SWITCH, INC. The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the consolidated financial statements and related condensed notes included in Part I, Item 1 of this Quarterly Report on Form 10-Q (this "Form 10-Q"), and with the audited consolidated financial statements and related notes included in our Annual Report on Form 10-K for the year endedDecember 31, 2019 . This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those discussed below. Factors that could cause or contribute to such differences include, but are not limited to, those identified below and those discussed in "Risk Factors" in Part I, Item 1A of our Annual Report on Form 10-K for the year endedDecember 31, 2019 . Unless the context otherwise requires, references to "we," "us," "our," the "Company," "Switch" and similar references refer toSwitch, Inc. , and, unless otherwise stated, all of its subsidiaries, includingSwitch, Ltd. , and, unless otherwise stated, all of its subsidiaries. Overview We are a technology infrastructure company powering the sustainable growth of the connected world and the Internet of Everything. Using our technology platform, we provide solutions to help enable that growth. Our advanced data centers are the center of our platform and provide power densities that exceed industry averages with efficient cooling, while being powered by 100% renewable energy. These hyperscale data centers address the growing challenges facing the data center industry. Our critical infrastructure components in our data centers are purpose-built to satisfy customers' needs, drive efficiency and enable the deployment of highly advanced computing technologies. We presently own and operate four primary campus locations, called Primes, which encompass 12 colocation facilities with an aggregate of up to 4.7 million gross square feet ("GSF") of space. Our Primes consist of The Core Campus inLas Vegas, Nevada ; The Citadel Campus nearReno, Nevada ; The Pyramid Campus inGrand Rapids, Michigan ; and The Keep Campus inAtlanta, Georgia , which opened during the first quarter of 2020. In addition to our Primes, we hold a 50% ownership interest inSUPERNAP International, S.A. ("SUPERNAP International "), which has deployed facilities inItaly andThailand . UntilMarch 31, 2018 , we accounted for this ownership interest under the equity method of accounting. We currently have more than 950 customers, including some of the world's largest technology and digital media companies, cloud, IT and software providers, financial institutions and network and telecommunications providers. Our ecosystem connects over 250 cloud, IT and software providers and more than 90 network and telecommunications providers. Our business is based on a recurring revenue model comprised of (1) colocation, which includes the licensing and leasing of cabinet space and power and (2) connectivity services, which include cross-connects, broadband services and external connectivity. We consider these services recurring because our customers are generally billed on a fixed and recurring basis each month for the duration of their contract. We generally derive more than 95% of our revenue from recurring revenue and we expect to continue to do so for the foreseeable future. Our non-recurring revenue is primarily comprised of installation services related to a customer's initial deployment. These services are non-recurring because they are typically billed once, upon completion of the installation. Factors that May Influence Future Results of Operations Impact of COVID-19. InMarch 2020 , theWorld Health Organization declared the outbreak of the novel coronavirus ("COVID-19") as a pandemic, which continues to be spread throughout theU.S. and the world. The impact from the rapidly changing market and economic conditions due to the COVID-19 outbreak is uncertain, disrupting the business of our customers, and may impact our business, consolidated results of operations, and financial condition in the future. While we have not incurred significant disruptions thus far from the COVID-19 outbreak, we are unable to accurately predict the full impact that COVID-19 will have due to numerous uncertainties, including the severity of the disease, the duration of the outbreak, actions that may be taken by governmental authorities, the impact to the business of our customers, partners and vendors, the impact and functioning of the global financial markets and other factors identified in Part II, Item 1A " Risk Factors " in this Form 10-Q. We will continue to evaluate the nature and extent of the impact to our business, consolidated results of operations, and financial condition.Switch, Inc. | Q2 2020 Form 10-Q | 20 -------------------------------------------------------------------------------- Table of Contents Market and Economic Conditions. We are affected by general business and economic conditions inthe United States and globally. These conditions include short-term and long-term interest rates, inflation, money supply, political issues, legislative and regulatory changes, fluctuations in both debt and equity capital markets and broad trends in industry and finance, all of which are beyond our control. Macroeconomic conditions that affect the economy and the economic outlook ofthe United States and the rest of the world, including as a result of the COVID-19 pandemic, could adversely affect our customers and vendors, which could adversely affect our results of operations and financial condition. Growth and Expansion Activities. Our future revenue growth will depend on our ability to maintain our existing revenue base while expanding and increasing utilization at our existing and developing Prime Campus locations. Our existing Prime Campus locations currently encompass 12 colocation facilities with an aggregate of up to 4.7 million GSF of space and up to 490 megawatts ("MW") of power. As ofJune 30, 2020 , the utilization rates at these Prime Campuses, based on currently available cabinets, were approximately 93%, 86%, 72%, and 23% at The Core Campus, The Citadel Campus, The Pyramid Campus, and The Keep Campus, respectively. Additionally, each of our existing Primes has room for further expansion. We may be unable to attract customers to our data centers or retain them for a number of reasons, including if we fail to provide competitive pricing terms, provide space that is deemed to be inferior to that of our competitors or are unable to provide services that our existing and potential customers desire. Cost of Power. We are a large consumer of power, and the cost of energy accounts for a significant portion of our cost of revenue. We require power supply to provide many services we offer, such as powering and cooling our customers' IT equipment and operating critical data center plant and equipment infrastructure. Pursuant to our service agreements, we provide our customers with a committed level of power supply availability and we have committed to operating our data centers with 100% clean and renewable energy. Most of our customer agreements provide the ability to increase our cost of service in response to an increase in the cost of energy; however, our gross profit can be adversely affected by increases in our cost of energy if we choose not to pass along the increases to our customers. For instance, the seasonal increase in energy costs during the summer months has not historically resulted in an adjustment to our customer pricing, and therefore has resulted in a decrease in our gross profit in those periods. Nonetheless, as an unbundled purchaser of energy inNevada , we are able to purchase power in the open market through long-term power contracts, which we believe reduces variability of energy costs. Additionally, our existing customers may not renew their contracts with us or may reduce the services purchased from us, or we may be unable to attract new customers, if we experience increased energy costs or limited availability of power resources, including clean and renewable energy. Our brand or reputation could be adversely affected if we are unable to operate our data centers with 100% clean and renewable energy. Capital Expenditures. Our growth and expansion initiatives require significant capital. The costs of constructing, developing, operating and maintaining data centers, and growing our operations are substantial. While we strive to match the growth of our facilities to the demand for services, we still must spend significant amounts before we receive any revenue. If we are unable to generate sufficient capital to meet our anticipated capital requirements, our growth could slow and operations could be adversely affected. Our maintenance capital expenditures were$3.2 million and$3.5 million for the six months endedJune 30, 2020 and 2019, respectively. Growth in Customers. Our results of operations could be significantly affected by the growth or reduction of our customer base. We have over 950 customers, including some of the world's largest technology and digital media companies, cloud, IT and software providers, financial institutions, and network and telecommunications providers. We believe we have significant opportunities to both grow penetration of our existing customers as well as attract new customers. Our ability to attract new customers depends on a number of factors, including our ability to offer high quality services at competitive prices and the capability of our marketing and sales team to attract new customers. Additionally, a significant portion of our revenue is highly dependent on our top 10 customers and the loss of these customers or any significant decrease in their business could adversely affect our results of operations.Switch, Inc. | Q2 2020 Form 10-Q | 21 --------------------------------------------------------------------------------
Table of Contents
Key Metrics and Non-GAAP Financial Measures
We monitor the following unaudited key metrics and financial measures, some of
which are not calculated in accordance with accounting principles generally
accepted in the United States of America ("GAAP") to help us evaluate our
business, identify trends affecting our business, formulate business plans and
make strategic decisions.
Three Months Ended Six Months Ended
June 30, June 30,
2020 2019 2020 2019
(dollars in thousands)
Recurring revenue $ 122,729 $ 109,582 $ 243,215 $ 214,073
Capital expenditures $ 85,554 $ 54,185 $ 166,452 $ 100,131
Adjusted EBITDA $ 69,116 $ 58,841 $ 130,605 $ 112,679
Adjusted EBITDA margin 54.5 % 52.6 % 51.2 % 51.4 %
Recurring Revenue
We calculate recurring revenue as contractual revenue under signed contracts
calculated in accordance with GAAP for the applicable period. Recurring revenue
does not include any installation or other one-time revenue, which would be
classified as non-recurring revenue. Management uses recurring revenue as a
supplemental performance measure because it provides a useful measure of
increases or decreases in contractual revenue from our customers and provides a
baseline revenue measure on which to plan expenses.
The following table sets forth a reconciliation of recurring revenue to total
revenue:
Three Months Ended Six Months Ended
June 30, June 30,
2020 2019 2020 2019
(in thousands)
Recurring revenue $ 122,729 $ 109,582 $ 243,215 $ 214,073
Non-recurring revenue 4,188 2,388 11,798 5,339
Revenue $ 126,917 $ 111,970 $ 255,013 $ 219,412
Capital Expenditures
We define capital expenditures as cash purchases of property and equipment
during a particular period. We believe that capital expenditures is a useful
metric because it provides information regarding the growth of our technology
infrastructure platform and the potential to expand our services and add new
customers.
Adjusted EBITDA and Adjusted EBITDA Margin
We define Adjusted EBITDA as net income adjusted for interest expense, interest
income, income taxes, depreciation and amortization of property and equipment
and for specific and defined supplemental adjustments to exclude (i) non-cash
equity-based compensation expense; (ii) equity in net losses of investments; and
(iii) certain other items that we believe are not indicative of our core
operating performance. We define Adjusted EBITDA margin as Adjusted EBITDA
divided by revenue.
Our Adjusted EBITDA and Adjusted EBITDA margin are not prepared in accordance
with GAAP, and should not be considered in isolation of, or as an alternative to
measures prepared in accordance with GAAP. We present Adjusted EBITDA and
Adjusted EBITDA margin because we believe certain investors use them as measures
of a company's historical operating performance and its ability to service and
incur debt and make capital expenditures. We believe that the inclusion of
certain adjustments in presenting Adjusted EBITDA and Adjusted EBITDA margin is
appropriate to provide additional information to investors because Adjusted
EBITDA and Adjusted EBITDA margin exclude certain items that we believe are not
indicative of our core operating performance and that are not excluded in the
calculation of EBITDA. Adjusted EBITDA is also similar to the measures used
under the debt covenants included in our credit facilities, except that the
definition used in our credit facilities does not exclude certain cash gains or
shareholder-related litigation expense. Accordingly, we believe that Adjusted
EBITDA and Adjusted EBITDA margin provide useful information to investors and
others in understanding and evaluating our operating results, enhancing the
overall understanding of our past performance and future prospects, and allowing
for greater transparency with respect to key financial metrics used by our
management in its financial and operational decision-making.
Switch, Inc. | Q2 2020 Form 10-Q | 22
--------------------------------------------------------------------------------
Table of Contents
Our non-GAAP financial measures have limitations as analytical tools and you
should not consider them in isolation or as a substitute for an analysis of our
results under GAAP. There are a number of limitations related to the use of
these non-GAAP financial measures versus their nearest GAAP equivalents.
Non-GAAP financial measures may not provide information directly comparable to
measures provided by other companies in our industry, as those other companies
may calculate their non-GAAP financial measures differently. In addition, the
non-GAAP financial measures exclude certain recurring expenses that have been
and will continue to be significant expenses of our business.
The following table sets forth a reconciliation of our net income to Adjusted
EBITDA:
Three Months Ended Six Months Ended
June 30, June 30,
2020 2019 2020 2019
(in thousands)
Net income $ 13,336 $ 4,672 $ 9,847 $ 8,518
Interest expense 6,693 7,541 14,128 14,672
Interest income(1) (44) (257) (77) (565)
Income tax expense 1,380 458 1,107 664
Depreciation and amortization of property and
equipment 36,013 29,857 68,531 58,415
Loss on disposal of property and equipment 38 64 98 107
Equity-based compensation 7,510 7,443 15,034 15,588
Shareholder-related litigation expense 47 282 239 1,514
Loss on interest rate swaps 4,143 8,781 21,698 13,766
Adjusted EBITDA $ 69,116 $ 58,841 $ 130,605 $ 112,679 ________________________________________
(1) Interest income is included in the "Other" line of other income (expense) in our consolidated statements of comprehensive income.
Components of Results of OperationsRevenue
During the three and six months endedJune 30, 2020 and 2019, we derived more than 95% of our revenue from recurring revenue streams, consisting primarily of (1) colocation, which includes the licensing and leasing of cabinet space and power and (2) connectivity services, which include cross-connects, broadband services and external connectivity. The remainder of our revenue is from non-recurring revenue, which primarily includes installation services related to a customer's initial deployment. The majority of our revenue contracts are classified as licenses, with the exception of certain contracts that contain lease components. Based on the current growth stage of our business, we expect increases in revenue to be driven primarily by increases in volume, rather than changes in the prices we charge to our customers. We recognize revenue when control of these goods and services is transferred to our customers in an amount that reflects the consideration we expect to be entitled to in exchange for those goods and services. Revenue from recurring revenue streams is generally billed monthly and recognized using a time-based measurement of progress as customers receive service benefits evenly throughout the term of the contract. Contracts with our customers generally have terms of three to five years. Non-recurring installation fees, although generally paid in a lump sum upon installation, are deferred and recognized ratably over the contract term, determined using a portfolio approach. Revenue is generally recognized on a gross basis as a principal versus on a net basis as an agent, largely because we are primarily responsible for fulfilling the contract, take title to services, and bear credit risk. Cost of Revenue Cost of revenue consists primarily of depreciation and amortization expense, expenses associated with the operations of our facilities, including electricity and other utility costs and repairs and maintenance, data center employees' salaries and benefits, including equity-based compensation, connectivity costs, and rental payments related to our leased buildings and land used in data center operations. A substantial portion of our cost of revenue is fixed in nature and may not vary significantly from period to period, unless we expand our existing data centers or open new data centers. However, there are certain costs that are considered more variable in nature, including utilities and supplies that are directly related to growth in our existing and new customer base. The largest portion of our utility costs is fixed and a smaller portion is variable with market conditions.Switch, Inc. | Q2 2020 Form 10-Q | 23 -------------------------------------------------------------------------------- Table of Contents Gross Profit and Gross Margin Gross profit, or revenue less cost of revenue, and gross margin, or gross profit as a percentage of revenue, has been and will continue to be affected by various factors, including customer growth, the expansion of our existing data centers or opening of new data centers, and the cost of our utilities, specifically electricity. Our gross margin may fluctuate from period to period depending on the interplay of these factors. Operating Expenses Selling, General and Administrative Expense Selling, general and administrative expense consists primarily of salaries and related expenses, including equity-based compensation, accounting, legal and other professional service fees, real estate and personal property taxes, rental payments related to our corporate office lease, marketing and selling expenses, including sponsorships, commissions paid to partners, travel, depreciation and amortization expense, insurance, and other facility and employee related costs. This expense classification may not be comparable to those of other companies. We expect to incur additional selling, general and administrative expenses as we continue to scale our operations to invest in sales and marketing initiatives to further increase our revenue and support our growth. We also expect to continue to incur general and administrative expenses as a result of operating as a public company, including expenses related to compliance with the rules and regulations of theSecurities and Exchange Commission ("SEC") and those of theNew York Stock Exchange , additional expenses related to the loss of our emerging growth company status as ofDecember 31, 2019 , additional insurance expenses, investor relations activities, and other administrative and professional services. Further, we expect to continue to incur general and administrative expenses in the form of equity-based compensation as a result of the continued vesting of awards of common membership interests inSwitch, Ltd. ("Common Units") granted to certain of our executives in 2017 and other equity awards. As a result, we expect that our selling, general and administrative expense will continue to increase in absolute dollars, but may fluctuate as a percentage of our revenue from period to period. Other Income (Expense) Interest Expense Interest expense consists primarily of interest on our credit facilities and amortization of debt issuance costs, net of amounts capitalized. Loss on Interest Rate Swaps Loss on interest rate swaps consists of changes in the fair value of interest rate swaps used to mitigate our exposure to interest rate risk, inclusive of periodic net settlement amounts. Other Other income (expense) primarily consists of other items that have impacted our results of operations such as interest income and gains and losses resulting from other transactions. Income Taxes We are the sole manager ofSwitch, Ltd. , which is treated as a partnership forU.S. federal and most applicable state and local income tax purposes. As a partnership,Switch, Ltd. is not subject toU.S. federal and certain state and local income taxes. Any taxable income or loss generated bySwitch, Ltd. is passed through to, and included in the taxable income or loss of, its members, including us, on a pro rata basis. We are subject toU.S. federal income taxes, in addition to state and local income taxes with respect to our allocable share of any taxable income or loss generated bySwitch, Ltd. Noncontrolling Interest As the sole manager ofSwitch, Ltd. , we operate and control all of the business and affairs ofSwitch, Ltd. and its subsidiaries. Although we have a minority economic interest inSwitch, Ltd. , we have the sole voting interest in, and control the management of,Switch, Ltd. Accordingly, we consolidate the financial results ofSwitch, Ltd. and report a noncontrolling interest on our consolidated statements comprehensive income, representing the portion of net income or loss and comprehensive income or loss attributable to the noncontrolling interest. The weighted average ownership percentages during the period are used to calculate the net income or loss and other comprehensive income or loss attributable toSwitch, Inc. and the noncontrolling interest.Switch, Inc. | Q2 2020 Form 10-Q | 24 --------------------------------------------------------------------------------
Table of Contents
Results of OperationsThe following table sets forth our results of operations:
Three Months Ended Six Months Ended
June 30, June 30,
2020 2019 2020 2019
(in thousands)
Consolidated Statements of Operations Data:
Revenue $ 126,917 $ 111,970 $ 255,013 $ 219,412
Cost of revenue 68,198 58,117 135,227 115,642
Gross profit 58,719 53,853 119,786 103,770
Selling, general and administrative expense 33,438 32,919 73,554 67,170
Income from operations 25,281 20,934 46,232 36,600
Other income (expense):
Interest expense, including amortization of debt
issuance costs (6,693) (7,541) (14,128) (14,672)
Loss on interest rate swaps (4,143) (8,781) (21,698) (13,766)
Other 271 518 548 1,020
Total other expense (10,565) (15,804) (35,278) (27,418)
Income before income taxes 14,716 5,130 10,954 9,182
Income tax expense (1,380) (458) (1,107) (664)
Net income 13,336 4,672 9,847 8,518
Less: net income attributable to noncontrolling
interest 8,239 3,483 5,966 6,596
Net income attributable to
The following table sets forth the consolidated statements of operations data presented as a percentage of revenue. Amounts may not sum due to rounding.
Three Months Ended Six Months Ended
June 30, June 30,
2020 2019 2020 2019
Consolidated Statements of Operations Data:
Revenue 100 % 100 % 100 % 100 %
Cost of revenue 54 52 53 53
Gross profit 46 48 47 47
Selling, general and administrative expense 26 29 29 31
Income from operations 20 19 18 17
Other income (expense):
Interest expense, including amortization of debt
issuance costs (5) (7) (6) (7)
Loss on interest rate swaps (3) (8) (9) (6)
Other - - - -
Total other expense (8) (14) (14) (12)
Income before income taxes 12 5 4 4
Income tax expense (1) - - -
Net income 11 4 4 4
Less: net income attributable to noncontrolling
interest 6 3 2 3
Net income attributable to Switch, Inc. 4 % 1 % 2 % 1 %
Switch, Inc. | Q2 2020 Form 10-Q | 25-------------------------------------------------------------------------------- Table of Contents Comparison of the Three Months EndedJune 30, 2020 and 2019 Revenue Three Months Ended June 30, Change 2020 2019 Amount % (dollars in thousands) Colocation$ 102,621 $ 90,963 $ 11,658 13 % Connectivity 22,753 19,589 3,164 16 % Other 1,543 1,418 125 9 % Revenue$ 126,917 $ 111,970 $ 14,947 13 % Revenue increased by$14.9 million , or 13%, for the three months endedJune 30, 2020 , compared to the three months endedJune 30, 2019 . The increase was primarily attributable to an increase of$11.7 million in colocation revenue. Of the overall increase, 19% was attributable to revenue from new customers initiating service afterJune 30, 2019 , and the remaining 81% was attributable to increased revenue from existing customers. Additionally, during the three months endedJune 30, 2020 , connectivity revenue included$0.6 million in non-recurring sales-type lease revenue. There was no sales-type lease revenue during the three months endedJune 30, 2019 . Cost of Revenue and Gross Margin Three Months Ended June 30, Change 2020 2019 Amount % (dollars in thousands) Cost of revenue$ 68,198 $ 58,117 $ 10,081 17 % Gross margin 46.3 % 48.1 % Cost of revenue increased by$10.1 million , or 17%, for the three months endedJune 30, 2020 , compared to the three months endedJune 30, 2019 . The increase was primarily attributable to increases of$5.9 million in depreciation and amortization expense due to additional property and equipment being placed into service,$2.3 million in connectivity costs and facilities costs associated with increased occupancy as a result of expansion activities,$1.1 million in salaries and related employee expenses largely due to a decrease in capitalized labor during the three months endedJune 30, 2020 , and$0.6 million in costs related to sales-type lease transactions. There were no sales-type lease transactions during the three months endedJune 30, 2019 . Gross margin decreased by 180 basis points for the three months endedJune 30, 2020 , compared to the three months endedJune 30, 2019 . Selling, General and Administrative Expense Three Months Ended June 30, Change 2020 2019 Amount % (dollars in thousands)
Selling, general and administrative expense
$ 519 2 % Selling, general and administrative expense increased by$0.5 million , or 2%, for the three months endedJune 30, 2020 , compared to the three months endedJune 30, 2019 . The increase was primarily attributable to increases of$1.7 million in salaries and related employee expenses due to an increase in headcount and$0.6 million in property taxes, partially offset by a decrease of$1.8 million in accounting, legal, and other professional service fees.Switch, Inc. | Q2 2020 Form 10-Q | 26 --------------------------------------------------------------------------------
Table of Contents
Other Income (Expense)
Three Months Ended
June 30, Change
2020 2019 Amount %
(dollars in thousands)
Other income (expense):
Interest expense $ (6,693) $ (7,541) $ 848 (11) %
Loss on interest rate swaps (4,143) (8,781) 4,638 (53) %
Other 271 518 (247) (48) %
Total other expense $ (10,565) $ (15,804) $ 5,239 (33) %
Interest Expense
Interest expense decreased by $0.8 million , or 11%, for the three months ended
June 30, 2020 , compared to the three months ended June 30, 2019 . The decrease
was primarily due to a decrease in our weighted average interest rate from 4.74%
during the three months ended June 30, 2019 to 2.59% during the three months
ended June 30, 2020 , partially offset by an increase in our weighted average
debt outstanding during the three months ended June 30, 2020 from borrowings on
our revolving credit facility.
Loss on Interest Rate Swaps
Loss on interest rate swaps decreased by $4.6 million , or 53%, for the three
months ended June 30, 2020 , compared to the three months ended June 30, 2019 .
The decrease was driven by changes in the fair value of interest rate swaps
largely from fluctuation in market interest rates.
Other
Other income decreased by $0.2 million , or 48%, for the three months ended June
30, 2020 , compared to the three months ended June 30, 2019 . The decrease was
primarily due to a decrease in interest income earned on our cash equivalents.
Income Tax Expense
Three Months Ended
June 30, Change
2020 2019 Amount %
(dollars in thousands)
Income tax expense $ (1,380) $ (458) $ (922) 201 %
Income tax expense was $1.4 million for the three months ended June 30, 2020 ,
compared to $0.5 million for the three months ended June 30, 2019 . Income tax
expense is driven by our allocable share of Switch, Ltd.'s income before income
taxes.
Net Income Attributable to Noncontrolling Interest
Three Months Ended
June 30, Change
2020 2019 Amount %
(dollars in thousands)
Net income attributable to noncontrolling
interest $ 8,239 $ 3,483 $ 4,756 137 %
Net income attributable to noncontrolling interest was
Switch, Inc. | Q2 2020 Form 10-Q | 27
--------------------------------------------------------------------------------
Table of Contents
Comparison of the Six Months Ended June 30, 2020 and 2019
Revenue
Six Months Ended
June 30, Change
2020 2019 Amount %
(dollars in thousands)
Colocation $ 203,835 $ 177,448 $ 26,387 15 %
Connectivity 47,944 38,584 9,360 24 %
Other 3,234 3,380 (146) (4) %
Revenue $ 255,013 $ 219,412 $ 35,601 16 %
Revenue increased by $35.6 million , or 16%, for the six months ended June 30,
2020 , compared to the six months ended June 30, 2019 . The increase was primarily
attributable to an increase of $26.4 million in colocation revenue. Of the
overall increase, 12% was attributable to revenue from new customers initiating
service after June 30, 2019 , and the remaining 88% was attributable to increased
revenue from existing customers. Additionally, during the six months ended June
30, 2020 , connectivity revenue included $4.8 million in non-recurring sales-type
lease revenue. There was no sales-type lease revenue during the six months ended
June 30, 2019 .
Cost of Revenue and Gross Margin
Six Months Ended
June 30, Change
2020 2019 Amount %
(dollars in thousands)
Cost of revenue $ 135,227 $ 115,642 $ 19,585 17 %
Gross margin 47.0 % 47.3 %
Cost of revenue increased by $19.6 million , or 17%, for the six months ended
June 30, 2020 , compared to the six months ended June 30, 2019 . The increase was
primarily attributable to increases of $9.3 million in depreciation and
amortization expense due to additional property and equipment being placed into
service, $4.2 million in connectivity costs and facilities costs associated with
increased occupancy as a result of expansion activities, $3.4 million in costs
related to sales-type lease transactions, and $2.4 million in salaries and
related employee expenses largely due to a decrease in capitalized labor during
the six months ended June 30, 2020 . There were no sales-type lease transactions
during the six months ended June 30, 2019 . Gross margin decreased by 30 basis
points for the six months ended June 30, 2020 , compared to the six months ended
June 30, 2019 .
Selling, General and Administrative Expense
Six Months Ended
June 30, Change
2020 2019 Amount %
(dollars in thousands)
Selling, general and administrative expense
Selling, general and administrative expense increased by$6.4 million , or 10%, for the six months endedJune 30, 2020 , compared to the six months endedJune 30, 2019 . The increase was primarily attributable to an increase of$3.2 million in salaries and related employee expenses,$3.9 million of which is largely due to an increase in headcount, partially offset by a decrease of$0.7 million in non-cash compensation expense primarily related to certain equity awards granted in 2017. Additionally, there were increases of$0.9 million in professional fees for accounting, consulting, and legal services,$0.8 million in depreciation and amortization expense,$0.8 million in property taxes, and$0.5 million in commission expense paid to partners.Switch, Inc. | Q2 2020 Form 10-Q | 28 --------------------------------------------------------------------------------
Table of Contents
Other Income (Expense)
Six Months Ended
June 30, Change
2020 2019 Amount %
(dollars in thousands)
Other income (expense):
Interest expense (14,128) (14,672) $ 544 (4) %
Loss on interest rate swaps (21,698) (13,766) (7,932) 58 %
Other 548 1,020 (472) (46) %
Total other expense $ (35,278) $ (27,418) $(7,860) 29 % Interest Expense Interest expense decreased by$0.5 million , or 4%, for the six months endedJune 30, 2020 , compared to the six months endedJune 30, 2019 . The decrease was primarily due to a decrease in our weighted average interest rate from 4.74% during the six months endedJune 30, 2019 to 3.13% during the six months endedJune 30, 2020 , partially offset by an increase in our weighted average debt outstanding during the six months endedJune 30, 2020 from borrowings on our revolving credit facility. Loss on Interest Rate Swaps Loss on interest rate swaps increased by$7.9 million , or 58%, for the six months endedJune 30, 2020 , compared to the six months endedJune 30, 2019 . The increase was driven by changes in the fair value of interest rate swaps largely from fluctuation in market interest rates. Other Other income decreased by$0.5 million , or 46%, for the six months endedJune 30, 2020 , compared to the six months endedJune 30, 2019 . The decrease was primarily due to a decrease in interest income earned on our cash equivalents. Income Tax Expense Six Months Ended June 30, Change 2020 2019 Amount % (dollars in thousands) Income tax expense$ (1,107) $ (664) $ (443) 67 %
Income tax expense was
Net Income Attributable to Noncontrolling Interest
Six Months Ended
June 30, Change
2020 2019 Amount %
(dollars in thousands)
Net income attributable to noncontrolling
interest $ 5,966 $ 6,596 $ (630) (10) %
Net income attributable to noncontrolling interest was $6.0 million for the six
months ended June 30, 2020 , compared to $6.6 million for the six months ended
June 30, 2019 . The change was primarily due to a decrease in ownership by
noncontrolling interest holders.
Switch, Inc. | Q2 2020 Form 10-Q | 29
--------------------------------------------------------------------------------Table of Contents
Liquidity and Capital Resources
Switch, Inc. is a holding company and has no material assets other than its
ownership of Common Units. As such, we have no independent means of generating
revenue or cash flow, and our ability to pay our taxes and operating expenses or
declare and pay dividends in the future, if any, will be dependent upon the
financial results and cash flows of Switch, Ltd. and its subsidiaries and any
distributions we receive from Switch, Ltd. The terms of the amended and restated
credit agreement limit the ability of Switch, Ltd. , among other things, to incur
additional debt, incur additional liens, encumbrances or contingent liabilities,
and pay distributions or make certain other restricted payments.
As of June 30, 2020 , we had $31.7 million in cash and cash equivalents. As of
June 30, 2020 , our total indebtedness was $896.3 million consisting of
(i) $578.8 million principal from our term loan facility (net of debt issuance
costs), (ii) $260.0 million from our revolving credit facility, and (iii) $57.5
million from our finance lease liabilities. As of June 30, 2020 , we had access
to $240.0 million in additional liquidity from our revolving credit facility.
For the year ending December 31, 2020 , we expect to incur $290 million to $340
million in capital expenditures for development and construction projects
related to our expansion (excluding acquisitions of land); however, the exact
amount will depend on a number of factors. We believe we have sufficient cash
and access to liquidity, coupled with anticipated cash generated from operating
activities, to satisfy our anticipated cash needs for working capital and
capital expenditures for at least the next 12 months, including repayment of the
current portion of our debt as it becomes due and completion of our development
projects. We also believe that our financial resources will allow us to manage
the anticipated impact of COVID-19 on our business operations for the
foreseeable future, which could include reductions in revenue and delays in
payments from customers and partners. The challenges posed by COVID-19 on our
business are expected to evolve. Consequently, we will continue to evaluate our
financial position in light of future developments, particularly those relating
to COVID-19.
In addition, we are obligated to make payments under the Tax Receivable
Agreement ("TRA"). Although the actual timing and amount of any payments we make
under the TRA will vary, we expect those payments will be significant. Any
payments we make under the TRA will generally reduce the amount of overall cash
flow that might have otherwise been available to us or to Switch, Ltd. and, to
the extent we are unable to make payments under the TRA for any reason, the
unpaid amounts generally will be deferred and will accrue interest until paid by
us.
Cash Flows
The following table summarizes our cash flows:
Six Months Ended
June 30,
2020 2019
(in thousands)
Net cash provided by operating activities $ 121,491
Net cash used in investing activities (167,351) (100,657)
Net cash provided by (used in) financing activities 52,869
(29,689)
Net increase (decrease) in cash and cash equivalents
Cash Flows from Operating Activities Cash from operating activities is primarily generated from operating income from our colocation and connectivity services. Net cash provided by operating activities for the six months endedJune 30, 2020 was$121.5 million , compared to$109.0 million for the six months endedJune 30, 2019 . The increase of$12.5 million was primarily due to increased operations in our expanded data center facilities and changes in our working capital accounts. Cash Flows from Investing Activities During the six months endedJune 30, 2020 , net cash used in investing activities was$167.4 million , primarily consisting of capital expenditures of$166.5 million related to the expansion of our data center facilities. During the six months endedJune 30, 2019 , net cash used in investing activities was$100.7 million , primarily consisting of capital expenditures of$100.1 million related to the expansion of our data center facilities.Switch, Inc. | Q2 2020 Form 10-Q | 30 -------------------------------------------------------------------------------- Table of Contents Cash Flows from Financing Activities During the six months endedJune 30, 2020 , net cash provided by financing activities was$52.9 million , primarily consisting of$90.0 million in proceeds from borrowings on our revolving credit facility, partially offset by$20.0 million for the repurchase of common units,$8.3 million in distributions paid to noncontrolling interest,$5.9 million in dividends paid, and$4.2 million for payments of tax withholdings upon settlement of restricted stock unit awards. During the six months endedJune 30, 2019 , net cash used in financing activities was$29.7 million , primarily consisting of$13.6 million for the repurchase of common units,$10.4 million in distributions paid to noncontrolling interest, and$3.9 million in dividends paid. Outstanding Indebtedness OnJune 27, 2017 , we entered into an amended and restated credit agreement withWells Fargo Bank, National Association , as administrative agent, and certain other lenders, consisting of a$600.0 million term loan facility, maturing onJune 27, 2024 , and a$500.0 million revolving credit facility, maturing onJune 27, 2022 , which replaced our prior credit facility. We refer to the term loan facility and the revolving credit facility as the credit facilities. We are required to repay the aggregate outstanding principal amount of the initial term loan in consecutive quarterly installments of$1.5 million , beginning onSeptember 30, 2017 , until the final payment of$559.5 million is made on the maturity date. The amended and restated credit agreement permits the issuance of letters of credit upon our request of up to$30.0 million . As ofJune 30, 2020 , we had$260.0 million outstanding under the revolving credit facility accruing interest at an underlying variable rate of 1.93% and$240.0 million of availability. As ofJune 30, 2020 , we had$578.8 million outstanding under the term loan (net of deferred debt issuance costs) with$400.0 million effectively fixed at 4.73% pursuant to interest rate swap agreements entered into in January andFebruary 2019 and the remaining borrowings outstanding accruing interest at an underlying variable rate of 2.43%. Upon satisfying certain conditions, the amended and restated credit agreement provides that we can increase the amount available for borrowing under the credit facilities no more than five times (up to an additional$75.0 million in total, plus an additional amount subject to certain leverage restrictions) during the term of the amended and restated credit agreement. The credit facilities are secured by a first priority security interest in substantially all ofSwitch, Ltd.'s tangible and intangible personal property and guaranteed by certain of its wholly-owned subsidiaries. Interest on the credit facilities is calculated based on the base rate plus the applicable margin or a LIBOR rate plus the applicable margin (each as defined in the amended and restated credit agreement), at our election. Interest calculations are based on 365/366 days for a base rate loan and 360 days for a LIBOR loan. Base rate interest payments are due and payable in arrears on the last day of each calendar quarter. LIBOR rate interest payments are due and payable on the last day of each selected interest period (not to extend beyond three-month intervals). In addition, under the revolving credit facility we incur a fee on unused lender commitments based on the applicable margin and payment is due and payable in arrears on the last day of each calendar quarter. The credit agreement contains affirmative and negative covenants customary for such financings, including, but not limited to, limitations, subject to specified exceptions and baskets, on incurring additional debt, incurring additional liens, encumbrances or contingent liabilities, making investments in other persons or property, selling or disposing of our assets, merging with or acquiring other companies, liquidating or dissolving ourselves or any of the subsidiary guarantors, engaging in any business that is not otherwise a related line of business, engaging in certain transactions with affiliates, paying dividends or making certain other restricted payments, and making loans, advances or guarantees. The terms of the credit agreement also require compliance with the consolidated total leverage ratio (as defined in the amended and restated credit agreement) starting with the fiscal quarter endedJune 30, 2017 . As ofJune 30, 2020 , the maximum consolidated total leverage ratio was 4.25 to 1.00. The maximum consolidated total leverage ratio decreases over time to, and remains at, 4.00 to 1.00 for the quarters endingSeptember 30, 2020 and thereafter through maturity. We were in compliance with this and our other covenants under the credit agreement as ofJune 30, 2020 . Events of default under the credit facilities, subject to specified thresholds, include but are not limited to: nonpayment of principal, interest, fees or any other payment obligations thereunder; failure to perform or observe covenants, conditions or agreements; material violation of any representation, warranty or certification; cross-defaults to certain material indebtedness; bankruptcy or insolvency ofSwitch Ltd.'s subsidiary guarantors; certain monetary judgments against the subsidiary guarantors; and any change of control occurrence.Switch, Inc. | Q2 2020 Form 10-Q | 31 --------------------------------------------------------------------------------
Table of Contents
Off-Balance Sheet ArrangementsWe do not have any off-balance sheet arrangements for any of the periods presented.
Contractual Obligations
In January and March 2020 , we entered into two power purchase and sale
agreements for electricity to purchase an aggregate firm commitment of 75 MW per
energy hour for a term of one year starting on July 1, 2020 . In June 2020 , we
entered into an additional power purchase and sale agreement for electricity to
purchase an incremental firm commitment of five MW per energy hour for a term of
one month starting on July 1, 2020 , or a total purchase commitment of $24.0
million , inclusive of scheduling services. Additional franchise tax amounts may
be due based on the data center location where the purchased power is used.
During the six months ended June 30, 2020 , we borrowed an aggregate of
$90.0 million under our revolving credit facility. In August 2020 , we borrowed
an additional $20.0 million under our revolving credit facility.
Outside of the aforementioned, and any routine transactions made in the ordinary
course of business, there have been no material changes to the contractual
obligations as disclosed in our Annual Report on Form 10-K for the year ended
December 31, 2019 .
Critical Accounting Policies and Estimates
Our consolidated financial statements are prepared in accordance with GAAP. The
preparation of these consolidated financial statements requires our management
to make estimates and assumptions that affect the reported amounts of assets,
liabilities, revenue, costs and expenses and related disclosures. Our estimates
are based on our historical experience and on various other factors that we
believe are reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying value of assets and liabilities
that are not readily apparent from other sources. Actual results may differ from
these judgments and estimates under different assumptions or conditions and any
such differences may be material. On an ongoing basis, we evaluate the continued
appropriateness of our accounting policies and resulting estimates to make
adjustments we consider appropriate under the facts and circumstances. There
have been no significant changes to our critical accounting policies as
disclosed in our Annual Report on Form 10-K for the year ended December 31,
2019 .
Cautionary Note Regarding Forward-Looking Statements
This Form 10-Q contains forward-looking statements within the meaning of the
federal securities laws, which statements involve substantial risks and
uncertainties. Forward-looking statements generally relate to future events or
our future financial or operating performance. In some cases, you can identify
forward-looking statements because they contain word such as "may," "will,"
"should," "expects," "plans," "anticipates," "could," "intends," "target,"
"projects," "contemplates," "believes," "estimates," "predicts," "potential" or
"continue" or the negative of these words or other similar terms or expressions
that concern our expectations, strategy, plans or intentions. Forward-looking
statements contained in this Form 10-Q include, but are not limited to,
statements about:
•our goals and strategies;
•our expansion plans, including timing for such plans;
•our future business development, financial condition and results of operations;
•the expected growth of the data center market;
•our belief regarding the anticipated impact of COVID-19 on our business
operations;
•our beliefs regarding our design technology and its advantages to our business
and financial results;
•our beliefs regarding opportunities that exist in the data center market due to
current industry limitations;
•our expectations regarding opportunities to grow penetration of existing
customers and attract new customers;
•our beliefs regarding our competitive strengths and the value of our brand;
•our expectations regarding our revenue streams and drivers of future revenue;
•our expectations regarding our future expenses, including anticipated
increases;
•our expectations regarding demand for, and market acceptance of, our services,
including any new services;
•our expectations regarding our customer growth rate;
•our estimated capital expenditures for 2020;
•our beliefs regarding the sufficiency of our cash and access to liquidity, and
cash generated from operating activities, to satisfy our working capital and
capital expenditures for at least the next 12 months;
•our intentions regarding sources of financing for our operations and capital
expenditures;
Switch, Inc. | Q2 2020 Form 10-Q | 32
--------------------------------------------------------------------------------
Table of Contents
•the network effects associated with our business;
•our plans to further invest in and grow our business, and our ability to
effectively manage our growth and associated investments;
•our ability to timely and effectively scale and adapt our existing technology;
•our ability to successfully enter new markets;
•our expectations to enter into joint ventures, strategic collaborations and
other similar arrangements;
•our beliefs regarding our ability to achieve reduced variability of power costs
as an unbundled purchaser of energy;
•our beliefs that we have the necessary permits and approvals to operate our
business and that our properties are in substantial compliance with applicable
laws;
•our ability to maintain, protect and enhance our intellectual property and not
infringe upon others' intellectual property;
•our beliefs regarding the adequacy of our insurance coverage;
•our beliefs regarding the merits of pending litigation;
•our beliefs regarding the effectiveness of efforts to improve our internal
control over financial reporting;
•our plans regarding our Common Unit repurchase program;
•our expectations regarding payment of dividends; and
•our expectations regarding payments under the TRA, contingent upon our taxable
income and the applicable tax rate.
We qualify all of our forward-looking statements by these cautionary statements.
The forward-looking statements in this Form 10-Q are only predictions. We have
based these forward-looking statements largely on our current expectations and
projections about future events and financial trends that we believe may affect
our business, financial condition and results of operations. Because
forward-looking statements are inherently subject to risks and uncertainties,
some of which cannot be predicted or quantified, you should not rely on these
forward-looking statements as predictions of future events. The events and
circumstances reflected in our forward-looking statements may not be achieved or
occur and actual results could differ materially from those projected in the
forward-looking statements. The most important factors that could prevent us
from achieving our goals and cause the assumptions underlying forward-looking
statements and the actual results to differ materially from those expressed in
or implied by the forward-looking statements include, but are not limited to,
the following:
•our ability to successfully implement our business strategies;
•our ability to effectively manage our growth and expansion plans;
•delays or unexpected costs in development and opening of data center
facilities;
•any slowdown in demand for our existing data center resources;
•our ability to attract new customers and achieve sufficient customer demand to
realize future expected returns on our investments;
•our ability to license space in our existing data centers, including in our new
Keep Campus;
•the impact of epidemics, pandemics or outbreaks, including COVID-19, on our
business and those of our customers and suppliers;
•the geographic concentration of our data centers in certain markets;
•local economic, credit and market conditions that impact our customers in these
markets;
•the impact of delays or disruptions in third-party network connectivity;
•developments in the technology and data center industries in general that
negatively impact us, including development of new technologies, adoption of new
industry standards, declines in the technology industry or slowdown in the
growth of the Internet;
•our ability to adapt to evolving technologies and customer demands in a timely
and cost-effective manner;
•financial market fluctuations;
•our ability to obtain necessary capital to fund our capital requirements and
our ability to continue to comply with covenants and terms in our credit
instruments;
•our ability to generate sufficient cash flow to meet our debt service and
working capital requirements;
•our ability to collect revenue on a timely basis;
•fluctuations in interest rates, including the impact of any discontinuance,
modification or other reform of LIBOR, or the establishment of alternative
reference rates;
•increased operating costs, including power costs;
•significant disruptions, security breaches, including cyber security breaches,
or system failures at any of our data center facilities;
•our ability to effectively compete in the data center market;
•the success of our strategic partnerships;
•our ability to protect our intellectual property rights and not infringe upon
others' intellectual property rights;
Switch, Inc. | Q2 2020 Form 10-Q | 33
--------------------------------------------------------------------------------
Table of Contents
•loss of significant customers or key personnel;
•losses in excess of our insurance coverage, including due to natural disasters
and other unforeseen damage;
•impact of the outcome of pending or future litigation;
•the impact of future changes in legislation and regulations, including changes
in real estate and zoning laws, ABA, environmental and other laws that impact
our business and industry;
•the success of our solar project;
•future increases in real estate taxes;
•early termination of data center leases or inability to renew on commercially
acceptable terms;
•our ability to successfully identity and consummate future joint ventures,
acquisitions or other strategic transactions;
•our realization of any benefit from the TRA, our Common Unit repurchase plan
and our organizational structure;
•our ability to sufficiently remediate the material weakness identified in our
internal control over financial reporting;
•volatility of our stock price, including due to future issuances of our Class A
common stock upon redemption or exchange of Common Units; and
•our ability to successfully estimate the impact of certain accounting and tax
matters, including the effect on our company of adopting certain accounting
pronouncements.
The foregoing list of important factors does not include all such factors,
nor necessarily present them in order of importance. In addition, you should
consult other disclosures made by us (such as in our other filings with the SEC
or in company press releases) for other factors that may cause actual results to
differ materially from those projected by us. You should read this Form 10-Q,
and the documents that we reference in this Form 10-Q and have filed with the
SEC , and our Annual Report on Form 10-K for the year ended December 31, 2019 ,
with the understanding that our actual future results, levels of activity,
performance, and events and circumstances may be materially different from what
we expect.
Except as required by applicable law, we do not plan to publicly update or
revise any forward-looking statements contained herein, whether as a result of
any new information, future events, changed circumstances or otherwise.
Item 3.Quantitative and Qualitative Disclosures About Market Risk.
We are exposed to financial market risks, primarily in interest rates related to
our debt obligations.
Interest Rate Risk
Our primary exposure to market risk is interest rate risk associated with our
long-term debt. We evaluate our exposure to market risk by monitoring interest
rates in the marketplace. As of June 30, 2020 , borrowings under our amended and
restated credit agreement bear interest at a margin above LIBOR or base rate
(each as defined in the amended and restated credit agreement) as selected by
us. In January and February 2019 , we entered into four interest rate swap
agreements; whereby, we pay a weighted average fixed interest rate (excluding
the applicable interest margin) of 2.48% on notional amounts corresponding to
borrowings of $400.0 million in exchange for receipts on the same notional
amount at a variable interest rate based on the applicable LIBOR at the time of
payment. The interest rate swap agreements mature in June 2024 . As of June 30,
2020 , we had $442.0 million outstanding under our credit facilities with an
underlying variable interest rate of 2.14%. As of June 30, 2020 , a hypothetical
increase or decrease of 100 basis points in LIBOR would cause our annual
interest cost to change by $4.4 million .
Switch, Inc. | Q2 2020 Form 10-Q | 34
--------------------------------------------------------------------------------Table of Contents
© Edgar Online, source
