Equinix Inc (EQIX) 2004 Q4 法說會逐字稿

Hello and welcome to the Q4 2004 conference call. This conference is being recorded for replay purposes. Today's presentation will be in listen-only format. Following the presentation there will be a question-and-answer session. Instructions will be given if you would like to ask a question at that time.

I would now like to introduce the host of today's conference, Mr. Jason Starr, Director of Investor Relations. Sir, you may begin.

Thank you. Good afternoon.

Welcome to Equinix's fourth quarter and year ended 2004 results conference call. Before we get started, I would like to remind everyone that some of the statements that we will be making today are forward-looking in nature and involve risks and uncertainties. Actual results may vary significantly from those statements and may be affected by the risks we identified in today's press release and those identified in our filings with the SEC, including our quarterly report of Form 10-Q filed on November 4th, 2004.

In addition, we will provide non-GAAP measures on today's conference call. We provide a reconciliation of those measures to the most directly comparable GAAP measures and a list of the reasons why the company uses these measures in today's press release and on the Equinix Investor Relations page at www.Equinix.com.

With us today are Peter Van Camp, Equinix's Chief Executive Officer, Renee Lanam, Equinix's Chief Financial Officer, and Keith Taylor, Equinix's Vice President of Finance and Chief Accounting Officer. At this time I will turn the call over to Peter.

Thanks, Jason. In just a minute I'm going to turn it over to Renee to provide some specifics on the quarter and the year. However, before I do, I'd just like to step back briefly and look at some of the highlights of '04.

This really was a breakout year for Equinix. Just to summarize some of the top metrics with fourth quarter results in, Equinix posted 163.7 million in revenues for '04, a 39 percent increase over '03, a result of 117.9. This is what I mean by breakout, as it's a 4 to 5 times faster growth rate than the analyst view of our industry.

EBITDA was up from an '03 result of 1.7 million to 35.6 million, providing strong evidence of the operating leverage in our business. The Company generated 16.2 million in free cash flow for the year. We accomplished this while still making important investments in our expansion and future growth opportunity. We exited the year with 108 million in cash on the balance sheet.

With the 3 expansion centers we've announced over the last 14 months, we smartly added over 25 percent to our cabinet capacity. And most importantly, we signed 324 new customers, taking our total customer base to 950. And an important note within this, we saw significant diversification in our customer base in 2004 with an enterprise influence growing stronger every day.

Continued success in the financial sector, government, and enterprise in general significantly broadens our revenue opportunity. This, coupled with a consistent contribution we've seen from our installed base of customers, provides a nice launch point for '05 growth.

Now let me hand it to Renee, then I'll come back and provide color on the quarter and what we see developing in '05.

Thanks, Peter.

Let me start by saying that 2004 was a terrific year for Equinix and exceeded our expectations. We grew our revenues by 39 percent while keeping our spending in check. This allowed to us generate better margins both on a gross profit and EBITDA line. On the balance sheet we managed our working capital efficiently and invested in key strategic assets in the Ashburn and Silicon Valley market. We also refinanced our debt facilities in 2004, reducing our average rate of interest from 10 percent to 2.5 percent.

We did all this while delivering higher than expected free cash flow and expanding the revenue capacity of our business through our expansion efforts. In addition, in early January 2005 we converted 95 percent of i-STT's convertible secured notes, which reduced the convertible debt on our balance sheet and eliminated 95 percent of the interest burden related to these notes.

Moving on to our results for the quarter and the year. Consistent with our past calls I will provide our results on both a cash and a noncash basis. As a reminder, our noncash costs include depreciation, amortization, accretion, stock-based comp, and noncash interest expense.

Attached to our press release and posted on our website behind our GAAP P&L statement is a non-GAAP cash-based P&L statement. Also, given the restructuring charge recorded in the quarter, we have excluded this charge from our non-GAAP P&L statement.

Also, beginning on our next conference call, given the recent addition of new IBXs and the impact these additions have on our key metrics, specifically gross profit, EBITDA and EBITDA flow-through percentages, I will also begin breaking out the results of same stores versus new stores. Or in our case, existing centers versus new centers. Our definition of a new center is an IBX that has been open for less than 4 full quarters.

So far for 2005 this means that our Ashburn IBX-- expansion IBX, which we'd opened in December of '04, and the new Silicon Valley IBX, which we expect to open in March of this year, will be reported as new centers with their results broken out from the operating results from our other centers. We will also, of course, continue to report our total company results, combining results for both existing and new centers. Hard to imagine but this means that the financial portion of the earnings call might actually get even longer.

Having said that, we continue to believe it is important to be as transparent as possible in reporting financial results.

Starting with revenues, Q4 revenues were 45 million, up 6 percent over the previous quarter. The core revenues of our business, our recurring revenues, were 42.6 million and represented 95 percent of our total revenues for the quarter.

As Peter mentioned, revenues for the year were 163.7 million, a 39 percent increase over last year. Recurring revenues were 154.5 million, up 40 percent over 2003. Recurring revenues accounted for 94 percent of our total 2004 revenues. Nonrecurring revenues for the quarter, consisting entirely of installation fees and professional services, were consistent with the prior quarter at 2.4 million.

For the year, nonrecurring revenues were 9.2 million, compared to 8 million for 2003, a 16 percent increase. Nonrecurring revenues, excluding customer settlements, increased 34 percent year-over-year. Breaking out revenues between U.S. and Asia for the quarters-- for the quarter revenues from our U.S. centers were 38.7 million, up 5 percent over last quarter, and represented 86 percent of our total revenues.

For the year, U.S. revenues were 100- were 141.6 million, up 42 percent over 2003. U.S. revenues accounted for 87 percent of total revenues in the quarter-- in the year.

For the quarter, revenues from our Asia Pacific centers were 6.3 million, up 11 percent over last quarter and were 22.1 million for the year, up 21 percent over 2003. One customer, IBM, represented 13 percent of our Q4 and total year revenues. This represents no change since the prior quarter and down from 15 percent last year.

Though this percentage has been declining slightly on an annual basis, IBM continues to grow with us each quarter in terms of absolute dollars. Just not as fast on a percentage basis as the rest of the business. No other customer accounted for more than 5 percent of our revenues.

Now, moving on to churn, as a reminder we calculate churn in 2 ways. Cabinet churn and monthly recurring revenue, or MRR churn. Our Q4 cabinet churn, which we calculate based on the number of cabinets returned to us by our customers in the quarter, as a percentage of the total cabinets booked at the beginning of the quarter, was 4.1 percent primarily due to our decision not to renew a sales order with a large customer in 1 of our IBX centers.

This anchor tenant installation was deployed several years ago and was aggressively priced to help drive the building to break even. Absent this decision, churn would have been in line with our churn targets for a quarter. For the year, cabinet and MRR churn were slightly less than 12 percent, or about 1 percent per month, which is consistent with our expectations for 2004 and going forward.

Moving on to gross profit and cash growth margins, the Company recognized gross profit of 10.3 million for the quarter, a 27 percent improvement over the previous quarter's gross profit of 8.1 million. For the quarter, gross profit margins improved to 23 percent as compared to 19 percent last quarter.

For 2004, the Company recognized gross profit of 26.7 million and a gross profit margin of 16 percent. In 2003, the company had a gross loss of 10.2 million. With respect to cash gross margins they improved to 53 percent from 51 percent last quarter. Our cash gross margins for the year were higher than expected, at 50 percent, up significantly from 38 percent in 2003.

On a regional basis, U.S. cash gross margins in the quarter were 56 percent, while our Asia Pacific cash gross margins were 37 percent. Separately, during the quarter we finalized the accounting treatment related to our Ashburn IBX expansion property. The lease for the center was recorded on the balance sheet both as a capital lease obligation in the amount of 35.3 million that will be amortized through the initial term of the lease, and it will be recorded as a capital lease asset, which is subject to depreciation over the life of the assets.

The accounting treatment for this lease is different than others, as this represents the first building where we leased both the building and the property and equipment. Because of the size of our lease commitment, vis-a-vis the fair market value of the building, the property and the equipment, the accounting rules required to us account for this lease entirely as a capital lease. While this does not have an impact on cash flow, it does benefit the EBITDA line in 2005 by approximately 4.2 million, 3 million of which was already assumed in our previous 2005 guidance.

Moving on to utilization rates, at the end of 2004, we had approximately 24.5 thousand cabinets available for sale. Approximately 80 percent of our cabinets are in the U.S. with the remaining 20 percent in Asia Pacific. As of December 31st, 2004, approximately 11,100 cabinets, or about 45 percent of our total cabinets, were billing. This compares to 10,750 cabinets, or 44 percent that were billing at the end of the previous quarter.

On a regional basis, our U.S. centers had approximately 8800 cabinets billing or 45 percent at the end of the year. While our Asia Pacific centers had approximately 2300 cabinets billing, or approximately 47 percent at the end of the year.

Breaking out utilization on a weighted average basis, meaning calculating the utilization rate, taking into account how long a cabinet was billing in the quarter, our utilization rate was approximately 45 percent. Or about 11,000 cabinets billing on average in the quarter. Looking at average revenue per cabinet and on a weighted average basis for the quarter, our average monthly recurring revenue per cabinet increased to $1,292 from $1,270 in Q3.

On a regional basis, revenue per cabinet on a weighted average basis was $1,422 in the U.S., up from $1,418 in Q3. Asia revenue per cabinet was $813, up from 752 the previous quarter. If you're still tracking our average revenue per cabinet by simply dividing the recurring revenues for the quarter by the number of cabinets billing at the end of the quarter, you will see total average monthly recurring revenue per cabinet quarter-over-quarter, increased to $1,318 from last quarter's $1,242.

As a reminder, and part of the reason we moved to weighted average basis reporting, these metrics, while important, can fluctuate quite substantially during a given quarter due to a large customer deployment or termination that happened at the end of the period, as occurred in this quarter.

Moving on to SG&A expenses, SG&A expenses were 13.1 million for the quarter, a 3 percent increase over the previous quarter. For the year, our SG&A expenses were 51.1 million, a 5 percent increase over the previous year. Cash SG&A expenses for the quarter were 11.7 million, a level consistent with the previous quarter. Cash SG&A expenses for 2004 were 45.6 million, a 6 percent increase over the previous year. This increase primarily relates to increased headcount and compensation costs, as well as additional costs related to Sarbanes-Oxley compliance.

Let me now briefly touch on the restructuring charge that we took in the quarter. In Q4 the company made the decision to exit 2 real-estate leases that it entered into several years ago. For expansion, space in Secaucus and Los Angeles. This space has not yet been fully built out.

This decision was made following our acquisition of fully built out centers in Silicon Valley and D.C. at a fraction of the cost we would have incurred if we'd built them out ourselves. We now believe we can acquire additional fully built out centers at significant discounts to what we would pay under a greenfield build, and therefore made the decision to exit these leases.

This charge reflects cash costs of 13.9 million and 3.8 million of noncash costs resulting from the write-off of assets related to these centers. The Company has sub-leased the extra space in Secaucus to the existing tenant for 2 years and we are currently evaluating opportunities for the excess lease space in Los Angeles. This charge is not expected to impact free cash flow , but will improve our 2005 EBITDA by approximately 1.8 million.

For those of you tracking us on an EBITDA basis, which we define as loss from operations less noncash depreciation, amortization, accretion, stock-based comp, and restructuring charge, in Q4 we were 12.4 million EBITDA positive, a 23 percent increase over the previous quarter.

This result represented a flow-through rate on incremental revenues to the EBITDA line of 90 percent in the quarter. The flow-through rate was higher than anticipated, as the company negotiated a favorable European capital tax settlement and received the benefit of certain utility and property tax rebates totaling approximately $425,000 in the quarter.

If you exclude this one-time settlement and these rebates, the EBITDA flow-through rate was approximately 73 percent for the quarter, consistent with our expectations on our existing centers. As you can see, our quarterly EBITDA flow-through rate can fluctuate quarter-over-quarter. We expect this fluctuation to continue, as one-time events can impact a given quarter.

These events can have a positive impact on flow-throughs, such as the tax settlements and rebates in Q4 that increased flow-through rates in the quarter to 90 percent. Or they can have a negative impact on flow-throughs as we've seen in other quarters where we've had negative fluctuations in utilities, taxes, employee benefits, or new centers. Key here is that although EBITDA flow-throughs may vary from quarter to quarter , we remain highly confident that the underlying core business, that is business from our existing centers, will continue to generate EBITDA flow-throughs on an annual basis in the 70 percent range.

For 2004, we were 35.6 million EBITDA positive, an increase of almost 34 million over the prior year. Consistent with our expectation of EBITDA flow-through rates on our existing centers on an annual basis, 2004 EBITDA flow-through rate was 74 percent. Looking at EBITDA on a regional basis for the quarter and the year, U.S. operations were EBITDA positive 12.3 million, up from 10.1 million positive last quarter, or an increase of 22 percent.

I'm pleased to report that Asia Pacific operations met their year-end objective and were slightly EBITDA positive for the quarter at $28,000. For the year, U.S. operations were EBITDA positive 37.5 million. Up from 10.1 million positive the previous year. Asia Pacific was EBITDA negative at 1.8 million, a strong improvement from 2003's results of EBITDA negative of 8.4 million.

Our net loss for the quarter on a total Company basis, was 22.7 million or $1.21 a share. Excluding the restructuring charge, our net loss was $5 million, or $0.27 a share, a 25 percent improvement over the prior quarter. Our net loss for the year on a total Company basis was 68.6 million or $3.87 a share. This number included the $17.7 million restructuring charge recorded in Q4, as well as the 16.2 million loss on debt extinguishment and conversion recorded in Q1, related to the early repayment of our credit facility and senior notes.

Excluding these charges our net loss for the year would have been 34.7 million, or $1.96 a share. Looking below the EBITDA line, let me briefly talk about our income taxes and stock option expenses. With respect to income taxes, we expect to pay minimum income taxes in 2005, primarily relating to alternative minimum tax. With respect to stock option expenses we, like many other companies, are currently evaluating the impact of the new FASB rules.

Having said that we thought it would be helpful to size the expense that you should anticipate seeing beginning in Q3 of this year. At this time, we estimate our stock expense charge commencing in Q3 will be in the range of 7.5 to 10 million per quarter.

Turning to our balance sheet, as of December 31 we had 108.1 million of cash, cash equivalents, and investments. This is a 9.3 million increase over the previous quarter. Our company-wide DSOs continue to remain below the 30-day level as we continue to experience extremely strong cash collections.

CapEx for the quarter was 6.2 million and 22.9 million for the year. During the quarter, ongoing CapEx was 3.5 million, expansion CapEx was 2.2 million primarily attributable to the Ashburn expansion and CapEx related to the U.S. Government buildout which we deem to be neither ongoing nor expansion, as the government fully reimburses us for this custom project with 539,000.

For the year, ongoing CapEx was 10.6 million, expansion CapEx was 9.9 million and CapEx related to the U.S. government buildout was 2.4 million.

Moving on to the statement of cash flows for the quarter, our net cash generated from operating activities was 10.6 million. This represented a slight decline quarter-over-quarter due to increases in our working capital balances. Net cash generated from operating activities for the year was 36.9 million, a $54.2 million improvement over the prior year.

Net cash used in investing activities for the quarter was 4.5 million, primarily related to 6.2 million of CapEx, offset by swapping out 1.8 million of restricted cash deposits for letters of credit issued under our new Silicon Valley bank credit facility in the quarter. Net cash used in activiting-- investing activities for year was 20.7 million. Primarily related to 22.9 million of CapEx, offset in part by the swapping out of the restricted cash deposits and a $458,000 increase in our accrued property and equipment balance.

This translates to 6.1 million of free cash flow in the quarter and represents a 14 percent improvement over the previous quarter. For the year, we generated free cash flow of 16.2 million, which represents a $36.5 million improvement over 2003. Our net cash generated from financing activities in the quarter was 3.4 million. For the year, net cash generated from financing activities was 19.2 million which includes proceeds from our convertible debenture offering in [technical difficulty] offset in part by the prepayment of our senior notes and other debt facilities.

Lastly, moving on to our capital structure, as noted in our announcement in January, we have converted 95 percent of i-STT's convertible secured notes into 4.1 million shares of common stock. This is a very important event for us, as it significantly reduced the amount of convertible debt on our balance sheet in a corresponding noncash interest expense.

The remaining 5 percent portion of the convertible secured notes can be converted into common stock in early 2006, provided the stock trades above a certain level for 30 consecutive days. Apart from the remaining 5 percent stub of convertible secured notes, the only other remaining convertible debt we have on the balance sheet, is the 86.3 million convertible debentures we did this time last year.

As a reminder, these debentures bear cash payable interest at a low rate of 2.5 percent. These debentures are convertible into 2.2 million shares of common stock. With respect to our-- with respect to our shares outstanding, as of December 31 we had approximately 19 million shares of common stock outstanding. Now, had the conversion of the 95 percent of i-STT's convertible notes occurred in Q4, we would have had 23.1 million shares of common stock outstanding as of year end.

Assuming conversion of i-STT's preferred stock as well as the remaining pick notes and warrants held by i-STT, we would have about 26 million shares of common stock outstanding. This number excludes the 2.2 million shares related to our convertible debentures I just mentioned, and about 4.1 million shares related to employee stock options and other warrants, the majority of which vest over the next 2 or 3 years.

This concludes my prepared remarks. Let me now turn the call back over to Peter.

Thank you, Renee.

Just before Renee's comments, I noted our strong customer growth in '04 and really what was particularly pleasing about this, was the growing diversity in our revenues and success in the enterprise segment. As we enter '05 we're coming off another great bookings quarter with a strong pipeline ahead. In fourth quarter, we had 69 wins, including The Gap, Solo Cup, Instanet, Arsenal Digital, Telecom New Zealand and Movielink.

Consistent with prior quarters, we also saw expansion orders from approximately half our existing U.S. customers, while more than 75 percent of our total bookings for the quarter came from our installed base. Some notable ones included Merrill Lynch ABN Amro, WebEx, Yahoo, and a sizable expansion from Ticketmaster.

While we continue to own the core of today's internet as the leading content and networking firms interconnect and grow within our IBX hubs, it's exciting to see the enterprise segment providing revenue diversity and upside in our business. In fact, at this point in time, the current base of enterprise customers represents 33 million in annual contract value.

As this has become an important sector in our business, we'd increased our focus and have begun to spend a great deal of time in understanding these customer needs. Just last month, we held our first enterprise-- enterprise advisory meeting. We brought the decision makers from 12 of our top enterprise customers together, to gain specific insight into the drivers for their outsourcing requirements and the value we provide them.

Just one of the take-aways from me from this meeting is the level of trust they've placed in us and how this has positioned us to continue to grow with them.

There was a strong message delivered about our value and the importance of our level of focus, our neutrality in both networks and services, and the difference they recognize in Equinix from other market players. Of note, 1 member of the council took the time to participate in our annual sales kickoff session, to convey the meaning of these points to an enthusiastic sales team as they pursue the enterprise buyer.

With more change ahead in the roster of today's set of network service providers, the value of our neutral model is only magnified for the enterprise customer, as they shield themselves from uncertainty and change.

As we said on our last call, we are making some specific sales and marketing investments in support of our '05 growth. The teams are now in place to lead our new vertical marketing initiative and our channel sales strategy. The business was built on the success we've had in several vertical markets, such as our Tier 1 backbone networks for peering, followed then by the broadband Tier 2 and international networks, joining us to peer with the Tier 1's or each other. This created tremendous value for the leading content players to locate their content next to the onramps of all these networks.

And of course, more recently we've had great success with both the financial and government sectors, which have increased 50 percent since we last reported in Q2 of '04 to now 15 million in annual contract value. In 2005, we will look to other verticals with strong interconnection requirements. Our current customer base has already shown early success in entertainment, gaming, software, and the retail sector. We still have work to do, but this looks to be a promising growth area in 2005.

Another point of focus is the development of our channel program. In fourth quarter, we saw 11 new deals including 1 with AboveNet, which is a sizable grid computing installation in Secaucus for a major hardware manufacturer. This is an area to watch as our traditional set of competitors continues to focus on the core telecom and networking businesses.

However, the need for colocation still exists with their customers, which positions Equinix as a great fit to partner and support these opportunities.

Just some good examples-- through this acquisition of our Sprint center and now the AboveNet center in San Jose, we've developed strong working partnerships with these companies, benefiting all parties. Our efforts in vertical marketing and our success in these new channels support a drive to market leadership.

Also important to this has been our market expansion through the acquisition of now 3 new centers, expanding our footprint by 25 percent. As an update, we've now brought our new Ashburn center online with its opening in December. I'm pleased to report we've already begun to install customers while we've also closed an anchor deal with a key regulatory agency.

We continue to be very excited about the prospects for our newly acquired centers and, in fact the pipeline is already forming for our recently announced property in San Jose. This is slated to open in March.

We really view our ability to acquire, Equinize, and market new centers as an emerging core competency of the Company. We plan to do more of these in support of our growth opportunity and drive to market leadership. Hopefully those of you who know us, will understand that we'll continue to be smart about this. In '05 we do expect to continue to see attractive expansion opportunities at rates significantly below the cost of a greenfield build.

As you now look at our current footprint, and include our new San Jose center, now at an 80 percent utilization-- or when at an 80 percent utilization level, this expands our annual revenue headroom to 340 million. As we build on our momentum this headroom can continue to grow.

We view our ability to smartly manage expansion as a key advantage. And we look at the competitors we face in the market every day, really, no one's doing this.

So now let's take a look at our guidance for 2005, and then the first quarter. Based on the strength of our Q4 pipeline and booking, s as well as the early success we've seen in our new centers, we're raising our annual revenue guidance to range between 205 and 215 million which now places the midpoint at 210, up from 207. We expect cash gross margins to increase to a range of 53 to 55 percent, up from our earlier expectation of 51 to 53 percent.

Investing in our growth, cash SG&A for 2005 is now expected to be in the range of 50 to 52 million. This reflects an increase of $2 million at the midpoint.

We are also increasing our expectation for '05 EBITDA to now be in the range of 60 to 65 million for the year. Up from our earlier expectation of 55 to 60 million. This lifts the midpoint by 5 million over prior expectations. I should note, this includes the benefits from the restructuring charge as well as the Ashburn capital lease treatment which Renee noted. But this also absorbs approximately 9 million in cost of revenues from our expansion in Ashburn and San Jose.

Total CapEx for 2005 remains unchanged, and will be between 23 and 27 million. This will be comprised of 13 to 15 million in ongoing CapEx and 10 to 12 million for expansion CapEx. Free cash flow will be greater than 32 million an increase of 2 million.

As we've now entered '05, the increased visibility we always gain with time has allowed to us lift our expectations for what we already anticipated to be a strong growth year. In looking at the picture just outlined, clearly our backlog and exit rate from '04, pipeline, and the interest level in our new buildings, have provided support for this which I should also note the '05 guidance reflects important investments in our growth.

As we begin to give color on this on our last call-- or we began to, these investments are reflected in our cost of revenue from our new centers, and our SG&A with investment and headcount in the team and our general infrastructure as we scale. Now as we move into guidance for the first quarter, we'll see the increasing momentum on the revenue line while you'll recognize that we begin to absorb much of our investment in the ongoing cost base.

For Q1 revenues are expected to be in the range of 48.5 to 49.5 million. Cash gross margins are expected to range between 51 percent and 52 percent. Cash SG&A is expected to be in the range of 12.5 to 13.5 million.

Next quarter's EBITDA is expected to be in the range of 12 to 13 million, a similar result to Q4, but again reflecting these investments in our cost base. CapEx is expected to be between 7 and 8 million, consisting of approximately 3 million of ongoing CapEx and 4 to 5 million of expansion CapEx to continue to Equinize the new San Jose and Ashburn IBXs. Free cash flow is expected to be greater than $3 million.

So, in closing, '04 really was a break out year and we're certainly excited by our prospects for '05. We continue to execute aggressively on all fronts and remain focused in serving our customers, while so many of our traditional competitors face significant questions and distractions as they go to market.

At this time we'll go ahead and open up for questions. Operator.

Thank you.

[OPERATOR INSTRUCTIONS]

Our first question is from Tom Watts with SG Cowen. You may begin.

Yes, Mr. Watts, sir, you may begin.

Yes. Congratulations on a great quarter.

Thank you, Tom.

Couple quick questions, first, could you just comment on the churn and the customer you elected not to renew, and is that something we're going to see more of? And then, secondly, I saw Arsenal Digital had come in your data (ph) center. I know they're working with some other companies who provide storage services.

Is that something you would consider, and will we see you moving up the stack in terms of value-added services you offer?

Sure, we'll hit both those questions.

Not disclosing the specific customer, this was an older relationship and install at a pretty aggressive rate in 1 of our buildings that churned out. Don't expect to see that on an ongoing basis. Obviously churn was a little higher this quarter, but as we've always guided, 3 percent on an annual basis is a good number to look at, and so I wouldn't expect this to happen. Certainly this one was also proactive.

The price point is something we didn't want and we just agreed that it was better to not renew because that space is valuable, and we expect to fill it with better retail-oriented revenue.

The other question about Arsenal, certainly great to have them as a customer. That certainly is something that would make them available to other customers in our center but we specifically have no plans at this time to start marketing any of their services, Tom.

Okay. Just a final question.

With SBC acquiring AT&T, I know you see AT&T in the marketplace frequently, do you think that will change their approach at all, particularly with SBC in the California market, do you expect any increased competition?

Well, actually, I would guess the competition to stay neutral to where we are right now or maybe even the distraction of everything that's going on, having been through acquisitions in prior lives I do know that it creates a challenge for sales teams and so forth with questions to answer. But, at the end of the day I don't feel there's increased competitive situation that would take place here.

Thanks very much.

Thank you. Our next question is from Michael Rollins with Smith Barney. You may begin.

Hi. Good afternoon.

Curious if you could give us just some more detail on the recurring revenue, rather than total revenue by region-- the U.S. versus Asia Pacific. And then secondly, I was wondering if you could talk about your marketing strategy a little bit.

Looks like you, as you mentioned on the call, invested a little bit more in sales, and I'm wondering as you look at pricing, are you going to start maybe to discount the base rent a little bit to draw in some customers, and try to get that upsale for the interconnection? And, do you see some of your competitors starting to respond to your success with pricing and discounting, etc., just curious if you can give us an update on that front.

I'll take the pricing one, and then let Keith or Renee follow up on specifics about recurring revenues at a regional breakout. But, on the pricing one overall, we're seeing pricing firmening (sic) and, in fact, we are not going to be doing any discount-- discounting from our marketing strategy to get customers in for the sake of interconnection or other services.

We haven't had to do this in the past and this continues to be certainly a strong pricing model and the value around coming in to do interconnection really allows us to not be discounting around it so, I'm feeling good about where our pricing is right now.

Just touching base on the recurring revenue. The way that we break it down is, as you know, the U.S. represents roughly 87 percent of the revenue and 95 percent of that revenue is broken down to recurring revenue, the other 5 percent being nonrecurring.

So with that said, you get a sense that both Asia and the U.S. is roughly somewhere between the 91 and 95 percent on the recurring revenue line.

Is that what you're looking for?

Yes, actually, I know in the Q's and K's you usually put the actual specific dollar numbers in there, so I was looking for those. But I could-- do the percentages and wait for the Q's or K's, that's fine.

And we're happy to give it to you. So, in the U.S. the recurring revenue in Q4 was 30-- just under 37 million, 36.9 million.

Okay.

Then in the Asia side, it's just under 5.7 million.

Great. Thanks very much.

Thank you. Our next question is from Joanna Makris with Adams Harkness. You may begin.

Good afternoon.

A question on the outlook for some of these next generation web offerings in the music, voice, video services. What does the pipeline look like for you, and what kind of contribution do you think those next-gen services could really do for your revenue growth looking out over the next 12 months?

That's actually 1 of the key verticals that we're looking at as we talk about just some of the new vertical programs. That's the number one that's on Maggie Backaus's list, who runs marketing for us. So, I do see that that's a key win going forward.

Clearly rich digital media has a huge benefit by being able to peer. So getting that directly on the downstream networks, avoids significant costs, from transit to get it to those networks, as well as it just enhances performance by eliminating hops across networks to get to direct end users. So, that's a perfect fit for the business and we see that will continue to contribute it-- contribute as you look at our '05 performance.

Great.

Secondly, what portion of your revenues right now are sort of federal and government related and what kind of prospects do you see for that portion of the business going forward?

I don't-- I don't have a specific government number for you as a percentage basis. I don't know that it will grow faster than the rest of the business, so I wouldn't expect to see it increasing on a percentage basis at all. But we did, as we've talked about before, put a lot of energy and specific team into the government sector.

The one number we did offer on the call was just the progress we've seen in the verticals this year of financial and government as a combined number, but that was $15 million and now we're up to an annual contract value between those 2 pieces of our vertical marketing effort, so that will give you direct items (ph) but, at the end of the day, I just don't see government growing faster than the rest of the business, because we've got so many other pieces growing well.

All right. Okay. Thank you.

Thank you. Our next question is from Andy Schroepfer with Tier One Research. You may begin.

Hi. Two questions for you guys. Good job on the quarter, by the way.

First, on your sales force, can you talk about maybe is it segmented at all? Like are there a couple of people going after just huge accounts, or is the whole team just trying to look at larger accounts? Has there been any change in the kind of customer that the entire sales force is looking at?

Well, we have always segmented the customer base at some level, and if you recall, certainly the networks themselves have been a key focus for 1 given team. We also do have a group-- we really call them our strategic accounts team, that focus on our biggest customers and certainly in that area that's where we're driving some of our new big relationships to, so that's another segment of key focus.

Now, what we have added this year as we talked about, is a focus on the channels as well, and putting a team together on that that will really run side by side some of these channel sales forces to help them sell our services. When we started the government, as well, we did put some specific focus there.

So , you can see some specific focus around the verticals. But we do have nationally, a general sales team that's geographically aligned that captures our efforts into all the major enterprise and internet-based companies we need to go after if they don't fit those categories I just outlined.

Maybe a different way to ask it more specifically, the revenue uplift that you're looking for in '05, are you looking for that to come from mostly extremely large accounts, or is that from a lot of blocking and tackling as well?

It will be a balance of both, Andy.

Pipeline isn't shifted more towards one or the other, or the goal of the sales force isn't targeted at one or the other?

No, I think that's the thing. When you think about these enterprise opportunities and how much we've grown that sector. There are a few big ones in there, of course, but ultimately, that group of customers is going to be typically a smaller footprint than a great big web implementation like from a Yahoo or something, so we're going to see a lot of balance across all areas.

Very good. Any unique things happen in AP in the quarter? Differences in demand? Deals that maybe were looking --?

Well, they generated positive EBITDA for the first time. I guess you would say that's unique. But, I think some benefit that we're seeing in the first-- in the first quarter in Asia Pac as well as what happened last quarter is, a little bit uptick in their interconnection revenues and a service mix that's doing some benefit in our return per cabinet that we're pleased to see.

So I think beyond just the colocation piece, the services they're driving over there are starting to show up in the revenue stream.

Excellent. And then, last question.

You mentioned in previous calls different potential partnership opportunities, I'll leave it vague at that with the likes of Qwest or a Verio. Any updates on any of those relationships?

Nothing specific to report as yet, nothing formal there as yet, but clearly that's a space to watch.

Without the specific names, is that as a group something that you'd still look for as '05 event for there to be something material to come out of that group of players?

Yes, over the course of the year I think, well, the number-- the channel team was put together to grow our output from our channel effort, so over the course of the year we'll see some value there.

Excellent. Keep it up.

Thank you.

Thanks.

Thank you.

Our next question is from Hampton Adams with IRG. You may begin.

Hi guys, great quarter.

Thank you.

Two questions. One will be on Asia Pacific, again. Now that we've turned the corner there, can we be pretty confident that we're not going to have to go back in the red in Asia Pacific?

And the second question being the gross margin line. Came in a little bit higher than I'd expected this quarter. It's going to drop back down the first quarter, yet '05 guidance is back above where it was before you did San Jose. So, I wanted just to understand if that's a timing of when these expansions are coming online or what's causing the fluctuations there?

First on Asia, don't expect it to go back the other way, and so expect it to now contribute in '05, and grow for us. But, with respect to just the increased cost in-- or impact on our margins in first quarter, really what we're seeing at the beginning of the year is a stepup of our cost base because of the new buildings we've talked about some investment in the team and so forth. I was looking at before it the call.

Actually, between fourth quarter and first quarter this year we're going to add 50 heads to the company. So that's a good sized number for us, so that's some of the investment we're talking about here.

So, you're going to see a step function up in our cost base in first quarter, and then as we get up, obviously flow-throughs and the increase in margins as the revenue grows against the new cost base is certainly back on track.

Have you had any kind of changes as you look out the full year, it would seem like that's a big jump up in gross margins from where we were say, back in December. So, I was just was trying to understand. Have you found anything at San Jose that says business is much better or across the whole business, I don't know.

No, I think it just gets back to the nature of the business model, and how it's largely a fixed cost business. Of course, we're incrementing that fixed cost base a little bit here, as we enter the year. But once it's in place incremental revenues are just coming in certainly at a very high flow-through on both margin and EBITDA, so that's driving the margin up. And so, I think if you look at our history and how our flow-through rates have impacted things that you'd find a similar trend there.

Certainly we can take a look at it and just confirm that after the call here, but I think that that's really what's driving it.

Thank you. Great quarter.

Thank you.

Thank you. We have time for one more question.

Jonathan Schildkraut with SG Cowen you may begin.

Hey, guys. Sorry if you've spoken on this, I missed a little bit of the call at the beginning.

I was wondering for the growth next year whether that was going to be coming primarily from increasing sales-- service sales to existing customers, or an expansion of cabinets. This quarter we saw the lowest increase in cabinet numbers for the year, so I was wondering about that.

And then I wanted to talk a little bit about the incremental EBITDA margins as they progress through the year. Based on your Q1 guidance, it looks as though the incremental EBITDA margin would be very low in Q1, somewhere in the high single digits, low double digits, and then thereafter based on your annual guidance it looks like the incremental EBITDA margin jump back up to levels we've been seeing over the last year.

And then just a couple of quick questions on the cap lease, just the implied interest rate on the cap lease and the length of the time on the cap lease. Thanks.

Hey, I'll start with that and may need to defer to Keith or Renee for a little bit of fill-in along the way. But, John, first, the growth in the coming year, I don't see any significant mix in-- in services, whether it be cabinets or interconnection or even the managed component of what we do, so as you look forward I would keep your thinking in line with where we've been in the return we get on a per cabinet capacity and the break out of the service mix on those cabinets.

Now, the second one you asked about is just seeing this EBITDA flow-through or incremental EBITDA on growth in first quarter being low as compared to the second, third, and fourth quarter of the year.

Now, this is my point again about just resizing our cost base, because we're investing in the team and certainly that's an impact also in the cost of revenues line as these buildings come on board as well.

So, you just think of a fixed cost business as we've always said we're uplifting it at the beginning of the year here, so the growth we're seeing in first quarter has to absorb that uplift but each successive quarter, we continue to see strong growth. We see it in the pipeline, we see in our backlog and so that's really what will now see those flow-throughs coming in at a high rate as they always come in above our fixed cost and that's why you'll see those margins continue with an increase. So there's just been a step function of cost here to really recognize.

We looked hard at this number, of course, as you might guess, prior to the call, and just a number of things happened at the beginning of the year beyond just the investment in teams.

We're adding all those salaries, a simple thing like FICA comes into play because now we've got a larger employee base, and so that comes on line as you pay that in, certainly in a bigger way, and other things that we're doing are investment in the team, we now are having a formalized corporate bonus program where historically, we've not in the company, so there's some incremental cost in team investment there.

And so all these things now layer in over the course of the year, but the flow-through and operating leverage of the business is just as strong as ever, and you'll just see that perform in the quarters as we proceed.

I forget, Keith, did you get last question?

Jonathan, just let me just follow on, say one more thing that PBC was referring to, when we talk about our cabinet utilization you refer to it as being the lowest you've seen in awhile. There's 2 things affecting that. Number one, of course, we had the churn in the quarter that we alluded to. So when you look at it on a net basis, of course, that's going to impact the absolute cabinet change quarter-over-quarter.

But when you look at our revenues, not only the revenues we had in Q4, more particularly the revenues we guided you in Q, you'll see that that's not going to have a major impact on revenues going forward. Moving to your other questions which was on the capital lease, the imputed rate of interest in the lease is 8.5 percent, and it's going to -- it's going to amortize through 2019.

All right. Thanks, guys. Excellent quarter.

Great. Thanks, Jonathan.

Thank you. I would now like to turn the conference back to Mr. Starr for any closing remarks.

Thank you for joining us, today. That concludes our conference call, actually. You may now disconnect.