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Aug. 9, 2022, 4:34 p.m. EDT

10-Q: SWITCH, INC.

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(EDGAR Online via COMTEX) -- Item 2.Management's Discussion and Analysis of Financial Condition and Results of Operations.

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 ended December 31, 2021. 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 Part I, Item 1A-Risk Factors of our Annual Report on Form 10-K for the year ended December 31, 2021. Unless the context otherwise requires, references to "we," "us," "our," the "Company," "Switch" and similar references refer to Switch, Inc., and, unless otherwise stated, all of its subsidiaries, including Switch, 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 exascale 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 five primary campus locations, called Primes, which encompass 17 colocation facilities with an aggregate of up to 5.4 million gross square feet ("GSF") of space. Our Primes consist of The Core Campus in Las Vegas, Nevada; The Citadel Campus near Reno, Nevada; The Pyramid Campus in Grand Rapids, Michigan; The Keep Campus in Atlanta, Georgia; and The Rock Campus in Austin, Texas, which was launched with our acquisition in June 2021 of all of the equity interests of Data Foundry, LLC ("Data Foundry") and certain real property interests used in connection with Data Foundry's operations.

In addition to our Primes, we held a 50% ownership interest in SUPERNAP International, S.A. ("SUPERNAP International"), which had deployed facilities in Italy and Thailand, until February 2021, when we acquired SUPERNAP International's 30% ownership interest in SUPERNAP (Thailand) Company Limited ("SUPERNAP Thailand"), the entity which has deployed the facility in Thailand, and sold our ownership interest in SUPERNAP International, thus disposing of our interest in the facility in Italy. We account for our ownership interest in SUPERNAP Thailand under the equity method of accounting.

We currently have more than 1,300 customers, including some of the world's largest technology and digital media companies, cloud, IT and software providers, as well as financial institutions and network and telecommunications providers. Our ecosystem connects over 350 cloud, IT and software providers and more than 100 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.

In November 2021, our board of directors approved the pursuit of a real estate investment trust ("REIT") conversion with a target of electing REIT status for the taxable year beginning January 1, 2023. We will report material developments and plans from time to time as the key steps for our conversion to a REIT are put in place and completed.

In May 2022, we entered into a definitive merger agreement with an affiliate of DigitalBridge Group, Inc. and IFM Investors pursuant to an Agreement and Plan of Merger (the "Merger Agreement") entered into by Switch, Inc., Switch, Ltd., Sunshine Bidco Inc., a Delaware corporation ("Parent"), Sunshine Merger Sub, Ltd., a Nevada limited liability company and a direct wholly owned subsidiary of Switch, Inc. ("Company Merger Sub"), and Sunshine Parent Merger Sub Inc., a Nevada corporation and a wholly owned subsidiary of Parent ("Parent Merger Sub"). The Merger Agreement provides that, upon the terms and subject to the conditions set forth therein, Parent Merger Sub will merge with and into Switch, Inc. with Switch, Inc. remaining as the surviving entity (the "Merger"), and immediately following the Merger, Company Merger Sub will merge with and into Switch Ltd. (the "LLC Merger" and, together with the Merger, the "Mergers").







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Subject to the terms and conditions of the Merger Agreement, at the effective time of the Merger, the issued and outstanding shares of our Class A common stock will be acquired for $34.25 per share in an all-cash transaction, and any issued and outstanding shares of our Class B common stock shall be cancelled and converted into the right to receive cash consideration of $34.25 per share.

Our stockholders voted to approve the Mergers and the other transactions contemplated by the Merger Agreement (the "DigitalBridge/IFM Transaction") at a special meeting of stockholders held for that purpose on August 4, 2022. The DigitalBridge/IFM Transaction is subject to the satisfaction of customary closing conditions, including the receipt of regulatory approvals and the satisfaction or waiver of the other conditions to the Mergers described in the Merger Agreement. The Mergers are expected to close during the second half of 2022. Upon completion of the DigitalBridge/IFM Transaction, we will no longer be traded or listed on any public securities exchange.

Factors that May Influence Future Results of Operations

Impact of COVID-19. The global health crisis caused by the COVID-19 pandemic and its resurgences has and may continue to negatively impact global economic activity, which, despite progress in vaccination efforts, remains uncertain and cannot be predicted with confidence. In addition, new variants of COVID-19 continue to emerge. While we have not incurred significant disruptions thus far from COVID-19, the impact of the COVID-19 pandemic and its variants cannot be predicted at this time, and could depend on numerous factors, including vaccination rates among the population, the effectiveness of COVID-19 vaccines against variants, the response by governmental bodies and regulators, the severity of the disease or any variant, the duration of the outbreak, the future impact to the business of our customers, partners and vendors, and other facts identified in Part I, Item 1A-Risk Factors of our Annual Report on Form 10-K for the year ended December 31, 2021. Given the ongoing and dynamic nature of the circumstances, it is difficult to predict the impact of the COVID-19 pandemic on our business. We will continue to evaluate the nature and extent of the impact of COVID-19 and its variants on the global economy and to our business, consolidated results of operations, and financial condition.

Market and Economic Conditions. We are affected by general business and economic conditions in the United States and globally. These conditions include short-term and long-term interest rates, inflationary pressures, supply chain issues, 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 of the United States and the rest of the world, including as a result of the COVID-19 pandemic and its variants, 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 17 colocation facilities with an aggregate of up to 5.4 million GSF of space and up to 558 megawatts of power. As of June 30, 2022, the utilization rates at these Prime Campuses, based on currently available cabinets, were approximately 98%, 100%, 98%, 100%, and 73% at The Core Campus, The Citadel Campus, The Pyramid Campus, The Keep Campus, and The Rock Campus, respectively. 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 prices 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, historically, we generally have intentionally not passed along the seasonal increase in energy costs during the summer months to the full extent permitted under our contracts in order to avoid seasonal adjustments to our customer pricing, and that practice has, therefore, resulted in a decrease in our gross profit in those periods. Beginning in July 2021, we increased certain customer pricing in response to an increase in the cost of energy. As an unbundled purchaser of energy in Nevada, we are able to purchase power in the open market through long-term power contracts, which we believe reduces variability of energy costs. Additionally, we enter into power swap agreements, which we believe manages our exposure to adverse changes in the price of power. 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







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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 $3.3 million for the six months ended June 30, 2022.

Growth in Customers. Our results of operations could be significantly affected by the growth or reduction of our customer base. We have over 1,300 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.







                          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,
                                     2022            2021            2022            2021
                                                    (dollars in thousands)
        Recurring revenue        $ 164,642       $ 138,422       $ 325,727       $ 266,399
        Capital expenditures     $ 135,514       $  95,362       $ 285,947       $ 195,786
        Adjusted EBITDA          $  84,561       $  78,969       $ 171,354       $ 152,411
        Adjusted EBITDA margin        50.3  %         55.7  %         51.5  %         55.9  %
        


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,
                                   2022           2021           2022           2021
                                                     (in thousands)
        Recurring revenue       $ 164,642      $ 138,422      $ 325,727      $ 266,399
        Non-recurring revenue       3,543          3,268          7,067          6,157
        Revenue                 $ 168,185      $ 141,690      $ 332,794      $ 272,556
        


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.

Switch, Inc. | Q2 2022 Form 10-Q | 20 Table of Contents

Adjusted EBITDA and Adjusted EBITDA Margin

We define Adjusted EBITDA as net income or loss adjusted for interest expense, interest income, income taxes, depreciation and amortization of property and equipment, amortization of customer relationships, 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, costs for REIT and related restructuring/strategic initiatives, or 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.

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,
                                                                 2022               2021               2022               2021
                                                                                        (in thousands)
        Net income                                           $  380,740          $  9,684          $ 404,674          $  34,078
        Interest expense                                         14,186            10,198             27,383             18,955
        Interest income(1)                                          (43)              (38)               (80)               (77)
        Income tax expense                                        1,803             1,911              6,043              4,565
        Depreciation and amortization of property and
        equipment                                                49,509            41,285             97,342             80,076
        Amortization of customer relationships                    1,563               417              3,125                417
        Loss on disposal of property and equipment                   45               372                238                179
        Equity-based compensation                                 6,980             7,528             13,661             14,825
        (Gain) loss on swaps                                     (2,353)            2,970            (16,002)              (235)
        REIT and related restructuring/strategic
        initiatives(2)                                            4,700                 -              7,539                  -
        Litigation expense(2)                                       215                 -                215                  -
        Gain on termination of tax receivable agreement        (372,784)                -           (372,784)                 -
        Equity in net losses of investments                           -               379                  -                599
        Acquisition-related costs(2)                                  -             4,263                  -              4,403
        Gain on sale of equity method investment                      -                 -                  -             (5,374)
        Adjusted EBITDA                                      $   84,561          $ 78,969          $ 171,354          $ 152,411
        ________________________________________
        








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Components of Results of Operations

Revenue

During each of the three and six months ended June 30, 2022 and 2021, we derived more than 97% 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, which is 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.

Gross Profit and Gross Margin

Gross profit, or revenue less cost of revenue, and gross margin, or gross profit as a percentage of revenue, have 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 the Securities and Exchange Commission ("SEC") and those of the New York Stock Exchange, 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 issuance and vesting of 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 senior unsecured notes and amortization of debt issuance costs and original issue discount, net of amounts capitalized.

Switch, Inc. | Q2 2022 Form 10-Q | 22 Table of Contents

Gain (Loss) on Swaps

Gain (loss) on swaps consists of changes in the fair value of interest rate swaps used to mitigate our exposure to interest rate risk and power swaps used to mitigate our exposure to adverse changes in the price of power, inclusive of periodic net settlement amounts.

Equity in Net Losses of Investments

Equity in net losses of investments consists of our share of results of operations from our equity method investments, including foreign currency translation adjustments. We held a 50% ownership interest in SUPERNAP International until February 2021, when we acquired SUPERNAP International's 30% ownership interest in SUPERNAP Thailand and sold our ownership interest in . . .

Aug 09, 2022

COMTEX_411941367/2041/2022-08-09T16:33:39

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