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Executives

Kathleen Haney – IR

Keith Olson – President & CEO

George Pollock – SVP, CFO & Treasurer

Analysts

Jonathan Atkin – RBC Capital Markets

Jonathan Schildkraut – Jefferies & Company

Sri Anantha – Oppenheimer

Richard Fetyko – MCF

Robert Dezego – SunTrust Robinson Humphrey

Eric Suppiger – Signal Hill

Gray Powell – Wachovia

Steve Salberta – Boenning & Scattergood

Mike McCormack – JP Morgan

Colby Synesael – Kaufman Brothers

Mark DeRussy – Raymond James

Switch & Data Facilities Company, Inc. (SDXC) Q1 2009 Earnings Call Transcript April 28, 2009 4:30 PM ET

Operator

Good day ladies and gentlemen and welcome to the first quarter 2009 Switch and Data Earnings conference call. My name is Kamitia [ph], and I will be your coordinator for today. (Operator instructions) I would now like to turn the call over today to Miss Kathleen Haney. Please proceed ma’am.

Kathleen Haney

Thank you and good afternoon everyone. This afternoon after the market closed Switch and Data released its first quarter 2009 financial results. A copy of the release may be found on the Web site at switchanddata.com in the Investor Relation section. We routinely post important information on the Investor Relation section of the Web site and we encourage you to make use of that resource. Making presentations today will be Keith Olson, President and Chief Executive Officer and George Pollock, Chief Financial Officer.

Before I turn the call over to them, I need to read the Safe Harbor statement. Part of our discussion today may include forward-looking statements. These statements are not guarantees of future performance and therefore undue reliance should not be placed upon them. The company undertakes no obligation to update any forward-looking statements in order to reflect events or circumstances that may arise after the date of this conference call.

We refer you to the company's recent filings with the SEC for a more detailed discussion of the risks that could impact the company's future operating results and financial condition. We will mention financial terms such as EBITDA and non-GAAP measure of financial performance. Management believes it is a common and useful tool in evaluating the company's performance.

EBITDA is defined as operating income plus non-cash items including depreciation, amortization, stock based compensation, lease litigation costs, deferred rent and certain other costs. A reconciliation of comparable GAAP measures can be found at the end of the earnings press release as well as on the company's Web site.

I will now turn the call over to Keith Olson, President and CEO.

Keith Olson

Thank you, Kathleen. Good afternoon ladies and gentlemen. Thank you for taking your time to join us this afternoon. I want to welcome you to Switch and Data's 2009 first quarter earnings call. I will review our first quarter’s highlights and George Pollock, our Chief Financial Officer, will review the financial results. After our presentations, we will open the call for your questions.

The first quarter marks our ninth consecutive quarter of growth since our IPO. Our earnings release reported the health and strength in our business results. Switch and Data posted strong sequential recurring revenue growth, improved margins, and stronger EBITDA growth for first quarter. In addition to our revenue and EBITDA growth, other key operating metrics for the first quarter exhibited continued strength. First quarter revenues grew 18.5% over the same quarter in 2008 and EBITDA grew 31.7% with respect to same period last year. Margins increased, recurring revenue measures saw sequential quarter over quarter growth comparing first quarter 2009 to fourth quarter 2008. George will provide additional details in his prepared remarks later in our presentation.

Before I recap our other key metrics for the quarter, I wish to reference the launch of our financial services practice that we had announced in March. We are excited about our opportunities in this market. Clearly, we are taking advantage of the market opportunity. Our investments in our New Jersey site and the carrier densities we support in our New York City metro sites just across the river.

In our press release, we included a link to an industry sourced report which we believe will assist investor interest for additional market intelligence. This report was produced by the Tabb Group. The Tabb Group is a financial markets research and strategic advisory firm. The report is called ‘Financial Data Centers: Power, Proximity and Profit.’ If you have not done so I invite you to visit Switch and Data’s Web site to gain access to this valuable report. It speaks to the decision points that financial services firms look to satisfy to support their businesses. I feel confident that as our financial practice develops we will speak about the success in this new market segment for our business.

Now onto our first quarter metrics. Door [ph] cabinets increased 11.8% from 7,034 in March 2008 to 7,864 in March 2009. Cross-connects increased 8.6% from 19,797 in March 2008 to 21,504 in March 2009. Our interconnect revenues were strong showing year over year and sequential quarter growth. We continue to see customers increasing their traffic through our sites. Peering exchange traffic grew 135% over March 2008. This is more than double the industry expected growth rate. The traffic volume growth as well as our interconnect revenue growth are measures that demonstrate the execution of our strategy.

Churn for the first quarter improved. Our churn for the first quarter was 1.3% down from 1.5% in the fourth quarter 2008. This was in line with our expectations. 53% of our new sales in the first quarter were in our new builds. Cabinet ARPU or average revenue per unit increased from $1,900 in March 2008 to $2,032 in March 2009. And our capacity utilization was 60.4% in the first quarter of 2009. With respect to capacity, our primary expansion project for 2009 is in our New Jersey site. This project is on track and we expect to finish the project by the end of September 2009.

Over the past three quarters, George and I have shared with you the impacts we have experienced from the prevailing economic conditions. We have communicated that some customers have been delaying decisions. We also have had customers request ramps or stage implementations for their deployments. On these calls, we also spoke about the small and medium-sized customers who are more affected by the broad economic conditions. We saw this impacting increased churn and slower growth rates from this customer segment. More recently we have been seeing some change in growth dynamics. We saw improving demand and new orders improving from small and midsized customers. We had a healthy quarter with respect to new customer sales in the first quarter. We executed contracts with 36 new companies or new logos. This was followed by 50 in the fourth quarter if we recall our comments and some of our metrics back in the fourth quarter.

Although these are limited data points, it makes sense when you think about the speed at which small and large companies operate. Our investments continue to enable us to win new deals and add to our frontal opportunities. Of the 3,300 cabinets added throughout 2008, most were in our top markets. These investments have been sporting the larger deals we continue to win as well as provide a platform for our sales team to increase the size of our sales volume [ph].

Even with macro financial issues that could fund so many aspects of our economy, we see continued growth, improved churn rates, and a growing number of large opportunities making their way into our sales pipeline.

Allow me to highlight a few first quarter wins. It provides insight into our growth story. Amazon expanded its presence in a number of sites and Internet exchanges to improve their business performance. Big Fish Games, a leading online gaming and interactive entertainment provider, was a significant win for us in the first quarter. You may recall we spoke about them as a new customer for Switch and Data in the latter part of 2008, while they expanded their operations in an incremental site with Switch and Data. Comcast, a provider of entertainment, information, and communication services increased their deployments in six of our top 10 markets. And Verizon, the world’s largest domain registry and a provider of Internet infrastructure services expanded with us in several sites. WhitePages.com, a new customer chose Switch and Data to support its growth and rollout of its new mobility services. These wins reflect our continued success in winning deployments from network dependent companies. It is these types of customers such as online retailers, content broadband and service providers that create the marketplace dynamics in our sites.

From an industry perspective, a number of reports continued to forecast growth. These reports indicate increases in traffic, user demographics, and application use trends. These trends our customers demand and our strategic investment support Switch and Data’s growth. Some of the reports included the following. A system study conducted in January particulars pertaining to the mobile data traffic forecasts. It is expected to double each year through 2013. Our WhitePages win is part of this growth story. In the same month, research firm IDC projected that capital constraints will accelerate the growth of software delivered over networks. More content, more applications over more networks, another recipe for success for our business.

And in March, comScore reported that more than a 140 million US Internet users watched an average of 90 videos per viewer in February, certainly a significant contributor for both content and broadband providers traffic growth. All of these external reports speak to network traffic growth and the additional use of network enabled applications. Growth in applications and traffic required increased network and infrastructure. These growth characteristics require data center capacities in the form of space, power, cooling, and interconnection.

Stepping back from our business and looking at the macro picture, the market drivers remain strong. Our target segments, customer segments continue to contribute to growth in applications and network traffic. We are extending our market reach with our new vertical practices and our investments in the new site capacities complement our existing and developing customer segment needs. These are the leading indicators that point to growth for Switch and Data services.

I will now turn the call over to George Pollock to review our financials.

George Pollock

Thank you, Keith. Thank you all for joining us today. I will share our first quarter financial results review and provide some insight into the remainder of 2009. We had another solid quarter. Revenues in the quarter increased 18.5% from $39.8 million in the first quarter of 2008 to $47.1 million in the first quarter of 2009. This revenue growth is inclusive of a $650,000 negative impact from foreign currency related to our Triam [ph] facility. Assuming the foreign exchange rate was held constant our revenue growth would be 20%.

Recurring revenues which consist of co-location and interconnection services were $44.9 million in the first quarter of 2009, representing growth of 19.2% over the first quarter 2008. On a sequential basis, over the fourth quarter 2008, recurring revenue increased 4.5%. This includes 4.2% increase in co-location revenue and a 5.1% increase in interconnection revenue. This represents our best interconnection revenue growth in the last three quarters.

Non-recurring revenues representing one time installation fees and services, increased from $2.2 million in the first quarter of 2008 to $2.3 million this quarter, up 6%.

Our overall revenue growth contributed a solid EBITDA and expanding EBITDA margins. EBITDA increased 31.7% from $12.6 million in the first quarter of 2008 to $16.6 million for the first quarter of 2009. And EBITDA margin increased from 31.7% to 35.2%. On a sequential basis, EBITDA increased 4.8% over the fourth quarter.

Our cost of revenues excluding depreciation and amortization increased from $20.4 million in the first quarter 2008 to $24.3 million in the first quarter of 2009. Most of this $3.9 million increase in cost of revenues is related to the investments we have made in our top markets to add product capacities. As we (inaudible) product capacities, we improve our gross margin.

On a sequential basis, over the fourth quarter 2008, our gross margin increased by $1.4 million, which is our best increase since 2007. On a percentage basis, gross margins improved from 46.7% in the fourth quarter 2008 to 48.5% in the first quarter 2009.

Our general and administrative expenses decreased as a percent of revenue from 11% in the first quarter 2008 to 10% in the first quarter 2009. G&A expenses in the quarter were $4.7 million versus $4.3 million in the first quarter last year.

With respect to sales and marketing expenses, these expenses also decreased as a percent of revenue from 13% in the first quarter 2008 to 11% in the first quarter this year. Our sales and marketing expenses this quarter were $5.2 million, which is unchanged from the first quarter a year ago.

Interest expense in the quarter was $4.4 million, which includes $2.5 million of interest on our bank debt, $1.2 million of interest on our capital leases, and $700,000 expense related to the fair value adjustment for the interest rate swap agreement.

Now turning to the balance sheet as of March 31, 2009; our cash balance was $22 million. Our day sales outstanding metric for accounts receivables improved from 24 days in the fourth quarter of 2008 to 22 days this quarter. Our bank debt was $142.5 million and our bank debt to EBITDA ratio was 2.2 times, and our total net debt to EBITDA ratio was 2.6 times.

Our cash capital expenditures were $24 million in the quarter of which $18 million was incurred in our New Jersey facility. For the full year, we are expecting $75 million in capital expenditures. As you may recall from our last earnings call, we increased our 2009 capital expense outlook from $65 million to $75 million to take into account a $10 million payment to a building contractor that was paid in January of this year instead of December of last year.

For our 2009 outlook, we are maintaining our guidance as follows. Revenue to be between $207 million and $210 million, which is 22% growth at the midpoint. And EBITDA to be between $71 million and $73 million, which is 27% growth at the midpoint.

Switch and Data continues to perform and execute to our long-term strategy of increasing revenues and EBITDA to improve shareholder value. We have enjoyed a good start to 2009 and we look forward to delivering another year of strong results.

And with that, Keith and I are happy to answer your questions.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from the line of Jonathan Atkin from RBC Capital Markets. Please proceed.

Jonathan Atkin – RBC Capital Markets

Yes. Kind of a broad question. You’ve been certainly ramping up your marketing efforts in specific industry verticals over the last several quarters, if not longer. And I am just wondering which ones are showing most momentum? And then kind of on housekeeping side, I wonder if you could just review kind of the trends that you have been seen in churn as well as in percentage of sales the new versus existing customers?

Keith Olson

Sure Jonathan. Thank you very much. First of course our content and entertainment practice has been an investment of ours longer than our financial services practice. And we have seen more momentum in the C&E practice than financials. I expect to see a building momentum in our finical services practice as we move throughout 2009 and into 2010. Our C&E practice is very much focused on what we would refer to as a digital media and entertainment segment where we’ve been talking about some of the specific wins through the last couple of quarters' calls. As it relates to churn, we spoke about the fourth quarter indicated that it has moved above the historical kinds of run rate to about 1.5%. At that time we had our outlook from sales and marketing saying that it was going to come back in line with our plan, which is right where our churn landed for the first quarter in 2009 and that is our expectation that we will end the year we give – our end of year guidance is tied to being in line with that churn rate of 1.3%.

Jonathan Atkin – RBC Capital Markets

And then, you’ve kept the guidance the same. I am just wondering in terms of the composition of the revenues, any change that you are seeing or expecting in the mix of recurring versus non-recurring or within the recurring category, the mix of interconnection versus co-lo.

Keith Olson

No. That’s an excellent question. I don’t believe we will see a big variance between recurring and non-recurring. Just based upon – George can answer this even more specifically around GAAP and the terms of contracts and things of that sort. But then the moment above monthly recurring revenues which we had a very strong kind of quarter over quarter growth. The interconnection, we see that adding between the 31, 32 down to 30-ish percentage, and that just has to do with how much incremental space and/or power in that particular quarter versus interconnection. And they don’t all land simultaneously. We see them come sometimes (inaudible) starts based upon deployment, turn-up, lamp and then interconnections are added on as what I would say as a more of a month to month product. But we don’t see a significant change for the 2009 year in those measures either.

Jonathan Atkin – RBC Capital Markets

And then I guess back to the first part of the question on the percentage of sales to new logos versus existing customer expansion.

Keith Olson

Sure. It was, 78% were existing customers.

Jonathan Atkin – RBC Capital Markets

Great, thanks very much.

Keith Olson

You are welcome.

Operator

And your next question comes from the line of Jonathan Schildkraut from Jefferies. Please proceed.

Jonathan Schildkraut – Jefferies & Company

Hello. Thank you for taking the questions. I have a couple of housekeeping items for George. I was wondering what the new gross square footage number was if it’s changed. And also for some reason, I have the customer count as of the end of last year and I was hoping I can grab that. Then I would like to kind of talk a little bit more about the business as we look at the results for the quarter, which were quite healthy to get to your guidance we certainly would need a little bit of a ramp to occur as we look through the next couple of quarters. I was wondering if there is kind of any catalyst to drive that growth whether it’s the opening off of additional capacity in New Jersey or if there is something else we should be looking at.

Keith Olson

George, why don’t you clean up some of the housekeeping –

George Pollock

Yes. Jonathan, two of your housekeeping questions. The first question, gross – real estate gross square foot, 1.050 million, which is essentially unchanged from the fourth quarter. And the customer count at the end of the fourth quarter was 952.

Jonathan Schildkraut – Jefferies & Company

Thank you.

Keith Olson

And Jonathan, on the aspect of our expected growth, we continue to see very strong demand in all of the regions, all of our geographic and in our vertical market segments pipelines and frontals. And we see it as just a natural state of continued momentum build throughout the year with increases in both monthly recurring revenue and in our (inaudible) to be able to get to our guidance numbers that George articulated.

Operator

And your next question comes from the line of Sri Anantha from Oppenheimer. Please proceed.

Sri Anantha – Oppenheimer

Yes. Thank you. A couple of questions. Keith, maybe you can talk about the booking trends in your recently opened data centers. Maybe if you can give us some color, rate of the utilization especially of the New Jersey data center currently stands. And maybe in that regard if you can talk about even the Seattle and the Toronto facilities too that would be helpful. And the second one, is there a significant difference in ARPUs between your recently opened data centers versus your legacy data centers? Thank you.

Keith Olson

Sure. Sri, the first point is that 53% of our sales in the quarter went to our new builds.

Sri Anantha – Oppenheimer

And when you say new builds, that’s coming mainly from Toronto, Seattle and –

Keith Olson

Yes, correct. It’s been the builds that we had made major expansions throughout 2008. Let me highlight them for you. It’s Seattle, it’s Sunnyvale, it’s New Jersey, it’s DC Metro, Toronto and Dallas.

Sri Anantha – Oppenheimer

Got it. Okay. And what about the utilization of your New Jersey data center currently?

Keith Olson

Right now, out of the initial footprint that we did the build out and launch at the beginning of the fourth quarter last year, it is about 40% utilized.

Sri Anantha – Oppenheimer

Got it. Okay. Thank you.

Keith Olson

Right. And I spoke a little bit in my comments about some customers requesting some staging or lamps to their deployments. Some of the new builds customers, of course as they were making larger implementations have asked for those types of ramps. So, we will see improving characteristics as they finish off their deployments.

Sri Anantha – Oppenheimer

Got it. Okay. And what about the ARPU differential between your new data centers as opposed to your legacy existing data centers.

Keith Olson

Yes. The – if you took across the average, they are equal to our existing install base. If you would highlight some of the ARPUs, you take a look at our ARPUs as in general at over $2,000 of revenue per month, that’s a very significant number when you compare interest versus a number of the other companies that report ARPUs. The strength that we see has to do with how we monetize the sites and as George articulated and I spoke to in some of my commentary we talk about ever increasing both year over year and quarter over quarter interconnection revenue growth that’s driving that. That’s across the board but of course the bigger markets concentrate our revenues and the concentration of revenues in our top 10 markets for the quarter was 87% of our recurring revenues fell inside of those markets. So that’s how you can get to kind of the strength in our ARPUs and the strength in our new builds.

Sri Anantha – Oppenheimer

Got it. Thanks guys.

Operator

And your next question comes from the line of Richard Fetyko from MCF. Please proceed.

Richard Fetyko – MCF

Thanks. Hi guys. Just curious if you could elaborate on your statement during the prepared remarks talking about improving operating environments. Obviously we saw churn tick down a bit. But it sounds like your sales pipeline perhaps has improved, your visibility has improved. I was just wondering if you could provide a little more color as to what you meant by that and did your sales cycle improve as well?

Keith Olson

Sure. We don’t see it in the large deals category. We don’t any further degradation in the sales cycle, but we are not seeing any rapid change to what was a lengthening type of decision process. The improvement I was speaking to was in the small and midsize customer that seems to be more impacted in the middle part and later stages of 2008. At the end of 2008, of course we saw a significant new logo or new customer quarter for us. We also saw in the first quarter more demand from our existing customers that seem to have compress some of their growth through the latter stages of 2008. That’s the operating environment we saw the improvements on seeing the mid to small size customer. A couple of month's worth of data doesn’t necessarily provide a lot of data points. But I thought it was worth referencing because the three quarters we spoke about that group or that customer segment being the most affected and now we are starting to see not only net new customers in two good quarters or two healthy quarters of new logos but also demand from our existing small and midsize customers starting to uptick.

Richard Fetyko – MCF

Got you. That’s good to hear. And then with respect to the linearity of the quarter, was it backend loaded? One of your comps reported couple of weeks ago or last week talk about relatively backend loaded quarter. I was just wondering if you saw the same trend. And then on New Jersey data center, utilization of 40% I thought it was sold at a higher rate than that. So is there – is the sell through rate different from utilization rate?

Keith Olson

Utilization rate would be fully deployed.

Richard Fetyko – MCF

Okay, that’s right.

Keith Olson

Okay? Let me answer your first part of the question. We saw improving new sales February over January and March over February. So it’s a trend that was kind of a stepping stone of new sales and that’s where we saw some of the uptick from the small and mid size customers as well as the characteristics that we’ve been seeing with our builds being able to attract and address larger scale opportunities, both from our existing customers as well as net new logos a number of those over the period we have communicated about their wins.

Richard Fetyko – MCF

Got it. Thanks. That’s all I had. Thanks.

Keith Olson

Thank you.

Operator

And your next question comes from the line of Robert Dezego of SunTrust Robinson Humphrey. Please proceed.

Robert Dezego – SunTrust Robinson Humphrey

Hi, good evening guys.

Keith Olson

Hello.

Robert Dezego – SunTrust Robinson Humphrey

Sort of quick follow up to the last question. You know the pace of sales during the quarters, you said that January was – February was better than January, March better than February. Was there a – was March – was it a lot better in March, was there a dramatic difference in between January and March? Or was it –

Keith Olson

It was a stepping stone.

Robert Dezego – SunTrust Robinson Humphrey

And would it be same if you excluded New Jersey from that?

Keith Olson

I haven’t looked at that level of detail at all.

Robert Dezego – SunTrust Robinson Humphrey

Okay. And then the other question I had is the MRR for cabinet, the growth seems to have slowed a little bit from the growth you’ve put up in the third and fourth quarter. I was wondering maybe you could talk a little bit what are your expectations for the full year on the MRR growth, especially with the New Jersey data center coming on, presumably will it be at a higher MRR?

Keith Olson

Not necessarily. Typically new cabinets don’t have the interconnect densities or the power densities of more mature sites. Certainly when you think of some of the sites like New York 10118 avenue and our Colorado sites, they have years and years worth of interconnection growth and power growth on top of the installed deployment. What we are seeing and the way the sites behaving is consistent with our plan as far as New Jersey is concerned. I know we’ve spoken about the differential between operating a site in New Jersey versus Manhattan. Utility expenses are lower, real estate expenses are lower. There is a lot of benefit in the scale of that site. And so we are able to take advantage of that.

Robert Dezego – SunTrust Robinson Humphrey

So, you would expect kind of the MRR to be slowing as you are adding all this new capacity in New Jersey?

Keith Olson

No, I would say that if you look at the history of our ARPU increases, they have kind of had certain quarters they will have larger jumps than others. And this is just one of those periods of time where especially given some of the commentaries that I spoke about and George referenced, which is ramps to implementation as people take one component and not yet fulfil other elements of the full build-up that could compress some ARPUs in earlier stages. It doesn’t compress ARPU over the long term.

Robert Dezego – SunTrust Robinson Humphrey

Okay. And then the last kind of question. If you look at pricing in the New Jersey data center, how is kind of comparing to other capacity you have in that market and perhaps other new markets that you’ve launched?

Keith Olson

Sure. I know we spoke a little bit about our promotional pricing that we’ve run in a couple of different sites. We see prices strengthening and consistent with our pricing models. Again, if you take a look and fall back to the ARPUs and the average revenue per unit (inaudible) equivalent, we are at the high end of the scale.

Robert Dezego – SunTrust Robinson Humphrey

Okay. Thank you very much.

Keith Olson

You are welcome.

Operator

And your next question comes from the line of Eric Suppiger from Signal Hill. Please proceed.

Eric Suppiger – Signal Hill

Good afternoon.

Keith Olson

Hi, Eric.

Eric Suppiger – Signal Hill

Couple of things. First off, Equinox had a decline in their interconnect revenues on a sequential basis. You had a reasonably good pick up. Any explanation what you might be doing differently or seeing differently from what they might be?

Keith Olson

I can’t comment on that. Ours is tied to the continued execution of our strategy on those network depended, network centric companies. That’s been our strategy and our mantra and that’s how we see our value proposition resonating with our carrier densities across the very broad footprint here in North America. Clearly when you looked at the 2008 statistics around traffic growth as reported by a number of different sources. North America still has the highest compound annual growth rate on top of the biggest mess. And again, we’ve been reporting our growth of being greater than the industry in traffic growth. I think that’s what’s really driving interconnection services for Switch.

Eric Suppiger – Signal Hill

Was there any anomaly that would have given you a little bit higher sequential pickup this quarter?

Keith Olson

None that came to my attention.

Eric Suppiger – Signal Hill

Okay. And I also noticed your cross-connect growth sequentially wasn’t as much as your sequential revenue growth. Are you seeing the customers that are buying, they are buying more of the high speed connections.

Keith Olson

Yes, medium and port speeds are driving that.

Eric Suppiger – Signal Hill

And then in terms of the newer markets that your higher growth markets, are you starting to run into any capacity constraints where you added capacity in 2008 or all of those markets still relatively – they still have capacity for sales.

Keith Olson

In the markets, we have capacity, in some sites in the markets we may have some constraints, which is one of the reasons why we’ve added capacities to be within 2008.

Eric Suppiger – Signal Hill

But you are not running into capacity constraints within given cities though.

Keith Olson

Well, on some given cities absolutely. Not in the ones where we did our builds.

Eric Suppiger – Signal Hill

Okay. In terms of pricing for any of the high end growth – or the high growth markets seeing any particular trends in pricing for some of the high growth markets.

Keith Olson

No.

Eric Suppiger – Signal Hill

Very good. Thank you very much.

Keith Olson

You are welcome.

Operator

And your next question comes from the line of Gray Powell from Wachovia. Please proceed.

Gray Powell – Wachovia

Hi, good afternoon everyone. I just had a few quick questions. At the start of 2009, you basically had about two times the amount of sellable capacity that you had at the start of 2008. Can you just talk about how that reflect [ph] into your pipeline? And are you potentially able to target larger deals?

Keith Olson

The answer is yes, and yes. And let me give some color. Whenever you have a constraint market you have customers wishing to increase their footprint, increase their capacity. Historically, we’ve spoken around 80% of our new sales come from our existing customers and it’s ranged in the 75% to 84% type of ranges certainly over the last four or five quarters. If my recollection is not correct, correct me, I know we post those. But the capacities that we’ve added not only are they in the biggest sites but also with our focus on larger deals to a broader set of digital media companies that feed their full site ecosystem. We see that as natural extensions to size of deal. And we continue to report out on significant deals when the customer allows us. Of course there are a number of customers that do not want us to be speaking to their deployment and of course we just secretly enjoy their revenues.

Gray Powell – Wachovia

All right. Fair enough. And then with credit markets loosening up the last couple of months. What are your thoughts about tapping capital markets in order to increase your expansion initiatives and I know you might not be able to answer that one. If not, how should we think about your target leverage longer term?

Keith Olson

Yes. So, 2008 was a very significant year for Switch and Data as it relates to our capacity in the critical markets. We continue to do some build outs in New Jersey to add capacities out to the end of September as I have indicated. There may be a couple of small fill-ins in one or two sites we’ll add a little cooling or maybe some incremental power distribution units to get a couple of more cabinets so to facilitate our customers increase in their power footprint inside of our sites. Right now, we are fully funded for our capacity plan and we have the capacities in the right markets to continue to attract and close large scale deals. As it relates to the capital markets, although we’ve been hearing that there is some life in certain sectors. Right now we don’t have any pressing needs and we will look at opportunity and growth as being the major drivers for us in the future.

Gray Powell – Wachovia

And then just last question, I know you’ve gotten a few on the pricing environment in general. Looking at – it looks like current utilization is about 60%. I am guessing closer to 75% plus in markets that are over 12 months old. Is there sort an inflexion point in the market where you really feel like you get leverage on pricing?

Keith Olson

Well, let me just help you with some of those numbers first. All of our builds with the exception of New Jersey were in existing markets. So, where we added a lot of capacities, it was where we’re already operating. And so just think of that as kind of the virtual neutral exchange point when we have kind of the new (inaudible). In Dallas, Toronto, and DC they were actually (inaudible) where we took on the capacity. Pricing opportunity is really tied to what we’ve been articulating for several years. We expect about 3% to 3.5% increase in our revenues from pricing. The rest of our growth is all tied to customer demand and incremental sales to new and existing customers. So, outside of that that’s how we see the kind of the makeup associated with the supply/demand in the pricing model. And this has been the consistent theme for us as we said, certainly on a number of these calls and then as it manifested itself in our revenue results.

Gray Powell – Wachovia

Okay. Thank you very much.

Keith Olson

Thank you.

Operator

And your next question comes from the line of Steve Salberta from Boenning & Scatt. Please proceed.

Steve Salberta – Boenning & Scattergood

Hi, guys. Last quarter, you spoke about some grooming that was underway in your inter-connect business. And I just hoping you could – the tremendous growth that you’ve put up in inter-connect, if you could talk about that. Did it just happen faster or at a lower rate than what you had initially thought?

Keith Olson

The grooming that we saw going on actually impacted the churn for the fourth quarter. Some of that grooming also creeps into the first quarter. And that’s where some companies said, I need to lower some of my operating expense. The inter-connect growth is really driven from inter-connection port capacity and the medium of cross-connect that we saw across the broader base of customers. And any of the industry reports come out that speak to the traffic growth that’s the kind of driver that increases the inter-connect from a net new building perspective. So, that’s where we’ve seen the growth.

Steve Salberta – Boenning & Scattergood

Can you help us understand 10 Gigabit connections, peering connections, how much of the inter-connect business is made up of that and what are you seeing in terms of shifting between 1 and 10 Gig connects?

Keith Olson

Sure. I can answer in a general direction. I can’t get down into some of the specificity. May of our historical single Gig customers have moved to 10 Gig. Many of them have multiple 10 Gig in multiple markets. Some have multiple 10 Gig in the same market. And it’s really driven from – peering is really simply state of two networks that want to exchange traffic but it’s a ‘1 to n’ environment. So you plug into the fabric which is the exchange and now when I want to have a peering relationship with, I can direct, redirect traffic directly as content becomes richer I can utilize peering as a very efficient way for me to improve my network performance. And that’s what we see moving on from the standpoint of scale of size of port, frequency of port, and then the deployment of ports over a broader number of exchanges.

Steve Salberta – Boenning & Scattergood

And one of your largest competitors has done some adjustments I guess in terms of pricing and I know you don’t look directly at what they are doing. But can you just speak to what your customers think or you know their satisfaction in terms of the pricing on inter-connect. Are they satisfied? Would they like to see a much lower price?

Keith Olson

Well, I think they would – they were always been interesting in a much lower price because when they look at it, they look at it from a – many of the network providers and service providers, their product management teams own kind of the P&L of the product. And so with ever decreasing revenue per package, revenue per transaction types of services the decrease in their price points; they want to be able to lower their overall costs to carry. Our whole philosophy and strategy has been to aggregate more inter-connections on a prorate basis to improve their costs per bit through our sites. That’s what we have been focusing on over the last couple of years with our investments ranging from technologies to sales conferencing. The customers would always like to see it, but are they satisfied with where we have been taking and how we have been managing our portfolio of interconnect products? Absolutely, it resonates through the customers that third-party analyses that come back. I think I’ve reported on the last call where we had the strongest in three years our levels of satisfaction. And if they were dissatisfied with something that usually jumps out in those types of reports.

Steve Salberta – Boenning & Scattergood

Okay. And my last question is in terms of reported monthly new recurring sales. You’re kind of coming – you entered the year as a – at a pretty strong position in terms of being at a lead in New Jersey, having some capacity there. Should we think about the year just from the new recurring sales standpoint is being a little bit more frontend loaded maybe whether it is just staging other customers have or just the capacity that you have in your own situation?

Keith Olsen

Our existing pipeline would not suggest that at all. Our existing pipeline would suggest that momentum is building.

Steve Salberta – Boenning & Scattergood

Okay. Great, thanks guys.

Keith Olsen

You’re welcome.

Operator

And your next question comes from the line of Mike McCormack from JP Morgan. Please proceed.

Mike McCormack – JP Morgan

Hi guys, thanks.

Keith Olsen

Hi Mike.

Mike McCormack – JP Morgan

Let me just – quick comment on the improving demand takes you there, just give us a sense if you can if there is any particular geographies that you’re seeing more or less of that occurring?

Keith Olsen

Thank you for asking that. I think when we’ve spoken about our percentage of new sale hood or demand orders across all footprint. Over the last couple of quarters, we had a much higher percentage in our new builds versus this past quarter.

One of the indicators that take back to my view from my marketing team was the increase in number of locations where we saw those demand orders coming from improved. If you look at the first quarter certainly versus third and fourth quarter, I’d have to go back and just look at second and first. But clearly, we didn’t have all the net new capacities in the first and second quarter to do that comparison. In the third and fourth quarter, we had most of our capacities on line and therefore we are seeing some significant trades outside of just our net new builds.

Mike McCormack – JP Morgan

Okay, great. Thanks guys.

Keith Olsen

Yes.

Operator

And your next question comes from the line of Colby Synesael from Kaufman Brothers. Please proceed.

Colby Synesael – Kaufman Brothers

Great. Thank you for taking my question.

Keith Olsen

Sure Colby.

Colby Synesael – Kaufman Brothers

You guys obviously have entered the financial space, you mentioned in March. Obviously there are some guys that have been in there for longer than you have and this is a business that’s based on the network of fact. Can you explain to us why customer would choose you guys over somebody else in a specific market for your financial services platform, especially I would assume that most of the exchanges, et cetera that connect you are already in other facilities? And then my next question has to do with just the overall economy. Obviously, we heard two different stories, we’ve heard one that people are more willing to outsource in this type of market environment, but at the same time, we’ve also heard that people are elongating their sales cycle that certainly has increased. Do you think that you guys are net beneficiary of the current economy, in other words, is one of those doing better than the other or are you guys are net – getting negatively impacted as it relates to the economy?

Keith Olsen

Yes, I am going to try to answer the second part of your question first, Colby. We’re not merely a big decision outsourcing. We’re focusing on – and operate our data centers as exchange points and so therefore, it’s not typical a build versus buy decision. People that provide outsourcing services to other enterprises are our customers. So when I think about people that are offering software and applications on tap or what I guess some of the terminology now it’s called clouds.

Some people have build clouds inside of our sites. We are not operating the cloud. They’re operating the cloud and they’re providing those types of services to their customers. So I see us as anything that drives incremental bits and packets regardless of whether it would be consumer-to-consumer, business-to-consumer or business-to-business, if it’s driving packets over networks and they require an efficient place to exchange aggregate and terminate traffic, that’s what drives our business.

And all of the – whether it’s build versus buy of different decision points, if it’s network based, we are going to participate somehow, because our customers are adding infrastructure to support the overall growth in transactions, video, queries, searches, et cetera.

Colby Synesael – Kaufman Brothers

Okay.

Keith Olsen

On the financial exchange side, we brought in some market savvy people to help us with our point of attack. Their assessment is, is that we certainly have the right location footprint and carry densities to be attractive to a segment of this market and it increases our reach.

And the value proposition that we offer these types of decisions is very consistent with our historical value proposition, which is power, cooling, technical competencies, a lot of network capabilities, low latency to be able to support their business and we saw this as a natural extension and we put at the point of attack while we have labelled them practice leads to be able to drive the mind share of the market.

And we have announced a couple of wins and there is a couple we’re not in position or we haven’t got clearance to announce. So we see ourselves in excellent position to join this wonderful opportunity of selling into the financial exchange and service providers.

Colby Synesael – Kaufman Brothers

Okay. So I guess you have got some survey or analysis that’s indicated to you that that customers would be willing to leave their current sites and come to you or that –

Keith Olsen

I haven’t done that. We have not done an analysis to say would you forklift out. We’ve just talked to a number of different participants about how attractive our metro play is with them and it’s resonated quite well.

Colby Synesael – Kaufman Brothers

Okay. And then I just have one follow-up, if that’s okay. Obviously the power and cooling technology for data centers has improved throughout the years. Now I would assume that the technology that you are putting into your new facilities is different than what you may have done just two years ago, how does that benefit you guys, does that benefit you from a margin standpoint or does that benefit you from when customers are evaluating particularly your service and maybe your offering a lower PV than other competitor in the market? Just any color there would be helpful. Thanks.

Keith Olsen

I think we would be better served if I had my construction engineering – engineers answering some of that. But clearly, there are some efficiencies garnered because of utilizing not only improve technologies and you think about just refrigeration systems and HVAC systems that over a year number of years just improve the sear factor, I will use that as – now you know how naïve I am about the engineering aspects.

However, the scale, the redundancy and the technologies that we deploy are a big piece of our collateral as we walk people through and they do compare and contrast on the technology. Site design and site operation are as important, because it is not just buying the right things, it’s then operating them as they service, which is what our customers benefit from.

And with the levels of repeat sales that we get from the largest players in the industry, we can make sure that we continue to stay on the frontlines of providing the right types of technologies and services for them to deploy their service.

Colby Synesael – Kaufman Brothers

Well maybe a simple way to asking the question is, are your new facilities that you have built able to provide a better margin for you than some of your older facilities in a hypothetical fully utilized situation?

Keith Olsen

I am going to ask George, because he’s from those models.

George Pollock

Colby, the answer is yes. It’s not all having to do with more or better efficiency of cooling. It also has to do with starting as Keith said, starting with site location, site specification, site design. The larger sites that we’re building in a couple of data points since as we look at a New Jersey for example which is public record in terms of that lease, lease rates are $17 versus $40 to $70 in New York City. Power rates are two-thirds of the cost vis-a-vis in New Jersey.

(inaudible) leverage on your technical support over a larger footprint as to the capacity in terms of the ability to drive better margin. So it’s not only the fact the equipment is more efficient and as Keith mentioned, refrigeration, it’s the same concept in a DA center, it cools more effectively and requires less power, which inherently is going to drive less expense and a higher margin. And we couple that with the design, the size, and the scale, we certainly have – we have expectations based on our financial analysis that we’re going to drive better margins out of the newer facilities for a number of reasons.

Colby Synesael – Kaufman Brothers

Great, thank you.

Operator

And your next question comes from the line of Mark DeRussy from Raymond James. Please proceed.

Mark DeRussy – Raymond James

Hi, good afternoon. Wanted to circle back to New Jersey again, Keith, what is it that you defined as 40% during the discussion about utilization, is that –

Keith Olsen

Power and cooled cabinets out of the total power and cooled cabinet capacity.

Mark DeRussy – Raymond James

That they’re building. They’re building 40%.

Keith Olsen

40% of the initial build out. That’s correct.

Mark DeRussy – Raymond James

And that was what 1,300 damage.

Keith Olsen

Yes.

Mark DeRussy – Raymond James

Okay. And then there was a higher percentage on sort of a – as sold basis, can you discuss that for us?

Keith Olsen

No, no. I think maybe – maybe you can explain that question a little bit more and I will provide context. When a customer asks to secure a cage environment and they haven’t fully deployed all of the interconnections and power that’s what I was referring to.

Mark DeRussy – Raymond James

That’s 40%.

Keith Olsen

Well that is correct.

Mark DeRussy – Raymond James

Okay, all right, that’s fine. And then the discussion earlier about capital markets opening up, maybe they will, maybe they won’t. But as sometime, I think we all believe that they will. What are your thoughts on being able to take advantage of that situation? I mean you guys have a war room somewhere with a white board that’s got projects on it, so you guys can get a fast start on any capital that may come to you?

Keith Olsen

As we have spoken on this call a number of times, we continue to look at buildings in markets where we have known run rates demands and market intelligence. And so we continue to look at the – at these types of properties and of course we are looking at that when we make a decision which is our priority one versus priority five, ten, for us to be able to build out. There is nothing – we don’t have the need to pull those triggers right now. And so therefore, we are forming and storming just looking at the lay of the land, because with the current conditions, material costs are improving. I just saw a recent article about the cost of steel is expected to come down due to iron ore, so there is some favorable dynamics in the market that we continue to watch. But right now for our business plan, the way we have outlook our business, we are in excellent shape from a capacity perspective.

Mark DeRussy – Raymond James

You think that there is demand out there, should you have the ability to add incremental capacity beyond the $75 million this year?

Keith Olsen

Demand from what standpoint, demand from customers?

Mark DeRussy – Raymond James

Yes.

Keith Olsen

There is more demand than we can satisfy right now. We’ve talked about that a number of times in markets where some of our sites are above the 75%, 80% utilization.

Mark DeRussy – Raymond James

And so hopefully the capital markets come around to at that reality and allow you to have more capital. Okay, thank you.

Keith Olsen

You’re welcome.

Operator

And we have one more – we have time for one more question. And we have a question in queue, a follow-up from Jonathan Atkin from RBC Capital Markets. Please proceed.

Jonathan Atkin – RBC Capital Markets

Yes, I wonder if you can comment on your – on the demand that you are seeing from overseas into your obviously US data centers. I think what we have been seeing is a fairly strong demand from the US into Europe, not necessarily going the other direction. What trends have you noticed in your data centers?

Keith Olsen

Yes, we have been announcing a number of our customer wins through kind of 2008. I am not sure if any of our customer announcements have been centered on the first quarter of 2009. But we have had a very good success with international service providers, Telcos, and companies deploying into our East Coast and West Coast data centers.

I don’t have an any real deep science to look up right now, Jonathan, but that’s something if you hit our website or we can put this together for you, we can provide you some of the significant deployments coming in from Asia and Europe landing in our New York and DC area sites and in the West Coast, our Seattle and our Bay Area sites.

Operator

And I assume there are no further questions in queue. I would now like to turn the call over to Mr. Keith Olsen for closing remarks.

Keith Olsen

Thank you very much. Ladies and gentlemen, thank you very much for your time and your interest in Switch and Data. We appreciate your support. You have a good evening.

Operator

Thank you for your participation in today’s conference. This concludes your presentation. You may now disconnect and have a wonderful day.

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Source: Switch & Data Facilities Company, Inc. Q1 2009 Earnings Call Transcript
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