Equinix Inc (EQIX) 2005 Q3 法說會逐字稿

Hello, and welcome to the Q3 2005 conference call. This call is being recorded for replay purposes. Today’s presentation will be in a 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.

Good afternoon. And welcome to our Q3 results conference call.

Before we get started, I would like to remind everyone that some of the statements that we’ll 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 Form 10-K filed on March 10th, 2005, Form 10-Q filed on August 2nd, 2005, and the registration statement on Form S-3 filed on October 6th, 2005.

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; Keith Taylor, Equinix ’s Chief Financial Officer; and Renee Lanam, Equinix’s Chief Development Officer.

At this time, I’ll turn the call over to Peter.

Thank you, Jason. And thanks, everyone, for joining the call.

Obviously, it’s been another busy quarter. So, today, I’d like to hit the highlights and add some color to the end of ’05. We’ll also update you on some of the expansion and financing activity around our new Los Angeles Center, and the acquisition of our D.C. Data Center Campus. And then, talk about our prospects for ’06. So, let’s get to highlights.

Total revenue for the Company was 58.1 million. This was our best ever quarter over quarter actual dollar increase since our acquisition of the Asia-Pacific Centers in 2002. It represents 37% growth over same quarter last year and approximately 11% increase over Q2. I should note we saw customer settlements that benefited this number, yet even without this this was still the best ever result.

EBITDA was 17.9 million, a 78% increase over last year and 12% sequentially. I’ll also note here there were some specific events in the quarter on the cost line that impacted our EBITDA result. Keith will detail these in a minute. However, excluding these costs and the previously mentioned customer settlements, EBITDA would have come in at a similar result.

Equinix closed 74 new customers in the third quarter, including wins from [BT Japan Corporation], Citigroup Services, L’Oreal, Raindance Communications, Time Warner Entertainment, and [Vonnage Australia]. Consistent with prior quarters over 50% of our bookings in the quarter came from the installed base.

We executed an agreement to purchase a new building in Los Angeles and followed this up earlier this month with the acquisition of the campus that houses our flagship IBX in the Washington D.C. area. We believe these moves have given us the strongest position in securing the best possible long-term economics for these Centers. As you saw in the announcement this morning, we’ve made significant progress. We have entered into an agreement to complete the sale leaseback of our LA Data Center ahead of schedule at a $3.5 million cash benefit.

Also announced was a non-binding letter of intent to finance our D.C. area Data Center Campus for $60 million and exit our existing San Jose ground lease. For those of you who may not be aware, we carried the lease on the property adjacent to our San Jose IBX for a number of years. We’re excited by the prospects of eliminating the costs associated with this in our ongoing results.

Another recent event was we filed a registration statement to support the divestiture of STT Communications Holdings. Now, as you know, there’s not a lot else we can say regarding this at this time due to SEC regulations.

Lastly, just to comment on some organization changes. Of course, as we talked about on our mid-quarter call, we’ve seen a change in Renee and Keith’s responsibilities. As you’ve seen in recent transaction, Renee has been busy, while I’m pleased to have Keith on the call in his new role.

Also, Jay Adelson, our Founder and CTO, has changed his role to a strategic advisor to the Company. And I should note that [Andy Ratcliffe], who was our founding VP with Benchmark Capital, is stepping down from the Board. We certainly thank Andy for his many contributions to the Company over the past seven years.

So, let me turn it over to Keith Taylor to cover the specifics of third quarter and more color on our recent expansion announcement.

Thanks, Peter. Good afternoon.

I’m pleased to provide you with our third quarter detailed financial results. We’ve had another great quarter, particularly across all of our key metrics. Our revenues continued to be the beneficiary of strong customer demand, and we had a healthy backlog with our quarterly bookings. Our recurring cash costs are consistent with our expectations for the quarter. We did have some additional costs from events that arose in the quarter, which I will discuss in a moment.

First, regarding revenues. Q3 revenues came in at 58.1 million, up 11% in the previous quarter, and up 37% over the same quarter last year. This represented a sequential dollar increase of 5.6 million, our largest increase since our acquisition of the Asia-Pacific Centers in 2002. This result included customer settlement fees of approximately 860,000, but greater than 800,000 coming from a negotiated pre-bankruptcy settlement with WorldCom, the predecessor to MCI.

Absent these settlement payments the revenues grew quarter over quarter by $4.8 million or 9%, still our largest sequential increase. The core of our business are recurring revenues, where 54.3 million, a sequential 10% increase over the previous quarter and a 36% increase over the same quarter last year. Nonrecurring revenues for the quarter were 3.8 million derived from installation fees and professional services, and the customer settlement fees as previously mentioned.

With regard to churn, in Q3 both our [TABNA] and our MRR churn continued to remain below our targeted levels of 3% per quarter. For Q3, MRR churn was 1.6% for the entire quarter, while our cabinet churn came in at less than 1% for the quarter.

Moving to gross profit and cash gross margins, the Company recognized the gross profit of 17.1 million for the quarter compared to 13.7 million the previous quarter, and 8.1 million the same quarter last year. Our cash gross margins increased to 57%, up from 56% last quarter.

As announced today, we’ve entered into several real estate financing transactions. First, we’ve entered into a definitive purchase and sale agreement to sell our LA Expansion Data Center for 38.7 million. This transaction remains subject to closing contingencies, although there can be no assurances these contingencies will be met. It is expected that these conditions will be removed on November 1st. This is expected to result in a $3.5 million cash benefit, and we expect to realize approximately $15 million in total savings over the initial term of the lease as opposed to entering into a direct lease with the previous owner.

We expect to close this transaction before the end of the year. From a lease treatment perspective we expect that approximately 75% of the lease cost will be treated as a capital lease, while the remaining costs will be treated as an operating lease.

Second, we entered into a non-binding letter agreement to place long-term debt financing on the D.C. area Data Center Campus. The proposed terms of this financing is $60 million at 8% amortizing over 20 years. We originally purchased this entire Campus for 53 million.

Finally, we entered into a non-binding letter agreement to modify our San Jose ground lease, whereby the Company will pay $10 million a year for the next four years commencing in January of 2006. This is an incremental 4 million per year over and above the current annual lease cost of approximately $6 million per year, and will eliminate all obligation through years 2010 through 2020.

Because we believe there are more attractive opportunities to expand in the Silicon Valley market than to build on this property the Company will record a restructuring charge in Q4 estimated to be between $35 million and $40 million.

As of October 24th, 2005, the date of this letter agreement, we expect that all the funding costs of this ground lease will be applied against the restructuring charge. And accordingly we will reduce our cost of revenues. Effectively, if we finalize the transaction on the proposed terms, we expect to exit the remaining $100 million commitment for roughly $40 million. For Q4 we expect the EBITDA benefit derived from this decision will approximate $750,000.

On to utilization rate. At the end of Q3 our operational cabinet capacity was approximately 26,200. This excludes the 4,900 cabinets we expect to add in the first half of 2006 from the Silicon Valley and LA Expansion Centers and the Chicago IBX Expansion. At the end of Q3 approximately 13,700 cabinets or about a 52% of our total cabinets were billing, an increase of 1,300 billing cabinets over the previous quarter.

Breaking out utilization on a weighted average basis, meaning calculating the utilization rate, taking into account when in the quarter a cabinet started billing, our utilization rate was approximately 51% or 13,300 cabinets billing on average in the quarter. The increase in cabinets billing is directly attributable to the strong, current and new customer bookings in Q1 and Q2, as Peter has mentioned on the last two earnings calls.

Looking at revenue per cabinet on a weighted average basis our average monthly recurring revenue per cabinet was 1,361, consistent with Q2’s result of 1,360. We experienced the same level of consistency across both our U.S. and Asia markets.

On to SG&A expenses. SG&A expenses, which include 1.4 million of stock based compensation expense was 16.9 million, a 5% increase over the previous quarter and a 33% increase over the same quarter last year. As we’ve previously discussed we continue to invest in our team and our systems to scale with our growth. From an SG&A headcount perspective we’ve increased our staffing from 290 at the beginning of the year to 330 at the end of this quarter, a 14% increase in headcount over the first nine months of the year.

Our cash SG&A expenses came in at 15.1 million, a 15% increase over the previous quarter and a 29% increase over the same quarter last year. The majority of this increase is attributed to events that arose in the quarter such as costs related to the S-3 filing for the proposed sale of STT shares and accrued severance expense. The balance of the increase came from performance related compensation expenses including sales commissions and costs associated with the scaling of the team, as previously noted.

Moving on to EBITDA, EBITDA for the quarter was 17.9 million, a 12% increase sequentially. Our customer settlements were received, excuse me, customer settlements we received in the period were offset by higher SG&A expenses, as noted. On a regional basis the U.S. generated positive EBITDA of 17.2 million, and Asia generated positive EBITDA of 663,000.

Our net loss for the quarter was 783,000 or $0.03 per share which included 1.4 million of stock based compensation expense. Consistent with our previous guidance if we were to exclude equity compensation expenses we would have been net income positive for the entire quarter.

On a cash basis our cash net income improved to 17.2 million, a 12% increase over the prior quarter.

Turning to the balance sheet, at the end of Q3 our cash and cash equivalents and investment balance was $108.3 million. This reflects the 34.7 million used to acquire the LA property.

Moving on to Q4 let me set the stage of where we expect our unrestricted cash balance to land at the end of the year, assuming we complete the financing transactions by the end of the year.

First, the impact of the purchase of the LA property will be offset by the anticipated sale and leaseback financing transaction from 38.7 million, again, a net cash benefit of 3.5 million. The $53 million purchase and expected long-term financing of the Ashburn Campus should improve our cash balances by approximately 5 million net of costs. As a result, we expect to exit 2005 with in excess of 160 million of unrestricted cash after fully repaying the $30 million draw under the Silicon Valley bank line.

Our DSO continues to operate at below 30-day levels.

Looking at CapEx, CapEx for the quarter was 7.1 million. Our expansion CapEx for our new center was 2.1 million while our ongoing CapEx was 5 million.

Moving to the statement of cash flows, our net cash generated from operating activities was 15.5 million. This represents a quarter over quarter decrease of 2.6 million primarily attributed to the interest payment on our convertible debentures, the funding of our annual insurance premiums, and other changes in our working capital.

Our net cash used in investing activities in the quarter was 42.1 million, related to, primarily related to the 34.7 million for the LA Center acquisition, and CapEx of approximately 7 million.

Our free cash flow was negative 26.6 million in the quarter. Excluding the impact of the LA Data Center acquisition we would have generated free cash flow of 8.1 million in the quarter. Our net cash generated from financing activities in the quarter was 3 million, primarily related to employee stock plans of 3.6 million, offset by debt financing activities.

Finally, with respect to our equity capital structure at the end of the quarter, we had approximately 24.2 million shares of common stock outstanding. Assuming the conversion of STT’s remaining holdings we would have approximately 27.3 million shares outstanding at the end of Q3. This number excludes 2.2 million shares related to our convertible subordinated debentures and 4.6 million related to employee stock plans and other warrants, the majority of which vest over the next two to four years.

So, let me turn the call back to Peter.

Thanks, Keith.

As you can see, we had a great quarter. As I’ve noted on some of our previous calls, our bookings have been very strong, and we’ve seen this materialize in revenue. The 10% sequential increase in monthly recurring revenue in the quarter was clearly evidence of this.

So, with a recurring revenue nature of our business we now have good visibility into the fourth quarter which pushed us into a position to wrap-up expectations for 2005. We’ve now increased annual revenues up to an expectation of $219.3 million to $220.3 million, representing 34% growth YOY. Cash gross margins are expected to be approximately 56% for the year. Cash SG&A is expected to be approximately 55 million. This includes impact from the specific events in the quarter, that Keith mentioned earlier, and the added costs around our accelerated growth.

We are also increasing our expectations for EBITDA. This is now expected to range between 69 million and 70 million, which is up 2.5 million at the midpoint. We are tightening our CapEx guidance to now range between 46 million and 48 million for the year. This consists of 21 to 22 million of ongoing CapEx, an increase of 4 million from our previous guidance. We should note here that some CapEx for ongoing programs, such as our internal systems upgrades and the addition of 10 Gig capability to our exchange platform, are coming ahead of anticipated schedule landing in Q4 instead of Q1 of ’06.

For expansion CapEx we will complete the year in the range of 25 million to 26 million, which reflects the investments we are making into the [equinazation] of expansions in D.C., Chicago, LA, and Silicon Valley markets in 2005.

We expect free cash flow, excluding the LA and D.C. real estate purchase transaction to be greater than 32 million, an increase of 2 million over our previous expectation. Just to be clear, this also excludes the cash benefit we mentioned from our LA transaction. The intent here is to highlight the result of the ongoing business performance that we’ve enjoyed.

Now, as we approach the end of ’05 we can look back on what’s really been a tremendous year in the Company’s development. Beyond our strong revenue growth, EBITDA will have almost doubled. We’ve also made significant investments in building the foundation for an enterprise with significant headroom for growth. These investments in teams, system, and expanded IBX capacity have all been funded by our strong cash flow.

With our expected 2005 results we exit the year with now a strong platform looking into ’06. Our market position, customer momentum and brand are strong. Demand for our services remains high, pricing firm, churn low, and at an industry level we believe there’s a scarcity of customer options at our level of service quality.

With this we now expect revenues for 2006 to be between 275 million and 285 million, an increase of 60 million at the midpoints of ’05 and ’06 guidance. Cash gross margins are expected to be between 57% and 59%. This includes the absorption of the added cost of bringing three new IBXs on line in the first half of 2006, as well as the benefit of the elimination of our Santa Fe ground lease, which has carried an annual cost of $6 million in our gross margins. Cash SG&A is expected to be in the range of 60 million to 64 million, or 22% of revenues, a decline from 25% this year. EBITDA is expected to range from 95 million to 105 million.

Moving on to anticipated capital expenditure in ’06, again, we’re in the process of [equinizing] three new IBXs that are expected to be available for customer installs over the first half of next year. As we’ve discussed previously, the remaining anticipated ’06 spend for this will translate into 35 million to 40 million of expansion CapEx. As we did in ’05, we will provide any guidance for additional expansions or acquisitions that may arise in our ’06 opportunity. In ongoing CapEx, we expect this to be approximately 20 million or 7% of our revenues at the midpoint. And free cash flow is expected to be greater than 40 million for the year.

Now, some closing comments. The Team is very excited about the prospects for ’06 and our ability to take Equinix to a new level on the path to market leadership and our goal to build a $500 million and revenue generating enterprise. As you’ve seen we put a high level of focus on expansion of our Data Center headroom to support this. We’re making investments in the upgrade of our exchange platform to continue to support our market leading position and interconnections.

We’re very excited by the announcement you may have seen yesterday in working with [New Star] to create a service capability on the exchange to support the effective network to network tiering of VoIP. We see this platform having extensibility to not just your voice, but to expand to a wide set of multimedia applications. These efforts and the investments we’re making in team and systems all support a significant opportunity for Equinix going forward.

Again, thanks, everyone, for joining the call. Operator, let’s take your questions.

[OPERATOR INSTRUCTIONS.]

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

Hi, Peter. Congratulations on the quarter.

Well, thank you, Tom.

I just wanted to work through and make sure I understood the impact of some of the financing transactions on the EBITDA. You mentioned the elimination of the ground lease will improve EBITDA about 6 million to 7 million. The D.C. facility, it sounds like mortgage interest is going to be about 4.8 million, with 50 million at 8%. What were the payments before for that facility that you are making that will come out of EBIT, should be EBITDA benefit?

Tom, it’s Keith here. So, on an annual basis we’re paying roughly $2 million per year for the lease payment for the three buildings that we occupy, or excuse me, the three buildings that we have under lease, two of which are occupied and [built] by us. And it is six buildings in total.

Okay. And then for that third building you can, you may be able to expand on that down the road?

That’s right, Tom.

Okay. And then, also, just on the El Segundo, the sale leaseback there, you had mentioned that 75% was going to be capitalized lease payments and 25% operating lease?

That’s correct.

And what was the total amount of that lease payment?

So, over the 20-year period, Tom, it’s going to be roughly 60 million to 65 million. And so the amount of debt that we’re going to put on our books under the expectation that the transaction will close will be just under $30 million. It’ll be somewhere between $28 million and $30 million.

Okay. If you’d look at that on an operating lease, it sounds like, you know, 60 million to 65 million over 20 years is like 3 million a year, and a quarter of that is going to be $750,000 or something. Is that, if you just do the operating lease of that would that have been a similar payment, or do you think it would have been higher? Do you have a sense?

Well, let me, [inaudible], I mean the incremental costs on that lease, computed in the lease at 7.5%, so that sort of gives you a sense of roughly what the cost of carrying that capital lease is. But absent that, I mean basically the breakdown is that it is, the initial terms are roughly $3 million a year, 107,000 s.f.

Okay. Great.

And then, also, just looking at the guidance going forward, it looks like your incremental EBITDA margins are about 51% if I take the midpoint of this year and versus midpoint next year? Do you think that’s representative of the operating leverage inherent in the business now? How much of that is, clearly a lot of that is related to expanding capacity, but is that what we should look at going forward in future years?

Well, it’s clearly related to expansion, Tom. I think the interesting numbers and, certainly, the interesting way to look at it, what the operating performance almost at a same-stores basis. And so at a same-stores number, because we were actually looking at that, it was approximately 70%. So, if you just think about the operating leverage for the business, core business continues to deliver these great flow-throughs, but, of course, we’re expanding towards this opportunity.

Okay. Thanks very much.

Great.

Thank you. Our next question is from Jonathan Shildkraut with Jefferies. You may begin.

Excellent quarter, guys. A couple of questions here. What was the net customer number at the end of the quarter?

We added 74 customers, Jonathan. And then on a net basis it was 44.

Okay, thanks. You know, you mentioned that there were some onetime costs in the SG&A that jumped up for the quarter. And you said I think that PVC also said that net net with the settlement it would have worked out, EBITDA would have worked out somewhat evenly for the quarter.

Yes, that’s right, Jonathan.

So, I just wanted to make sure that we can expect to see G&A drop probably then next quarter?

Yes, I think so. I think you probably need – I haven’t done the math that looks specifically at fourth quarter. I don’t have it right in front of me, but go back and certainly you can now see that since we’ve given you the annual guidance.

Now, in terms of the new facility, in terms of the D.C. property acquisition, I note in your earlier releases you said you’d spent 40 million on building out or investing into that facility over the next two years, or at least 2006, 2007. It didn’t seem that any of that money was captured in your CapEx guidance?

You mean for ’06 guidance?

Yes, ’06 CapEx?

Yes, you’re right. It wasn’t, I mean there will be opportunistic in that spend, and I can’t give you timing on when that might take place. We still have capacity in that market and we’re managing to it. So, I think as I also said, we would update you if we’re going to employ any of that capital.

And what is the size of that warehouse, anyway?

Pretty good sized center, I think it’s about 78,000 s.f.

Right, great. My next question is more on business, and I don’t know if Margie is in the room? She may be a great person to answer this one. But there seems to be a lot going on right now with level three and [cogent] in terms of what can be passed between network providers in terms of traffic.

And from all of the arguments I’ve been seeing, it seems to point more and more towards a metered type of service which somewhat made me think of Equinix Direct. I’m wondering if there’s any increased interest in that product? And if so, you know, what are you guys forecasting going forward?

Well, Jonathan, I would have been happy to answer the question, but coincidentally, Margie was just walking by, so we will let her answer it!

Hey, Jonathan. It’s Margie. There’s a couple of things. I mean as you kind of see tiering play out, and we’ve had these discussions. I think there’s always a lot of politics and things that go into, you know, what we see with tiering. Things like the cogent level three things. Actually, we don’t see a big difference in that just because somebody stopped tiering, you know, they just run that cross-neck over to a transit relationship to get to those end users, so we don’t see any difference in that.

I think, you know, as it relates to Equinix Direct, the primary, today’s primary customer for that service is an enterprise or content customer that generally uses 100 megs or less. And they’re primarily using that for multi-homing. So, we actually in the last two quarters have seen a fairly good traffic growth in that service. As you know, it’s still not a significant revenue contributor to us, but as we continue to see that.

The other thing we’re seeing from a trend perspective is some interest from some players who are going to start using paid tiering relationships. As you know, over the exchange most people do that at no cost to each other today. So, what we’re seeing is some interest for some networks and some other people who want to at least gain some money for their tiering relationships and are looking to do that over Equinix Direct. So, I think we’ll see that play out in ’06, but we’ll give you an update on that as we have some real customer announcements.

All right. Wonderful, thanks, Margie.

One last question, Keith, on the mortgage, on the D.C. property is that just a straight amortization over the period?

Yes, it will be over 20 years, Jonathan, 8% straight, P&I.

Wonderful. Thanks a lot for taking questions, guys.

Thanks.

Thank you. Our next question comes from Michael Rollins with the Citigroup. You may begin.

Hi, good afternoon.

Hi, Mike.

I have a broad question to ask you, and then just needed some data points. So, up to the data point that I need, maybe, and then launch into sort of the big fanatic question.

I was just curious if you could break-out cabinets between domestic, international? Give us the cross-connects and DB ports that you’ve given us in the past? And then also break down recurring revenue, domestic versus international?

But the brooder question I wanted to ask you guys was how do you think about the longer term capital structure of the business and the financial strategy? Especially as you go through, and I think there’s a lot of detail in all of the financing that you’re doing for these different centers.

But if you take a step back, you know, what do you want to do with your balance sheet over time in terms of leverage, if any? And how are you thinking about using the free cash flow from the business in terms of what to do with it over the next 12 and maybe 24 months? Thank you.

Sure. Well, maybe if you don’t mind, I’ll focus while Keith picks up, or Mike, I’m sorry, I’ll focus on the bigger question a little bit here, and then Keith can fill in some of those details. He’s just going to get the numbers right now, and then we’ll just add any more color to it.

But, you know, on the overall question about leverage on the balance sheet, I think I’ve even said this in a prior call, you know, as you look at it historically we’ve not had a lot of leverage and based on our expansion opportunities we do see an ability to carry a certain amount on our balance sheet.

And I think it was the last call or maybe the mid-quarter call, the thought I expressed there that we feel very good about is the three times EBITDA leverage is a very reasonable thing. Actually, you could look at four and feel comfortable about that, as well. But we’re somewhere in that range in terms of how we’ll think about the business going forward.

Now, when you think about the operating cash flows that we’re generating, well, you know, clearly we’re demonstrating some of the use of that in our expansions, and really putting the Company into a position to be this $500 million revenue generating enterprise we talk about.

You know, that said, I think one of the points that came through on the call is actually in Keith’s comments that certainly pleases me as I look at all of these financing transactions. Obviously, it adds some complexity, and by adjusting everything that’s going on, but provided all these things are completed as planned, we’re going to exit this year at $160 million on the balance sheet. So, I think that gives you the sense that this is just a good move, giving a strong cash position for our continued growth. So, you know, I’m feeling very good about these transactions. Obviously, they do, again, add some complexity in the quarter as you digest them all.

So, I don’t know, Keith, any comments to the bigger question? And then those?

So, Michael, my overall feeling, I concur with PVC. We believe the sign and as we execute against these financing transactions, we will have the capital and the, I would call expand the liquidity with the SVD line on our balance sheet to continue to grow the business and expand the business.

Clearly, you know, we do look at our capital structure today. I don’t want to go out, go out on a limb and give you any sort of guidance on what our ultimate targets are, but as a general statement I think we believe we are under leveraged. And even with these capital lease transactions we’ll remain under leveraged. And so from that perspective I absolutely concur with PVC.

So, just to follow-up there, is the focus over the next 12 months is it fair to ask about the focusing more on the growth front towards your target revenue goal as opposed to the notion of some form of repatriation, or could you see both happening over the next 12 to 24 months? Thanks.

I think the focus is on our growth over the next year. And just to remind everyone, as you look at this, because again we’re generating these strong cash flows, but when we make these investments and expansions we do it with some pretty high return targets. And so we’re going to continue to be very smart about the expansions we do and certainly test those returns as we make decisions to expand.

So, you know, the demand from our customer still appears to be strong. We need to support their growth needs. So, we do see an opportunity to stay on this growth path over the next year. But, again, we’ll always be smart about it because, you know, cash invested doesn’t produce the returns we’re after, it doesn’t make sense to us.

Some other notes, John, just back to your – oh, I’m sorry, Keith wants to add one more thing.

So, hey, Michael, I just wanted to go and update you on the questions, the other questions you had. First and foremost was that, you know, the cabinets billing. In the U.S. there's, again, they’re both roughly the same at 52 in the U.S. and 54% in Asia cabinets billing. So, in the U.S. we have 11,000 cabinets billing and in Asia 2,700 cabinets billing.

Then getting into the specifics of recurring versus nonrecurring revenue, so on the Asia front in Q3 we had 7.1 million of recurring revenues, while in the U.S. front we had 47.2 million of recurring revenues.

On the nonrecurring revenue basis the U.S. had 3.3 million of nonrecurring revenues, while Asia had 492,000 of nonrecurring revenues.

The last couple of points that you had asked were cross-connects, at the end of the quarter 11,218 cross-connects at the end of Q3, so an increase of 826 over the prior quarter. So, an 8% increase, so quite a healthy increase in cross-connects. And then the ports went up, the ports went up to 353 ports in the quarter.

Hey, Mike. It’s Peter, again. One quick apology, it seems with us, I keep making a mistake on the name. I do apologize, but just a little bit more color on just interconnection. One thing you’ll see there with the upgrade to 10 Gig is that on a port count basis it’s going to be a little difficult to track that metric on an ongoing basis, just in specific exchange ports, because clearly a number of our customers are grooming their traffic and taking advantage of a just higher capacity over time.

But that said, interconnection still is a strong piece of our business, and obviously the cross-connects portion of it was a very great growth number this quarter, and I do know a lot of that is being contributed now from our FX efforts and the financial exchange. And that vertical we’ve been pursuing.

Thanks, and thank you for all of that detail. I appreciate it.

Sure. Okay, Mike.

Thank you. Our next question is from [Eric Vangroth] with Morgan Joseph. You may begin.

Hi, good afternoon. And contrast, again, on a great quarter. A couple of quick questions.

First of all, in terms of, you know, your ROI targets that you set for expansion, and cash flow profitability for new centers, has ROI characteristic gotten any better or worse as, you know, you continued to expand, and there’s some scarcity added to the equation? And then, number two, are you seeing the same kind of, you know, pace to get the cash flow positive at newer data centers?

And then the follow-on to that would be, I know when we last spoke we discussed some of the progress in Chicago with a financial services vertical, I was hoping you could talk about any further progress possibly on the New York side of the equation, and other new vertical markets that you’re attacking?

Okay, Eric, so let me at least deal with the first question or set of questions which was around financial metrics. The Company sort of objective or target is to get sort of achieve an IRR of roughly 40% on our investment, so consistent with the strategies that were deployed to expand in each of the markets, so the Chicago market, the Aspen market, the LA market, or the Silicon Valley market, those are the objectives that we’re shooting to achieve.

The one interesting point is that as we become more mature you’re seeing that our cost to borrow is actually decreasing which is really helping us get the right return, so that’s something that we continue to remain focused on is managing our cash flows and trying to drive our costs of borrowing down as low as possible.

The second part of that question was really along the lines of the expansions themselves and the cash objectives. When you look at our most recent ones, as we’ve said, basically all of our IBX around, you know, whether it’s the U.S. or Asia, all of them are generating positive EBITDA today. That also includes our Aspen expansion property that came online in Q1, and our San Jose Silicon Valley expansion property that came in in December, and I think I have them backwards, but they’re both generation positive EBITDA so the timeline to cash flow and EBITDA positive right now we see it at least accelerating over those first two, and that’s what we modeled, sort of something we look forward to as we open up our new IBXs.

Do you see that, like, you know, would you say it’s a safe assumption to bring in that timeframe by say a quarter or two from your sort of prior statements of four to six quarters?

We still feel, I think it’s prudent just to say that we believe over 12 to 18 months that’s the right time horizon for us to achieve our EBITDA and cash flow objectives.

Okay.

You had asked one other question about FX and just their momentum in that as well as maybe in New York. You know, currently from an FX standpoint, and just the vertical pursuit there, well, we lumped it in with our Government efforts as well, but those efforts this year are up to 22.5 million now that we hold in annual contract value. And so just recently last quarter, those commitments actually increased 2.5 million which was almost entirely FX contracts, so that was certainly a nice boost that shows the momentum there. Some of these deals are landing in New York, as well.

Just another comment on other verticals, Digital Media continues to be an important an interesting one to us, we’re putting focus behind that. Clearly, the launch in LA, or the opening of that building is instrumental in our strategy there. And I would say we are winning certain customers. I don’t think we’re at that inflection point where a network affect starts as yet, where they’re feeding off of each other much as the FX has already started to produce that in a nice way.

And clearly, with Digital Media, the New Star announcement was very much related to our efforts in trying to enhance our position and service capabilities as we focus on that opportunity.

Can you highlight for the group sort of the model customer that you’re targeting in the media space and where you see the value propositions?

Well, there are two different fronts there. I mean the basic model customer for us is anybody who is distributing digital media content, whether that be voice, video, et cetera. Gaming is another important area because all of this plays very well into the basic tiering infrastructure that we already have in place. And so, those are just more content tiering opportunities in my mind. And, of course, anytime you add interconnection in a customer that’s enhancing its value, as well.

So, then video distribution, certainly, in the movie industry is a very interesting area right now, where we’re seeing some interesting opportunity and conversations take place. It’s too early to tell you anything about how that will work. But, you know, similar rules apply. Any time you’ve got to move significant amount of bandwidths to various destinations in network end points, that’s where our model shows up very well.

Great. Thank you.

You’re welcome.

thank you. Our next question is from [Andy Shroper] with [Tier One Research]. You may begin.

Hey, I’d give everyone a high five if I were in the room. Congrats. It’s awesome work.

Let’s see, with all the new facilities that you’re expanding on, which I think you guys are wise to be doing, can you talk about contract duration’s on your end customers? And maybe do it in two parts, one for the 74 new customers that you’ve got on, what kind of average duration do we have? And then as customers are coming up for renewal, what kind of turns are you seeing there?

Well, we continue to be pretty consistent with our past efforts there. Obviously, we’re doing long-term agreements, but not significantly long. You know, two years. We’re actually happy with one-year agreements as the stickiness of the business model supports that well. You know, I think as you’ve followed, Andy, we’ve seen more and more price firming to even price increase take place in the industry here. So, the shorter terms have made sense from a business standpoint. And, you know, churn continues to be low. So, we aren’t really changing our strategy at this point around length of term on agreement.

Okay. Are you getting – are customers asking for them, or?

Yes, I think customers will often ask for longer terms than that. But, you know, historically, in the whole telecom space in general if I was to include networking and other components that have been considered in telecom, there was always this tradeoff of term for better price.

When you’re in a market like ours now, where price has firmed, and, you know, clearly it’s not a bandwidth, a competitive story in collocation, it’s very different than that. We’ve seen that come and gone.

It’s just the price erosion that took place years ago, we just aren’t responding to that in our pricing. It’s not appropriate, so we’re keeping the terms the same, and not offering discounts or longer terms which really breaks the model with what some telecoms spend in purchases historically have been.

And on your price increases, if you could just refresh my memory? I assume you just increase prices on renewals? Or is it that you just, when you decide to increase prices it’s across the board for all customers?

No, not across the board for all customers. Again, it’s a service, a business. We’ve, first, certainly in new business increased our price points and rate sheets all around where the market sits today. So, that’s where the primary focus and price increase is taking place with the new business that we’re selling into.

Then as the customer’s term comes due, then we will see some price increase at that level, and move customers I would say more over time to increased pricing. So, don’t expect this huge shift in our revenue, because obviously this base we have out there is significant, and, you know, a lot of consistent revenue there. We’ll just inch up over time as we renew agreements.

Yes, okay. By market? I know you don’t give updates of where your cabinets were installed, but any comments on markets that were either less active or more active?

No specifics on that, no. I would just say even as a little color in the next year, clearly, we’ve been reaching capacities in some of these key markets that we’ve done so well in. And so, you know, these expansions into LA, our expansion into Chicago. You know, those are certainly coming in for our plans for next year’s revenue. And all of those are happening at the beginning of the year, and so we feel very good about the timeline those are on. But we have contemplated in our guidance and we’ve arranged our revenue guidance accordingly, just in case that one of these centers should slip a little bit there might be some chunkiness as to how we bring revenue onboard.

Just a little more color to your question now, as I think about it, of key markets we have seen some success in, it even relates to a prior question about how quickly these buildings are turning to cash flow positive. I will say that both our, the new San Jose Facility that we opened, I believe it was March of this year, and then we opened a new Northern Virginia or D.C. market facility at the end of last year. Both of those moved very well, and both of them are contributing cash already. And so those were both coming in ahead of that, and, of course, those have been good markets where we’ve seen growth.

Any updated comments on your overall pipeline? I know you said last quarter that it was the biggest in history. Care to make that comment again?

This quarter was not the biggest in history.

Okay! Let’s see, pipeline, is pipeline chunky, as well, in terms of market, where pipeline is coming from?

Well, it can be. Obviously, that was a bit of my comments going forward.

Okay.

Certainly, as we reach a capacity in a certain market, and, you know, the extreme case of it, obviously, is Dallas it virtually is full. And so we haven’t been focused n marketing into that opportunity. And so, as a result, we aren’t seeing anything in that market.

Got you. And I always challenge myself to find things to pick on since there’s fewer and fewer things to do so. The number of customers that churned looked like it was higher this quarter. Anything unique happen to a certain sector of customers?

No, nothing there. No, I mean it was a pretty low churn quarter overall. And, you know, I think again in the past we tried to coach everyone to understand the number of customers isn’t the biggest issue for us in a quarter.

In fact, the last quarter, I think was our largest ever in cabinet adds. I think like 1,300 cabinet adds showed up in bookings. And, of course, you saw that great increase in recurring revenue quarter over quarter. 10% increase there says that, obviously, it’s not just a new customer issue as you look at our growth.

Got you. So, it would be more of a small customer pricing decision? For the 30 that left?

Either. I think it’s been more, as in the past, just applications that have been cancelled, or customers that we’ve just not seen had success in their business model, if they were somewhat of a startup or play something of that nature.

I’m getting to the end of my questions, I promise. On the customers that had deployed legacy application in your Center that are maybe adopting the sales force dot com type model, are you seeing, are you planning on that as a trend to impact any customers that are already in your sites?

Well, I’m not exactly clear on the question, Andy?

Say a customer had three racks to deploy what would have otherwise been an on premise application that they’re using just for their own needs?

And then they move to an ASP model for support of those applications?

Yes.

That’s a good question. I haven’t seen any impact from trends that way. I have seen that we’ve, you know, certainly won business out of it, ASP customers.

You certainly have.

You mentioned one. But that is something that hasn’t shown up as a negative in any way with the business.

Good, so that’ll hurt your competitors and not you guys. Well, I’ll round out by saying I’m glad you found a way to keep Jay attached to the Company.

Yes, I am, too.

Congrats on everything, again. Take care.

Thank you.

thank you. And our last question comes from Vik Grover with Thomas Weisel Partners. You may begin.

This is actually [Colby Trebec]. Talking about the New Star deal, which you guys announced yesterday, can you talk a little bit about the economics and how that differs from your current model that you guys are doing right now?

Well, no, really what it enhances is the feature set for the ports we sell. So, our model and our piece of that is designed to generate more ports on the exchange and certainly more revenue from those ports, but it’s not really a different service model.

Okay. And then my next question, the 500 million revenue goal which you guys speak of, is there anything meaningful [inaudible], I guess opposed to where your guidance is for ’06 or where people might be following you guys? I guess just why 500 million on the books here?

Well, we thought it was important as we really started to expand and move away from what was really just a simpler story, to be honest. A couple of years ago the operating leverage and cash flow story of the Company was very strong. Frankly, I continue to believe it’s very strong, but we’re just taking those cash flows and making investments.

But just the size, our beliefs and the size of the market we have, how we are gearing up the Company to meet our opportunity, 500 isn’t a flat out hard number by any stretch, and this market could continue to expand, and we will evaluate our opportunity at that time. But just as a long-term guidance I think everybody had been caught in this long-term model that we would talk about of just how many data centers we had.

And so we thought it was important to say this is an opportunity we feel the Company has in front of it, and we’ll expand to pursue that opportunity at a data center footprint standpoint, at a team, at a systems standpoint. Even gives us a rallying cry inside the Company because, you know, frankly, that’s more than twice the size of our revenues in ’05. So, it gives us, certainly, an objective to manage around going forward that’s just helpful tool as we build the business.

Do you think that when you hit somewhere around 500 that you could signal that you’ve reached the point where there’s enough data centers out there that you think could manage the opportunity that’s out there from a penetration standpoint? And that possibly at that point the amount of free cash flow that you guys could be generating, you know, you would see different uses for it so you wouldn’t necessarily be putting it back in this business. But at that point you could take the free cash flow and give it back to shareholders?

Yes, certainly, wouldn’t comment or give anybody specific guidance towards what would happen at that time. But, boy, just think of the power of the Company at that time. Whether it be strategic choices or whether some would go back to investors, you know, the options are many. But, my, having a company generating that form of revenue with its market position. And, obviously, the cash flows and cash we’ll have strategically, that’s a pretty powerful thing for us to be chasing.

Yes, a problem you would like to have. But, also, another question I have is on the $40 million which you guys talked about for the D.C. Center, someone asked earlier if that’s in your ’06 guidance and you commented that it wasn’t. You know, it seems like that is something that you will have to invest at some point, I guess depending on the contract you guys might have signed. Is that something then that we should be putting into our ’07 number?

Just not giving anything in ’07. It is something out there, and I guess what we are signaling is there’s expansion opportunity in that center, but we aren’t ready to make any commitments around that number as yet.

But you have to, I mean, you will have to spend 40 million. So, if it’s not in ’06, it has to be in ’07, is that correct?

Yes, the 40 million has to be spent in the campus, so you could be investing some more in our existing IBXs. So, the 40 million, as Peter says, I think it’s just a little bit, it’s premature as to how we’re going to spend it. There is that potential to leave it out there. But until we are further along in the sort of letter agreements it’s just a bit too early to guide the Street.

Okay, and then my last question. Any color on the next market to get an IBX? You guys mentioned Dallas this Fall. Anything else you could add to that?

No, not at this time.

Okay. that’s it.

Great, Colby.

This concludes our conference call today. Thank you for joining us.