SAVVIS, Inc. Q1 2009 Earnings Call Transcript

SAVVIS, Inc. (SVVS)

Q1 2009 Earnings Call

April 29, 2009 10:00 am ET

Executives

Peggy Reilly Tharp – Director of Investor Relations

Philip J. Koen – Chief Executive Officer

Jeffrey Von Deylen – Senior Vice President of Global Operations & Service

Analysts

Srinivas Anantha – Oppenheimer & Company

Colby Synesael – Kaufman Bros.

Mark Kelleher – Brigantine Advisors

Simon Flannery – Morgan Stanley

Jonathan Schildkraut – Jefferies & Co.

Eric Suppiger – Signal Hill Capital Group LLC

Jonathan Atkin – RBC Capital Markets

Vincent Lin – Goldman Sachs

Presentation

Operator

Good day, ladies and gentlemen, and welcome to the SAVVIS First Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions). As a reminder, this call is being recorded.

I'd like to introduce your host for today’s conference Ms. Peggy Tharp. Ms. Tharp, please go ahead.

Peggy Reilly Tharp

Thank you. Good morning and thank you for participating in the SAVVIS first quarter 2009 earnings call. I am Peggy Reilly Tharp, Director of Investor Relations for SAVVIS.

Earlier this morning, we distributed a press release with detailed financial tables, which is available on our website at savvis.net. In addition, we have corresponding slides available on our website, which will be referenced during this call.

As always, please be aware that today's discussion contains forward-looking statements as defined under Federal Securities Laws. Actual results could differ materially from our projections due to various risk factors including but not limited to the factors disclosed in the company's Form 10-K and other filings with the U.S. Securities and Exchange Commission. And we encourage you to review those disclosures.

Our presentation today will include references to certain non-GAAP financial measures that provide additional information for investors. In compliance with the SEC's Regulation-G, our press release distributed today which is posted on our website and furnished to the SEC on Form 8-K includes both our rationale for why we believe non-GAAP information is important in describing our operating performance and the full reconciliation with the corresponding GAAP numbers.

Today, we'll begin with a brief overview from Phil Koen, our Chief Executive Officer; Jeff Von Deylen, our Senior Vice President of Global Operations and Services who will follow with a financial update. Phil will then provide a review of our business model strategy and focus before turning the call back over to the moderator for Q&A. Greg Freiberg, SAVVIS’s CFO is also joining the call today.

I'd now like to turn the call over to Phil Koen.

Philip J. Koen

Thank you, Peggy, and good morning everyone. Before we begin today, I’d like to take a moment to welcome Greg Freiberg to SAVVIS. Greg joined us last week as Senior Vice President and Chief Financial Officer. Greg will oversee finance, legal, corporate development and of course Investor Relations. So, you will likely be seeing him on the role very soon. Greg has great financial and industry experience both domestically and internationally. His financial leadership, proven track record and global experience will be a valuable asset to our company. Greg is a strong addition to our team and we are excited to have him on Board. So, welcome Greg.

Now let’s turn to a brief overview of our first quarter results. Once again, SAVVIS delivered on the metrics that mean the most to investors. We reported first quarter revenue of $221.5 million, an increase of 9% over the first quarter of 2008 as shown on slide four.

For overall hosting, revenue for the first quarter was $152.3 million, or 18% growth over the first quarter of 2008. And in the first quarter, Colocation was up 24% year-over-year, while managed hosting was up 11% over the first quarter of 2008.

I would like to point out that during the first quarter, we had non-recurring termination fees of $3 million, which were unrelated to the American Stock Exchange cancellation. The majority of this one-time item is due to a U.K. customer, who departed SAVVIS following a downturn in their business.

Adjusted EBITDA for the first quarter of 2009 was $58.8 million, a 46% improvement year-over-year. For the second quarter in a row, SAVVIS reported positive adjusted free cash flow of $33.2 million, which is a significant improvement over the $44.3 million of adjusted free cash flow reported in the fourth quarter of 2008.

We believe that free cash flow is an important success factor for SAVVIS in 2009, and we continue to manage the company with this in mind. These significant improvements in adjusted EBITDA and adjusted free cash flow are due to our strong focus on driving efficiencies. These results also validate our business model, which we believe will deliver a superior return on invested capital. In addition to reporting strong financials, we achieved several other accomplishments in the first quarter.

We demonstrated a further commitment to the Financial Vertical by announcing two new low latency offerings. Our Proximity Hosting offering continues to be managed out of our NJ2 Data Center, which is the premier Proximity Hosting facility in the world. We also provided details around our first Cloud Compute offering. Through 2009, we will be making additional product development investments in Cloud Compute and other related services, and this amount makes up a significant percentage of our overall development budget. As we progress through the year, you can expect to learn more about our Cloud Compute expansion and how we plan to be the leader in enterprise cloud solutions for infrastructure services.

Finally, we have some very exciting news around the new customer. As we mentioned in today’s press release, we booked a significant outsourcing deal with a large online digital media services company. This enterprise will be outsourcing more than 10 petabytes of storage to SAVVIS.

In addition, we will work to re-architect the customer’s platform to drive efficiencies and cost savings. This is exciting news, as this contract has five-year total revenue in excess of $40 million, and as the first step in growing through the loss of the American Stock Exchange. As customers continue to focus on cost savings during these trying economic times, we expect to see more and more outsourcing deals of this nature and are actively targeting these opportunities.

Before moving onto Jeff and his financial review, I would like to once again say how pleased I'm that SAVVIS delivered on those critical and faster metrics, adjusted EBITDA and adjusted free cash flow in the first quarter. Later in the call, I will provide an update on the industry and some color around our business going forward.

And with that, I would like to turn things over to Jeff for an update on the quarter and a more in-depth financial review.

Jeffrey Von Deylen

Thank you, Phil. Good morning everyone. Our review today will include a summary of this quarter’s operating results, our view of the cash flow and balance sheet position and finally an update of our updated guidance. Let’s get started.

Slide 6 shows the first quarter that we reported revenue of $221.5 million, an increase over the first quarter of 2008, and generally in line with the fourth quarter. During the quarter, as Phil mentioned, SAVVIS was positively impacted by approximately $3 million in non-recurring termination fees related primarily to hosting revenue. Just some outflows due to adjusted EBITDA and adjusted free cash flow as well.

On the other hand, we were negatively impacted by approximately $1.4 million of total currency impact during this quarter, as the pound continued to slip against the dollar. On a year-over-year basis, this impact was approximately $4.1 million and would imply a year-over-year growth of 11% in the first quarter on a currency-adjusted basis.

Adjusted EBITDA was $58.8 million for the first quarter, which was a 46% improvement over the first quarter of 2008 and reflected 13% growth over the fourth quarter of 2008. In addition, adjusted EBITDA margins expanded to 26.5% of revenue in the quarter up from just under 20% a year ago. We continued to target cost savings and efficiencies in every area of the business. Compared to the fourth quarter, we saw a total improvement of $4.6 million in cost of revenues of which $3.6 million related to utilities, maintenance and other operational costs and $1 million related to a reduction in network costs, as our network revenue continued to decline. As most of you know, utility costs, in particular are seasonal and we would expect those to increase in Q2 and Q3.

In addition, on the SG&A line, we saw a $3.2 million improvement over the fourth quarter; about half of this improvement was a result of lower personnel related expenses.

Turning to our business unit update on slide seven, I'd like to give you a brief summary of our financial verticals, our hosting business, and our network services. Our financial vertical continues to be a large component of our overall business at 26% of total revenue, while we did see year-over-year growth of 12% in the first quarter of 2009. Sequentially, this vertical is down 3% due to the continued turmoil in this market. In addition, Colocation customers in this vertical are holding off on advanced purchases and moving to more of a just in time model.

For 2009, our overall outlook in this vertical continues to be cautious. In addition to the departure of the American Stock Exchange due to its acquisition by NYSE Euronext, we continue to see uncertain economic conditions persisting in this industry. In the first quarter, we did receive a full quarter revenue from MX.

For our Hosting business, first quarter revenue was a $152.3 million, which was an 18% improvement over the first quarter of 2008. Our Software-as-a-Service or SaaS offerings help contribute to our hosting revenue, as nearly 90% of SaaS revenue is reflected in our hosting business, with 55% of that being Managed and 45% being Colo.

For the quarter, SaaS showed an 8% growth over the fourth quarter of 2008. In addition, we exceeded our SaaS bookings targets for the first quarter. For the first quarter, our network revenue declined 7% on a year-over-year basis and 3% sequentially. This overall network revenue result was inline with our expectation. And while we did see some expected churn related to the downturn in the economy, this amount was about what we expected.

Our network strategy still call through us to shift our focus to network customers within our service profile, which is primarily focused on customers suite by services and our data center, or who are in close proximity to our data center. Our approach will be similar to the tack we took over the past 18 months with our low paying and less profitable Colocation customers. And we expected to result in improved network margins over the long-term.

As you can see on slide eight, total revenue for the quarter of $221.5 million was up 9% year-over-year and relatively flat compared to the fourth quarter. Again revenue for the first quarter included a full quarter of American Stock Exchange revenue. As this contract was terminated in March; you can expect to see total revenue and our hosting revenue in particular to decline sequentially quarter-over-quarter.

Adjusted EBITDA improved over both the first quarter and the fourth quarter of 2008. In addition, we improved our gross profit to $102.5 million in the quarter for year-over-year margin improvement of approximately 200 basis points. At the same time, SG&A margin decreased by approximately 400 basis points year-over-year to only 20% of revenue as we did a nice job of controlling costs during this period of economic uncertainty.

Slide 9 shows the success we’ve had in grooming our Colocation customer profile. As we have been able to move our business away from customers paying below market rates through a concerted effort over the past 18 months. We have been able to improve our revenue per square foot for Colocation. The $48 yield for the first quarter is the 20% improvement year-over-year, and a 5% sequential improvement. And this number should continue to improve as our expanded data center footprint continues to fill. I would also like to point out that our total data center average yield per square foot improved to $93 held by our customer a mix shift in Colocation and Managed Services.

And slide 10 shows we have actively moved from 53% of our Colocation footprint being occupied by large content customers in the fourth quarter of 2006 to only 12% in the first quarter of 2009. Correspondingly, Colocation revenue for the fourth quarter of 2006 was just under $60 million while in the first quarter of this year it was $84.2 million. With nearly 90% of our installed footprint being utilized by enterprise customers, we have been able to shift to a more profitable customer mix. This process took time, nearly 24 months and while there were quarterly revenue fluctuations along the way, the long-term value of this effort is now apparent.

As we continue to focus on enterprise needs with offerings like SAVVIS Cloud Compute, we continue to move our mix towards these customers. Enterprise customers are willing to pay market rates and are interested in adding managed hosting services to their portfolio, as they look to cut costs, improve flexibility and avoid capital expenditures. As of the first quarter, our investment in capital expenditures was slightly lower than normal. However, we expect the amount to tick up to the guidance you can say on slide 11 related to expanding our customer success and cloud based offerings.

For the full year, we still expect customer and product growth to make up a big part of our capital expenditures at approximately $65 million. In addition, you can also expect to see approximately $45 million in maintenance and IT CapEx, which historically represents about 5% to 7% of our total revenue. Maximizing our returns on invested capital is important as we continue to focus on the metrics that mean most to investors. The first of these have adjusted free cash flow as we have depicted on slide 12.

In the first quarter, we showed significant positive adjusted free cash flow of $33.2 million, while we recognize this was a very strong quarter. I’d like to remind everyone that we have semi annual convertible note interest payments of approximately $5 million due in the second and fourth quarters.

In addition as I just mentioned, we expect our CapEx spending will increase in the remaining quarters. Another metric, we would like to draw your attention to is on slide 13. SAVVIS continues to focus on the quality of our return on capital employed, which is shown here as operating cash flow divided by assets deployed over the most recently reported 12 months. We believe this measure represents the cash generation of the assets deployed and the relative returns on a percentage basis.

Once again, on a trailing 12-month basis, you can see that company has focused on more long-term offerings such as managed hosting, are able to provide a better return on capital employed. We continue to expect to make the most of our existing data center space and to only put capital in the ground when we find ourselves in a high return growth situation.

Before turning to our guidance, I'd like to quickly review our outstanding debt agreements as shown on slide 14. Of note, due to our adoption of SP APB 14-1 on January 1 of this year, we have separated the liability and equity components of our convertible notes. The net carrying amount of our convert on the balance sheet is $295.1 million. An important point on this slide is a fact that our leverage that’s calculated on a trailing 12 month adjusted EBITDA basis is 3 times on a gross basis and 2.3 times on a net of cash basis. We believe we have a very strong balance sheet with no significant near term debt maturities and are reasonably levered in this environment.

Now, let’s look at our guidance for 2009 on slide 15. As we mentioned in our earnings release today, we are increasing adjusted EBITDA guidance range to $190 million to $200 million, reflecting our strong first quarter results. We continue to make strides in our long-term target of driving EBITDA margins from the mid 20% range to our 30% target.

As I've already mentioned, we continue to expect cash capital expenditures between, $110 million to $140 million in 2009. And we should see cash interest expense in the $40 million to $45 million range. And as we detailed in our release, we increased our adjusted free cash flow guidance consistent with our increase in adjusted EBITDA.

I would like to remind everyone that while we are not providing any annual revenue guidance, there are specific risks that we are facing in 2009. Specifically, our contract with American Stock Exchange was terminated in March due to the acquisition of NYSE Euronext. This customer historically provided annualized revenue of approximately $27 million.

And with that, I would like to turn the call over to Phil for a review of our business and the industry.

Philip J. Koen

Thank you, Jeff. Before I start I would like to take just some few moments to thank Jeff for significant contributions and for his service as Chief Financial Officer of SAVVIS over the past six years. As you know, Jeff will continue with the company in his role as Senior Vice President of global operation and client services where he will concentrate his efforts on driving efficiencies on a global scale. During his time as CFO, Jeff steered SAVVIS through a period of growth while strengthening the balance sheet.

As you can imagine, I'm very pleased to have someone like Jeff dedicating his focus to operations and service, who will oversee customer delivery and ongoing support, ensure our global approach to improving customer loyalty and help drive further margin expansion. Jeff, thank you very much for your valuable contributions and considerable time being spent working hard at making SAVVIS what it is today.

Now turning to slide 17, I would like to talk a little bit about what I've seen and heard over the past quarter, while traveling and meeting with customers. Beginning with the managed hosting, we continue to see active interest in the IT infrastructure solutions that we offered. Enterprise customers remain focused on cost savings and this is their main driver. As a result, they are dramatically shifting their IT spend from growth projects to efficiency projects and we’ve seen a corresponding decline in project supporting growth efforts.

Customers are interested in virtualization and consolidation as they look to drive savings. More and more, we see reduction in total cost of ownership, improvement in return on investment and financial business cases as the motivators behind customer sales. We also continue to see additional and higher level layers of approvals. The higher up the executive chain a deal goes, the more important the financial business case becomes, especially during final reviews prior to a commitment. As you know, SAVVIS prides itself on its ability to save its enterprise customers’ money. And we have invested time and talent into our TCO analysis team. I can tell you that these individuals, the models they use on in high demand of our sales force and their customers. For our Colocation business as Jeff mentioned, purchasing has moved to a more just in time model, as the global economy begins to impact customers. Specifically in the financial vertical, Colocation customers are delaying purchases of additional space and power whenever possible.

During the quarter, we saw a modest strength in Silicon Valley, Washington, D.C., and the New York-New Jersey markets. In Chicago, we have the opportunity to become more aggressive to drive volume our way following the reclamation of space in December of 2008. This space was priced at below $10 per square foot. So we had a benefit of expanded space without any of the associate capital investment. This puts us in a good position in this market where competitors are trying to fill recently built data centers.

As we stated during our fourth quarter call, while we see no reason to expand our footprint at this time, we would consider adding more space if it allowed us to attack a new geographic market or to further penetrate a key market opportunity such as proximity hosting.

Our proximity hosting franchise relies on a network effect and we always want to have a capacity expand as needed, as this product commands a higher pricing compared to standard Colo. At present, we have an interesting opportunity in one highly constrained market. However, any changes to our footprint will require business case that meets our objectives.

From a bookings perspective, our overall hosting business in the first quarter was roughly in line with the third and fourth quarter of 2008. While we began to see some delays in Colo bookings, managed hosting bookings were up slightly over the fourth quarter. A great example of this is the deal we completed during the quarter with a large online digital media services company, which I mentioned earlier in the call. I expect we will continue to see deals as the year unfolds.

As enterprise customers look to consolidate and transform their IT infrastructure, they are turning to outsourcing. Here at SAVVIS, we are in a strong position to help these customers to streamline their operations and save money, as we offer the products and solutions that make this possible.

In terms of the industry, there are few areas I would like to highlight and you can see these on slide 18. First off in managed hosting; we are seeing the deal focus shifting. Customers are implementing a selective sourcing strategy and moving away from mega-providers to companies with flexible expertise and business models like SAVVIS. Enterprises are looking for specialist firms to offer solutions such as web hosting, SaaS, test and development and storage as a service.

As customers are looking to accelerate the time to value, they are starting to unbundle large projects. At SAVVIS, we have already segmented the market and the industry is now starting to fragment our favor. We are in a good position to take advantage of this emerging trend. According to Gartner, over the past three years, deals with a total contract value of $10 million or less, are the fastest growing segment of outsourcing with deals between $10 million and $15 million a close second. We are a natural beneficiary of these kinds of deals and our customers consistently point to our agility and flexibility on awarding us contracts with total values in these ranges.

While managed hosting has a longer sales cycle, as it is a difficult more complex sale we are well situated in this market for a long-term success. We have a great managed hosting offering and through our outsourcing solutions, we provide the total cost of ownership benefits that enterprises require with a quicker time to value.

In Colo, we are also seeing some shifts, but this is more in terms of pricing. For larger deals, pricing has become significantly more competitive. Big Colo deals are done by big companies and these folks are knowledgeable shoppers, they were targeting lower prices and with their size they can command a better than market rate. The enterprise customers that we are targeting do not fit into this category, as SAVVIS is providing machine critical managed hosting services the enterprises that need flexible solution.

Surveys have shown that price is the single most important factor that customers are looking at when evaluating Colo space. Colo pricing seems re-trading within a dollar per kilowatt band and there is no visibility of any breakaway prices. Large footprint deals are generally found at the lower end of this band and are under pricing pressure.

For smaller enterprise deals like the one SAVVIS targets, pricing is higher and it is not under as much pressure. Jeff spoke about this earlier, and I would like to expand on his comments. We are well on our way to a blended $50 per square foot average as we told you we would be 24 months ago, when we began reviewing our customer profiles and embarked upon our global data center expansion.

We made a concerted effort to target the more profitable enterprise customers. We're now seeing the fruits of our labors. Finally I would like to talk a little bit about our network business and the trends we're seeing there. Our application transport network bookings were up on a quarter-over-quarter basis for the first quarter and this is the second sequential quarter of improvement. While network bookings hit a low point in the third quarter, we are now seeing some evidence of a trend in the right direction. I find it’s encouraging and an indication that our network strategy is gaining traction. While there is still pricing pressure in our bandwidth business, for the first quarter, our hosted area network revenue was up 4% year-over-year and in line quarter-over-quarter. However, this was offset by churn primarily from network customers that are not attached to our data center operation.

Our focus continues to be to grow the number of customers, who are attached to our data centers through products such as our hosted area network and our IP VPN offerings. The continued quarterly improvement in network bookings is very accounting and shows our efforts to target the right network customers will be successful over the long-term, and we will report back on our progress, as we begin to make headwind in this effort.

Internationally, we had a solid first quarter with going up against some tough international competitors and wining deals. In addition to providing the cost savings and flexibilities that customers require, we’re able to be more competitive due to our global footprint. SAVVIS has 29 data centers across three continents, and we work successfully as a global team to bring our business units together to win deals.

As a multinational company, we’re able to address enterprise needs around the world. We continue to see customer deals with a number of global locations, since we are one of a handful of international companies going to offer managed hosting, integrated with network and Colo on three continents. Another interesting data point is that cloud computing is becoming to generate some discussion interest in Europe.

On slide 19, you can see that in U.S., we’ve seen our Cloud Compute offering opening customer doors for us. Customers are very interested in learning more about this exciting new area of IT and we’re making great progress. I have to tell you that every other customer questions about Cloud. We're determined to be the leading provider of enterprise quality infrastructure services. We are thrilled to be technology partners of companies like HP, Cisco and VMware.

During the first quarter, we announced some exciting news in this area. Such as our SAVVIS Cloud Compute, a new virtual data center hosting a private cloud computing solution. In 2009, we'll continue to make additional investments in Cloud product development, which will help differentiate our offering. But whenever you talk about Cloud, you must also talk about security.

Without a doubt, security is a single largest customer concern around Cloud. In addition, you couldn’t have a Cloud without network. At SAVVIS, we have our own highly secured network available for our customers. Just last week, we announced a new Cloud security offering at the RSA show. For SAVVIS enterprise customers we’re running mission-critical applications 24/7, strong network security is a must.

With our global network, we can meet the Cloud more secure, and when it comes to enterprise customers in Cloud adoption, security is always top of mind. SAVVIS was just positioned in the Visionaries Quadrant in Gartner's Magic Quadrant for managed security service providers. We are pleased to add this distinction to our positioning the leader’s quadrant for Gartner's 2008 North American Web Hosting Magic Quadrant.

Before we wrap up today. I’d like to emphasize a few items on slide 20. First we remain dedicated to our long-term managed hosting strategy and this continues to be the center point of our company. As I mentioned previously, during the first quarter, we had a significant storage win, and this type of deal is likely to be repeated going forward. In addition, we're looking to lead the web hosting solutions market. We have already had great success with some significantly large brands and we expect to be able to replicate this model. Jeff mentioned this earlier, but I want to stress the SAVVIS long-term model continues to move in the right direction.

We've seen revenue mix improving and we’re moving toward higher margin solutions. I would also remind people that, while the first quarter was successful and included a full quarter of American Stock Exchange revenue and 3 million of non-recurring termination fees, unrelated to American Stock Exchange.

For the first quarter of 2009 storage win, we have taken a significant step in backing the revenue loss related to the acquisition of the American Stock Exchange by NYSE Euronext. While we expect to be down sequentially in the second and third quarters of this year as we grow through this loss, we expect to see revenue rebound in the fourth quarter.

All in all, I think we are in a strong position in the industry. While, in the short term we will see an impact on revenue, it’s long-term that I focused on. Today, we are one of a few companies that is in a position to provide outsourced infrastructure services to companies around the world. As the innovations like cloud become the delivery mechanism for security, hosting, management and other services, SAVVIS will be beneficiary of these trends. Everyone here at SAVVIS is committed to taking advantage in these opportunities, as are ready to position SAVVIS as a leader for enterprise infrastructure services.

And with that, I would like thank you for your time today and I’ll turn the call back over to our moderator for questions and answers.

Question-and-Answer Session

Operator

Thank you. (Operator instructions) Our first question comes from Sri Anantha from Oppenheimer. Your line is open.

Srinivas Anantha – Oppenheimer & Company

Yeah. Thank you, and congratulations on a good quarter. And Jeff, I didn’t realize that you were going to be this motivated in cutting expenses? A couple of questions, I know you've talked about still the difficult environment. Could you just give us some color, if there has been any incremental change within the sales cycle, just on a monthly basis, if March was better than February or if you have seen any significant differences. And also from which verticals are you seeing the most interest today compared to what you have been seeing six months ago, three months ago? And the second one is on cloud computing, I know there is still a lot of variables or there is still lots of doubts when you especially speak to large enterprises, but when you pitch your cloud services today, where do you see the most interest. Is that coming mainly from the SME segment or is it the medium and large enterprise? Thank you.

Philip J. Koen

Well, Sri, first of all thanks for the complement and you are right Jeff is highly motivated in driving efficiencies, it’s great to see. Let me take your first question, and if I miss it most one please, please pop back in, but with regard to the sales cycle, I haven’t seen in my visits in talking to our sales organization, any real change in the length of time. It is still on that 9 to 12 month type of horizon. The only color I would add and we tried to state this on our prepared remarks is, the level of inspection and the number of approval levels have definitely increased. And the thing that especially as you are going through the quarter is that, what you find is even fluid, people would think that they understood the decision making cycle, only to find that in some instances, decisions now or have to made at a Board level or now they are at a CEO level. So I think our biggest challenge for sales organization is really mapping and understanding these approval processes, which tend to be highly fluid, but having said that, actual length of time, I really don’t see that the 9 to 12 months is still probably operative.

With regard to the question around vertical, clearly the most challenged one as you would expect is the financial. But, I want to also say that having said that, I am very pleased with our, what we’ve been able to achieve here, because within that financial vertical, the solutions that we are selling truly are most likely revenue generating core to their ongoing strategy. So, while we are faced with clearly a more challenging environment which makes the decision-making process difficult, the types of things that we are continuing to see are core to what this particular vertical is trying to achieve. And I would say that’s the one that we are working at the most closely, given the fact that it’s such a large piece of our revenue stream.

With regard to Cloud Computing, you are right, we are probably without doubt on the high curve, almost at the peak. And I will tell you, we will not avoid and no one will avoid the [Inaudible] cycle. It will come, but fundamentally the concept that Cloud Computing offers as a new paradigm is how view a pool of resources and be able to manage the pool for ability to maximize utilization, drive a lower total cost of ownership is a reality. And what we’re seeing right now is that across all sizes of businesses, remember we tend to be more medium to large enterprise. We really don’t play in a very small enterprise base, it’s never been our focus, but across the segment that we touch and across all types of verticals, this very compelling idea is something that people are taking about and are very eager to learn more about. And on my prepared remarks, I've said that this is a core initiative and we are dedicating substantial R&D dollars to accelerate our cloud offering and as you can see we've already made a couple of product announcements and stay tuned, there will be more coming as we go through this year.

Srinivas Anantha – Oppenheimer & Company

Yeah. Thank you. That’s helpful.

Operator

Our next question comes from Colby Synesael from Kaufman & Brothers. Your line is open.

Colby Synesael – Kaufman Bros.

Great. Thank you. Just a few questions, one as it relates to the $40 million contract that you disclosed. Can you give us an idea when that’s going to start out and what the linearity of that is, in other words is that even payments in each year. Also as it relates to the $3 million termination fee that you noted from a U.K. customer. Is that revenue already gone or is that going to be leaving in the second quarter and if so how much. And then just my last question, you noted early hinted at the fact, you may be looking to expand your data center footprint, maybe at the end of this year potentially in 2010. How would you go about paying for that considering your cash and debt position? Thank you.

Jeff Von Deylen

Sure. Hi Colby, it's Jeff. On the $40 million contract, is that will be installed in the second quarter, it is a contract, as you can imagine given the timeframe as it grows overtime, but it was one of those opportunities that the customer was really looking for us to step in very quickly. It's one of those kind of transformations that we are, in the second quarter will be recognizing revenue. And then as their environment grows, the opportunity for that revenue to grow overtime will be there. But certainly a considerable amount of that monthly recurring revenue will be realized this year. Regarding the termination contract, that customer did leave during the first quarter. So, we repaid that termination fee during the quarter. So, the MRR for that customer obviously will -- we won't see going forward.

Colby Synesael – Kaufman Bros.

Can you break that out how much that was?

Jeff Von Deylen

That was $3 million contract and I think the monthly recurring was just over a 100,000 a month in terms of contract. But they were very short and very early into their contract term and they had an issue where they lost their underlying contracts, while the termination certainly was pretty high. And then finally you said on the data center footprint, again I think what we wanted to message is that we continue to look at opportunities. We obviously have existing footprint that if we expand, we can expand pretty economically. I think we said on our total balance sheet position at 2.3 times net leverage, we think we are in good shape. We generated as you saw this quarter significant operating cash flow and free cash flow. So certainly if we did anything it would be through our own means. And again I think when we think about expansion; the last two years we had a significant expansion. So anything that we would look at or consider going forward would be certainly much more modest than we’ve done in the past.

Colby Synesael – Kaufman Bros.

Great. Thank you.

Operator

Our next question comes from Mark Kelleher from Brigantine Advisors. Your line is open.

Mark Kelleher – Brigantine Advisors

Great. Thanks. Just a quick clarification on the $3 million non-recurring termination fees, that would drop down to the gross margin in the EBITDA line, pretty much 100%, right?

Jeff Von Deylen

That’s correct.

Mark Kelleher – Brigantine Advisors

And the American Stock Exchange. Is that just stop or is that a ramp down?

Jeff Von Deylen

They terminated in the first quarter. So we are not providing service going forward.

Mark Kelleher – Brigantine Advisors

Okay. And my last question is that the new deal of 10 petabytes of storage, that’s really fantastic. Where do you sit right now in terms of your capacity utilization on your managed services platform? And do you foresee having to spend CapEx to build that out to handle some of these bigger deals?

Jeff Von Deylen

We are certainly, when you land a deal like that, there is capital to involve -- to scale up to deliver that. I think the duty of our platforms, as they are very scalable on a terabyte or petabyte basis. So that’s one of the kind of hints in the CapEx section as that’s installed in the second quarter, we will see some of the capital from that hit in the second quarter, as part of our success base capital. Those models whether it’s storage, compute, additional network are very scalable with the infrastructure that we’ve got in place.

Mark Kelleher – Brigantine Advisors

Okay, great. Thanks.

Operator

Our next question comes from Simon Flannery from Morgan Stanley. Your line is open.

Simon Flannery – Morgan Stanley

Okay. Thank you very much. You had a interesting chart on the Colocation transformation and the customer mix shift. Are we pretty much through that transition now or do you think you’re still 12% large content. Do you think there are other opportunities to kind of enhance the revenues from replacing existing customers or just adding a lot more higher revenue customers. How far through that transition are we generally? And you had a fairly cautious turn on the financial vertical, are you concerned that there may be other customers who you may terminate later in the year? Or is it just nothing specific, but generally just the headlines that we are seeing and just in due course rather than any specific issues?

Jeff Von Deylen

Yeah. I think on the financial vertical first, Simon I think it is just being cautious and certainly mindful of growing that environment -- new sales are difficult. I think the approval cycles, as Phil mentioned, are probably -- we are seeing most crazy in that industry as they go through a consolidation, people go and just approval processes happen one way and then they changed and going in other way. So I think this is general caution around sort of that environment, but no known termination. And then the first question regarding the content, I think we feel great about where we are positioned with this large content, but our focus really is by providing enterprise infrastructure services. So, the more enterprises we have in those data centers, who ultimately are going to buy mix of services the better. I don’t see a point where we get to zero because there are some of these large contemplates that are increasingly looking at their business models, where I think that the customers that you will see remain with us are going to be those who said, maybe owning and building data centers isn’t the best strategic use of their cash. So they are going to go to providers like us, whereas the ones who are largely accessed, really owning and building data centers is one of the core pieces of their assets.

Simon Flannery – Morgan Stanley

Okay. But this revenue per square foot, you could certainly see that heading up to the mid to high 50s over the next several quarters, do you think?

Jeff Von Deylen

Well, I think the stuff -- the functions that you’ve seen overtime, there is no [Inaudible] step function that we go from 48 to 55 in a quarter. I think it’s largely, we will continue to see increasing higher utilization and higher yield in the centers we moved to more enterprise customers and as we feel the higher density footprint.

Philip J. Koen

Simon. This is Phil. Just to put a little more clarity around that. $50 of blended rate across our entire footprint and I just marked to be – you might look back that, we look at our footprint in the three different groups being standard, mid, and high power. So clearly, a standard facility is not at that 50, but high power is considerably north to that. So I fully expect that we will continue to converge on that $50 line, which we say 24 months that what’s going to happen.

Simon Flannery – Morgan Stanley

Great. Thank you.

Operator

Our next question comes from Jonathan Schildkraut from Jefferies. Your line is open.

Jonathan Schildkraut – Jefferies & Co.

Good morning. Thank you for taking the questions. Jeff, in your prepared remarks, you commented that $3 million of revenue was largely in hosting. Is that correct?

Jeffrey Von Deylen

Yeah. That is correct.

Jonathan Schildkraut – Jefferies & Co.

Okay, great. And as we look at that number even if you back that out I think the results on the cost side were quite remarkable, as we look forward, your EBITDA guidance seems to imply a fairly large step down in results maybe 45, $46 million on average over the next three quarters of what is almost $59 million this quarter, could you kind of take us through how we should think about the rest of the year and maybe what other cost savings opportunities are out there?

Jeffrey Von Deylen

Yeah. I mean a couple of points, obviously the $3 million one-time we would not expect to occur again. So, that’s factored in our go-forward results I think clearly the first quarter, our utility cost in particular from a seasonality perspective have a pretty favorable result. So, I really don't I can take credit for being cooler and for us being able to cool the data centers more effectively. So, we certainly would expect energy cost to rise in second and third quarter as the weather changes and I think that really on the cost side, we are really, we will continue to drive efficiencies, I think we got some nice wins, we’ll continue to make sure that our network cost are in line with our network revenue, but I wouldn't expect any significant sequential quarter-on-quarter cost reductions. I think it's, we are going to have to fight through the fact as we said that our revenue sequentially is going to decline. So, that revenue declines obviously there is some variable cost, but as you know, there is a fairly big fixed cost business.

Jonathan Schildkraut – Jefferies & Co.

Were you surprised by this quarter's results?

Jeffrey Von Deylen

I think we were pleased. Pleased with it.

Philip J. Koen

We are very pleased.

Jonathan Schildkraut – Jefferies & Co.

Very pleased. Great, your last question is on this win on the storage side, I was just wondering if you guys are going to be doing that off of your cloud infrastructure or is it going to be occurring on a dedicated basis?

Jeffrey Von Deylen

It's not on the cloud platform. So, it is part of our additional storage product portfolio that we have.

Jonathan Schildkraut – Jefferies & Co.

All right. Thank you so much.

Operator

Our next question comes from Eric Suppiger from Signal Hill. Your line is open.

Eric Suppiger – Signal Hill Capital Group LLC

Good morning.

Philip J. Koen

Good morning.

Eric Suppiger – Signal Hill Capital Group LLC

A couple of things, you talked about some good growth in your sub-$10 million deal size accounts. Are you seeing strength coming from your mid-market customers or is this just large enterprise customers that are being selective and segmenting the deals that they have?

Philip J. Koen

Yeah. I think it’s a combination of both. One of the biggest growth factors is our SaaS offering. And we continue to be very pleased with the take-up rate that we're seeing there. Additionally, I think that we are the beneficiary of just a bigger trend that I talked about on our prepared remarks where outsourcing deals generally speaking are getting broken into smaller chunks as people really focussed on maximizing time to value. That's what you hear when to talk to customers over and over again. How quickly can you get me to value and to the extent that they can break particular IT outsourcing decisions into regional chunks such as I have a store, I need a storage as a service, or I need to move closer to a SaaS type delivery model. It plays very well into our sweet spot. Generally speaking for our customer, our real sweet spot is that mid-to-large enterprise that's a market that traditionally has been underserved because the really big IPO guys just can’t come down to that space. And there is a fair amount of complexity that we have a great solution for them to be able to take advantage of it. And what I will call the mass hosting providers don’t have a full capability -- integrated solution set that we offer to address that market. So, at the end of the day, it appears to me that we continually are getting good traction and good penetration around that area.

Eric Suppiger – Signal Hill Capital Group LLC

If I hear you, it sounds like it’s more the larger customers dividing the deals into more selective sourcing partners, I don’t hear you talking too much about mid-size customers upticking, is that correct?

Philip J. Koen

It’s both, what you see is large customers who are absolutely fragmenting their outsourcing decision and you’re seeing the midsize guy who are looking at making a more holistic decision about outsourcing and trying to get time to market advantage as quickly as possible.

Eric Suppiger – Signal Hill Capital Group LLC

And on the cost savings front, what did headcount do during the quarter?

Jeffrey Von Deylen

Headcount on an absolute basis was up slightly I will say we are taking some steps in consolidations during the quarter. So, expect that to, as we exit going to April, we will be down slightly as we did some consolidation of [inaudible]some of that impacted folks who were still in the payroll at the end of the quarter, but we’ll see a slight decrease as we head into the second quarter.

Eric Suppiger – Signal Hill Capital Group LLC

I thought the reduced cost was somewhat due to personnel reductions, is that correct?

Jeffrey Von Deylen

Yes. Well I think what we’ve done is over the last, really two quarters is, and we talked about this in the fourth quarter, where we did a selected small downsizing, I think we've reduced the average cost of our headcount and again as I said our headcount at the end of the quarter was really slightly overstated as we just have some folks who are on notice at the end of the quarter, but our average headcount costs was certainly down quarter-on-quarter.

Eric Suppiger – Signal Hill Capital Group LLC

Okay, then lastly in your Cloud service, you've talked about using the newer products on the unified computing front, do you think that’s in your evaluations, do you think that will give you some advantage in terms of offerings that you can offer for Cloud services?

Philip J. Koen

We are absolutely hopeful of that. Clearly we have a very strong technical alliance with both Cisco and VMware. We were one of the featured service providers in VMware’s vSphere launch last week, and we are standardizing on the NEXA switch. We have their California server, we’ve had that in our labs now for a number of months working on it, and I think we’re a big believer that as you think about cloud computing, the integration of the network into the compute platform is an very important way of being able to drive cost than giving more what we call elasticity to the product offering. So, that's where we are headed and we still have some hard work, but we’re pretty optimistic.

Eric Suppiger – Signal Hill Capital Group LLC

Is the biggest advantage there, the efficiencies in cost savings or is there much in the way of innovative services that you can develop?

Philip J. Koen

Both.

Eric Suppiger – Signal Hill Capital Group LLC

Thank you.

Operator

Our next question comes from Jonathan Atkin from RBC Capital Markets. Your line is open.

Jonathan Atkin – RBC Capital Markets

Yeah. RBC. So on the network side, as you said, application transport bookings were up and was this all related to new Colo bookings or do you think customers are checking network services.

Jeffrey Von Deylen

Let me take a stab at it. The bookings as we try to make some improvement in this network business, which we’re first in that, we still have a lot of wood to chop, so I don’t want to declare success at all at this particular point in time, but we are beginning to see, as we get more focused on customers that what we call insider service profiles, so, as we are cross selling customers that are in our data center very close to our data center and being able to move, make penetration or a hand offering or some IP VPN solutions that can maximize the opportunity as we are hosting applications in these facilities.

I think our sales organization is doing a pretty good job now really focusing on that. So, the fact that we see now back-to-back quarters were the net MRR bookings has actually increased is a good trend. Clearly or it’s not at a level to overcome the churn that we are seeing out of this, and as Jeff talked about in the prepared remarks, I think to be very specific what we’re going to see is what we had to kind of go through at the Colo business. We’re going to have to go through kind of an exercise here of containing to re-sort the customer and the services that are inside our sweet spot and we are going to see those customers that don’t fit that will shed out. Hopefully we can do that in a positive manner that continues to grow the EBITDA margin and that’s where we are very, very focused on.

Jonathan Atkin – RBC Capital Markets

And then you said you saw strength in Silicon Valley D.C. and kind of the New York New Jersey metro area and was that on the Colo side specifically or did you mean that you referred to the managed?

Jeffrey Von Deylen

I was talking about the whole thing in general, so it includes our managed center Colocation.

Jonathan Atkin – RBC Capital Markets

And then on international, you talked about the advantages of your global footprint, any way to get kind of approximate handle quantitatively on what portion of bookings were multi-region in nature?

Jeffrey Von Deylen

No, we never have really disclosed that. I can just give you kind of anecdotal stories around where we are beginning to see -- especially in what I will call multinationals, where they are looking across their entire footprint and saying how can we consolidate and virtualize the IT infrastructure.,We are just getting a increased inquiry rate because everyone tends to want to focus on three continents, it's U.S., it’s Europe and it’s Asia. And we are very well situated and our footprint and our capability across those three continents, so, we are now being included in what I will call opportunities that’s primarily companies with just three letters tend to play out. And we are doing well, we are doing well especially when we are able to get them focussed on what I’ll call time to value components of that. We have I think given our flexibility and agility to enjoy competitive advantage. So, I suspect that this is going to be an increasing trend and we are just seeing kind of the early signs of that.

Jonathan Atkin – RBC Capital Markets

Great. Thank you very much.

Operator

Our next question comes from Vincent Lin from Goldman Sachs. Your line is open.

Vincent Lin – Goldman Sachs

Thanks for taking the question. Maybe just to hit cost one more time, last year 2Q and 3Q utility cost went incremental $2 million to $3 million quarter-over-quarter is that what you’re looking for this year as well. And will that be annual component development cost that could affect margins? And maybe the second question on Chicago, you mentioned a willingness to be aggressive in driving volume there. So, what kind of pricing levels are you setting versus your peers, and what other levers do you have in driving volume?

Philip J. Koen

Well, let me take the pricing and I will let Jeff talk about the cost. We are in a anvil position, we didn't go and spend over $100 million or so dollars to plunge down a new data center and have all the cost associated with that. And we know that that particular Chicago market is relative to other markets a lighter demand market. And we have considerable pricing power there, and just seems to us as a good business then to take advantage of it, just so wise you're not going out and walking up radically so long-term contract. We have the space available, we are going to be aggressive and I’ll just leave you with that.

Jeffrey Von Deylen

On your cost questions, Vincent, I think you know the utility expected increase sequentially so I think that’s about right. And then on the [car] program, clearly there is a portion of that that's capital but there is certainly a portion of the people that are part of our cost structure and part of our operating expense. And we continue to, that team has grown slightly overtime. So, you could expect that, that's one of the pillars and so made it clear that we are not going to touch and it's very important for us to invest and we are maintaining that investment throughout the year.

Vincent Lin – Goldman Sachs

Is there any way to ballpark the impact there and is it spread equally over the next three quarters?

Philip J. Koen

It’s already in the number. So, it's counted for its breakdown, it’s a development team that is in place in a steady run rate.

Vincent Lin – Goldman Sachs

Okay, great. And maybe just one housekeeping item, on the non-recurring revenues you mentioned it was allocated to hosting, but just to be clear, is that Colocation or managed hosting. Just trying to think through the revenue per square foot trends here for the next quarter? Thanks.

Jeffrey Von Deylen

The termination fee was primarily managed hosting.

Vincent Lin – Goldman Sachs

Okay. Thank you.

Operator

There are no further questions. Please continue.

Philip J. Koen

Well thank you very much for joining us on our call. And I look forward to being able to report to you results of Q2 on the next call. Thank you.

Operator

Ladies and gentlemen thank you for participating in today's conference. This concludes the program. You may all disconnect. Everyone have a great day.

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