UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2010

or

 

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                  to                 

Commission File Number: 001-33302

 

 

SWITCH & DATA FACILITIES COMPANY, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware		59-3641081
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

1715 Westshore Boulevard, Suite 650, Tampa, Florida 33607

(Address of principal executive offices) (Zip Code)

(813) 207-7700

(Registrant’s telephone number, including area code)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes   x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer  ¨				Accelerated filer  x
Non-accelerated filer   ¨		(Do not check if a smaller reporting company)		Smaller reporting company  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

The number of shares outstanding of the registrant’s Common Stock as of April 28, 2010 was 35,153,874

 

 

 

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PART I: FINANCIAL INFORMATION		3
Item 1: Financial Statements		3
Item 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations		17
Item 3: Quantitative and Qualitative Disclosures About Market Risk		28
Item 4: Controls and Procedures		29
PART II: OTHER INFORMATION		29
Item 1: Legal Proceedings		29
Item 1A: Risk Factors		29
Item 2: Unregistered Sales of Equity Securities and Use of Proceeds		29
Item 3: Defaults Upon Senior Securities		29
Item 4: Removed and Reserved		29
Item 5: Other Information		30
Item 6: Exhibits		30

 

2

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PART I: FINANCIAL INFORMATION

 

Item 1:

Financial Statements

 

3

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SWITCH & DATA FACILITIES COMPANY, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(IN THOUSANDS)

(UNAUDITED)

 

		December 31, 2009				March 31, 2010
Assets
Current assets
Cash and cash equivalents		$	28,528			$	24,120
Accounts receivable, net of allowance for bad debts of $1,056 and $752, respectively			13,930				13,540
Prepaids and other assets			2,849				2,477
Total current assets			45,307				40,137
Property and equipment, net			297,312				308,266
Goodwill			36,023				36,023
Other intangible assets, net			15,274				14,443
Other long-term assets, net			6,464				6,312
Total assets		$	400,380			$	405,181
Liabilities and Stockholders’ Equity
Current liabilities
Accounts payable and accrued expenses		$	23,741			$	24,515
Derivative liability			8,713				9,543
Current portion of unearned revenue			3,275				3,694
Current portion of deferred rent			336				343
Current portion of customer security deposits			577				492
Current portion of long-term debt			14,250				17,813
Current portion of capital lease obligations			1,934				1,967
Total current liabilities			52,826				58,367
Unearned revenue, less current portion			1,506				1,870
Deferred rent, less current portion			26,287				27,810
Customer security deposits, less current portion			319				385
Long-term debt, less current portion			128,250				121,125
Long-term portion of capital lease obligations			58,364				57,917
Total liabilities			267,552				267,474
Commitments and contingencies
Stockholders’ equity
Common stock, $0.0001 par value, 200,000 shares authorized; 34,737 and 34,965 shares issued and outstanding as of December 31, 2009 and March 31, 2010, respectively			3				3
Preferred stock, $0.0001 par value, 25,000 shares authorized; no shares issued			—				—
Additional paid-in capital			356,624				361,426
Accumulated deficit			(224,126	)			(224,635	)
Accumulated other comprehensive loss			327				913
Total stockholders’ equity			132,828				137,707
Total liabilities and stockholders’ equity		$	400,380			$	405,181

The accompanying notes are an integral part of these consolidated financial statements

 

4

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SWITCH & DATA FACILITIES COMPANY, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

(UNAUDITED)

 

		For the three months ended March 31,
		2009				2010
Revenues		$	47,133			$	56,695
Costs and operating expenses
Cost of revenues, exclusive of depreciation and amortization			24,293				27,299
Sales and marketing			5,224				5,924
General and administrative			4,682				5,004
Depreciation and amortization			10,046				11,117
Total costs and operating expenses			44,245				49,344
Operating income			2,888				7,351
Interest income			3				12
Interest expense			(4,358	)			(5,004	)
Other expense, net			(238	)			(2,570	)
Loss before income taxes			(1,705	)			(211	)
Provision for income taxes			(275	)			(298	)
Net loss		$	(1,980	)		$	(509	)
Loss per common share—basic and diluted		$	(0.06	)		$	(0.01	)
Weighted average common shares outstanding—basic and diluted			34,563				34,771

The accompanying notes are an integral part of these consolidated financial statements

 

5

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SWITCH & DATA FACILITIES COMPANY, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(IN THOUSANDS)

(UNAUDITED)

 

		For the three months ended March 31,
		2009				2010
Cash flows from operating activities:
Net loss		$	(1,980	)		$	(509	)
Adjustments to reconcile net loss to net cash provided by operating activities
Depreciation			9,144				10,236
Amortization of debt issuance costs			230				230
Amortization of other intangible assets			903				883
Stock compensation expense			1,365				1,878
Provision for bad debts, net of recoveries			223				876
Deferred rent			2,270				1,459
Change in fair value of derivative			739				830
Gain on disposal of fixed assets			(5	)			(1	)
Changes in operating assets and liabilities
Decrease (increase) in accounts receivable			673				(449	)
Decrease in prepaids and other assets			844				374
Increase in other long-term assets			(275	)			(79	)
Decrease in accounts payable, accrued expenses, and other liabilities			(4,904	)			(2,588	)
Increase (decrease) in unearned revenue			(263	)			750
Net cash provided by operating activities			8,964				13,890
Cash flows from investing activities:
Purchase of property and equipment			(23,734	)			(17,216	)
Net cash used in investing activities			(23,734	)			(17,216	)
Cash flows from financing activities:
Principal payments under long-term debt			—				(3,562	)
Principal payments under capital lease			—				(471	)
Proceeds from exercise of stock options			—				2,925
Proceeds from long-term debt			22,500				—
Net cash provided by (used in) financing activities			22,500				(1,108	)
Net increase (decrease) in cash and cash equivalents			7,730				(4,434	)
Effect of exchange rate changes on cash			(15	)			26
Cash and cash equivalents:
Beginning of the period			14,706				28,528
End of the period		$	22,421			$	24,120
Supplemental disclosure of cash flow information:
Cash paid for interest		$	5,482			$	4,487
Cash paid for taxes		$	215			$	894
Supplemental schedule of non-cash investing and financing activities:
Purchased property and equipment in accounts payable and accrued expenses		$	10,583			$	9,780

The accompanying notes are an integral part of these consolidated financial statements

 

6

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SWITCH & DATA FACILITIES COMPANY, INC AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(IN THOUSANDS, EXCEPT PER SHARE DATA)

(UNAUDITED)

1. Organization

Description of Business

Switch & Data Facilities Company, Inc. (together with its subsidiaries, except where the context requires, the “Company”) is a premier provider of network-neutral data centers that house, power, and interconnect customers through the Internet and other networks. Leading content companies, enterprises, and communications service providers rely on the Company to connect to customers and exchange network traffic.

On October 21, 2009, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Equinix, Inc. (“Equinix”) and Sundance Acquisition Corporation, a wholly-owned subsidiary of Equinix (“Merger Sub”). Pursuant to the terms of the Merger Agreement and subject to the satisfaction or waiver of the conditions therein, Merger Sub will merge with and into the Company, with the Company surviving as a wholly-owned subsidiary of Equinix (the “Merger”).

Subject to the terms and conditions of the Merger Agreement, at the effective time of and as a result of the Merger, each of the Company’s outstanding shares of common stock (other than dissenting shares and shares held by the Company as treasury stock or owned by Equinix) will be converted into merger consideration that will consist of 0.19409 shares of Equinix’s common stock, $19.06 in cash or a combination of shares of Equinix’s common stock and cash. Under the Merger Agreement, the Company’s stockholders had the opportunity to elect whether they would prefer to receive 0.19409 shares of Equinix’s common stock or $19.06 in cash for each share of the Company’s common stock that they hold.

The Merger Agreement further provides that the overall consideration to be paid by Equinix in the Merger will consist 80% of Equinix common stock and 20% of cash. At the effective time of and as a result of the Merger, each of the Company’s outstanding shares of common stock will be canceled and extinguished.

The Company’s stockholders voted on January 29, 2010 to approve the Merger. On April 23, 2010, Equinix received notification from the United States Department of Justice (the “DOJ”) that the DOJ has closed its investigation with respect to the proposed acquisition of the Company by Equinix and also received notification from the Federal Trade Commission that the waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976 has been terminated. Equinix and the Company expect the Merger to close on April 30, 2010, subject to the satisfaction or waiver of the other closing conditions set forth in the Merger Agreement.

Additional information regarding the Merger is provided in the Current Report on Form 8-K that was filed with the SEC on October 22, 2009, as well as subsequent SEC filings.

2. Summary of Significant Accounting Policies

Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared by the Company and reflect all adjustments, consisting of normal recurring adjustments, which in the opinion of management are necessary to fairly state the financial position and the results of operations for the interim periods presented. The financial statements have been prepared in accordance with the regulations of the SEC, but omit certain information and footnote disclosures necessary to present the statements in accordance with accounting principles generally accepted in the United States. For further information, refer to the Consolidated Financial Statements and Notes thereto included in the Company’s Annual Report on Form 10-K as filed with the SEC on February 22, 2010. Results for the interim periods are not necessarily indicative of results for the entire fiscal year.

The preparation of these financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates.

 

7

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SWITCH & DATA FACILITIES COMPANY, INC AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(IN THOUSANDS, EXCEPT PER SHARE DATA)

(UNAUDITED)

 

Fair Value

The following table provides the assets and liabilities carried at fair value measured on a recurring basis:

 

		Fair value measurement at December 31, 2009 using:						Fair value measurement at March 31, 2010 using:
		Quoted prices in active markets (Level 1)			Significant other observable inputs (Level 2)			Quoted prices in active markets (Level 1)			Significant other observable inputs (Level 2)
Cash and cash equivalents		$	28,528		$	—		$	24,120		$	—
Derivative liability		$	—		$	8,713		$	—		$	9,543

The following is a description of the Company’s valuation methodology for assets and liabilities measured at fair value:

Cash and Cash Equivalents, accounts receivable net of the allowance for doubtful accounts, other current assets, accounts payable, accrued expenses, and other current liabilities. Cash equivalents are carried at fair value based on quoted market prices in active markets. All other financial instruments are not carried at fair value, but are carried at amounts that approximate fair value due to their short-term nature and generally negligible credit risk.

Interest Rate Swaps. These financial instruments are carried at fair value, calculated as the present value of amounts estimated to be received or paid to a marketplace participant in a selling transaction. These derivatives are valued using a model based on significant other observable inputs (Level 2 inputs). The model utilizes Eurodollar Futures settlement pricing from the Chicago Mercantile Exchange to estimate future LIBOR rates and in turn estimate amounts to be received or paid under the terms of the interest rate swap agreements.

The fair value of the Company’s long-term debt, which is not traded in the market, is estimated by using the Company’s credit worthiness, current rates available to the Company for debt of the same remaining maturities and the terms of the debt. After considering the items above and the floating interest rate associated with the long-term debt, the Company believes the carrying amount of the Company’s long-term debt approximates fair value.

Stock-Based Compensation

As of March 31, 2010, there was $7,780 of unrecognized compensation cost related to non-vested stock-based compensation arrangements granted under the Company’s stock-based compensation plans. These costs are to be recognized ratably over a weighted average period of less than four years. The Company recorded $1,778 of compensation expense for the three months ended March 31, 2010.

The Company recognized compensation expense for restricted stock of $100 for the three months ended March 31, 2010. The Company did not grant restricted stock prior to 2009.

The Company did not grant any equity awards during the three months ended March 31, 2010.

Comprehensive Income (loss)

The components of comprehensive income (loss) are as follows:

 

		For the three months ended March 31,
		2009				2010
Net loss		$	(1,980	)		$	(509	)
Currency translation adjustments			(373	)			586
Comprehensive income (loss)		$	(2,353	)		$	77

 

8

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SWITCH & DATA FACILITIES COMPANY, INC AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-Continued

(IN THOUSANDS, EXCEPT PER SHARE DATA)

(UNAUDITED)

 

The Company’s foreign operations use the local currency as their functional currency. Assets and liabilities of these operations are translated at the exchange rates in effect on the balance sheet date. Revenues and expenses of these operations are translated at monthly average rates.

Recent Accounting Pronouncements

In January 2010, the FASB issued an accounting standard update regarding fair value measurements and disclosures. The new guidance requires new disclosures for significant transfers in and out of Level 1 and 2 of the fair value hierarchy and the activity within Level 3 of the fair value hierarchy. The updated guidance also clarifies existing disclosures regarding the level of disaggregation of assets or liabilities and the valuation techniques and inputs used to measure fair value. The updated guidance is effective for interim and annual reporting periods beginning after December 15, 2009, with the exception of the new Level 3 activity disclosures, which are effective for interim and annual reporting periods beginning after December 15, 2010. The Company adopted the new guidance during the first quarter of 2010.

In February 2010, the FASB issued an accounting standard update regarding subsequent events. The new guidance reiterates that an SEC filer is required to evaluate subsequent events through the date that the financial statements are issued and removes the requirement for an SEC filer to disclose the date through which subsequent events have been evaluated. The updated guidance was effective upon issuance. The Company adopted the new guidance during the first quarter of 2010.

The adoption of new accounting guidance did not have a material effect on the Company’s consolidated financial statements.

3. Property and Equipment, Net

The Company capitalized costs of $20,317 during the three months ended March 31, 2010, primarily associated with constructing a new data center.

4. Goodwill and Other Long-Term Assets, Net

Included in other long-term assets, net, on the Consolidated Balance Sheets are debt issuance costs, net, of $4,032 and $3,802 as of December 31, 2009 and March 31, 2009, respectively.

5. Financing Obligations

Long-Term Debt

The Company’s long-term debt consisted of the following:

 

		December 31, 2009				March 31, 2010
Credit Facility - Total cost of outstanding debt was 6.2% at March 31, 2010		$	142,500			$	138,938
Less current portion			(14,250	)			(17,813	)
Long-term debt		$	128,250			$	121,125

Accrued interest included in accounts payable and accrued expenses related to long-term debt in the Consolidated Balance Sheets is $719 and $374 at December 31, 2009 and March 31, 2010, respectively.

On March 27, 2008, the Company entered into a Fourth Amended and Restated Credit Agreement which provided for: (i) a $120,000 term loan (the “Term Loan”); (ii) a $22,500 delayed draw term loan (the “Delayed Draw Term Loan”), to be funded at the option of the Company no later than March 27, 2009; (iii) a $15,000 revolving loan (the “Revolver”); and (iv) the option to request an incremental term loan before March 27, 2009, of up to $50,000 (the “Incremental Term Loan”) subject to

 

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SWITCH & DATA FACILITIES COMPANY, INC AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-Continued

(IN THOUSANDS, EXCEPT PER SHARE DATA)

(UNAUDITED)

 

the willingness of the lenders to make such loan. On March 28, 2008, the full $120,000 of the Term Loan was funded, of which $38,189 was used to refinance the $38,189 of term debt remaining outstanding under the Company’s previous credit agreement. On January 5, 2009, the Company borrowed $22,500 under the Delayed Draw Term Loan. The Incremental Term Loan expired unused on March 27, 2009.

On September 4, 2009, the Company entered into the First Amendment to the Fourth Amended and Restated Credit Agreement (as amended, the “Credit Facility”) which, among other things, provided the Company with an additional delayed draw term loan of up to $100,000 (the “Additional Delayed Draw Term Loan”).

Total fees incurred for the First Amendment to the Fourth Amended and Restated Credit Agreement were $1,425 of which $1,388 were capitalized and $37 were expensed.

As of March 31, 2010, no borrowings have occurred under the Revolver or the Additional Delayed Draw Term Loan. A $1,390 letter of credit has been issued under the Revolver as a security deposit.

The proceeds of the Credit Facility not used to refinance the $38,189 of term debt must be used for working capital, general corporate purposes, and for capital expenditures of the Company.

Substantially all of the assets of the Company and its restricted subsidiaries are pledged as collateral under the Credit Facility. Interest under the Term Loan, the Revolver, the Delayed Draw Term Loan and the Additional Delayed Draw Term Loan is paid at a rate equal to: (i) 2.5% to 3.5% above the alternate base rate (which is equal to the greater of the administrative agent’s prime rate, 0.5% above the federal funds rate, and 3.0% per annum) or (ii) 3.5% to 4.5% above the adjusted LIBOR rate (which is equal to the greater of the LIBOR rate for such interest period and 2.0% per annum); where in each case the applicable margin changes based on the Company’s consolidated total leverage ratio. The current rate of interest is 3.0% above the alternate base rate or 4.0% above the LIBOR rate. The Company also pays unused facility fees equal to 0.5% per annum on the unused portion of the Revolver and 1.0% on the Additional Delayed Draw Term Loan.

The Credit Facility requires compliance with various financial covenant ratios, including a consolidated total leverage ratio, a consolidated senior leverage ratio, an annualized consolidated interest coverage ratio, an annualized consolidated fixed charge coverage ratio, and a maximum capital expenditure limit.

The Credit Facility requires that the Company comply with certain other covenants which, among other things, restrict the Company’s ability to incur additional debt, pay dividends and make other restricted payments, sell assets, enter into affiliate transactions and take other actions. The breach of any of these covenants could result in a default and, if not cured within any applicable cure period or waived by the lenders, could trigger acceleration of repayment and the exercise of remedies against the collateral and otherwise. The Company was in compliance with all covenants as of March 31, 2010.

Borrowings under the Revolver are available until September 26, 2013. Borrowings under the Additional Delayed Draw Term Loan are available until September 4, 2010. Repayments of principal under the Term Loan and the Delayed Draw Term Loan are due in scheduled quarterly installments, with the final payment due and payable on March 27, 2014. Quarterly payments of principal outstanding under the Additional Delayed Draw Term Loan, if any, will commence on March 31, 2011.

As of March 31, 2010, scheduled maturities of the Term Loan for the next five years are as follows:

 

Year		Amount
2010		$	10,688
2011			28,500
2012			28,500
2013			57,000
2014			14,250
Total		$	138,938

At December 31, 2009 and March 31, 2010, the fair value of the Company’s debt was estimated at $142,500 and $138,938, respectively, which approximates the carrying value.

 

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SWITCH & DATA FACILITIES COMPANY, INC AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-Continued

(IN THOUSANDS, EXCEPT PER SHARE DATA)

(UNAUDITED)

 

Capital Lease Obligations

During 2009, the Company recorded capital leases totaling $10,001 for data center equipment. Monthly payments under these capital leases commenced in July 2009 and will be made through March 2014, at a weighted average effective interest rate of 7.0% per annum.

As of March 31, 2010, total capital lease obligations were $59,884. As of March 31, 2010, future minimum capital lease payments for the next five years and thereafter are as follows:

 

Year		Amount
Remainder of 2010		$	5,279
2011			7,084
2012			7,138
2013			7,330
2014			5,605
Thereafter			108,589
Total future minimum capital lease payments			141,025
Less: Interest component of capital lease payments			(81,141	)
Present value of minimum capital lease payments			59,884
Less: Current portion of capital lease obligations			(1,967	)
Long-term capital lease obligations		$	57,917

Accrued interest included in accounts payable and accrued expenses related to capital lease obligations in the Consolidated Balance Sheets is $394 at December 31, 2009 and March 31, 2010, respectively.

Interest Rate Derivatives

The Credit Facility requires the Company to fix its floating interest rate on no less than 50% of the principal of the Credit Facility. The Company utilizes interest rate swap agreements to manage its exposure to fluctuations in interest rates. These agreements are recorded at fair value, and the changes in fair value are included in interest expense. The Company does not elect hedge accounting on any of these agreements. The fair value of these agreements is reflected in a separate line item on the Consolidated Balance Sheets. Changes in the fair value of these agreements are included in Interest Expense on the Consolidated Statements of Operations and detailed further in this discussion.

In January 2009, the Company entered into an interest rate swap agreement with a notional value of $120,000. There was no up-front cost for this agreement. The agreement states that the Company pays 1.71% from February 2009 through February 2010 and 4.99% from February 2010 through February 2012. The counterparty either pays to the Company or receives from the Company the difference between the actual LIBOR rate and the contracted rates for the given periods.

The fair value of the interest rate derivative represents the estimated receipts or payments that would be made to terminate the agreement prior to expiration. As of December 31, 2009 and March 31, 2010, the Company recorded interest rate derivative liabilities to the balance sheet of approximately $8,713 and $9,543, respectively. The changes in fair value of $739 and $830 are recorded as increases in interest expense in the Consolidated Statements of Operations for the three months ended March 31, 2009 and 2010, respectively.

 

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SWITCH & DATA FACILITIES COMPANY, INC AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-Continued

(IN THOUSANDS, EXCEPT PER SHARE DATA)

(UNAUDITED)

 

6. Loss Per Common Share

The following table sets forth the detail for the computation of basic and diluted loss per common share attributable to common stockholders.

 

		For the three months ended March 31,
		2009				2010
Numerator:
Net loss		$	(1,980	)		$	(509	)
Denominator:
Weighted average common shares outstanding - basic			34,563				34,771
Plus: dilutive effect of stock options			—				—
Plus: dilutive effect of performance-based restricted shares			—				—
Weighted average common shares outstanding - diluted			34,563				34,771
Net loss per common share - basic and diluted		$	(0.06	)		$	(0.01	)

The following table sets forth the potential common shares not included in the diluted net loss per common share calculation because these shares are anti-dilutive:

 

		For the three months ended March 31,
		2009		2010
Common stock options		2,681		2,825
Performance-based restricted stock		205		205

7. Income Taxes

For the three months ended March 31, 2010, the Company recorded income tax expense of $298, on a loss before income taxes of $211. Comparatively, for the three months ended March 31, 2009, the Company recorded income tax expense of $275, on a loss before income taxes of $1,705.

The tax provision for the three months ended March 31, 2010 was calculated by estimating the U.S. and Canadian effective income tax rates expected to be applicable for the full year ended December 31, 2010.

The Company has federal net operating loss (“NOL”) carryforwards of approximately $110,909 at December 31, 2009 available to reduce future federal income taxes.

The Company maintains a full valuation allowance on deferred tax assets arising primarily from NOL carryforwards and other tax attributes because the future realization of such benefits is uncertain. As a result, to the extent that those benefits are realized in future periods, they will favorably affect tax expense and net income. The NOLs will begin to expire in 2022 and the alternative minimum tax credit does not expire.

The Company has approximately $163 and $165 of total unrecognized tax benefits related to uncertain tax positions as of December 31, 2009 and March 31, 2010. The final outcome of these uncertain tax positions is not yet determinable.

 

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SWITCH & DATA FACILITIES COMPANY, INC AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-Continued

(IN THOUSANDS, EXCEPT PER SHARE DATA)

(UNAUDITED)

 

8. Stock Based Compensation

Stock Options

The following table summarizes common stock option activity for the three months ended March 31, 2010:

 

		Number of Shares			Weighted Average Exercise Price
Outstanding as of December 31, 2009		3,086			$	10.85
Options granted		—			$	—
Options exercised		(232	)		$	12.62
Options forfeited or cancelled		(29	)		$	11.16
Outstanding as of March 31, 2010		2,825			$	10.70

The following table summarizes nonvested stock option activity for the three months ended March 31, 2010:

 

		Nonvested Common Stock Options			Weighted Average Grant Date Fair Value Per Option
Nonvested at December 31, 2009		1,774			$	8.76
Options granted		—			$	—
Options vested		(566	)		$	9.75
Options forfeited		(29	)		$	8.31
Nonvested at March 31, 2010		1,179			$	8.30

The following table summarizes information about common stock options outstanding as of March 31, 2010:

 

Exercise Price		Number of Options		Weighted Average Remaining Contractual Life
$   0.00 - $4.00		577		3.98
$   4.01 - $8.00		516		8.91
$   8.01 - $12.00		684		7.96
$ 12.01 - $16.00		48		8.98
$ 16.01 - $20.00		1,000		6.96
Total options outstanding		2,825		6.98
Total options exerciseable		1,646		6.98

The aggregate intrinsic value of options outstanding as of March 31, 2010 was $20,025. The aggregate intrinsic value of options exercisable as of March 31, 2010 was $12,214.

 

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SWITCH & DATA FACILITIES COMPANY, INC AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-Continued

(IN THOUSANDS, EXCEPT PER SHARE DATA)

(UNAUDITED)

 

Restricted Stock

The following table summarizes the changes in restricted stock awards for the three months ended March 31, 2010:

 

		Performance Based Restricted Stock		Weighted Average Grant Date Fair Value Per Share
Performance-based restricted stock at December 31, 2009		205		$	5.84
Shares granted		—		$	—
Shares vested		—		$	—
Shares forfeited		—		$	—
Performance-based restricted stock at March 31, 2010		205		$	5.84

The aggregate intrinsic value of restricted stock outstanding as of March 31, 2010 was $3,641.

9. Commitments and Contingencies

Operating Lease Payments

The Company and its subsidiaries are engaged in the operation of data centers, most of which are held under non-cancelable operating leases expiring at various dates through 2025. Certain of these non-cancelable operating leases provide for renewal options.

As of March 31, 2010 minimum future lease payments under these non-cancelable operating leases for the next five years and thereafter are as follows:

 

Year		Amount
Remainder of 2010		$	24,583
2011			32,243
2012			32,076
2013			32,799
2014			30,806
Thereafter			195,138
Total minimum lease payments		$	347,645

Power Purchase Agreements

The Company has commitments to purchase power in six of its U.S. markets through December 2012. Such agreements are entered into on a normal purchase, normal sale basis. As of March 31, 2010, future payments under such agreements are estimated to be $1,494, $598, and $161 for the remainder of 2010, 2011, and 2012, respectively.

Legal Proceedings

On October 27, 2009, a purported stockholder class action lawsuit was filed in the Delaware Chancery Court against the Company, members of the Company’s board of directors, Merger Sub and Equinix. The lawsuit, Gibbs v. Switch & Data Facilities Company, Inc., et al. (Case No. 5027-VCS), alleged that the members of the Company’s board of directors breached their fiduciary duties to the Company’s stockholders in connection with the Merger by, among other things, entering into the

 

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SWITCH & DATA FACILITIES COMPANY, INC AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-Continued

(IN THOUSANDS, EXCEPT PER SHARE DATA)

(UNAUDITED)

 

Merger Agreement without first taking steps to obtain adequate, fair and maximum consideration for stockholders, by structuring the transaction to benefit themselves and by including provisions intended to dissuade other potential suitors from making competing offers. The complaint also alleged that the Company and Equinix aided and abetted those supposed breaches of duty. The complaint sought various forms of relief, including but not limited to an injunction prohibiting the consummation of the Merger.

On October 30, 2009, a second purported stockholder class action lawsuit, Jiannaras v. Switch & Data Facilities Company, Inc., et al. (Case No. 09-CA-027950), was filed against the same defendants in a Hillsborough County, Florida state court. The complaint alleges that the members of the Company’s board of directors breached their fiduciary duties to the Company’s stockholders by, among other things, failing to take steps to maximize the Company’s value to its public stockholders, failing to value properly the Company, failing to protect against the directors’ conflicts of interest, and failing to disclose all material information to allow a fully informed vote by the stockholders. Specifically, plaintiffs contended that the defendants timed the Merger to take advantage of the recent downturn in the Company’s share price to sell the Company at an illusory premium that did not reflect its financial performance, thereby depriving the Company’s stockholders of the true value of their shares and allowing defendants to reap disproportionate benefits to themselves instead of maximizing stockholder value. Plaintiffs further asserted that the Company and Equinix aided and abetted the alleged breaches of duty by the Company’s directors. The complaint sought various relief, including but not limited to an injunction prohibiting the consummation of the Merger.

On December 7, 2009, a third purported stockholder class action lawsuit, Broadbased Equities v. Keith Olsen, et al. (Case No. 8:09-CV-02473), was filed against the same defendants (other than Merger Sub, which was not named) in the United States District Court for the Middle District of Florida. The complaint alleged that the defendants have provided materially incomplete information to the Company’s stockholders in the Proxy Statement, that the Company’s Chief Executive Officer and President

sought to advance his own interests at the expense of the Company’s stockholders in connection with the Merger, and that the Company’s directors breached their fiduciary duties in connection with the Merger, including by agreeing to provisions in the Merger Agreement intended to dissuade other potential suitors from making competing offers. The complaint also alleged that Equinix aided and abetted those supposed breaches of duty. The complaint sought various forms of relief, including but not limited to an injunction prohibiting the consummation of the Merger.

On January 19, 2010, counsel for parties in all three lawsuits entered into a memorandum of understanding in which they agreed upon the terms of a settlement of all lawsuits. In connection with this settlement, the three lawsuits and all claims asserted therein will be dismissed with prejudice, including the claims brought against the Company and its directors. The parties have sought approval of the settlement in the Florida state court. The parties have stayed the actions pending in the Delaware Chancery Court and the United States District Court for the Middle District of Florida. The proposed settlement is conditional upon, among other things, consummation of the Merger and final approval of the proposed settlement by the Florida state court. The proposed settlement contemplates that plaintiffs’ counsel will apply to the Florida state court for an award of attorneys’ fees and costs in an aggregate amount of $900, and that the defendants will not oppose or undermine this application. These attorneys’ fees and costs will not be deducted from the Merger consideration. Both the Company and Equinix will share in the payment of such settlement. As of December 31, 2009, the Company accrued $630, its portion of the settlement and recorded $380 as an insurance receivable.

The Company is subject to other legal proceedings and claims which arise in the ordinary course of business. Based upon currently available information, management, based upon advice of legal counsel, believes that the amounts accrued in the Consolidated Balance Sheets are adequate for the aforementioned proceedings and claims and the amount of any additional liability with respect to these actions will not materially affect the financial position, results of operations or liquidity of the Company.

Taxes

The Company is examined in the normal course of business by various state and local taxing authorities regarding various tax matters. As of March 31, 2010 the Company is not under examination by any taxing authority related to non-income tax matters. The Company has accrued $133 as of March 31, 2010 in anticipation of future examinations.

 

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SWITCH & DATA FACILITIES COMPANY, INC AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-Continued

(IN THOUSANDS, EXCEPT PER SHARE DATA)

(UNAUDITED)

 

10. Segment Information

The Company manages its business as one reportable segment. Although the Company provides services in several markets, these operations have been aggregated into one reportable segment based on the similar economic characteristics among all markets, including the nature of the services provided and the type of customers purchasing such services.

The Company’s geographic revenues are as follows:

 

		For the three months ended March 31,
		2009			2010
Revenues
United States		$	44,396		$	51,908
Canada			2,737			4,787
		$	47,133		$	56,695

The Company’s long-lived assets are located in the following geographic regions:

 

		December 31, 2009			March 31, 2010
Long-lived assets
United States		$	278,088		$	288,839
Canada			19,224			19,427
		$	297,312		$	308,266

 

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Item 2:

Management’s Discussion and Analysis of Financial Condition and Results of Operations

This Quarterly Report on Form 10-Q contains certain statements that are, or may be deemed to be, forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 and are made in reliance upon the protections provided by such acts for forward-looking statements. These forward-looking statements (such as when we describe what “will”, “may” or “should” occur, what we “plan”, “intend”, “estimate”, “believe”, “expect”, or “anticipate” will occur, and other similar statements) include, but are not limited to, statements regarding future sales and operating results, future prospects, anticipated benefits of proposed (or future) acquisitions and new data centers, growth, the capabilities and capacities of business operations, any financial or other guidance, and all statements that are not based on historical fact, but rather reflect our current expectations concerning future results and events. We make certain assumptions when making forward-looking statements, any of which could prove inaccurate, including, but not limited to, statements about our future operating results and business plans. Therefore, we can give no assurance that the results implied by these forward-looking statements will be realized. Furthermore, the inclusion of forward-looking information should not be regarded as a representation by the Company or any other person that future events, plans or expectations contemplated by the Company will be achieved. The ultimate correctness of these forward-looking statements is dependent upon a number of known and unknown risks and events and is subject to various uncertainties and other factors that may cause our actual results, performance, or achievements to be different from any future results, performance, or achievements expressed or implied by these statements. The following important factors, among others, could affect future results and events, causing those results and events to differ materially from those expressed or implied in our forward-looking statements:

 

•

our pending merger with and into a wholly-owned subsidiary of Equinix, Inc. (“Equinix”);

 

•

business conditions and growth or declines in our industry, our customers’ industries and the general economy;

 

•

variability of operating results;

 

•

our ability to complete capital expenditure projects on time and on budget;

 

•

the availability and cost of sufficient electrical power and cooling capacity;

 

•

the non-renewal of any of our data center leases;

 

•

the variability of customer requirements;

 

•

other economic, business, and competitive factors affecting our customers, our industry and business generally;

 

•

seasonality; and

 

•

other factors that we may not have currently identified or quantified.

For a further list and description of various risks, relevant factors and uncertainties that could cause future results or events to differ materially from those expressed or implied in our forward-looking statements, see the “Risk Factors” section contained in Part II of this document and in our Annual Report on Form 10-K. Given these risks and uncertainties, the reader should not place undue reliance on these forward-looking statements.

All forward-looking statements included in this Quarterly Report on Form 10-Q are made only as of the date of this Quarterly Report on Form 10-Q, and we do not undertake any obligation to publicly update or correct any forward-looking statements to reflect events or circumstances that subsequently occur, or which we hereafter become aware. You should read this document and the documents that we incorporate by reference into this Quarterly Report on Form 10-Q completely and with the understanding that our actual future results may be materially different from what we expect. We may not update these forward-looking statements, even if our situation changes in the future. All forward-looking statements attributable to us are expressly qualified by these cautionary statements.

 

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Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is intended to provide a reader of our financial statements with a narrative from the perspective of our management on our financial condition, results of operations, liquidity, and certain other factors that may affect our future results. Our MD&A is presented in six sections:

 

•

Overview

 

•

Critical Accounting Policies and Estimates

 

•

Key Components of our Results of Operations

 

•

Results of Operations

 

•

Liquidity and Capital Resources

 

•

Recent Accounting Pronouncements

This MD&A should be read in conjunction with the Consolidated Financial Statements and related Notes in Part I, Item 1, “Financial Statements.” This MD&A should also be read in conjunction with the MD&A included in our 2009 Annual Report on Form 10-K.

OVERVIEW

Pending Merger with and into a Wholly-Owned Subsidiary of Equinix

On October 21, 2009, we entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Equinix and Sundance Acquisition Corporation, a wholly-owned subsidiary of Equinix (“Merger Sub”). Pursuant to the terms of the Merger Agreement and subject to the satisfaction or waiver of the conditions therein, Merger Sub will merge with and into us, with us surviving as a wholly-owned subsidiary of Equinix (the “Merger”).

Subject to the terms and conditions of the Merger Agreement, at the effective time of and as a result of the Merger, each of our outstanding shares of common stock (other than dissenting shares and shares held by us as treasury stock or owned by Equinix) will be converted into merger consideration that will consist of 0.19409 shares of Equinix’s common stock, $19.06 in cash or a combination of shares of Equinix’s common stock and cash. Under the Merger Agreement, our stockholders had the opportunity to elect whether they would prefer to receive 0.19409 shares of Equinix’s common stock or $19.06 in cash for each share of our common stock that they hold.

The Merger Agreement further provides that the overall consideration to be paid by Equinix in the Merger will consist 80% of Equinix common stock and 20% of cash. At the effective time of and as a result of the Merger, each of our outstanding shares of common stock will be canceled and extinguished.

Our stockholders voted on January 29, 2010 to approve the Merger. On April 23, 2010, Equinix received notification from the United States Department of Justice (the “DOJ”) that the DOJ has closed its investigation with respect to the proposed acquisition of the Company by Equinix and also received notification from the Federal Trade Commission that the waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976 has been terminated. Equinix and the Company expect the Merger to close on April 30, 2010, subject to the satisfaction or waiver of the other closing conditions set forth in the Merger Agreement.

Additional information regarding the Merger is provided in the Current Report on Form 8-K that we filed with the SEC on October 22, 2009.

Operations

We are a premier provider of network-neutral data centers that house, power, and interconnect the Internet. Leading content companies, enterprises, and communications service providers rely on us to connect to customers and exchange network traffic. Our colocation services provide space and power for customers’ networking and computing equipment allowing those customers to avoid the costs of building and maintaining their own data centers. As a network-neutral provider, we do not own or operate our own network, and, as a result, our interconnection services enable our customers to exchange network traffic through direct connections with each other or through peering connections with multiple parties. We provide our services in 34 data centers, which is the broadest network-neutral footprint in North America. Our footprint includes our data center in Palo

 

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Alto, one of the first commercial Internet exchanges in the world. Our high network densities, as demonstrated by approximately 22,400 cross connects between our customers, create a network effect, which provides an incentive for our existing customers to remain within our data centers and is a differentiating factor in attracting new customers.

The highlights of our financial and operational results for the three months ended March 31, 2010 were as follows:

 

•

Revenues increased to $56.7 million from $47.1 million in the same period of 2009.

 

•

Cabinet equivalents billed increased 13.4% and cross connects increased by 4.1% over the same period of 2009.

 

•

Existing customers accounted for 85% of new sales.

 

•

Over 43% of new sales were in our new or expanded data centers.

Demand for our colocation and interconnection services continues to be driven by the increase in network traffic growth associated with bandwidth-intensive content and web-enabled applications. Our customers continue to offer new services and applications in our data centers to serve their customers, which creates revenue drivers for us. Our broad footprint of data centers located across key markets, our Internet exchanges, and our network-neutral service offering are attractive to network centric businesses as they expand their operations.

As a result of this growth in customer demand and our reputation for service quality, sales to both new and existing customers have continued to grow in our data centers. Our sales to new and existing customers reflects both a high level of demand for our service offerings from new and existing customers and a high level of customer satisfaction from our existing customers.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Our financial statements and accompanying notes are prepared in accordance with generally accepted accounting principles in the United States of America. Preparing financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. These estimates and assumptions are affected by management’s application of accounting policies. On an on-going basis, management evaluates its estimates and judgments. Critical accounting policies for the Company are discussed in more detail under the caption “Critical Accounting Policies and Estimates” in our 2009 Annual Report on Form 10-K.

KEY COMPONENTS OF OUR RESULTS OF OPERATIONS

Metrics

We use several primary metrics to analyze our revenues and measure our performance. These metrics include:

Number of cross connects. Cross connects enable one-to-one interconnections between customers within a data center, reduce network costs, and lower network latency. The number of cross connects is a measure of our network density. By increasing network densities within our data centers, we are able to further enhance our value proposition to our customers. We target customers with bandwidth intensive and network centric requirements. These customers require data centers with high network densities to optimize their services and enhance the experiences of their customers. We expect the number of cross connects to increase as new and existing customers grow in our data centers.

Cabinet equivalents billed. Our data centers have a finite amount of space and power that can be utilized to provide colocation services. This space is measured in cabinet equivalents, which includes an assessment of available power and cooling. Cabinet equivalents billed is a measure of how much space in our data centers is used by customers. Cabinet equivalents billed is the sum of the total cage square footage billed divided by 20 (“20” is the estimated square feet required to support a single customer cabinet), plus the actual cabinets billed in each data center. We expect the number of cabinet equivalents billed to increase as new and existing customers grow in our data centers.

 

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Utilization rate. The utilization rate represents the percentage of our data center space that has been sold to customers. The utilization rate increases with sales to customers and decreases when new data center capacity is added or when customers exit. The utilization rate is calculated as a percentage, the numerator of which is equal to the total space licensed to our customers and the denominator of which is equal to the total licensable space taking into account existing power and cooling. We expect our utilization rate to increase as new and existing customers grow in our data centers.

Percentage of incremental sales to existing customers. This percentage is a measure of sales to existing customers. Over the past few years, approximately 80% of all new sales have been from existing customers. We believe this percentage is a testament to our customers’ satisfaction with our quality of service and product offerings.

Churn as a percentage of recurring revenues. Churn represents lost revenues during a given period. Our business is based on a recurring revenue model, so lost revenues in a period affect future periods. From March 31, 2009 to March 31, 2010, churn has ranged between 1.1% to 1.4% of monthly recurring revenue.

New sales. New sales represent the recurring revenues from orders initiated during the given quarter. Recurring revenue from new sales represents new service agreements entered into by new and existing customers during the given quarter. Revenue from these agreements will recur monthly over the life of the agreement. Non-recurring revenue represents the one-time installation fees associated with new service agreements. These one-time fees are billed to customers upon completion of the installation service and such revenue is recognized on a straight-line basis over the life of the agreement.

The following tables present a summary of these metrics for the periods indicated:

 

		March 31, 2009				June 30, 2009				September 30, 2009				December 31, 2009				March 31, 2010
Number of cross connects			21,504				21,705				22,085				22,277				22,386
Cabinet equivalents billed			7,864				7,982				8,110				8,588				8,920
Utilization rate			60.4	%			61.2	%			57.7	%			61.3	%			63.7	%
		For the three months ended
		March 31, 2009				June 30, 2009				September 30, 2009				December 31, 2009				March 31, 2010
Percentage of incremental sales to existing customers			78	%			84	%			73	%			92	%			85	%
Churn as a percentage of recurring revenues			1.3	%			1.3	%			1.1	%			1.4	%			1.2	%
New Sales (in Thousands):
Recurring revenue		$	1,297			$	1,382			$	1,269			$	1,640			$	1,488
Non-recurring revenue			1,825				3,321				4,165				2,339				2,969
New Sales		$	3,122			$	4,703			$	5,434			$	3,979			$	4,457

Revenues

Our revenues consist of recurring and non-recurring revenues. We generate recurring revenue from our network-neutral interconnection and colocation services. Our ability to sell our colocation space within each data center is limited by the space required by our existing power and cooling infrastructure, as well as the customer requirements for power and cooling. Power and cooling requirements continue to grow on a per cabinet or square foot basis. We carefully monitor the power and cooling usage in each of our data centers and plan to invest in our power and cooling infrastructure to maximize the amount of utilizable space in our data centers. We generate non-recurring revenue from our TechSmart technical support services and installation services.

Colocation.

Space. We provide colocation space for a recurring monthly fee for a cabinet or rack, or on a per square foot basis for cage space. Our customers that license cage space typically use between 50 and 500 square feet in a data center, and often license such space in multiple data centers. Customers sign a service order, governed by the terms and conditions of a master services agreement, typically for one to three years.

Power. We provide conditioned power on a coterminous basis with space, for a recurring monthly fee under both arrangements. We provide both alternating current and direct current power circuits. Our customers pay for power on a per amp basis, typically in 20 to 30 amp increments.

 

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Interconnection Services.

Our interconnection services include our cross connect and Internet exchange services. Our cross connect services enable our customers to connect directly to a telecommunications carrier, Internet service provider, or other customers in our data centers. These services are typically provided for a recurring monthly fee per connection. Our Internet exchange services enable our customers to connect directly to our Internet exchange, which provides for public or private peering with other customers. Our customers license ports to connect to our Internet exchange for a recurring monthly fee per port, based on port capacity. Customers typically sign one year agreements for our Internet exchange services and month-to-month agreements for our cross connect services. We also generate recurring revenues from reselling Internet access, which we do to accommodate certain customers. We contract with certain Internet service providers and then resell their Internet access service to customers typically in one megabit per second to one hundred megabits per second increments. Customers typically sign a one-year contract for this service and pay us a recurring monthly fee per megabits per second.

Non-recurring Revenue.

We generate non-recurring revenue from the following services:

Installation Services. We receive one-time installation fees related to our interconnection and colocation services. The complexity of the installation determines the amount of fees charged to the customer. We typically receive a one-time fee per circuit or port for the installation of our interconnection services. We receive a one-time fee per cabinet or rack or per linear foot of cage space for the installation of our colocation services. We receive a one-time fee per amp for the installation of power, depending on the size of circuit and amount of voltage provided.

TechSmart Technical Support Services. We provide technical support services to assist customers with installation, circuit testing, equipment rebooting, and other related services. Customers pay for these services on an hourly basis or under contractual arrangements for a certain number of hours of technical support per month. We recognize revenue once the services have been provided.

The following table presents our revenues and percentage of revenues for the periods presented:

 

		For the three months ended March 31,
($ in Thousands)		2009						2010
Revenues
Colocation		$	30,228		64	%		$	37,143		66	%
Interconnection			14,629		31	%			16,648		29	%
Recurring Total		$	44,857		95	%		$	53,791		95	%
Non-recurring			2,276		5	%			2,904		5	%
Total		$	47,133		100	%		$	56,695		100	%

Cost of Revenues, Exclusive of Depreciation and Amortization

Cost of Revenues. Cost of revenues is comprised primarily of lease, utilities, personnel related expenses, maintenance and repair, telecommunications services, security, and property taxes. The components of our cost of revenues are mostly fixed in nature and do not vary significantly from period to period. However, certain components of our cost of revenues are variable in nature and are directly related to the growth of our revenues. We expect our utilities expenses to increase in the future on a per unit basis due to an increase in rates from our utility providers and increased power usage by our customers. Further, we experience seasonality in our utilities expenses based on temperatures and seasonal rate adjustments, which causes the amount of these expenses to fluctuate during the year. As a result of our expansions, we typically incur lease, utilities, and personnel related expenses prior to being able to accept customers for, and generate revenue from, new data centers. As we expand our data centers primarily in our top 10 markets, we expect cost of revenues to increase.

 

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Operating Expenses

Sales and Marketing. Sales and marketing expenses consist primarily of personnel related expenses for our sales and marketing employees, including wages, benefits, bonuses, commissions, travel, and the cost of marketing programs such as sales support, trade shows, corporate communications, promotional events, and advertising. We expect our sales and marketing expenses to increase in absolute dollars as we increase the headcount of our sales staff and increase our marketing and promotional efforts.

General and Administrative. General and administrative expenses include personnel related costs as well as travel, rent, insurance, legal, accounting, and consulting expenses. Personnel related expenses include wages, benefits and bonuses for our executive management as well as for our accounting, legal, data center design and construction, information technology, and human resources employees. We expect general and administrative expenses to increase in absolute dollars as we incur additional costs to support the growth of the Company, including higher personnel, legal, insurance, and financial reporting expenses, but we expect general and administrative expenses to decrease as a percentage of revenues.

Depreciation and Amortization. Depreciation expense includes depreciation of our leasehold improvements, generators, uninterruptible power systems, direct current power plants, heating, ventilation and air-conditioning equipment, furniture and fixtures. Amortization expense is composed of the amortization of our customer based intangible assets related to our acquisitions and debt issuance costs.

Other Expense, Net

Other Expense, Net. Other expenses primarily include non-income based taxes and related interest and penalties.

RESULTS OF OPERATIONS

Three Months Ended March 31, 2009 compared to the Three Months Ended March 31, 2010

The following is a more detailed discussion of our financial condition and results of operations for the periods presented. The quarter-to-quarter comparison of financial results is not necessarily indicative of future results.

Revenues

 

		For the three months ended March 31,						$ Change			% Change
($ in Thousands)		2009			2010
Revenues		$	47,133		$	56,695		$	9,562		20	%

Revenues increased 20% for the three months ended March 31, 2010 over the same period in 2009. Approximately 43% of new sales in the three months ended March 31, 2010 were in our new or expanded data centers. Recurring revenue increased by $8.9 million. The recurring revenue increase consisted of colocation and interconnection revenue of $6.9 million and $2.0 million, respectively. Cabinet equivalents billed were 8,920 at March 31, 2010, which is a 13% increase over the March 31, 2009 cabinet equivalents billed of 7,864. The number of cross connects was 22,386 at March 31, 2010, which is a 4% increase over March 31, 2009 cross connects of 21,504. Sales to existing customers were 85% of sales during the three months ended March 31, 2010. Non-recurring revenue was $2.9 million for the three months ended March 31, 2010 as compared to $2.3 million for the three months ended March 31, 2009.

 

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Cost of Revenues, Exclusive of Depreciation and Amortization

 

		For the three months ended March 31,								$ Change			% Change
($ in Thousands)		2009				2010
Cost of revenues, exclusive of depreciation and amortization		$	24,293			$	27,299			$	3,006		12	%
As a percent of revenue			52	%			48	%

Cost of revenues, exclusive of depreciation and amortization, increased primarily due to utilities, bad debt expense, rent, and personnel related expenses. Utilities increased by $0.8 million, primarily due to additional usage by customers in our New York Metro area data centers. Bad debt expense increased by $0.7 million, due to write-offs of uncollectable receivables. Rent expense increased by $0.5 million primarily due to expanded and renewed leases in Toronto and Atlanta. Personnel related expenses increased by $0.5 million, primarily related to the hiring of additional personnel in our new and expanded data centers. Cost of revenues included non-cash stock compensation expense of $0.4 million and $0.2 million for the three months ended March 31, 2010 and 2009, respectively. We expect our cost of revenues will increase in absolute dollars as we continue our growth and expansion plan.

Sales and Marketing

 

		For the three  months ended March 31,								$ Change			% Change
($ in Thousands)		2009				2010
Sales and marketing		$	5,224			$	5,924			$	700		13	%
As a percent of revenue			11	%			10	%

Sales and marketing expenses increased by $0.7 million. The increase was primarily due to increases in personnel related expenses commensurate with additional employees. Sales and marketing expenses included non-cash stock compensation expense of $0.7 million and $0.5 million for the three months ended March 31, 2010 and 2009, respectively. We expect sales and marketing expenses will continue to decrease as a percentage of revenues as we expect revenues to increase at a higher rate than our sales and marketing expenses.

General and Administrative

 

		For the three  months ended March 31,								$ Change			% Change
($ in Thousands)		2009				2010
General and administrative		$	4,682			$	5,004			$	322		7	%
As a percent of revenue			10	%			9	%

General and administrative expenses increased by $0.3 million. The increase was primarily due to increases in personnel related expenses of $0.3 million. General and administrative expenses included non-cash stock compensation expenses of $0.8 million and $0.7 million for the three months ended March 31, 2010 and 2009, respectively. We expect general and administrative expenses to continue to decrease as a percentage of revenues because we expect revenues to increase at a higher rate than our general and administrative expenses.

 

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Depreciation and Amortization

 

		For the three months ended March 31,								$ Change			% Change
($ in Thousands)		2009				2010
Depreciation and amortization		$	10,046			$	11,117			$	1,071		11	%
As a percent of revenue			21	%			20	%

Depreciation and amortization expenses increased by $1.1 million. The increase was primarily related to the expansion of our data centers in the New York Metro area, which resulted in an increase in depreciable assets. We expect depreciation and amortization to continue to increase as we make capital investments in new and existing data centers.

Operating Income

 

		For the three  months ended March 31,								$ Change			% Change
($ in Thousands)		2009				2010
Operating income		$	2,888			$	7,351			$	4,463		155	%
As a percent of revenue			6	%			13	%

Operating income increased by $4.5 million. The increase was primarily related to increased revenues of $9.6 million. The increase in revenues was partially offset by an increase in expenses of $5.1 million, including $3.0 million, $1.1 million, $0.7 million, and $0.3 million for cost of revenues, depreciation and amortization, sales and marketing, and general and administrative, respectively.

Interest Expense

 

		For the three months ended March 31,								$ Change				% Change
($ in Thousands)		2009				2010
Interest expense		$	(4,358	)		$	(5,004	)		$	(646	)		15	%

Interest expense increased by $0.6 million. The increase in interest expense is primarily due to a decrease in the fair market value of our interest rate swap. We convert a portion of our outstanding debt to fixed interest rates through the use of interest rate swaps. These instruments are marked to fair value at the end of each quarter, with the non-cash gains and losses treated as decreases or increases to interest expense. The decrease in fair value of our swap resulted in an increase in interest expense of $0.8 million for the three months ended March 31, 2010, as a result of a decline in LIBOR rates.

Other Expense, Net

 

		For the three  months ended March 31,								$ Change				% Change
($ in Thousands)		2009				2010
Other expense, net		$	(238	)		$	(2,570	)		$	(2,332	)		980	%

Other expense, net increased to $2.3 million. The increase is primarily related to costs associated with the Merger, including but not limited to legal and travel costs.

 

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Net Loss

 

		For the three  months ended March 31,								$ Change			% Change
($ in Thousands)		2009				2010
Net loss		$	(1,980	)		$	(509	)		$	1,471		(74	%)

Net loss improved by $1.5 million. Net loss was $0.5 million for the three months ended March 31, 2010, compared to a $2.0 million net loss for the three months ended March 31, 2009. The net income increase is attributable to the factors previously described in this “Results of Operations” section.

LIQUIDITY AND CAPITAL RESOURCES

Overview

The following table sets forth a summary of our cash flows for the periods indicated:

 

		For the three months ended March 31,
($ in Thousands)		2009				2010
Cash provided by (used in):
Operating activities		$	8,964			$	13,890
Investing activities			(23,734	)			(17,216	)
Financing activities			22,500				(1,108	)

Sources and Uses of Cash

Our principal sources of cash are from our operating activities and the funds available to us from our debt borrowings. On March 27, 2008, we entered into a Fourth Amended and Restated Credit Agreement which provided for: (i) a $120.0 million term loan (the “Term Loan”); (ii) a $22.5 million delayed draw term loan (the “Delayed Draw Term Loan”), to be funded at our option no later than March 27, 2009; (iii) a $15.0 million revolving loan (the “Revolver”); and (iv) the option to request an incremental term loan before March 27, 2009, of up to $50.0 million (the “Incremental Term Loan”) subject to the willingness of lenders to make such loan. On March 28, 2008, the $120.0 million of the Term Loan was funded, of which $38.2 million was used to refinance the $38.2 million of term debt remaining outstanding under our previous credit agreement. On January 5, 2009, we borrowed the $22.5 million Delayed Draw Term Loan. The Incremental Term Loan expired unused on March 27, 2009.

On September 4, 2009, we entered into the First Amendment to the Fourth Amended and Restated Credit Agreement (as amended, the “Credit Facility”) which, among other things, provided us with an additional delayed draw term loan of up to $100.0 million (the “Additional Delayed Draw Term Loan”).

As of March 31, 2010, no borrowings have occurred under the Revolver or the Additional Delayed Draw Term Loan. A $1.4 million letter of credit has been issued under the Revolver as a security deposit.

For the three months ended March 31, 2010, our capital expenditures were $17.2 million. Our capital expenditures are expected to total approximately $97.0 million in 2010. Such expenditures are expected to be funded from cash flows from operations, our cash on hand, and our Additional Delayed Draw Term Loan. We do not expect to access funds under our Revolver in 2010. Our 2010 capital expenditures will include the completion of our expansion in Atlanta. These investments will increase product availability, which we believe will enable us to increase revenue and potentially reduce our accumulated deficit. We typically incur lease, utility, and personnel related expenses prior to being able to accept customers for, and generate revenue from the additional capacity. As a result of the operating leverage inherent in our business model, we believe incremental revenue from these expansions will increase operating cash flow. In addition, because most of our costs are fixed, once a market achieves positive cash flow from its operations, new revenues typically generate cash flow at higher operating margins. While we expect our cash flow from operations will continue to increase, we expect our cash flow used in investing activities, primarily as a result of our expansion efforts, to be greater than our cash flows generated from operating activities for at least the next twelve months.

 

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While we cannot provide any assurances, given our current cash position and cash needs, we believe that our cash generated from operating activities, existing cash balance, and available borrowings under the Credit Facility will be sufficient to meet our anticipated capital expenditures, debt service and working capital requirements for at least the next twelve months.

Net Cash Provided by Operating Activities

Net cash provided by operating activities for the three months ended March 31, 2010 was $13.9 million. This consisted primarily of a net loss of $0.5 million and depreciation, amortization, and other non-cash charges of $16.4 million. Also affecting net cash provided by operating activities was an increase in assets of $0.2 million, primarily related to increases in accounts receivable, and a decrease in liabilities of $1.8 million, primarily due to timing differences in end of period payables.

Net cash provided by operating activities for the three months ended March 31, 2009 was $9.0 million. This was primarily attributable to a net loss of $2.0 million and depreciation, amortization, and other non-cash charges of $14.9 million. Also affecting net cash provided by operating activities was a decrease in assets of $1.2 million, and a decrease in liabilities of $5.2 million.

Net Cash Used in Investing Activities

Net cash used in investing activities for the three months ended March 31, 2010 was $17.2 million compared to $23.7 million for the three months ended March 31, 2009. Cash used in investing activities in the three months ended March 31, 2010 was for capital expenditures associated with our expansion efforts, primarily in Atlanta. Cash used in investing activities in the three months ended March 31, 2009 was primarily for capital expenditures associated with expansion efforts in the New York Metro area.

Net Cash Provided by Financing Activities

Net cash used in financing activities for the three months ended March 31, 2010 was $1.1 million compared to net cash provided by financing activities of $22.5 million for the three months ended March 31, 2009. Cash used by financing activities in the three months ended March 31, 2010 was related to long-term debt payments, which were partially offset by cash received from stock option exercises. Cash provided from financing activities in the three months ended March 31, 2009 was primarily from the Delayed Draw Term Loan of our Credit Facility.

Debt Obligations

As of March 31, 2010, we have $138.9 million in principal outstanding under the Term Loan and Delayed Draw Term Loan, and a $1.4 million letter of credit outstanding under the Revolver.

Substantially all of the assets of the Company and its restricted subsidiaries are pledged as collateral for the Credit Facility, and the Credit Facility is guaranteed by the Company’s restricted subsidiaries. All loans under the Credit Facility bear interest at a rate equal to: (a) 2.5% to 3.5% above the alternate base rate (which is equal to the greater of the administrative agent’s prime rate, 0.5% above the federal funds rate, and 3.0% per annum) or (b) 3.5% to 4.5% above the adjusted LIBOR rate (which is equal to the greater of the LIBOR rate for such interest period and 2.0% per annum), where in each case the applicable margin changes based on our consolidated total leverage ratio. The current rate of interest is 3.0% above the alternate base rate or 4.0% above the LIBOR rate. We also pay unused facility fees equal to 0.50% per annum on the unused portion of the Revolver and 1.0% per annum on the unused portion of the Additional Delayed Draw Term Loan.

Borrowings under the Revolver are available until September 26, 2013. Borrowings under the Additional Delayed Draw Term Loan are available until September 4, 2010. Repayments of principal under the Term Loan and the Delayed Draw Term Loan are due in scheduled quarterly installments, beginning March 31, 2010, with the final payment due and payable on March 27, 2014. All outstanding amounts under the Revolver will be due and payable on September 27, 2013. Quarterly payments of principal outstanding under the Additional Delayed Draw Term Loan, if any, will commence on March 31, 2011.

The Credit Facility requires compliance with certain financial covenant ratios including a consolidated total leverage ratio, a consolidated senior leverage ratio, an annualized consolidated interest coverage ratio, and an annualized consolidated fixed charge coverage ratio. The Credit Facility also limits capital expenditures. We were in compliance with all such financial covenants as of March 31, 2010. A 10% change in the financial covenant ratios would not change our compliance status.

 

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The Credit Facility also requires that we comply with certain other covenants which, among other things, restrict our ability to incur additional debt, pay dividends and make other restricted payments, sell assets, enter into affiliate transactions and take other actions. We were in compliance with all such covenants as of March 31, 2010.

The ability to comply with these provisions may be affected by events beyond our control. The breach of any of these covenants could result in a default, subject to customary cure rights, under the Credit Facility and, if not cured within any applicable cure period or waived by our lenders, could trigger acceleration of repayment and the exercise of remedies against the collateral and otherwise, thus adversely affecting the business.

Capital Lease Obligations

Obligations under capital leases at March 31, 2010 totaled $59.9 million.

Contractual Obligations

The following table summarizes, as of March 31, 2010, our minimum payments for long-term debt and other obligations for the next five years and thereafter:

 

($ in Thousands)		Total			Remainder of 2010			2011 and 2012			2013 and 2014			Thereafter
Operating lease obligations		$	347,645		$	24,583		$	64,319		$	63,605		$	195,138
Capital lease obligations *			141,025			5,279			14,222			12,935			108,588
Long-term debt			138,938			10,688			57,000			71,250			—
Interest expense on long-term debt **			27,942			7,444			15,681			4,817			—
Power Purchase Agreements			2,253			1,494			759			—			—
Total contractual obligations ***		$	657,802		$	49,488		$	151,981		$	152,607		$	303,726

 

*	Minimum payments for capital lease obligations includes imputed interest included in the capital lease accounting.

**	The interest expense forecast is based on the greater of the LIBOR rate or 6.5% as of March 31, 2010. Interest expense was calculated by multiplying the outstanding balance by the interest rate for the given time period.

***	The contractual obligations table above does not include accruals for uncertain income tax liabilities of $0.2 million, due to their uncertain nature and timing.

Off Balance Sheet Arrangements

As of December 31, 2009 and March 31, 2010 we did not have any relationships with unconsolidated entities or financial partnerships, such as entities referred to as structured finance or special purpose entities, which were established for the purpose of facilitating off balance sheet arrangements.

We lease space for a majority of our data centers through operating leases. This space is not represented as an asset, nor is the obligation associated with the lease arrangements represented as a liability on our Consolidated Balance Sheets. Minimum payments for such operating lease obligations are disclosed in the footnotes to our financial statements and are included in the contractual obligations table above.

Pending Merger with and into Equinix

Our ability to, among other things, make acquisitions, incur debt, make capital expenditures and expend funds outside of the ordinary course of business is limited by the Merger Agreement.

RECENT ACCOUNTING PRONOUNCEMENTS

In January 2010, the FASB issued an accounting standard update regarding fair value measurements and disclosures. The new guidance requires new disclosures for significant transfers in and out of Level 1 and 2 of the fair value hierarchy and the activity within Level 3 of the fair value hierarchy. The updated guidance also clarifies existing disclosures regarding the level of

 

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disaggregation of assets or liabilities and the valuation techniques and inputs used to measure fair value. The updated guidance is effective for interim and annual reporting periods beginning after December 15, 2009, with the exception of the new Level 3 activity disclosures, which are effective for interim and annual reporting periods beginning after December 15, 2010. We adopted the new guidance during the first quarter of 2010.

In February 2010, the FASB issued an accounting standard update regarding subsequent events. The new guidance reiterates that an SEC filer is required to evaluate subsequent events through the date that the financial statements are issued and removes the requirement for an SEC filer to disclose the date through which subsequent events have been evaluated. The updated guidance was effective upon issuance. We adopted the new guidance during the first quarter of 2010.

The adoption of new accounting guidance did not have a material effect on our consolidated financial statements.

 

Item 3:

Quantitative and Qualitative Disclosures About Market Risk

Interest Rate Risk

We are required by our credit agreements to manage the interest rate risk on our debt. A portion of the floating interest rate on the outstanding debt of $138.9 million is swapped to fixed rate through an interest rate swap derivative, thus minimizing interest rate risk.

Our existing interest rate swap was entered into on January 15, 2009, has a notional amount of $120.0 million, and a maturity date of February 2012. There was no up-front cost for this agreement. The fixed LIBOR rates associated with this swap are 1.71% from February 2009 through February 2010 and 4.99% from February 2010 through February 2012. If the three-month LIBOR rate is higher than these fixed rates for the given periods, we will receive cash payments for the difference between actual three-month LIBOR and the fixed rates for the given periods. If the three-month LIBOR rate is lower than these fixed rates for the given periods, we will pay the difference between actual three-month LIBOR and the fixed rates for the given periods.

As of March 31, 2010, the three-month LIBOR rate was 0.29%, which is lower than our contracted rates. A 10% change in the current LIBOR rate would not change our current net pay position.

Foreign Currency Risk

We have a data center located in Toronto, Canada. Revenue from this data center was 8.4% of total revenues for the three months ended March 31, 2010. We primarily receive payment for services provided at this data center, and primarily pay expenses related to it, in Canadian dollars, which mitigates our exposure to currency exchange rate risk. However, fluctuating foreign currency exchange rates have a direct impact on how our international results of operations translate into U.S. dollars. During the first quarters of 2009 and 2010, the U.S. dollar was generally stronger relative to the Canadian dollar. This change adversely impacted our results of operations as amounts in Canadian dollars generally translated into fewer U.S. dollars. We have determined that the impact of a near-term 10% appreciation or depreciation of the U.S. dollar relative to the Canadian dollar would not have a significant effect on our financial position, results of operations, or cash flows. We do not maintain any derivative instruments to mitigate the exposure to translation and transaction risk. Our foreign exchange transaction gains and losses are included in our results of operations and were not material for all periods presented.

Fair Value Risk

We do not have material exposure to market risk with respect to investments as our investments consist primarily of highly liquid cash equivalent securities. We do not use derivative financial instruments for speculative or trading purposes; however, this does not preclude our adoption of specific hedging strategies in the future.

Commodity Price Risk

Operating costs incurred by us are subject to price fluctuations caused by the volatility of underlying electricity prices at some of our data centers. We monitor the cost of electricity at our data centers. In a limited number of our data centers, we enter into power purchase agreements to fix the price at which we acquire electricity.

 

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Item 4:

Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Our Chief Executive Officer and our Chief Financial Officer, after evaluating the effectiveness of our “disclosure controls and procedures” (as defined in the Securities Exchange Act of 1934 (the “Exchange Act”) Rules 13a-15(e) or 15d-15(e)) as of the end of the period covered by this quarterly report, have concluded that our disclosure controls and procedures are effective based on their evaluation of these controls and procedures required by paragraph (b) of Exchange Act Rules 13a-15 or 15d-15.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Exchange Act Rules 13a-15 or 15d-15 that occurred during our last fiscal quarter that have materially affected or are reasonably likely to materially affect our internal control over financial reporting.

PART II: OTHER INFORMATION

 

Item 1:

Legal Proceedings

As we disclosed in our Annual Report on Form 10-K for our year ended December 31, 2009, three purported stockholder class action lawsuits were filed against us, members of our board of directors, Merger Sub (which was named as a defendant in only two of the lawsuits) and Equinix.

On January 19, 2010, counsel for parties in all three lawsuits entered into a memorandum of understanding in which they agreed upon the terms of a settlement of all lawsuits. In connection with this settlement, the three lawsuits and all claims asserted therein will be dismissed with prejudice, including the claims brought against us and our directors. The parties have sought approval of the settlement in the Florida state court. The parties have stayed the actions pending in the Delaware Chancery Court and the United States District Court for the Middle District of Florida. The proposed settlement is conditional upon, among other things, consummation of the Merger and final approval of the proposed settlement by the Florida state court. The proposed settlement contemplates that plaintiffs’ counsel will apply to the Florida state court for an award of attorneys’ fees and costs in an aggregate amount of $0.9 million, and that the defendants will not oppose or undermine this application. These attorneys’ fees and costs will not be deducted from the Merger consideration. Both Equinix and us will share in the payment of such settlement. As of December 31, 2009, we accrued $0.6 million, our portion of the settlement and recorded $0.4 million as an insurance receivable.

We are subject to other legal proceedings and claims which arise in the ordinary course of business. Based upon currently available information, management, based upon advice of legal counsel, believes that the amounts accrued in the Consolidated Balance Sheets are adequate for the aforementioned proceedings and claims and the amount of any additional liability with respect to these actions will not materially affect our financial position, results of operations, or liquidity.

 

Item 1A:

Risk Factors

No material changes from the risk factors previously disclosed in our Annual Report on Form 10-K for our year ended December 31, 2009 have occurred. Additional risks and uncertainties of which we are unaware, or that are currently deemed immaterial by us, may become important factors that affect us in the future.

 

Item 2:

Unregistered Sales of Equity Securities and Use of Proceeds

None

 

Item 3:

Defaults Upon Senior Securities

None

 

Item 4:

Removed and Reserved

None

 

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Item 5:

Other Information

None

 

Item 6:

Exhibits

 

Exhibit Number		Description of Document		Incorporated By Reference		Form Date		Filed Herein
10.1		Memorandum of Understanding, dated January 19, 2010 – Jiannaras v. Switch & Data Facilities Co., Inc., et al.; Gibbs v. Switch & Data Facilities Co., Inc., et al.; and Broadbased Equities v. Keith Olsen, et al.						X
31.1		Chief Executive Officer Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002						X
31.2		Chief Financial Officer Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002						X
32.1		Chief Executive Officer Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002						X
32.2		Chief Financial Officer Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002						X

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

				Switch & Data Facilities Company, Inc.
Date: April 30, 2010				By:		/s/    KEITH OLSEN
						Keith Olsen
						Chief Executive Officer
Date: April 30, 2010				By:		/s/    GEORGE POLLOCK, JR.
						George Pollock, Jr.
						Senior Vice President and Chief Financial Officer

 

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Exhibit Index

 

Exhibit Number		Description of Document		Incorporated By Reference		Form Date		Filed Herein
10.1		Memorandum of Understanding, dated January 19, 2010 – Jiannaras v. Switch & Data Facilities Co., Inc., et al.; Gibbs v. Switch & Data Facilities Co., Inc., et al.; and Broadbased Equities v. Keith Olsen, et al.						X
31.1		Chief Executive Officer Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002						X
31.2		Chief Financial Officer Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002						X
32.1		Chief Executive Officer Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002						X
32.2		Chief Financial Officer Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002						X

 

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