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Edited Transcript of TGO.TO earnings conference call or presentation 7-Aug-19 12:30pm GMT

Q2 2019 Terago Inc Earnings Call

THORNHILL Aug 12, 2019 (Thomson StreetEvents) -- Edited Transcript of Terago Inc earnings conference call or presentation Wednesday, August 7, 2019 at 12:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Antonio P. Ciciretto

TeraGo Inc. - President, CEO & Director

* David Charron

TeraGo Inc. - CFO

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Conference Call Participants

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* Bentley Cross

TD Securities Equity Research - Associate

* Maher Yaghi

Desjardins Securities Inc., Research Division - VP, Telecom, Media & Tech Analyst and Intellectual Property Analyst

* Siddhant Dilawari

Cormark Securities Inc., Research Division - Associate of Institutional Equity Research

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Presentation

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Operator [1]

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Good morning, ladies and gentlemen. Welcome to TeraGo's Q2 2019 Financial Results Conference Call. (Operator Instructions) I would like to remind everyone that this conference call is being recorded.

TeraGo would like to remind listeners that the company's remarks and answers to your questions today may contain forward-looking statements that are based upon management's current expectations. All such statements are made pursuant to the safe harbor provisions of and are intended to be forward-looking statements under applicable Canadian securities legislation. When applying -- when relying on forward-looking statements to make decisions with respect to the company, you should carefully consider the risks set forth in the Risk Factors section in the annual MD&A for the year ended December 31, 2018, which is available on www.sedar.com, and also consider all other uncertainties and potential events. Except as maybe required by Canadian securities law, the company does not undertake any obligation to update any forward-looking statements as a result of new information.

We'd also like to remind listeners that TeraGo uses certain non-GAAP financial measures to arrive at adjusted results to assess its business and to measure overall performance. TeraGo believes the financial measures provide readers with a better understanding of how management views the company's overall performance.

I will now turn the conference over to Mr. Tony Ciciretto, President and Chief Executive Officer of TeraGo. Please go ahead.

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Antonio P. Ciciretto, TeraGo Inc. - President, CEO & Director [2]

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Thank you, Jack, and good morning, everyone. Welcome to TeraGo's Second Quarter 2019 Earnings Call. Joining me on the call today is David Charron, TeraGo's Chief Financial Officer.

TeraGo released its second quarter 2019 financial results after the market closed on August 6. Our press release, financial statements and MD&A are currently available on SEDAR and our company website, along with slide presentations accompanying this call.

Earnings results for the second quarter were consistent with the first quarter of 2019 as we delivered positive adjusted EBITDA of $4.5 million while managing costs to preserve our balance sheet ahead of upcoming investments in 5G.

As discussed last quarter, this year we have been working to improve sales effectiveness, build our pipeline and broaden our sales reach through channel partnerships. In addition to adding a new VP of sales in the first quarter, we continue to strengthen the sales and marketing leadership in our organization with the appointment of Blake Wetzel as our new Chief Revenue Officer. Blake brings extensive sales and business development experience from previous executive sales roles at Rackspace, CenturyLink and Qwest Communications. He has a long and successful track record in building large-scale channel programs, and developing a premier channel and alliance program for TeraGo will be one of Blake's primary missions.

Today, our channel program is in its infancy, but we do see great opportunity to broaden our sales reach domestically and to target a large number of multinational companies that have operations in Canada. Last week, we partnered with U.S.-based master distributor, Converged Network Services, to bring a complete Canadian IT infrastructure and managed services offering to their extensive network of customers. We also consummated a partnership last week with TBI, the largest privately owned master agent and technology distributor. We are now working to develop programs with our channel partners to enhance awareness. We're very encouraged by the progress made so far, but the expected impact from these initiatives to our backlog will likely take a couple of more quarters to be realized.

We are focused on positioning TeraGo for 5G fixed wireless. Just after the end of the second quarter, we completed a bought deal financing that included the exercise of the full over-allotment option for gross proceeds of $8.9 million. As I will discuss a little later, this financing provides funds to support technical and customer 5G fixed wireless trials, and this has the greatest potential to drive significant growth in our business.

Now moving on to our operating metrics on Slide 6. In the second quarter, we experienced some additional churn in both connectivity and cloud and colocation that impacted our top line. At the same time, the new initiatives to strengthen our sales funnel have not yet converted into backlog. Average revenue per user declined modestly from the prior year period. This was primarily driven by customer mix, but it remains within the range of prior quarters.

For the second half of this year, we will continue to operate efficiently to preserve EBITDA and cash flow ahead of our 5G investments. Early indications suggest that our customers will be very receptive to the enhancements and new products a 5G-driven network would enable, and our spectrum assets provide a key time-to-market advantage that we intend to leverage in order to drive growth and value creation for our business.

Moving on to Slide 7. In June, ISED released an important decision regarding our 38-gigahertz fixed wireless spectrum licenses, allowing all existing 38-gigahertz licensees to retain all of the spectrum and apply for flexible use licenses in 2025 or earlier upon licensee application. As Canada's largest holder of 38-gigahertz wireless spectrum with 25 of the 27 issued licenses, future conversion under a flexible use model provides much of the needed clarity to provide continuity for our business and reaffirms the value of our spectrum assets as a critical resource in delivering 5G services in the future. Now that the decision on the 38-gigahertz spectrum has been made, we hope to see this rationale also applied to our 24-gigahertz licenses when ISED considers this band as part of Canada's 5G spectrum plan. The 24-gigahertz band is a critical component in delivering our current connectivity services, and TeraGo has 14 of the 20 licenses issued, including coverage across Canada's 6 largest markets. Following ISED's release of the decision on releasing millimeter-wave spectrum to support 5G, we met with ISED department officials in Ottawa to present the TeraGo story and our latest developments on moving ahead with a 5G fixed wireless business. The information shared was positively received, and we agreed to keep them apprised of our progress.

With the successful completion of the 24-gigahertz auction in the U.S. for mobile 5G use, we believe it is important that Canada also adds 24 gigahertz to its 5G program and move it from priority 2 to priority 1 to allow for a harmonized approach spectrum use across North America. This will let both service providers and consumers benefit from the best and broadest range of technology options that will be made available.

As discussed in prior quarters, we expect to receive updated 5G NR equipment in Q4 as we are preparing for the second phase of a technical trial towards the end of the year. Following second technical trial, we will look to perform customer trials in 2020. With the completion of our recent bought deal offering -- financing, excuse me, TeraGo is in a strong financial position to complete our 5G fixed wireless trials and prepare for customer deployments. The time-to-market advantage provided by our spectrum assets is unique to TeraGo and will allow us to be one of the first service providers with commercial 5G deployments in Canada.

With that, I'll turn the call over to Dave to walk through some of the financials in the quarter in greater detail. Dave?

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David Charron, TeraGo Inc. - CFO [3]

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Thanks, Tony. I am on Slide 9 now. In the second quarter, total revenue declined 10.9% than the prior year period to $12.2 million. The churn experienced in the third and fourth quarters of 2018 resulted in a lower base of revenue entering the year, and this was coupled with a lower level of new sales provisioning activity in the first half of 2019. Connectivity revenue for the second quarter declined 13.6% from the prior year period, while cloud and colocation revenue declined 6.1% from the prior year period. Specifically, on connectivity revenues, we're seeing decline coming from our low bandwidth customer and product segments and starting to see more favorable trends in higher bandwidth segments. Although revenue continues to be impacted by churn and lower sales activity, we have continued to manage costs with a focus on maintaining our levels of profitability.

Adjusted EBITDA in the second quarter was $4.5 million, including the impact of IFRS 16, an increase of 45.2% from the prior year period. The adoption of IFRS 16 at the beginning of 2019 resulted in a $1.6 million positive impact to adjusted EBITDA. Excluding the impact of IFRS 16, adjusted EBITDA for the second quarter would have been $2.9 million compared to $3.1 million in the prior year period.

Our reported net loss for the second quarter was $2.8 million compared to a net loss of $1.5 million in the prior year period. The increase in net loss was driven by a number of factors: first, the onetime revaluation of stock-based compensation as a result of an amendment to the RSU plan; two, the impact of the adoption of IFRS 16; and three, restructuring expense and a decrease in revenue.

Turning now to Slide 11. In the second quarter, we generated $3.1 million in cash flow from operating activities and incurred $1.8 million in lease payments. Our capital expenditures were $1.8 million or 14.7% of revenue for the quarter. We're focused on remaining capital-efficient for the remainder of the year ahead of the modest investments we'll be making in our 5G fixed wireless trials.

At the end of the second quarter, we had $1.6 million in cash, and we continue to have an undrawn $10 million operating line and a $25 million acquisition and CapEx facility that will allow us to invest in growth activities. And with the proceeds from our $8.9 million bought deal financing that closed just after the quarter, we have increased financial flexibility to reinvest at the appropriate time to drive our future growth initiatives.

And lastly, our leverage at the end of the second quarter stands at 2.5x adjusted EBITDA, excluding the impact of IFRS 16, which is flat compared to last quarter and remains well below our covenant of 3.5x.

I'll now turn the call back to Tony for his closing remarks.

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Antonio P. Ciciretto, TeraGo Inc. - President, CEO & Director [4]

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Thank you, David. In summary, TeraGo has made significant progress towards completing our initiatives to enhance sales execution and effectiveness and to develop new channel partnerships that will serve us well as we position the company for future growth by capitalizing on our 5G investments. We're controlling our costs ahead of these investments, and this has successfully allowed us to operate at a level that preserves adjusted EBITDA while managing our cash.

Lastly, we remain laser-focused on servicing value from our 24- and 38-gigahertz spectrum assets that provides us with a unique time-to-market advantage. With our strengthened balance sheet and customer trials planned for early next year, we are well positioned to be the first carrier in Canada to launch 5G fixed wireless services.

With that, I'll now turn it over to Jack to take questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Bentley Cross with TD Securities.

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Bentley Cross, TD Securities Equity Research - Associate [2]

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First, I just wanted to touch on the trials. Maybe you can kind of handicap the potential size and scope as well as if you guys are exploring any partners on -- sorry, the commercial side on the newer side of the business or potential newer avenue?

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Antonio P. Ciciretto, TeraGo Inc. - President, CEO & Director [3]

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Sure. Thanks, Bentley. So from a trial perspective, we certainly are going to start, obviously, with technical trials as we mentioned near the end of this calendar year. That will help us position certainly for customer trials at the beginning of 2020. We, first, will start with, I think, what we believe is a modest number of business customers where we have existing relationships with. And we'll start with the trials within the business market. And then we'll actually extend that to trials in the consumer market later on. The partners we have had numerous discussions to date with a number of partners in the real estate, technical and distribution side. Yet to progress to a point where we can make any type of announcements, but we're certainly very encouraged with the reception that we've received when -- in entering into those discussions. So I think more to come on that.

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Bentley Cross, TD Securities Equity Research - Associate [4]

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And just following on that, I mean, Verizon has been doing this for some time already. Is the lag between you guys and them just because they're using nonstandard gear and essentially have gone in alone so you guys have to back fill and make sure that more standard gear works? Is that kind of the right logic?

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Antonio P. Ciciretto, TeraGo Inc. - President, CEO & Director [5]

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Yes. That's exactly it, Bentley, because standards at the end of the day won't be confirmed till the fall meeting of WRC and then finalized early in 2020. And that's really one of -- another reason why you see the lag in hardware availability. So that is exactly the case.

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Bentley Cross, TD Securities Equity Research - Associate [6]

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Okay. And then last one for me. Just -- with all this focus on connectivity business, is there any potential to potentially divest the data center businesses? It just seems to be somewhat noncore at this point.

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Antonio P. Ciciretto, TeraGo Inc. - President, CEO & Director [7]

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Yes. So certainly -- thanks, Bentley. So while we're -- again, we've announced and we are continuing to invest in 5G technical and customer trials, and we're very enthused about that area. At this time, cloud and colo still provides us with an opportunity for revenue growth and cash flow. So for now we're just -- I think that's the way we would actually proceed.

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Operator [8]

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(Operator Instructions) Your next question comes from the line of Maher Yaghi with Desjardins.

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Maher Yaghi, Desjardins Securities Inc., Research Division - VP, Telecom, Media & Tech Analyst and Intellectual Property Analyst [9]

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I wanted to ask you in terms of the trends you're seeing in cloud and colocation in -- churn and pricing, et cetera, can you discuss a little bit what you expect to see in the second half of this year in that business? We've seen the backlog decline recently. Trying to see out -- I'm trying to figure out the reason behind that decline, and what are you guys doing in terms of trying to bring growth back into that business specifically.

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Antonio P. Ciciretto, TeraGo Inc. - President, CEO & Director [10]

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Yes. So I think a couple of things. Certainly, from a churn perspective, as we've indicated in past calls, we have experienced some higher-level onetime churn events in Q3 and Q4 of last year. And so that certainly has impacted the jump-off for the year. The churn levels we expect certainly will stabilize in the remaining part of the year at 1.5 to 1.6 range for connectivity. And for cloud and colo, of course, it is a bit more lumpy in nature. So we still see that within reasonable levels.

I think from a cloud perspective, certainly, we have had some -- certainly some success upselling our managed services to existing customers, but we do see sales cycles continue to be lengthy. And I think there's -- as we had explained, there is certainly a need. We're not happy with where things are at from a customer-acquisition perspective. But we do need to step up and have taken action around broadening our sales reach around the channels. We have made significant headway there. We've announced a couple already. But we've actually been very surprised and very encouraged by the receptiveness that we have received from particularly U.S. partners that hope to operate and manage their environment in Canada. So we certainly will see that.

Some of the structural changes that we've made as well to our sales organization, bringing in the VP of Sales last quarter and also bringing in Blake, the Chief Revenue Officer, this quarter and making the associated changes in the organization, our pipeline has started to grow and actually is back on track. And I think we'll start to see some of this in the next few quarters.

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Maher Yaghi, Desjardins Securities Inc., Research Division - VP, Telecom, Media & Tech Analyst and Intellectual Property Analyst [11]

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So I'm trying to just understand what the implication will be from the decline and the backlog of monthly recurring revenues and cloud and colocation. If we were to look at Q1 and Q2, that drop of $20,000 of monthly recurring revenue, are we going to see that reflected in the second half of the year in terms of the average run rate and revenues that you guys report? Or -- I'm just trying to understand the implication of that decline, what it will mean on your top line.

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David Charron, TeraGo Inc. - CFO [12]

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Yes. No, without getting too specific, Maher, I think what we will expect is as we continue to, well, work with the channels that Tony talked about and build up the pipeline, that will convert into orders and order backlog. So we expect our order backlog to increase in the second half of the year with revenue coming in shortly thereafter.

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Maher Yaghi, Desjardins Securities Inc., Research Division - VP, Telecom, Media & Tech Analyst and Intellectual Property Analyst [13]

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Okay. So what you're saying, David, is that in the second half, the top line for cloud and colocation could be at or slightly below where we are right now but should start to pick up in the first half of 2020, if I'm understanding what you're saying well.

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David Charron, TeraGo Inc. - CFO [14]

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That's correct. That's correct, Maher.

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Maher Yaghi, Desjardins Securities Inc., Research Division - VP, Telecom, Media & Tech Analyst and Intellectual Property Analyst [15]

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Okay. And in terms of your operating costs, I mean, you guys have held your margins adjusted for IFRS 16 quite well in the face of this decline in the top line with a significant reduction in SG&A. How much more you have flexibility on that front to hold your margins stable as you go through this transition model and into the 5G deployment?

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David Charron, TeraGo Inc. - CFO [16]

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Yes. We're going to continue to be very prudent in how we manage both operating costs and our cash. As we start to see our pipeline build and orders come in, then we will start to reinvest as needed. But I think we've been, as you pointed out, Maher, we've been successful in the past in managing our costs, and we will continue to be prudent and support the continued improvement in our sales organization.

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Maher Yaghi, Desjardins Securities Inc., Research Division - VP, Telecom, Media & Tech Analyst and Intellectual Property Analyst [17]

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Okay. And my last question on 5G testing and investment. Can you discuss the quantity and timing of those investments, if you can?

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David Charron, TeraGo Inc. - CFO [18]

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So as Tony mentioned, we're expecting to receive the next version of 5G NR equipment in the fourth quarter. We'll -- at that point, we'll conduct our technical trials. The capital expense for conducting the technical trials will be minimal. The -- as we move into the customer trials, there will be some capital spending that will be required and some OpEx spending. I expect that won't be more than a couple of million dollars, frankly. We're going to be again very prudent and focused on how we spend in those trials. But we really want to give ourselves the -- and as I mentioned in my remarks earlier, we want to be flexible, and we want to have the strength in our balance sheet to be able to launch 5G services at the successful completion of those trials.

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Maher Yaghi, Desjardins Securities Inc., Research Division - VP, Telecom, Media & Tech Analyst and Intellectual Property Analyst [19]

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Okay. And when you talked about being first in Canada in offering 5G, can you share the time line and when you expect to launch an actual service on 5G?

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Antonio P. Ciciretto, TeraGo Inc. - President, CEO & Director [20]

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Yes. I think based on our current plans with customer trials in the first half of 2020, we would expect if everything were to go out -- work well that we will start to launch commercial opportunities in the second half of 2020. And then again, with respect to consumer, I think, we would like to take that a little bit more prudently in that we need to -- since it's a business that we are not currently in, we want to make sure that we understand the economics and the ROI on that business very well before we actually go to commercial products, which obviously, with a customer trial, will enable us to do that.

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Maher Yaghi, Desjardins Securities Inc., Research Division - VP, Telecom, Media & Tech Analyst and Intellectual Property Analyst [21]

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Okay. And would you say that you are looking to launch these services alone or through a partner or having a partner to deploy -- basically, to share the cost of the deployment and help you in actual commercial phase of the product?

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Antonio P. Ciciretto, TeraGo Inc. - President, CEO & Director [22]

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Well, I think certainly, we believe that a partnership model is work, we're -- we would not be adverse to any particular model at this particular time. But we do think that we need to have an ecosystem importantly related to real estate. We have a number of real estate relationships today. We have over 600 sites across Canada, where we deal with many of the real estate partners who have expressed interest in working with us, so -- and then, obviously, the technical trials and to some degree the distribution channel because that I think is also an area that we're really investigating as well to have the back-office systems and the expertise in that area.

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Operator [23]

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There are no further questions at this time. I'd like to turn the call back over to Tony Ciciretto for closing remarks -- oh, we do actually have another question from Sid Dilawari with Cormark Securities.

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Siddhant Dilawari, Cormark Securities Inc., Research Division - Associate of Institutional Equity Research [24]

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So just on the connectivity side, the connectivity ARPU was down 4% during the quarter, which is, I think, the fourth quarter of consecutive decline in connectivity ARPU. You guys said that it was mainly due to your focus on small- to medium-sized businesses. So do you see this ARPU stabilizing at any point? It it going to stay above $1,000 in particular? Or are the margins lower with these small- and medium-sized businesses? Or just looking for some color on that?

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Antonio P. Ciciretto, TeraGo Inc. - President, CEO & Director [25]

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Yes. We -- Sid, thank you for the call -- the question. We expect that the churn rates in the lower end of the customer base will continue to rise while we actually have made significant strides in improving the growth rates in the upper bandwidth services. And that's demonstrated really by our ability to keep our ARPU relatively flat. So we continue to see that phenomenon happen.

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Siddhant Dilawari, Cormark Securities Inc., Research Division - Associate of Institutional Equity Research [26]

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Okay. And then just one on colocation side. What kind of capacity utilization rates are you guys seeing in terms of storage units or cabinets per se?

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Antonio P. Ciciretto, TeraGo Inc. - President, CEO & Director [27]

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Well, we -- the way I would categorize it, Sid, is that some of the -- the view is that we are at about a little over 50% utilization in our data centers for colocation. We still have ample room in invested capital that has already been expensed, and we'll continue to reap the benefits of that and not have to put in a lot of capital to add in more customers.

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Siddhant Dilawari, Cormark Securities Inc., Research Division - Associate of Institutional Equity Research [28]

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Congrats on your results.

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Antonio P. Ciciretto, TeraGo Inc. - President, CEO & Director [29]

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All right. Thanks, Sid.

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Operator [30]

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There are no further questions at this time. I would like to turn the call back over to Tony Ciciretto for closing remarks.

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Antonio P. Ciciretto, TeraGo Inc. - President, CEO & Director [31]

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Great. Thanks, Jack. And thanks again, everyone, for listening to our call. We look forward to speaking to you again on our next quarterly call. Goodbye.

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Operator [32]

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This concludes TeraGo's Q2 2019 Financial Results Conference Call. We thank you for your participation. You may now disconnect.