 1) Upfront service establishment fees, 2) guaranteed minimum monthly recurring revenue (recorded as MRR), 3) an estimated scaled subscriber/device fee schedule based upon customer-provided estimates, and, 4) current MRR/run rate revenue generated from existing customers which today is our primary base of revenue. Each of these key revenue drivers has its own time frame for revenue recognition.

Measurement and Metrics

A SaaS business like ours has many variable components which impact revenue recognition including timing as it relates to system implementation, the velocity or rate of subscriber/device ramp-up, and ultimately, the total potential volume of individual subscriber device we are managing. Therefore, the key metrics we use to capture the progress of our company are:

  • Revenue per Employee
  • Subscribers (people and devices, not simply SIMs)
  • Contracted revenue backlog (“rolling 36-month view”)

These are metrics we intend to report on quarterly so that you visibly see and appreciate our continued progress as well.

The Future is Stable, Predictable Backlog Revenue

Built on a now stabilized foundation, one that is more fully able to support the business, we are delivering, and expect to continue to deliver growth within our business as we move through the ramping period and progress into the run rate stages of our contracts over the remainder of 2017, we will begin to see that committed backlog revenue convert into earned revenue, contributing to top-line growth in an escalating manner. We believe that this will begin the process of increasing the Company’ market valuation that is long overdue.

Finally, in the tradition of closing our Chairman Letters with a quotation that I believe is both insightful and relevant, I wish to leave you the following from Steve Jobs:

“If you really look closely, most overnight successes took a long time.”

With the enduring commitment and dedication and talent of our team, over many months, our progress in steering this Company back from the brink of insolvency has been substantial. As we stand today, we have created a more stable business and are seeing marketplace traction for our technology increase. For these reasons, we continue to be optimistic that the results of our efforts will be made clear.

Through continued open lines of communications with our shareholders, timely and measurable reports on our progress and a commitment to transparency, it is our desire that our enthusiasm and excitement for the business will be conveyed. It is my belief that by committing to continually improving the understanding of our business that its true potential and the unrecognized value of the Company can be realized. We look forward to maintaining frequent communications with you so please send any questions you may have to

All good wishes to you our shareholders,

Robert H. Turner
Executive Chairman & Principal Executive Officer
Pareteum Corporation (NYSE MKT: TEUM)

Forward Looking Statements:

Certain statements contained herein constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements may include, without limitation, statements with respect to Pareteum’s plans and objectives, projections, expectations and intentions. These forward-looking statements are based on current expectations, estimates and projections about Pareteum’s industry, management’s beliefs and certain assumptions made by management. Readers are cautioned that any such forward-looking statements are not guarantees of future performance and are subject to certain risks, uncertainties and assumptions that are difficult to predict. Because such statements involve risks and uncertainties, the actual results and performance of Pareteum may differ materially from the results expressed or implied by such forward-looking statements. Given these uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements. Unless otherwise required by law, Pareteum also disclaims any obligation to update its view of any such risks or uncertainties or to announce publicly the result of any revisions to the forward-looking statements made here. Additional information concerning certain risks and uncertainties that could cause actual results to differ materially from those projected or suggested in Pareteum’s filings with the Securities and Exchange Commission, copies of which are available from the SEC or may be obtained upon request from Pareteum Corporation.