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, 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 endedDecember 31, 2021 . 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 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 inLas Vegas, Nevada ; The Citadel Campus nearReno, Nevada ; The Pyramid Campus inGrand Rapids, Michigan ; The Keep Campus inAtlanta, Georgia ; and The Rock Campus inAustin, Texas , which was launched with our acquisition inJune 2021 of all of the equity interests ofData 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 inSUPERNAP International, S.A. ("SUPERNAP International "), which had deployed facilities inItaly andThailand , untilFebruary 2021 , when we acquiredSUPERNAP International's 30% ownership interest inSUPERNAP (Thailand) Company Limited ("SUPERNAP Thailand"), the entity which has deployed the facility inThailand , and sold our ownership interest inSUPERNAP International , thus disposing of our interest in the facility inItaly . 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.
InNovember 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 beginningJanuary 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. InMay 2022 , we entered into a definitive merger agreement with an affiliate ofDigitalBridge Group, Inc. andIFM Investors pursuant to an Agreement and Plan of Merger (the "Merger Agreement") entered into bySwitch, Inc. ,Switch, Ltd. ,Sunshine Bidco Inc. , aDelaware corporation ("Parent"),Sunshine Merger Sub, Ltd. , aNevada limited liability company and a direct wholly owned subsidiary ofSwitch, Inc. ("Company Merger Sub"), andSunshine Parent Merger Sub Inc. , aNevada 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 intoSwitch, Inc. withSwitch, Inc. remaining as the surviving entity (the "Merger"), and immediately following the Merger, Company Merger Sub will merge with and intoSwitch Ltd. (the "LLC Merger" and, together with the Merger, the "Mergers").Switch, Inc. | Q3 2022 Form 10-Q | 21
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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 onAugust 4, 2022 . TheDigitalBridge /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 fourth quarter of 2022. Upon completion of theDigitalBridge /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 endedDecember 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 inthe 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 ofthe 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 ofSeptember 30, 2022 , the utilization rates at these Prime Campuses, based on currently available cabinets, were approximately 97%, 98%, 96%, 100%, and 76% 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 inJuly 2021 , we increased certain customer pricing in response to an increase in the cost of energy. 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, 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 powerSwitch, Inc. | Q3 2022 Form 10-Q | 22
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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$4.0 million for the nine months endedSeptember 30, 2022 . Growth in Customers. Our results of operations could be significantly affected by the growth or reduction of our customer base. We have over 1,300 customers, including some of the world's largest technology and digital media companies, cloud, IT and software providers, financial institutions, and network and telecommunications providers. We believe we have significant opportunities to both grow penetration of our existing customers as well as attract new customers. Our ability to attract new customers depends on a number of factors, including our ability to offer high quality services at competitive prices and the capability of our marketing and sales team to attract new customers. Additionally, a significant portion of our revenue is highly dependent on our top 10 customers and the loss of these customers or any significant decrease in their business could adversely affect our results of operations. Key Metrics and Non-GAAP Financial Measures We monitor the following unaudited key metrics and financial measures, some of which are not calculated in accordance with accounting principles generally accepted inthe United States of America ("GAAP") to help us evaluate our business, identify trends affecting our business, formulate business plans and make strategic decisions. Three Months Ended Nine Months Ended September 30, September 30, 2022 2021 2022 2021 (dollars in thousands) Recurring revenue$ 171,040 $ 153,932 $ 496,767 $ 420,331 Capital expenditures$ 152,404 $ 135,873 $ 438,351 $ 331,659 Adjusted EBITDA$ 69,480 $ 76,894 $ 240,834 $ 229,305 Adjusted EBITDA margin 39.8 % 48.6 % 47.5 % 53.2 % 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 Nine Months Ended September 30, September 30, 2022 2021 2022 2021 (in thousands) Recurring revenue$ 171,040 $ 153,932 $ 496,767 $ 420,331 Non-recurring revenue 3,427 4,172 10,494 10,329 Revenue$ 174,467 $ 158,104 $ 507,261 $ 430,660 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. | Q3 2022 Form 10-Q | 23
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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 (loss) income to
Adjusted EBITDA:
Three Months Ended Nine Months Ended
September 30, September 30,
2022 2021 2022 2021
(in thousands)
Net (loss) income $ (232) $ (867) $ 404,442 $ 33,211
Interest expense 16,696 15,166 44,079 34,121
Interest income(1) (63) (36) (143) (113)
Income tax expense (benefit) 409 (278) 6,452 4,287
Depreciation and amortization of property and
equipment 50,544 45,138 147,886 125,214
Amortization of customer relationships 1,562 1,562 4,687 1,979
Loss on disposal of property and equipment 348 32 586 211
Equity-based compensation 7,104 7,053 20,765 21,878
(Gain) loss on swaps (8,830) 3,853 (24,832) 3,618
Litigation expense(2) 213 4,717 428 4,717
REIT and related restructuring/strategic
initiatives(2) 1,729 - 9,268 -
Gain on termination of tax receivable agreement - - (372,784) -
Loss on extinguishment of debt - 146 - 146
Equity in net losses of investments - 326 - 925
Acquisition-related costs(2) - 82 - 4,485
Gain on sale of equity method investment - - - (5,374)
Adjusted EBITDA $ 69,480 $ 76,894 $ 240,834 $ 229,305 ________________________________________
(1)Interest income is included in the "Other" line of other income (expense) in
our consolidated statements of comprehensive (loss) income.
(2)Litigation expense, REIT and related restructuring/strategic initiatives, and
acquisition-related costs are included in the "Selling, general and
administrative expense" line in our consolidated statements of comprehensive
(loss) income.
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Components of Results of Operations
Revenue
During each of the three and nine months ended September 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 theSecurities and Exchange Commission ("SEC") and those of theNew 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.
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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 inSUPERNAP International untilFebruary 2021 , when we acquiredSUPERNAP International's 30% ownership interest in SUPERNAP Thailand and sold our ownership interest inSUPERNAP International . We had discontinued the equity method of accounting for our investment inSUPERNAP International as the carrying value of our investment was reduced to zero as a result of recording our share of its losses. Our interest in SUPERNAP Thailand was accounted for under the equity method of accounting throughDecember 31, 2021 . As ofDecember 31, 2021 , the carrying value of our investment in SUPERNAP Thailand was reduced to zero as a result of recording our share of operating losses and foreign currency translation adjustments. Accordingly, we discontinued the equity method of accounting for our investment in SUPERNAP Thailand as ofDecember 31, 2021 and will not provide for additional losses until our share of future net income, if any, equals the share of net losses not recognized during the period the equity method was suspended. Our losses will continue to include the foreign currency translation adjustments in our investment.
Gain on Sale of
Gain on sale of equity method investment consists of the gain resulting from the sale of our ownership interest inSUPERNAP International , inclusive of foreign currency translation gains realized.
Gain on Termination of Tax Receivable Agreement
Gain on termination of tax receivable agreement consists of the gain resulting from amending the tax receivable agreement to provide that in exchange for the termination of the tax receivable agreement, each member party thereto is entitled to receive a payment in cash of$0.37 per common unit ofSwitch, Ltd. ("Common Unit") on the earlier of the closing of a change of control, as defined by the tax receivable agreement, orDecember 31, 2022 .
Other
Other primarily consists of other items that have impacted our results of operations such as interest income on our cash equivalents and gains and losses resulting from other transactions.
Income Taxes
Switch, Ltd. 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 We consolidate the financial results ofSwitch, Ltd. and report a noncontrolling interest on our consolidated statements of comprehensive (loss) 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. | Q3 2022 Form 10-Q | 26
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Results of OperationsThe following table sets forth our results of operations:
Three Months Ended Nine Months Ended
September 30, September 30,
2022 2021 2022 2021
(in thousands)
Consolidated Statements of Operations Data:
Revenue $ 174,467 $ 158,104 $ 507,261 $ 430,660
Cost of revenue 126,582 97,413 322,425 246,100
Gross profit 47,885 60,691 184,836 184,560
Selling, general and administrative expense 40,373 42,845 128,891 117,718
Income from operations 7,512 17,846 55,945 66,842
Other income (expense):
Interest expense, including amortization of
debt issuance costs and original issue discount (16,696) (15,166) (44,079) (34,121)
Gain (loss) on swaps 8,830 (3,853) 24,832 (3,618)
Loss extinguishment of debt - (146) - (146)
Equity in net losses of investments - (326) - (925)
Gain on sale of equity method investment - - - 5,374
Gain on termination of tax receivable agreement - - 372,784 -
Other 531 500 1,412 4,092
Total other (expense) income (7,335) (18,991) 354,949 (29,344)
Income (loss) before income taxes 177 (1,145) 410,894 37,498
Income tax (expense) benefit (409) 278 (6,452) (4,287)
Net (loss) income (232) (867) 404,442 33,211
Less: net income (loss) attributable to
noncontrolling interest 25 (498) 15,071 17,578
Net (loss) income attributable to
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The following table sets forth the consolidated statements of income (loss) data
presented as a percentage of revenue. Amounts may not sum due to rounding.
Three Months Ended Nine Months Ended
September 30, September 30,
2022 2021 2022 2021
Consolidated Statements of Operations Data:
Revenue 100 % 100 % 100 % 100 %
Cost of revenue 73 62 64 57
Gross profit 27 38 36 43
Selling, general and administrative expense 23 27 25 27
Income from operations 4 11 11 16
Other income (expense):
Interest expense, including amortization of
debt issuance costs and original issue discount (10) (10) (9) (8)
Gain (loss) on swaps 5 (2) 5 (1)
Loss on extinguishment of debt - - - -
Equity in net losses of investments - - - -
Gain on sale of equity method investment - - - 1
Gain on termination of tax receivable agreement - - 73 -
Other - - - 1
Total other (expense) income (4) (12) 70 (7)
Income (loss) before income taxes - (1) 81 9
Income tax (expense) benefit - - (1) (1)
Net (loss) income - (1) 80 8
Less: net income (loss) attributable to
noncontrolling interest - - 3 4
Net (loss) income attributable to Switch, Inc. - % - % 77 % 4 %
Comparison of the Three Months Ended
Revenue
Three Months Ended
September 30, Change
2022 2021 Amount %
(dollars in thousands)
Colocation $ 139,751 $ 125,945 $ 13,806 11 %
Connectivity 31,861 29,305 2,556 9 %
Other 2,855 2,854 1 - %
Revenue $ 174,467 $ 158,104 $ 16,363 10 %
Revenue increased by $16.4 million , or 10%, for the three months ended September
30, 2022 , compared to the three months ended September 30, 2021 . Of the overall
increase, 16% was attributable to revenue from new customers initiating service
after September 30, 2021 , and the remaining 84% was attributable to increased
revenue from existing customers.
Cost of Revenue and Gross Margin
Three Months Ended
September 30, Change
2022 2021 Amount %
(dollars in thousands)
Cost of revenue $ 126,582 $ 97,413 $ 29,169 30 %
Gross margin 27.4 % 38.4 %
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Cost of revenue increased by$29.2 million , or 30%, for the three months endedSeptember 30, 2022 , compared to the three months endedSeptember 30, 2021 . The increase was primarily attributable to increases of$22.2 million in facilities costs due to increased power costs and$5.4 million in depreciation and amortization expense due to additional property and equipment being placed into service. Accordingly, gross margin decreased by 1,100 basis points for the three months endedSeptember 30, 2022 , compared to the three months endedSeptember 30, 2021 .
Selling, General and Administrative Expense
Three Months Ended
September 30, Change
2022 2021 Amount %
(dollars in thousands)
Selling, general and administrative expense
Selling, general and administrative expense decreased by$2.5 million , or 6%, for the three months endedSeptember 30, 2022 , compared to the three months endedSeptember 30, 2021 . The decrease was primarily attributable to a decrease of$3.4 million in professional fees, partially offset by an increase of$1.0 million in real estate and personal property taxes. Other Income (Expense) Three Months Ended September 30, Change 2022 2021 Amount % (dollars in thousands) Other income (expense): Interest expense$ (16,696) $ (15,166) $ (1,530) 10 % Gain (loss) on swaps 8,830 (3,853) 12,683 NM Loss on extinguishment of debt - (146) 146 (100) % Equity in net losses of investments - (326) 326 (100) % Other 531 500 31 6 % Total other expense$ (7,335) $ (18,991) $ 11,656 (61) %
________________________________________
NM - Not meaningful
Interest Expense
Interest expense increased by$1.5 million , or 10%, for the three months endedSeptember 30, 2022 , compared to the three months endedSeptember 30, 2021 , primarily due to increases in our weighted average debt outstanding from our revolving credit facility and our weighted average interest rate from 3.42% during the three months endedSeptember 30, 2021 to 4.15% during the three months endedSeptember 30, 2022 .
Gain (Loss) on Swaps
During the three months endedSeptember 30, 2022 , we incurred a gain on swaps of$8.8 million , compared to a loss on swaps of$3.9 million for the three months endedSeptember 30, 2021 . The current period was driven by gains of$7.2 million on interest rate swaps due to the fluctuation in market interest rates and$1.6 million on power swaps due to the fluctuation in the price of power.
Income Tax (Expense) Benefit
Three Months Ended
September 30, Change
2022 2021 Amount %
(dollars in thousands)
Income tax (expense) benefit $ (409) $ 278 $ (687) (247) %
During the three months endedSeptember 30, 2022 , we incurred income tax expense of$0.4 million compared to an income tax benefit of$0.3 million during the three months endedSeptember 30, 2021 . Income tax expense and benefit are driven by our allocable share ofSwitch, Ltd.'s income before income taxes.Switch, Inc. | Q3 2022 Form 10-Q | 29
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Net Income (Loss) Attributable to Noncontrolling Interest
Three Months Ended
September 30, Change
2022 2021 Amount %
(dollars in thousands)
Net income (loss) attributable to
noncontrolling interest $ 25 $ (498) $ 523 (105) %
Net income attributable to noncontrolling interest increased by $0.5 million for
the three months ended September 30, 2022 , compared to the three months ended
September 30, 2021 . The change was due to an increase in net income during the
three months ended September 30, 2022 .
Comparison of the Nine Months Ended
Revenue
Nine Months Ended
September 30, Change
2022 2021 Amount %
(dollars in thousands)
Colocation $ 405,472 $ 347,544 $ 57,928 17 %
Connectivity 93,302 76,101 17,201 23 %
Other 8,487 7,015 1,472 21 %
Revenue $ 507,261 $ 430,660 $ 76,601 18 %
Revenue increased by $76.6 million , or 18%, for the nine months ended September
30, 2022 , compared to the nine months ended September 30, 2021 . Data Foundry
contributed $22.4 million of the increase, with 7% of the remaining increase
attributable to revenue from new customers initiating service after September
30, 2021 , and 93% attributable to increased revenue from existing customers.
Cost of Revenue and Gross Margin
Nine Months Ended
September 30, Change
2022 2021 Amount %
(dollars in thousands)
Cost of revenue $ 322,425 $ 246,100 $ 76,325 31 %
Gross margin 36.4 % 42.9 %
Cost of revenue increased by $76.3 million , or 31%, for the nine months ended
September 30, 2022 , compared to the nine months ended September 30, 2021 . The
increase was primarily attributable to an increase of $19.6 million incurred by
Data Foundry, with the remaining increase attributable to increases of
$37.1 million in facilities costs due to increased power costs and $14.4 million
in depreciation and amortization expense due to additional property and
equipment being placed into service. Accordingly, gross margin decreased by 650
basis points for the nine months ended September 30, 2022 , compared to the nine
months ended September 30, 2021 .
Selling, General and Administrative Expense
Nine Months Ended
September 30, Change
2022 2021 Amount %
(dollars in thousands)
Selling, general and administrative expense
Selling, general and administrative expense increased by$11.2 million , or 9%, for the nine months endedSeptember 30, 2022 , compared to the nine months endedSeptember 30, 2021 . The increase was primarily attributable to increases of$4.2 million in real estate and personal property taxes,$4.1 million in professional fees, and$2.7 million in amortization of acquired customer relationships.Switch, Inc. | Q3 2022 Form 10-Q | 30
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Other Income (Expense)
Nine Months Ended
September 30, Change
2022 2021 Amount %
(dollars in thousands)
Other income (expense):
Interest expense $ (44,079) $ (34,121) $ (9,958) 29 %
Gain on swaps 24,832 (3,618) 28,450 NM
Loss on extinguishment of debt - (146) 146 (100) %
Equity in net losses of investments - (925) 925 (100) %
Gain on sale of equity method investment - 5,374 (5,374) (100) %
Gain on termination of tax receivable
agreement 372,784 - 372,784 NM
Other 1,412 4,092 (2,680) (65) %
Total other income (expense) $ 354,949 $ (29,344) $ 384,293 NM
________________________________________
NM - Not meaningful
Interest Expense
Interest expense increased by$10.0 million , or 29%, for the nine months endedSeptember 30, 2022 , compared to the nine months endedSeptember 30, 2021 , primarily due to increases in our weighted average debt outstanding from our revolving credit facility and our weighted average interest rate from 3.30% during the nine months endedSeptember 30, 2021 to 3.68% during the nine months endedSeptember 30, 2022 . Gain (Loss) on Swaps During the nine months endedSeptember 30, 2022 , we incurred a gain on swaps of$24.8 million , compared to a loss on swaps of$3.6 million for the nine months endedSeptember 30, 2021 . The current period was driven by a$22.3 million gain on interest rate swaps due to the fluctuation in market interest rates and a$2.5 million gain on power swaps due to the fluctuation in the price of power.
Other
Other decreased by$2.7 million for the nine months endedSeptember 30, 2022 , compared to the nine months endedSeptember 30, 2021 , primarily due to non-recurring license fee income of$2.8 million recorded pursuant to a technology license agreement during the nine months endedSeptember 30, 2021 . Income Tax Expense Nine Months Ended September 30, Change 2022 2021 Amount % (dollars in thousands) Income tax expense$ (6,452) $ (4,287) $ (2,165) 51 % During the nine months endedSeptember 30, 2022 , we incurred income tax expense of$6.5 million , compared to$4.3 million during the nine months endedSeptember 30, 2021 . Income tax expense is driven by our allocable share ofSwitch, Ltd.'s income before income taxes.
Net Income Attributable to Noncontrolling Interest
Nine Months Ended
September 30, Change
2022 2021 Amount %
(dollars in thousands)
Net income attributable to noncontrolling
interest $ 15,071 $ 17,578 $ (2,507) (14) %
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Net income attributable to noncontrolling interest was$15.1 million for the nine months endedSeptember 30, 2022 , compared to$17.6 million for the nine months endedSeptember 30, 2021 . The change was the result of a decrease in ownership by noncontrolling interest holders during the nine months endedSeptember 30, 2022 . Liquidity and Capital ResourcesSwitch, Inc. is a holding company and has no material assets other than its ownership of common membership interests inSwitch, Ltd. As such, we have no independent means of generating revenue or cash flow, and our ability to pay our taxes or declare and pay dividends in the future, if any, will be dependent upon the financial results and cash flows ofSwitch, Ltd. and its subsidiaries and any distributions we receive fromSwitch, Ltd. The terms of the amended and restated credit agreement and the indentures governing our senior unsecured notes limit the ability ofSwitch, Ltd. , among other things, to incur additional debt, incur additional liens, encumbrances or contingent liabilities, and pay distributions or make certain other restricted payments.
Cash Sources
We have historically relied primarily on cash flows from operations, borrowings under our credit facilities, and issuances of notes. We regularly explore financing alternatives, including new credit agreements, unsecured and secured note issuances, and equity financing. As ofSeptember 30, 2022 , we had$41.3 million in cash and cash equivalents and our total indebtedness was approximately$1.96 billion (excluding debt issuance costs and original issue discount) consisting of (i)$1.10 billion principal from our senior unsecured notes, (ii)$806.0 million principal from our credit facilities,$406.0 million of which is accruing interest at an underlying variable interest rate of 4.83% and$400.0 million of which is effectively fixed at 4.48% pursuant to interest rate swap agreements, and (iii)$57.3 million from our finance lease liabilities. As ofSeptember 30, 2022 , we had access to$83.1 million in additional liquidity from our revolving credit facility, net of outstanding letters of credit. In addition, upon satisfying certain conditions, we can increase the amount available to borrow under our credit agreement no more than five times up to an additional$75.0 million in total debt, plus an additional amount subject to certain leverage restrictions.
Senior Unsecured Notes
OnSeptember 17, 2020 , we issued$600.0 million aggregate principal amount of our 3.75% senior unsecured notes due 2028. The notes bear interest at the rate of 3.75% per annum and mature onSeptember 15, 2028 . Interest on the notes is payable semi-annually in cash in arrears onMarch 15 andSeptember 15 of each year. OnJune 7, 2021 , we issued$500.0 million aggregate principal amount of our 4.125% senior unsecured notes due 2029. The notes bear interest at the rate of 4.125% per annum and mature onJune 15, 2029 . Interest on the notes is payable semi-annually in cash in arrears onJune 15 andDecember 15 of each year. The indentures to the notes contain covenants that, subject to exceptions and qualifications, among other things, limit our ability to incur additional indebtedness and guarantee indebtedness, pay dividends or make other distributions or repurchase or redeem our capital stock, prepay, redeem or repurchase certain indebtedness, issue certain preferred stock or similar equity securities, make loans and investments, dispose of assets, incur liens, enter into transactions with affiliates, enter into agreements restricting our ability to pay dividends, and consolidate, merge or sell all or substantially all of our assets. Credit Agreement We are party to an amended and restated credit agreement (as amended onDecember 28, 2017 ,September 17, 2020 , andJuly 29, 2021 ) withWells Fargo Bank, National Association , as administrative agent, and certain other lenders, consisting of a$400.0 million term loan facility, maturing inJuly 2028 , and a$500.0 million revolving credit facility, maturing inJuly 2026 . The term loan facility is subject to quarterly principal amortization payments of$1.0 million , followed by a final payment of$373.0 million upon maturity. The amended 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 amended credit agreement also require compliance with the consolidated secured leverage ratio (as defined in the amended credit agreement) of 4.00 to 1.00 for each fiscal quarter.
We were in compliance with all applicable covenants as of
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Cash Uses
For the year endingDecember 31, 2022 , we expect to incur approximately$560 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 completion of our development projects. We also believe that our financial resources will allow us to manage the anticipated impact of COVID-19 and its variants 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 and its variants 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 and its variants. In addition, we were obligated to make payments under the Tax Receivable Agreement, dated as ofOctober 5, 2017 , by and amongSwitch, Inc. ,Switch, Ltd. and the members ofSwitch, Ltd. party thereto ("TRA"). Concurrent with the execution of the Merger Agreement inMay 2022 , we executed an amendment to the TRA, which provides that in exchange for the termination of the TRA, each member party thereto is entitled to receive a payment in cash of$0.37 per Common Unit on the earlier of the closing of a change of control, as defined by the TRA, orDecember 31, 2022 . As ofSeptember 30, 2022 , we recorded a liability under the TRA of$75.1 million . Pursuant to the Merger Agreement, we also have agreed to various specific restrictions relating to the conduct of our business between the date of the Merger Agreement and the time at which the Merger becomes effective, including but not limited to, agreeing to not to (i) issue or sell shares of our common stock, partnership interests or other equity or voting interests, (ii) issue or sell any debt securities or warrants or other rights to acquire any debt securities of us and our wholly owned subsidiaries and (iii) incur or assume any indebtedness, in each case subject to the terms of the Merger Agreement and any exceptions set forth therein. In March andSeptember 2022 , we entered into power purchase and sale agreements to purchase an aggregate firm commitment of 629,280 megawatt-hours, or a purchase commitment of$37.4 million , inclusive of scheduling services, during terms of 19 months, which started onMay 1, 2022 , and three months, which starts onOctober 1, 2022 , respectively. Additional franchise tax amounts may be due based on the data center location where the purchased power is used. Future power purchase commitments for the remainder of 2022 and 2023 are$18.2 million and$17.4 million , respectively, with no additional commitments upon termination of the agreement thereafter. InMay 2022 , in connection with the execution of the Merger Agreement, we entered into a purchase and sale agreement with entities in which a member of our board of directors has beneficial ownership interests for the acquisition of land and a data center building currently being leased from these entities for a total purchase price of$300.0 million , of which$21.0 million was paid as a nonrefundable deposit and recorded in long-term deposit on the consolidated balance sheet as ofSeptember 30, 2022 . Pursuant to the purchase and sale agreement, the closing on the acquisition of the purchased property will be conditioned upon, among other things, the consummation of the Mergers. Outside of the aforementioned, and any routine transactions made in the ordinary course of business, there have been no significant changes to our material cash requirements as disclosed in our Annual Report on Form 10-K for the year endedDecember 31, 2021 . Cash Flows
The following table summarizes our cash flows:
Nine Months Ended
September 30,
2022 2021
(in thousands)
Net cash provided by operating activities $ 208,973 $ 196,267
Net cash used in investing activities (443,578) (738,272)
Net cash provided by financing activities 225,641
490,494
Net decrease in cash, cash equivalents, and restricted cash
Cash Flows from Operating Activities
Cash from operating activities is primarily generated from operating income from our colocation and connectivity services.
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Net cash provided by operating activities for the nine months endedSeptember 30, 2022 was$209.0 million , compared to$196.3 million for the nine months endedSeptember 30, 2021 . The increase of$12.7 million was primarily due to increased operations in our data center facilities.
Cash Flows from Investing Activities
During the nine months ended
During the nine months endedSeptember 30, 2021 , net cash used in investing activities was$738.3 million , primarily consisting of$409.1 million related to the acquisition of Data Foundry, net of cash acquired, and capital expenditures of$331.7 million related to the expansion of our data center facilities.
Cash Flows from Financing Activities
During the nine months endedSeptember 30, 2022 , net cash provided by financing activities was$225.6 million , primarily consisting of$280.0 million in proceeds from borrowings under our credit facilities, partially offset by$24.0 million in dividends paid,$14.6 million in distributions paid to noncontrolling interest, and$13.5 million for the payment of tax withholdings upon settlement of restricted stock unit awards. During the nine months endedSeptember 30, 2021 , net cash provided by financing activities was$490.5 million , primarily consisting of$536.3 million in proceeds from the issuance of our senior unsecured notes, net of original issue discount, and net borrowings on our revolving credit facility, partially offset by$20.1 million in dividends paid,$17.1 million in distributions paid to noncontrolling interest,$6.5 million for the payment of tax withholdings upon settlement of restricted stock unit awards, and$4.8 million for the payment of debt issuance costs related to our senior unsecured notes and credit agreement amendment. 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 endedDecember 31, 2021 .Switch, Inc. | Q3 2022 Form 10-Q | 34
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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,"
"expects," "plans," "anticipates," "could," "intends," "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:
•risks associated with our ability to consummate the Mergers, and the timing of
the closing of the Mergers, including the risks that a condition to closing will
not be satisfied within the expected timeframe or at all or that the closing of
the Mergers will not occur;
•the occurrence of any change, effect, event, circumstance, occurrence or state
of facts that could give rise to the termination of the Merger Agreement;
•the outcome of any legal proceedings that have been or may be instituted
against the parties to, and others related to, the Mergers and the Merger
Agreement;
•unanticipated difficulties or expenditures relating to receiving approvals from
governmental entities to consummate the DigitalBridge /IFM Transaction;
•unanticipated difficulties or expenditures relating to the closing of the land
purchase pursuant to that certain Purchase and Sale Agreement and Joint Escrow
Instructions, by and among Switch, Ltd. , Beltway Business Park, L.L.C. , Beltway
Business Park Warehouse No. 3, LLC, Beltway Business Park Warehouse No. 4, LLC,
Beltway Business Park Warehouse No. 6, LLC and Beltway Business Park Warehouse
No. 8, LLC (collectively, the "Beltway Entities") (the "Land Purchase
Agreement");
•unanticipated difficulties or expenditures relating to the transaction, the
response of business partners and competitors to the announcement of the
transaction and/or potential difficulties in employee retention as a result of
the announcement and pendency of the DigitalBridge /IFM Transaction;
•the Mergers diverting management's attention from our ongoing business
operations;
•restrictions on our ability to pay dividends pursuant to the Merger Agreement;
•our goals and strategies;
•the limitation on our right to recover from Parent and Parent Merger Sub an
amount equal to the $693 million parent termination fee in circumstances in
which such fee is payable, which may not be adequate to cover our damages;
•our expectations regarding our plans to pursue a conversion to a REIT,
including the timing related to such conversion;
•our expansion plans, including timing for such plans;
•our future business development, financial condition and results of operations;
•our anticipated levels of capital expenditures;
•the expected growth of the data center market;
•our belief regarding the anticipated impact of COVID-19 and its variants on our
business operations;
•our belief that our financial resources will allow us to manage the anticipated
impact of COVID-19 and its variants;
•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 and types 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 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;
•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 expectations regarding construction projects and the estimated timelines,
additional floorspace, and renewable power available to such data centers;
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•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 expectations regarding payment of dividends;
•our expectations regarding the recognition of our remaining performance
obligations in future periods;
•our expectations regarding our interest rate and power swaps;
•our expectations regarding our ability to realize deferred tax assets; and
•our expectations regarding the reissuance of retired shares of Class B common
stock.
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. 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. 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. Such risks and uncertainties include, among
others, those risks discussed in Part I, Item 1A-Risk Factors and throughout
Part II, Item 7-Management's Discussion and Analysis of Financial Condition and
Results of our Annual Report on Form 10-K for the year ended December 31, 2021 ,
and in Part II, Item 1A- Risk Factors and elsewhere of this Form 10-Q. 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, 2021 , 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.
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