Terremark Worldwide, Inc. F2Q09 (Qtr End 09/30/08) Earnings Call Transcript

| About: Terremark Worldwide, (TMRK)

Terremark Worldwide, Inc. (NASDAQ:TMRK)

F2Q09 Earnings Call

November 4, 2008 5:00 pm ET


Hunter Blankenbaker – Vice President, Investor Relations

Manuel D. Medina – President and Chief Executive Officer

Jose A. Segrera - Chief Financial Officer


Jonathan Schildkraut - Jefferies & Co.

Manuel Recarey - Kaufman Bros.

Christopher Larsen - Credit Suisse

Josh Anderjack - FirstBank

Doug Worman - JP Morgan

Srinivas Anantha - Oppenheimer & Co.


Good day ladies and gentlemen and welcome to the Q2 2009 Terremark Worldwide Incorporated’s earnings conference call. (Operator Instructions) I would now like to turn the presentation over to your host for today’s call, Mr. Hunter Blankenbaker, Vice President of Investor Relations.

Hunter Blankenbaker

Good afternoon everyone, and welcome to Terremark ‘s fiscal 2009 second quarter earnings conference call. With us we have Manny Medina, Terremark’s Chief Executive Officer, and Jose Segrera, our Chief Financial Officer. Please note that slides related to today’s call are available on Terremark’s website at www.terremark.com under the Investor Relations link.

During our call today we will be making forward-looking statements. Any statements that refer to expectations, projections, or other characterization of future events, including financial projections and future market conditions is a forward-looking statement. Actual results may differ materially from those expressed in these forward-looking statements. For more information please refer to the risk factors discussed in Terremark’s Form 10-K for fiscal 2008, the Form 8-K filed with the SEC, and today’s press release. Terremark does not undertake any obligation to revise these forward-looking statements to reflect future events or circumstances.

We will also provide non-GAAP measures on today’s conference call. We provide a reconciliation of those measures to the most directly comparable GAAP measures and a list of reasons why the company uses those measures in today’s press release.

With that, I would like to turn the call over to Manny.

Manuel D. Medina

Good afternoon and thank you for joining us today. Terremark delivered a solid second quarter, further demonstrating the benefits of our diverse customer base, broad portfolio of IT infrastructure services, and our differentiated business model.

Our Q2 revenue was $59.6 million, at the high end of our guidance. 91% of that revenue, or $54.0 million, was recurring.

EBITDA was $9.9 million, which was below our expectations, but represented 27% growth from the prior-year period. With regards to our EBITDA performance, I would like to share with you details of a potential strategic transaction which proved to be a significant distraction to the organization and ultimately impacted our second quarter EBITDA.

In April 2008 Terremark received an unsolicited expression of interest from a reputable financial sponsor regarding a potential acquisition of all the outstanding shares of Terremark stock at a significant premium to the then current trading price. In response to this interest, the Board of Directors formed the strategic committee to conduct a market check and to authorize an overseas managements’ preliminary exploratory process to identify transactional alternatives in order to maximize shareholders’ value.

In the course of conducting this analysis, which lasted well into September, the company as well as the strategic planning committee of the Board, engaged outside professional advisors and primarily during the second fiscal quarter incurred significant administrative, legal, and financial advisor fees and expenses. These one-time costs had a tangible effect on the company expenses and operations due in the second quarter.

Ultimately, it should come as no surprise in light of global economic conditions, more specifically the crisis in the credit markets worldwide, that no definitive transaction with any third party ensured as a result of the process and the Board determined that it was in the shareholders’ best interest to continue executing its business plan.

With the transaction behind us, I want to emphasize that we are very excited about our future. Our business is performing very well and we are happy to be able to continue driving the business forward.

With that I would like to provide our perspective of what we’re seeing in the market place, given the unprecedented macroeconomic environment of today.

First, we believe this economy is intensifying the pressure on CIOs as companies in every industry re-examine their IT budgets in an effort to get more out of every dollar spent on IT, reduce capex, yet continue to drive efficiencies in the business.

Second, as the value proposition of infrastructure outsourcing continues to resonant, CIOs are looking for a financially sound long-term strategic partner to outsource and simply their IT infrastructure needs. We spend a great deal of time working with our customers, prospects, and partners to understand their true needs and then work with them to design the appropriate solution. This is the power of Terremark and our complete service portfolio, which is unique in the industry and the basis for building a long-term partnership.

Third, pricing for our colocation and managed services remains firm and our second quarter sales cycle remained consistent with the trends of previous quarters. We believe these trends are a reflection of our ability to deliver a full suite of services that make solid economic sense and our ability to enable CIOs to customize their solutions to meet their strategic needs.

During the quarter we added 80 new customers, including Ascension, Kaplan Educational, Crow Holdings, the investment firm of the Trammell Crow family, and Nokia, who established their first point of presses with Terremark in the map of the Americas to serve their new mobile OVI portal, a dynamic web-enabled service they view as key market differentiator.

One of the real highlights of the quarter was our sales team’s ability to successfully convert our strong Q1 pipeline into Q2 contracts as we recorded $27.6 million of annual bookings, a 30% increase over the prior-year’s quarter.

We continue to see strength in our pipeline, which we believe represents the market’s validation of our differentiated business model and acceptance of our message around value, specifically in terms of cost savings, limited capital expenditures, and return on investments. We are well positioned to capitalize on these strengths, as customers are increasingly turning to Terremark to help fully optimize their IT budgets.

We were also pleased with our ability to generate $27.0 million of operating cash flow in the first half of the year and we continue to show strong progress from cash generation and working capital management.

Given the quality of our cash flow generation, combined with our current cash position, we have more than sufficient liquidity to internally fund 100% of our expansion plans, a good place to be in today’s capital-constrained markets.

I will now turn the call over to Jose to discuss the financial results in more detail.

Jose A. Segrera

During my discussion today I will cover the quarter-over-quarter comparison of our results of operations, our balance sheet, and capital expenditures, and then our guidance for the third quarter and fiscal year 2009.

Total revenues for the second quarter were $59.6 million, at the high end of our $58.0 million to $60.0 million guidance range, a 6% increase over the $56.1 million in the first quarter of fiscal 2009 and a 31% increase over the prior-year period.

Our recurring revenue increased $54.0 million, from $51.6 million the prior quarter and $42.2 million during the prior-year period, increases of 5% and 28% respectively.

The federal government accounted for $11.0 million, or 18% of our September 2008 revenues. Total project-type revenue was $5.6 million in the second quarter compared to $4.5 million in the prior quarter. The main components of project revenue during Q2 were equipment resales and federal government projects.

In Q2 managed services represented 59% of revenues, colocation increased to 34% of revenue, and exchange point services was 7%. Our annualized recurring revenue yield per square foot was 2,169 in the second quarter compared to 2,223 in the prior quarter and 2,145 in the prior-year period.

The decrease from Q1 is attributable of the ramp up of Nap of the Capital Region, or NCR customers, which have initially purchased our colocation offering. We expect revenue per square foot to remain steady over the next couple of quarters as we continue deploying NCR customers. However, over the next few months we expect to complete the deployment of our Infinistructure pod at NCR and begin selling managed hosting and our E Cloud project offerings out of NCR, consequently generating more managed services revenue from this location.

Our overall churn remains steady at approximately 1% of annual recurring revenue in the commercial side and zero for our federal government customers.

At September 30 total net colocation space increased to 443,000 square feet and billed-out colocation space increased to 188,000 square feet, primarily driven by the additional space we added at NCR. Utilization of total net colocation space now stands at 23.3% and utilization of billed-out colocation space is 55%. With our large amount of available square footage and the addition of our Infinistructure pod and E Cloud offering at our NCR facility, we have ample room for continued strong revenue growth.

Cross-connects billed to customers increased to 7,459 as of September 30, 2008, from 7,232 at the end of the previous quarter and 6,119 a year earlier.

Total cost of revenue was $35.1 million for the September 2008 quarter compared to $32.1 million in the prior quarter. Our second quarter gross profit margin was 41% compared to 43% in the first quarter of fiscal 2009. Our expectations were for a steady gross profit margin quarter-over-quarter driven by the continued ramp of costs and our NCR and Columbia Naps. However, our gross profit margin was impacted by higher than expected one-time costs related to a federal government project and the strategic process that Manny mentioned.

Our headcount increased to 796 employees from 759 primarily as a result of growth at our NCR and Columbia facilities as well as the growth of our sales engagement team, which has contributed significantly to the efficiency of our sales process. As of September 30 we have completed the majority of our headcount growth we had anticipated for the fiscal year.

Very similar to last year, we expect our headcount to remain steady during the third and fourth quarters and this will significantly drive improving gross profit and flow-through margins during the second half of our fiscal year.

Our sales and marketing expenses for the September 2008 quarter increased to $6.8 million compared to $5.7 million in the first quarter. We had expected sales and marketing expense in the $6.0 million range for the September quarter. The majority of the increase over our expectations was due to approximately $700,000 of bad debt expense that we recognized during this quarter, which we believe to be a prudent measure in today’s macroeconomic environment.

In the third quarter we expect sales and marketing expense to decrease to around $6.0 million to $6.5 million.

General and administrative expenses increased to $11.0 million for the September 2008 quarter from $8.9 million in the June 2008 quarter. We had expected general and administrative expenses in the $9.5 million range for the September quarter. The increase over our expectations was caused by non-recurring legal and professional fees related to the strategic process that Manny discussed earlier and an increase in our stock-based compensation expense.

In the third quarter we expect our general and administrative expenses to return to their normal historical levels of approximately $9.0 million to $9.5 million.

For the quarter ended September 30, 2008, our adjusted EBITDA was $9.7 million, or 17% of revenue. The three components we just discussed, the higher than expected one-time cost on the federal government project, the increased bad debt expense, and the expenses related to the strategic process, accounted for over $2.0 million in additional expenses. Excluding the impact of these items, our EBITDA for the quarter came in as we had expected.

Our revenue and EBITDA contributed by our foreign operations remained steady at 14%. As a result, our exposure to foreign exchange rate volatility is limited. We have assumed steady exchange rates for the Euro and the Brazilian real from the October 30 levels for the remainder of our fiscal year.

Moving on to the balance sheet, accounts receivable continued to improve and decreased from $35.5 million last quarter to $31.1 million at September 30. Although we are very pleased with this improvement, in light of the current economic conditions, we are one, monitoring our receivable aging extra closely and being very proactive with customers in this regard and two, being extra diligent in examining the credit profile of new and existing customers. Although we have not seen an increase in our aging of receivables we are taking these steps in a proactive fashion to avoid any surprises.

Our debt remains steady with the prior quarter comprised of the $250.0 million first and second lien notes and approximately $90.0 million of convertible debt. The first and second lien notes have maturity dates in 2012 and as you will recall, in February we swapped our floating LIBOR-based rate for a fixed rate on the first and second lien and now have a blended fixed rate of approximately 8% on all of our outstanding debt.

Approximately $58.0 million of the convertible debt has a maturity in 2013 as a result of a private note exchange we completed last June. The remaining $32.0 million of convertible debt matures in June 2009. We are currently considering all of our options with regards to the 2009 converts. Part of that decision will be based upon where the convertible debt markets and our share price are at the time and our ability to extend the maturities, or we may choose to repay to high coupon debt.

At the end of fiscal year we expect to have a 3.5x to 4x net debt to last quarter annualized EBITDA and are in a comfortable liquidity position.

Moving on to our capital plans. In the second quarter we continued to make investments in our existing Santa Clara facility creating an additional 4,000 square feet of available capacity that we are selling into now and will come online in the December quarter. We expect to complete our design development phase for our expansion in California this quarter and break ground by the end of this fiscal year.

At NCR we have the plans and design ready to begin the second datacenter pod. At this point we have no specific ground breaking date for the second datacenter pod but are ready to stay ahead of demand as necessary and are monitoring the pipeline closely.

In Miami we are currently finishing the build out of an additional 20,000 saleable square feet which we expect to come online during the December 2008 quarter. This additional space in Miami, together with the power upgrade we are in the process of completing, provides us sufficient space and power to accommodate to planned growth for the foreseeable future.

Capital expenditures for the September 2008 quarter were approximately $21.0 million. Approximately $11.0 million was for our construction of the Nap of the Capital Region and $5.0 million related to power and space expansion in our Miami facility. An additional $5.0 million was spent on technology and maintenance items.

For this fiscal year we continue to expect to capital expenditures to be in the $80.0 million range.

Depreciation and amortization expense increased to $6.9 million for the September 2008 quarter from $5.6 million in the prior quarter. The increase was related to bringing our NCR facility online.

Our cash balances at September 30, 2008, were approximately $60.0 million and we continue to have the comfortable liquidity position and fully funded expansion plan. Our current plan is highly conservative and allows us to continue with all of our planned growth.

During the first six months of this fiscal year we generated $27.0 million of operating cash flow. We are [break in audio] for the second half of this fiscal year. Consequently, our expected cash balance at the end of the fiscal year will be in the $55.0 million range. With this available liquidity at March 31, 2009, we can comfortably repay the $30.0 million on the convertible debt in June 2009 and maintain our planned capital expenditure plan.

Looking ahead to our third quarter guidance, we expect revenue of $65.0 million to $67.0 million, including approximately $8.0 million to $9.0 million in non-recurring revenue. For the December 2008 quarter we expect EBITDA to range from $15.0 million to $16.0 million.

As Manny mentioned, we remain comfortable with our fiscal 2009 guidance of revenue between $255.0 million and $260.0 million and EBITDA between $58.0 million and $60.0 million.

Similar to last year, we have very strong visibility into the second half of the fiscal year. Our comfort level with our full year guidance is based on the following. We are guiding to sequential quarterly revenue growth of approximately 12%. This includes an increase in non-recurring revenue for the second half of the year, which is based on specific customer contracts and opportunities and consistent with our trend in the second half of last fiscal year.

Our EBITDA flow-through for the second half of the year, excluding the approximately $2.0 million of one-time costs this quarter, is projected to be approximately 55%. Given that we have completed the initial staffing of our new operations for this year and have the right cost structure in place, we expect minimal headcount increases for the remainder of the fiscal year and are comfortable with this projected flow-through.

Additionally, we continue to very closely monitor our discretionary costs and have implemented several cost-containment initiatives across the company to continue to ensure that every dollar is effectively invested towards growing the business.

Now let me turn the call back to Manny so that he can tell you about additional highlights of the quarter.

Manuel D. Medina

As you can tell, the company is driving forward very hard and fast and we feel very good about where we are today. But occasionally it is important to stop and look at what has been accomplished. Over the past year we have signed blue-chip customers such as Nortel, Visa, New Bounds, CSC, Preferred Hotels, Microsoft, Intel, IBM, and TigerDirect.

These are very strong, profitable, creditworthy customers with solid balance sheets that are well positioned to withstand the current economic turbulence. These companies are utilizing our entire product portfolio and some are using multiple offerings, both domestically and internationally. This is the value of the Terremark model and more than 70% of our bookings this quarter came from existing customers.

On our last quarterly call we talked about the Enterprise Cloud launch and our initial success in customer acceptance. The positive momentum continued this quarter as we took the Enterprise Cloud message to the market in a significant way, showcasing the solution on leading IT campuses and hosting webinars.

Based on the feedback we received from walking the show floors, conversations with the executives, peers and analysts, Terremark’s Enterprise Cloud is establishing clear and distinct market leadership, a position established by our long and successful history with virtualized solutions that will only get stronger as we add to the next generation of Enterprise Cloud services.

The current economic climate makes the value proposition of the Enterprise Cloud even more compelling and it is accelerating the demand and adoption of the platform. No product resonates more with customers looking to control IT budgets. Real time server deployment eliminates wasted infrastructure that has traditionally been built to meet projected growth needs and the massive, multi-tenancy architecture eliminates the capex burden inherent in traditional infrastructure, while providing access to Enterprise Cloud’s level of performance and availability.

We see significant and growing interest in this game-changing platform and continue to aggressively take our message to market with programs including a national road show tour to showcase the platform.

An exciting by-product of our marketing campaign around the E Cloud has been the opportunities created for other offerings, such as colocation, managed hosting, security services, and disaster recovery.

With a complete understanding of our full suite of services, we are able to work with prospects to design the appropriate and most cost-effective solution for their environment.

Turning now to the federal sector, our federal government business generated revenues in the second quarter of $11.0 million, a 62% increase over the prior-year period. Our federal pipeline is extremely strong and we continue to see momentum, particularly with the NCR.

Additionally, regardless of the winner of today’s election, one thing for certain is that the new administration will be looking for ways to reduce capital and operating expenditures and Terremark’s history of providing reliable solutions for our federal customers positions us well to capture this trend.

We also firmly believe that our diverse product set is the answer for federal government CIOs looking to reduce costs and increase efficiencies in the same way it addresses the needs of enterprise CIOs.

It is for this reason that we are excited our Infinistructure platform will be up and running at the Nap of the Capital Region by the end of December.

We have seen considerable interest from the federal government in the Enterprise Cloud and based on conversations with many of our federal customers, they will be under the same budgetary pressures as enterprise CIOs. We believe that [inaudible] consolidation, cost control, and the use of technology to maximize allocated amounts in Congressionally approved budgets will be the new mantra for our federal customers and Terremark is uniquely positioned to serve these customers with both classified and unclassified solutions.

Our European and Latin American businesses continue to strengthen and accounted for 14% of our Q2 revenues and recorded 6% quarter-over-quarter revenue growth. In August we announced the complete deployment of the Infinistructure structured utility completed platform in our Madrid and Amsterdam facilities. We have already signed several customers and the pipeline is strong.

Highlighting the importance of our international presses, Microsoft established a second node with Terremark for their new Windows Live services. The second location is at our Nap do Brazil facility and is designed to serve the Portuguese-speaking market. Microsoft chose Terremark because of our massive peering infrastructure and our status as the largest peering point in Latin America.

Even with all the successes, we realize that we are operating in a tough, macroeconomic environment, however, we believe that we have built a company that is well positioned for this environment and will continue to perform based on several factors, including, first, 91% of our revenue is recurring. As IT cost pressure mounts and capital budgets are reduced, we expect an increasing number of enterprise customers to look at our products to help reduce capex, decrease costs, and drive efficiencies.

We have a diverse customer base comprised of established enterprises. What [inaudible] companies. The federal government, carrier and Internet infrastructure companies. We have a fully funded growth strategy. We have world-class network-neutral facilities and a competitively differentiated product set that offers CIOs increased flexibility and better performance of their essential business obligations at a significantly lower cost.

In closing, while the state of the economy and its impact on our customers is not something we can control, what we can and will do is to continue to focus on leveraging our competitive strengths while closely managing the business to reflect the current environment, tightly managing costs, and continue investing in our product set to strengthen customer relationships.

With that, we would now like to take your questions.

Question-and-Answer Session


(Operator Instructions) Your first question comes from Jonathan Schildkraut - Jefferies & Co.

Jonathan Schildkraut - Jefferies & Co.

Could you tell us what the recurring, non-recurring EBITDA split was for the quarter?

Jose A. Segrera

On the project revenues we recognized about $1.5 million of EBITDA on the project revenues so then the recurring including all the one-time costs we had in the quarter, would be $8.4 million.

Jonathan Schildkraut - Jefferies & Co.

And how much of the federal bookings was project based for the quarter?

Jose A. Segrera

The majority of the federal bookings, just under $3.0 million, were recurring in nature so almost none of it was project based.

Jonathan Schildkraut - Jefferies & Co.

I would love for you to spend a little bit more time on the one-time costs in the quarter. I looked at your EBITDA build up in the back and I guess it seemed to indicate that you had added back some of the professional services fees that you had spent regarding this strategic opportunity, in your $9.9 million EBITDA. Are there other things that are one-time here that we should be backing out to get to a more normalized EBITDA level?

Jose A. Segrera

Let’s walk through it so if we kind of, top down and you start off with, we talked about the gross profit margins and we had a federal government contract, we announced this contract earlier this year, $140.0 million total contract value, and we incurred some more costs than we had expected on some of the deployments related to that contract. So that’s one component that wasn’t related to the transaction which impacted the results for this year. So when we say the gross profit margins come in around 41% so it was close to a million dollars related to that and some other items related to that contract. So just a little bit under a million dollars on that. So that’s one specific item.

We talked about the bad debt expense, which came in higher than anticipated.

And then like you pointed out on the EBITDA we added back the direct, professional, and out-of-pocket fees related to the process. There were a series of others, if you could call them indirect costs related to the process from other fees. And another thing that impacted the results that will get you, if you add up those three components, you’ll be right at about $2.0 million of costs.

So in our minds that’s what gets us from this right around $10.0 million of reported EBITDA to where we had expected to be of the $12.0 million.

Jonathan Schildkraut - Jefferies & Co.

Does that mean in your initial guidance that you had kind of been more conservative and you had greater leeway in order to maintain that guidance today, or does that mean that as you have moved through this quarter and you look into the back half of your fiscal year, it looks like you are going to get better leverage out of your current set of assets.

Jose A. Segrera

I think the answer to both questions is yes. You know, we’re tracking to expectations so I think the one thing to focus on is the first thing is obviously you want to understand EBITDA, but the great thing is you look at top line. So we’re hitting and on track with what we had anticipated on the top line growth, good recurring revenue growth. We will continue to see now in the back half of the year NCR continue to ramp and similar to what we went through in the last fiscal year, we have very good visibility in the second half of the year, so we are still very comfortable for the guidance for the full year.

Jonathan Schildkraut - Jefferies & Co.

I was fortunate enough to see the Cloud hosting Infinistructure demonstration, which I thought was really cool. I’m wondering how rolled out is that. Are your sales guys actively selling that product or is it still in the process of being rolled out. And then maybe give us some color as to how much of your managed services revenue it represents today.

Manuel D. Medina

Absolutely, it’s on our product portfolio being sold. Obviously as the product develops it’s going to have a substantial number of more features that will actually make the product to adapt and to adopt. But we are being greatly successful today. One of the things that is actually pleasantly surprising is that the size of the deals is substantially larger, it’s actually kind of commensurate to our deals on a traditional managed hosting customers. So actually for the large customers’ adoption that it has actually been well adopted.

We also are very pleased with the level of turn out for the product itself. So right now it’s small, as a percentage of our managed services, obviously because it just rolled out at the end of June but we do expect it to become a more important part as time goes by;.

Jose A. Segrera

And one other thing that I think is worth pointing out when you focus on top line in a new product and we mentioned it on the call, this September quarter we signed up a record number of new customers. So 80 new customers coming online and when you look at the delta quarter-over-quarter, it’s the strong pipeline we’ve talked about, bringing on the new customers, and then also the incremental products that with the Cloud, which has allowed us to penetrate some new markets and bring some new customers and some new dollars in.

Manuel D. Medina

I would like to be able to point something out regarding this transaction that I don’t really think is reflected in the numbers and that is that the transaction was incredibly disruptive. I mean, it was just something that took a lot of energy and [break in audio] the destruction aspect of the transaction, and the process, was something that is difficult to quantify. But it definitely had an impact, not just on the cost side, but it also had an impact on the revenue side. Notwithstanding that, we still were at the high end of the revenue that we had seen. So I just wanted to add that, that it’s kind of difficult to put a real dollar value on the distraction of senior management of having gone through a process like that.


Your next question comes from Manuel Recarey - Kaufman Bros.

Manuel Recarey - Kaufman Bros.

The EBITDA full year guidance, what number are we using? A normalized figure for the September quarter?

Jose A. Segrera

Yes. So the way we look at the back half of the year is if when you go through the add backs and you are at a run rate of $12.0 million for the quarter, what we’re looking at for the back half of the year and the ramp to get us there is flow-through about 55%. So the launching point we’re using is this $12.0 million number for the September quarter and then the flow-through to Q3 and Q4 based on the revenue trajectory we have, is 55% quarter-over-quarter.

Manuel Recarey - Kaufman Bros.

And the bad debt expense that you took, did I hear you correctly in that the aging of the accounts receivable really hasn’t changed at all?

Jose A. Segrera

That’s correct. If you look at the overall receivable balances and you can look at the trends, if you go back to the March to June and June to September, we are seeing very positive trends on the receivables. So we didn’t have to take an increase to the allowance, a conservative move, and it was also based on some specific items. And what we’re doing is just monitoring this very closely and staying ahead of it.

Manuel Recarey - Kaufman Bros.

So if things work out the way you expect you don’t believe you are going to have another write down?

Jose A. Segrera

Nothing significant. There’s always some dollars you take in during the quarter but we don’t expect to.

Manuel Recarey - Kaufman Bros.

As far as the NCR pod 2, how quickly can you ramp that up?

Manuel D. Medina

From day zero, the day we pull the trigger, we can have it up and running in around seven or eight months.

Manuel Recarey - Kaufman Bros.

And the Nap, the west, I think you mentioned the second half of this fiscal year where you expect to break ground on that?

Manuel D. Medina

Yes, we are continuing with the plans, basically as Jose said in his script, we actually turned up around 4,000 feet right away, which is actually helping us because basically by putting in additional power in our existing facility we were able to utilize space that was not being utilized before.

But the main project is still in line to break ground at the end of this fiscal year.


Your next question comes from Christopher Larsen - Credit Suisse.

Christopher Larsen - Credit Suisse

There was a big increase in the non-recurring revenues and a lot of it seemed to be from equipment sales. Is that a fair indication that those were installations that we will see coming on turning into recurring revenues in future quarters?

Secondly, I’m wondering if you can give us an idea of what the percentage of revenues are exposed to the FX that you talked about for the real?

And is there a sense that the buyer would come back if the capital markets opened up again.

Jose A. Segrera

I will take the first two. When you see the increase we had quarter-over-quarter of just over $1.0 million increase on the non-recurring revenues, those are linked to typically larger customer installations where there may be some equipment associated with those, so as part of accommodating the deal the customer may buy the equipment through us and then we will turn up the recurring revenue.

One thing that is important to also understand and it’s our model is different than other folks out there in the market, particularly on the hosting side. When we are selling dedicated hosting solutions to customers we are not buying that equipment and carrying it on our balance sheet. The customer can provide the equipment themselves or we will sell it to them. We fielded questions in the past about why our capital spend is lower than other hosting providers and that really is a big differentiator.

So the answer to your question is yes, you see that spike in the non-recurring equipment, it’s related to larger, typically hosting deals. Sometimes it might be liked to a colocation deal.

And on the FX exposure to the real, it’s insignificant. If you look at our international footprint, the majority of international business comes from Europe so the real is insignificant.

Manuel D. Medina

And as far as the strategic question that you were asking, the Board right now, and this process being over, we are fully engaged in executing our business plan and you can see the level of excitement as Jose and I mentioned. Our business if roaring on all 12 cylinders and we are really very happy just moving forward.

Having said that, the Board of Directors always has an obligation to consider serious offers. As far as the particular financial sponsor who started this whole process, we maintain a very good relationship with that sponsor and I don’t know what the future will bring, but certainly our focus is 100% in executing the plan that we have today.

I think you’re going to find us really performing well in this environment and again, I am personally happy that the transaction is over and that I’m only working 18 hours a day instead of 26. Because basically it’s just very, very, very consuming.

You know what it is to be a director in a public company and any time you have a valid offer from a creditworthy, reputable you have to take it into consideration. And that’s what the Board did in fulfilling its duties to the shareholders.


Your next question comes from Josh Anderjack – FirstBank.

Josh Anderjack - FirstBank

I have a question regarding the company’s liquidity, specifically the utilization of cash and the decrease in cash, looking back to fiscal year end March 31, 2007, to today, it’s $60.0 million in cash, and how that affects the company’s liquidity working forward.

Jose A. Segrera

If you look at that, the liquidity trends and how that has trended over the past five quarters, or since we brought in the $250.0 million of debt last August, is well within, and as expected. We embarked about 12 to 15 months ago on a capital plan to build out new space or infrastructure in Virginia, add space to Miami, and some capital deployed in California so it’s all fallen within line. We are at a point now where we are going to see a decreasing trend of capital expenditures over the next couple of quarters and then obviously what is happening now is you are seeing an increasing trend with the operating cash flow that the business is generating.

So where we stand right now, our outlook for the next several quarters, we’re very comfortable, and where we are today is where we expected to be five or six quarters ago.


Your next question comes from Doug Worman - JP Morgan.

Doug Worman - JP Morgan

I just wanted to drill down a little bit more on the unsolicited bid process. I do understand the Board has an obligation to review any of these scenarios that pop up. I think, frankly, in this situation it doesn’t seem like they did a good job. So I just wanted to get that out of the way. And before I get into a couple of questions, maybe I’ll jump into some questions. Did the perspective buyer have any material non-public information and is there a reason why we didn’t know about this last quarter in August given that the process began in April and the credit markets were basically unfolding well into August when you gave your last conference call? And given the fact that the stock has basically been unchanged for the last five years, what were the other alternatives that they were looking at, that took them so long to determine that they shouldn’t hit a bid that’s at a premium to the current stock price?

Manuel D. Medina

First of all, we didn’t say anything in the last call because there was really nothing to say. I mean, at that particular stage the Board had actually instructed us to go out and do a market check and everything that that implies. And the market check, when the Board is fulfilling its duty, it means you go out and do a market check and every aspect of it.

So that’s why we didn’t say anything. There was really nothing to say and what the Board was doing was looking at whether the offer that was presented or the expression of interest that was presented at the time from a reputable financial sponsor was something that they should really consider. And in order for them to do that it essentially required us to go out and do a very exhaustive market check, as instructed by the Board.

And again, with the advisors, and these were all very reputable, top-notch advisors. As time went by, basically as the Board considered all the alternatives, and the Board decided in September when the process was completed that basically it was in the best interest of the shareholders in the company to continue executing the current business plan.

So that’s pretty much the short and sweet of it.

Doug Worman - JP Morgan

So they had material non-public information when they made this bid or did you ever give the books back and forth or what?

Manuel D. Medina

I don’t really want to get into that. Basically there was an expression of interest, basically based on what they knew about the company, and basically with that the Board, on the credibility of the financial buyer, went out and said go out and do this market check. And we maintain a great relationship with everybody.

Something else that happened in this process by the way, is we.

Doug Worman - JP Morgan

I should hope something went different along this process because between April and August it took four months to do a market check.

Manuel D. Medina

It took probably 45 days to get NDA signed. I will tell you, the Board did a thorough job and then basically it’s unfortunate, things moved slow. Nobody was more anxious to get over this process one way or the other than senior management of the company, being that we have a thriving business but it’s roaring on all 12 cylinders and the process is all consuming. At the same time they were running a very prosperous business.

Doug Worman - JP Morgan

Even at a prosperous business with all the things you talked about going through the business, at any premium to where the stock was trading in April, that was a premium bid that you guys should have hit. And you could line that up against any of your peers and that would have been a high-five transaction. So next time that comes along hopefully you will hit it.


Your next question comes from Srinivas Anantha - Oppenheimer & Co.

Srinivas Anantha - Oppenheimer & Co.

Jose, when I am looking at the guidance here and I’m looking at the margin improvement from Q3 to Q4, you’re pretty much expecting a pretty steep ramp in margin expansion, even after excluding the $2.0 million. And you are also guiding to higher than expected project-related non-core revenues. Could you just talk about some of the drivers of the margin expansion?

Jose A. Segrera

When you look at the project revenue mix for the full fiscal year, we have always talked about just under 10% mix for the full fiscal year. Right now where we stand and given the visibility we have from executed contracts and very specific opportunities, we will probably end up at 10% to 11% of total revenue for the full fiscal year.

So if you compare that to last fiscal year, which was about 13%, maybe 14%, it is still the trend that we had expected overall for the year.

And when you look at, very specifically, the back half flow-through margins, we are very comfortable, you can very clearly look at it and see and understand the ramp in costs that occurred during Q1 and Q2, a lot related to the new operations that we put in place. So we’re very comfortable with the back half of the year.

And the other thing to point to is if you look at last fiscal year, what we’re looking at for this fiscal year it’s even more conservative or less of a growth than we experienced in the back half of last fiscal year.

Srinivas Anantha - Oppenheimer & Co.

Because even if I’m looking at last year, the margin expansion was not that much when you look from Q3 to Q4, but this year Q3 to Q4 you’re expecting margins to improve from 23% to 27% to meet the mid-range of the guidance. So that’s why I was trying to get the way it was that incremental EBITDA margin was coming from.

Jose A. Segrera

If you run the numbers you are going to see flow-throughs of 54% in Q3 and 63% in Q4 so you blend it out to about 55% or 56%. So those are the numbers.

Srinivas Anantha - Oppenheimer & Co.

I’m looking at your bookings and this is the first time [inaudible] saying your bookings down, during the past couple of quarters, on a sequential basis, whether it’s the total of the recurring bookings. Could you talk about what happened there, or did you have any push outs during the quarter that are going to be coming in Q3 or Q4, or what happened with the bookings here?

Manuel D. Medina

First of all, the bookings for Q1 included the CSC booking which is a very large booking on the federal side. If you take a look at commercial bookings, they were actually up quarter-over-quarter. So basically on the federal bookings, as you know, have always been more lumpy, up and down, so that basically was the only reason.

If you take away the CSC booking, commercial bookings were up and federal bookings were still healthy, and our pipeline is very healthy right now so we expect bookings to be very strong continuing forward.

Srinivas Anantha - Oppenheimer & Co.

And Manny, you also indicated that your sales cycle is relatively stable. What is the typical sales cycle for you and what was it a year ago?

Manuel D. Medina

Basically, right now because so much of revenue is managed services, the sales cycle is actually shortened. Some of the Cloud products, for example, the sales cycle is two weeks. And for the managed hosting product on our virtual platform, typically you are running anywhere from six to 12 weeks. And the colocation about the same. So that basically has maintained itself pretty steady.

Srinivas Anantha - Oppenheimer & Co.

And you are saying the managed services sales cycle has shortened right now?

Manuel D. Medina

Yes, because of the Cloud. The Cloud is actually something that you buy. Also we have a sales engagement team that is really doing extremely well, that basically is taking orders literally over the Web. So basically it doesn’t really involve face-to-face, so actually our sales cycle, because of the new product set, has actually shortened.


There are no further questions.

Manuel D. Medina

Again, thank you very much for joining us this memorial day of change in our country. Basically we are very pleased with where we are with our company and we are very glad to be reporting to you today and look forward to our next call.


This concludes today’s conference call.

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