CyrusOne's CEO Discusses Q4 2012 Results - Earnings Call Transcript

| About: CyrusOne (CONE)

CyrusOne Inc. (NASDAQ:CONE)

Q4 2012 Results Earnings Call

February 26, 2013 5:00 PM ET


John Caulfield - Vice President and Treasurer

Gary Wojtaszek - President and CEO

Kim Sheehy - Chief Financial Officer


Zhi Zhang - Bank of America Merrill Lynch

Vincent Chao - Deutsche Bank

Sergey Dluzhevskiy - Gabelli & Company

Jordan Sadler - KeyBanc Capital Markets

Jamie Feldman - Bank of America Merrill Lynch


Please standby. Good day, ladies and gentlemen. Thank you for standing by. Welcome to CyrusOne Fourth Quarter and Year End 2012 Earnings Conference Call. My name is Shannon, and I’ll be your conference operator for today. At this time, all participants are in a listen-only mode. After the prepared remarks the management from CyrusOne will conduct the question-and-answer session and conference participants will be given instructions at that time. As a reminder, today’s conference is being recorded.

I would now like to turn the call over to Mr. John Caulfield, the company’s Vice President and Treasurer. Please go ahead, sir.

John Caulfield

Thank you. Good evening, everyone. And welcome to CyrusOne’s fourth quarter 2012 Earnings call. Today I’m joined by Gary Wojtaszek, President and CEO; and Kim Sheehy, Chief Financial Officer.

Before we begin, I would like to remind you that our fourth quarter earnings release along with fourth quarter financial tables, earnings supplement and presentation are available on the Investor Relations section of our website at under the Investor Relations tab.

I’d also like to remind you that comments made on today’s call and some of the responses to your questions deal with forward-looking statements related to CyrusOne that are subject to risks and uncertainties. Factors that may cause our actual results to differ from expectations are detailed in the company’s filings with the SEC, which you may access on the SEC’s website or on We undertake no obligation to revise these statements following the date of this conference call except as required by law.

In addition, some of the company’s remarks this evening contained non-GAAP financial measures. You can find reconciliation of these measures to the most comparable GAAP measures in the earnings release and financial tables which are posted on the Investor Relations section of the company’s website.

I would now like to turn the call over to our President and CEO, Gary Wojtaszek.

Gary Wojtaszek

Thank you, John. Good evening, everyone. Welcome to our fourth quarter 2012 earnings conference call. Today after my remarks, Kim will discuss the quarterly and annual financial results in more detail. Before we discuss the financial results, I’d like to acknowledge the success of our recent IPO and express my appreciation to our team for their hard work that led to a successful offering.

As shown on slide three, 2012 was been a very busy and successful year for us. We managed to grow our revenue which is all organic in excess of 20%. We entered the Phoenix and San Antonio markets, launched our new Internet exchange product line, manage to end the year coming nine of the Fortune 20 as our customers and to make it even a little more interesting completed what our bankers told us was the most successful IPO in REIT industry in the past 15 years. In summary was a pretty good year.

CyrusOne continued its growth trend as revenue for the quarter came in at $58 million which is up 21% year-over-year. I’m pleased to note that we delivered at least 20% year-over-year revenue growth for each quarter of 2012 thus highlighting the strong demand for the enterprise-class products and services that CyrusOne sells.

We continue to execute our strategy, what we call converting the unconverted and managed to forge new partnerships with first time customers as we added 30 new logos to our portfolio in the quarter, bringing our total count to 518 customers.

We also continue to be sharply focused on executing our strategy of becoming the preferred data center provider to the Fortune 1000, which currently accounts for more than 75% of our annualized rent.

This quarter we signed up seven Fortune 1000 customers bringing our total Fortune 1000 account to 115, about 65% of our growth over the last 12 months came from existing customers. We still believe that the vast majority of the data center demands are managed internally, which presents a great opportunity for growth.

On slide four you can see that our revenue streams continued to be well-diversified across multiple industries with 57% of our annualized rent generated from investment grade companies, a dominant presence in the data intensive energy sector continues and accounts for approximately 37% of our annualized rent, down 1% from last quarter as a result of the growth from other sectors.

As we mentioned to you on our road show, we expect that the oil and gas industry will become a smaller percentage of our business as our penetration in other industries accelerate. You can also see that our mix of full service and metered power products continue to be well-diversified with our annualized rent split evenly between the customer segments.

This is a competitive advantage that we have as we are well-positioned to serve a diverse range of products because of our advanced customer service delivery model. To provide a little more color, of the 30 new customers that we signed this quarter, 46% purchased our full service or retail product and 54% purchased our wholesale product.

Importantly, the weighted average length of these new contracts was six years, which is longer than our average portfolio maturity. Additionally, two-thirds of these contracts had automatic price escalators built into them.

As we discussed on the road show, the lease duration of our customer contracts has historically been for three years or less, and typically did not include the more typical 3% price escalator language.

Overtime, we would expect that as we obtain more customers on our existing contracts renew that our average lease duration will increase with more contracts containing escalators.

Lastly, now you can see from that our Hotel California effect continues to ensure that once our customers check in they may never leave. This quarter our churn dropped down to 0.6%, which is consistent with our historical levers -- levels.

For the year our churn was 4.6% with 1% of that derive from one customer that had a 20-year agreement with us, which we had already expected to reach churn space back to us as part of that contract. We believe this metric is among the best in the industry and one that we are very proud of.

Our EBITDA in the quarter was $28 million which represents an EBITDA margin of 47.9% in line with our projections but down about 8 percentage points from last year.

As I have discussed in prior earnings call and during our IPO road show presentation, the higher operating expenses that we have seen are largely the result of the investments we are making in the business that will enable us to prepare for our future growth as a standalone public entity.

Our headcount at the end of the fourth quarter was 243 employees, which is an increase of 83 employees or 51% since the beginning of the year, of the 83 employees that we hired this year, 26 were in corporate staff functions, 21 were in sales and marketing, and another 30 were hired in customer service delivery.

The near 100% year-over-year increase in our corporate staff and sales marketing functions is a trend that we would not expect to continue in 2013. Additionally, the 30 members that we hired in customer service delivery operations will require to ramp up service capabilities for the new sites in Phoenix, San Antonio, Dallas and Austin that we expanded into this year.

We’ll make CyrusOne unique is our focus on customer service. 148 of our team members or roughly 61% of our staff are solely focused on providing the high level of customer service that our company is known for. We believe this is a huge competitive advantage that we offer to our customers, given that the industry-standard is outsourced function to third-party providers.

Last quarter, I mentioned that Tesh Durvasula joined our company as a Chief Commercial Officer responsible for sales and marketing. I’m glad to report that he successfully reorganized our sales organization with the regionally focused -- from a regionally focused organization to a globally focused organization with specific coverage for the top 40 markets across the U.S. Additionally, our new marketing initiatives are really starting to take off.

We are seeing a tremendous improvement in our lead generation and channel programs that we recently started which we expect will complement our sales efforts. Our data center capacity and utilization are detailed on slide five.

Data center utilization at the end of the fourth quarter of ‘12 was 78%. We had a very strong leasing quarter managed to sign approximately 41,000 square feet of deals maintaining our utilization compared to last quarter but which would have been 82% if we exclude the newly built Phoenix facility that we just commissioned in December.

At the end of the quarter, our San Antonio facility which we just commissioned in July was 60% sold out. Our London facility sold out and basically everything in Houston sold out plus we sold some additional space across the rest of our portfolio.

In spite of the fiscal cliff concerns, our customers continue to purchase from us to the point where we had record sales in the quarter. Our Phoenix facility pictured on slide six was commissioned in December 2012 with 36,000 square feet of space.

This was the first phase of the company’s massively modular data center facility which has the potential to offer 110 megawatts of power capacity across 1 million square feet. This facility was a Greenfield construction project and was commissioned in a record-setting seven months from the commencement of construction when we literally had to remove the ship from the alfalfa field in May of 2012.

The Phoenix facility is one of the largest, most energy-efficient multi-tenant data centers in the country and the amount of demand that we are seeing for this product, has been strong. Throughout 2012, CyrusOne has commissioned three other new data centers in Austin, Dallas and San Antonio in addition to an expansion in Houston, heading a total of 195,000 square feet of raised floor space. Our massively modular design approach building our products enables us to deliver facilities in record-setting time at the lowest cost in the industry.

Let me take a second to discuss our massively modular product and why we think it is such a critically important part of our strategy. First, I think many of you know that Kevin Timmons, who is our CTO has arguably built more data centers in this country than anyone in some of the most obscure locations around the world as part of his tenure at Microsoft and Yahoo.

Many of the facilities he designed have been noted as being some of the most innovative facilities over the time, including what is likely the largest modular data center project ever built in Chicago. At CyrusOne, what we’re simply trying to do is make the web scale product that has only been available to a select number of Internet companies available to the Fortune 1000 companies that we are targeting.

The design intent that we’re working toward is to be the most cost effective, operationally efficient, flexible, scalable and environmentally sustainable facility in the world. It is critically important objectives for us and our customers as it enables us to minimize our capital deployment to best match our customer demands, which translates into lower capital costs for us and our customers.

Additionally, having highly efficient facilities, which operate at a very low PUE is incredibly important to help our profitability and lower the utility cost to our customers and also help save the environment. To be clear, we’re generating a significant amount of green savings for our customers.

To put into perspective, our Phoenix facility would save a typical 1 megawatt wholesale customer, roughly $8 million over a 10-year period, which are real green dollars like a rate back into our customers’ pockets. Additionally, many of our customers particularly in the oil and gas industry are having to calculate their carbon footprint as part of the regulatory environment in Europe, which we think would just be a matter of time before that reporting is required in U.S.

Turning to slide seven, our interconnection platform is tracking to plan. And we expect this product will be fully operational by the end of the first quarter. This platform connects our data centers and key networking, telecom hubs across the four major metropolitan areas of Texas, representing a true paradigm shift in the exchange of traffic for the enterprise customer.

Customers in such industries as the energy, geophysical processing sector, financials or any enterprise facing the challenges of moving big data rapidly can now exchange traffic with the partners using the CyrusOne ethernet and optical exchanges across multiple data centers just as the large internet company does today.

The traffic from existing and new clients including those in the Internet sector has been very positive, given the savings offered by the services on the statewide platform which is something no other colocation vendor is offering in U.S. We believe that we have created the IX but we are -- what we’ve created with the IX platform will eventually become self-perpetuating ecosystem of interconnected parties, thus striving incremental data center space by existing and new enterprise customers.

At CyrusOne, we enable businesses to successfully run their cloud infrastructure systems. And the IX platform is the ultimate tool to facilitate the maximum use of that infrastructure across multiple interconnected facilities.

Lastly, I would point out that CyrusOne has received approval from the IRS that our IX business is considered good REIT income. This is unique benefit that we have which we believe creates great value for our company.

As I stated in my opening remarks, the CyrusOne team is very pleased with what we’ve been able to accomplish in 2012. Now, that the IPO is behind us, we will be free to exclusively focus on executing our strategy of becoming the preferred global data center provider to the Fortune 1000.

I believe that CyrusOne is offering the most innovative product solutions on the market today. Our massively modular product combined with superior service capabilities provided by our own operational staff allows us to provide solutions that solve the needs of the Fortune 1000 customers that we’re partnering with.

Additionally, our IX product presents -- represents a true paradigm shift in the way we have addressed our customer’s data center platform challenges. And we expect this product to accelerate our revenue growth.

In summary, we are excited to begin 23rd as new -- 2013 as a new public entity. And I will now turn the call over to Kim.

Kim Sheehy

Thank you, Gary. Good evening, everyone and thank you for joining us today. Before I begin my remark, I’d like to remind everyone on the call that for all periods presented, CyrusOne was a wholly-owned subsidiary of Cincinnati Bell.

Results for the fourth quarter and full-year 2012 are reported for CyrusOne on a standalone basis and no per share amount will be given or discussed. Slide nine shows our revenue for the fourth quarter of $58 million, an increase of 21% from $48 million in 2011.

As Gary previously mentioned, approximately 65% of this growth came from existing customers. We currently have 518 customers, which represents a net increase of 31 customers from 487 at the beginning of the year. 115 of those customers are Fortune 1000 equivalent companies.

Leasing in the fourth quarter was the strongest of the year as we signed leases for 41,000 square feet of data center space across eight facilities. We anticipate that most of these leases will commence billing in the first half of 2013.

Revenue for the full year was $221 million, an increase of 22% from $182 million in 2011. We consistently maintained our topline growth rate above 20%. And over the course of 2012, we doubled the size of our direct sales force.

We are now well positioned for 2013 and beyond to take advantage of the growing market and future customer expansion. We have the capacity, geographic footprint and the sales team to capitalize on these growth trends.

Moving to slide 10, net operating income of $37 million for the fourth quarter grew 13% over the same period of 2011 on higher revenue. The growth rate in NOI was greater than the revenue growth due to the addition of fixed operating cost at our newly opened facilities.

For the full-year, NOI grew 17%. Adjusted EBITDA grew 4% to $28 million for the fourth quarter of 2012. For the full-year 2012, adjusted EBITDA of $113 million was 14% higher than 2011.

During the year and particularly in the fourth quarter, we invested heavily in sales and marketing both through personnel additions as well as advertising and marketing events. This spend was across five cities, including two new markets.

Our general and administrative costs increased by $1 million over the fourth quarter of 2011 and $8 million, when comparing the full-year 2012 to 2011. Payroll related expenses in 2012 reflect the full year of the executive team hired in 2011, as well as incremental headcount build in established platforms that can support our existing and expanding portfolio of customers and facilities.

During the second half of 2012, we also began additional -- adding additional resources to support corporate functions that were previously covered by Cincinnati Bell. As we began 2013, we are incurring additional cost, supports CyrusOne as a public company, such as legal, accounting, other costs related to corporate governance and SEC reporting.

In S-11, we mentioned that we expect an additional $5 million of public company cost before stock compensation and we still think that is a reasonable estimate on a year-over-year basis.

Normalized funds from operations or normalized FFO, was $17 million for the fourth quarter of 2012, an increase of 18% over the prior year. In addition to the growth of adjusted EBITDA, this increase was primarily a result of charges in 2011 that did not recur in the fourth quarter of 2012.

In 2011, we recorded a loss on sales receivables incurred as part of a securitization program with Cincinnati Bell, which we stop participating since the beginning of the fourth quarter of 2012. In addition, in 2011, we realized a loss of extinguishment of debt, when we purchased our previously leased Houston West facility.

Normalized FFO for the 2012 full year of $67 million increased 19% over the same period of 2011 for similar reasons. Before I move to capital, I want to take a moment to explain our decisions to report a normalized FFO figure and to foreshadow a non-cash charge that will be reported in the first quarter of 2013.

Normalized FFO removes transaction costs from the FFO metric, which we think is appropriate as we have incurred non-recurring expenses related to our initial public offering. These expenses do not support ongoing operations and do not relate to the performance of our portfolio.

Similar to transaction costs, in the first quarter of 2013, we will record a non-cash expense for incentive compensation plans prior to the IPO. The estimated expense is between $18 million and $25 million. This plan was established by Cincinnati Bell at the end of 2010 and will be a payment made to certain CyrusOne employees by Cincinnati Bell. However, even those is a cash liability of Cincinnati Bell, the proper GAAP treatment is that we recognized the expense against our net income.

In our FORM S-11, this was described as a Cincinnati Bell 2010 CyrusOne Performance Plan. This will be a non-cash expense for CyrusOne and will increase the non-controlling interest caption in the equity section of our balance sheet. This expense and other transaction costs related to the IPO are added back to prevent our normalized FFO.

On slide 11, capital expenditures were $82 million in the fourth quarter of 2012, double what was mentioned in the corresponding quarter last year. For the year, we spent $228 million, which was $110 million, or 93% higher than in the prior year.

Data center development and capital totaled $221 million for the year. Construction was completed on 310,000 net rentable square feet, which include the 195,000 square feet of customer colocation space. Our three largest sites were in Phoenix, San Antonio and Carrollton, where we spent approximately $143 million on 220,000 of net rentable square feet, which includes 120,000 square feet of customer colocation space. This amount includes $23 million for the purchase of land and the shell at Carrollton site.

We also completed 41,000 square feet of customer colocation in our New Austin facility, while commissioning 31,000 square feet of additional colocation space at our existing Houston West data center. In addition, $9 million was spent during the year on landing construction on the second facility on our Houston West campus. This facility will provide approximately 85,000 square feet of colocation space and will be commissioned in the second quarter.

Lastly, significant projects were undertaken to bring on additional sellable power to the existing Lewisville and Houston West facilities, while an additional $7 million was spent on network assets for our interconnection business.

In 2013, we expect our development capital expenditures to be in the range of $200 million, but the ultimate number will be subject to customer demand. The design and intent of our capital spent is to stay slightly ahead of the demand and position ourselves to be able to adapt and build quickly in reaction to customer signings. With the flexibility of our construction methodology, we have the ability to slowdown or accelerate the spent based on the demand in each of our markets.

Slide 12 shows the component of our debt outstanding and our liquidity. In November of 2012, we issued $525 million of senior secured notes at 6.375% for 10 years. We also established a $225 million senior secured revolver that was undrawn at year-end.

Our net debt as of December 31, 2012 was $541 million or $204 million, once we pro forma for the IPO proceeds. This gives us an adjusted EBITDA leverage of less than two times. Our pro forma liquidity of $579 million and no significant debt maturity for 10 years gives us the flexibility to scale and expand rapidly without having to access the equity and debt capital markets. That said, we’re in a capital intensive business that requires investments to grow and we will access the markets when necessary, choosing the appropriate financing methods at that time with the goal to eventually becoming investment grade.

Before we open the call for questions, we would like to address the topic of guidance for CyrusOne. At this time, we are not providing guidance for 2013. We just completed our initial public offering one month ago and as we navigate the waters of being a new independent public company, we think it is better to provide guidance once we have additional time to analyze and assess the appropriate measures on which to guide.

Our story is not changed and neither as our outlook on the industry, the opportunity or our ability to execute. We have reviewed the research coverage of the analysts covering us and are comfortable with their understanding of our business. We will give guidance at the appropriate time in the future.

In summary, we believe that CyrusOne is well-positioned to take advantage of the two broad secular trends driving this industry, which are an explosion of big data and the beginning of an infrastructure outsourcing trend by the Fortune 1000 Companies.

Our ability to provide varying products on the data center floor, combined with a singular focus on customer service provides enterprise customers with a very compelling solution in the market, a solution which allows us to attract and retain enterprise customers at a higher blended price than wholesale peers.

Lastly, we believe our massively modular design methodology allows us to develop product at the lowest cost effect, turn to market and the industry, thus maximizing returns on capital for shareholders.

As that concludes our prepared remarks and we are going to turn the call over to the operator to open the line for questions.

Question-and-Answer Session


Thank you. (Operator Instructions) And our first question will come from Jamie Feldman of Bank of America Merrill Lynch.

Zhi Zhang - Bank of America Merrill Lynch

Hi. This is actually Zhi Zhang for Jamie. Thank you for taking my question and congratulations on the quarter and IPO. I understand you are not providing guidance for 2013, but can you maybe talk a little bit about your leasing pipeline and maybe if you can frame in terms of the different stages and negotiation, so that we can get sense what couldn’t sign or commence in 2013?

Gary Wojtaszek

Sure. Hey, Zhi, it’s Gary. Thank you. Thank you very much. With regard to guidance, where we are right now, we feel really comfortable about the business and we plan to give guidance on our next earnings call, we’re going to be giving out annual guidance.

As of now though since there is some noise in our numbers, particularly relates to EPS and those sorts of things, we thought that’s hold off on that, we’ll come out with guidance for full year next quarter. But looking at the consensus estimates that all the analysts had put out we feel very comfortable that those are in the ballpark of what we are going to be able to deliver.

In terms of our pipeline, we feel really good, we came off record quarter for us in the fourth quarter, our pipeline is very robust and we think that 2013 is going to be a consistent year for us very similar to what we are able to do in 2012.

Zhi Zhang - Bank of America Merrill Lynch

If I look at the 41,000 colocation square feet signed during the fourth quarter, I know, I understand it was your strongest leasing quarter in 2012? If that kind of a similar level of run rate we should expect in 2013, was there anything kind of special going on in fourth quarter of ‘12.

Gary Wojtaszek

No. There is nothing special going on, I mean, those all deals that we have been working on for months and in just the natural evolution of how it take -- how long it takes to close deals, sometime they all come together, sometimes they come more regularly over certain periods.

Our funnel though, in terms of your first question in terms of our pipeline, I mean we are feeling really good, we are actually sitting on a very strong funnel, and looking into 2013 we think we’re going to do just as well as we did last year.

Zhi Zhang - Bank of America Merrill Lynch

Okay. And just one last question, can you talk a little bit about your expansion strategy in terms of the markets? You talked about focusing on the top 40 markets across the U.S. just making sure you cover your bases? So in terms of your future expansion, what other markets are you looking at either in the U.S. or internationally? I saw that you added square footage, plan to add square footage in London? So maybe you can talk about where else you are planning to grow.

Gary Wojtaszek

Sure. Sure. So there is two different points there. The 40 market number that you mentioned there, that is how we are attacking from a sales and marketing prospect of our distribution.

So we believe that this business is national or international play, you have to have a very broad base platform to sell to the target customers that we are going after which are the Fortune 1000.

By their nature of those customers are national and international type companies, and we just did our sales force this quarter to better align with how we are going to attack those various customers. So that’s what the 40 market reference points too.

In terms of our expansion capabilities or desires there, this is a global play, right. So we are looking at broadening out our platforms both nationally in U.S., as well as internationally.

If you look at our U.S. platform and you drew latency circles around our existing facilities, what you would come up with some soft spots in our current portfolio particularly on the East Coast and somewhere in the Pacific Northwest, Northern California area, where we don’t have facilities today, which are required in order to provide for the latency requirements of all the applications that our customers are going to be running.

So, geographically, that’s where we would be looking to expand in the U.S. in terms of new markets. But the predominance of our -- of additional capital investment this year will be in the existing markets that we currently are at as we look to expand with the demand driven by our customers.

Internationally, I think what we’ve said historically is that we are going to follow our customers. We expanded into London and Singapore last year following our customers there. As you pointed out, we were successful in selling out our London facility. The second half of that is actually pre-sold that will be developed by the end of this month and that will be completely sold out.

So we are going to be looking at additional expansion there and then outside of that market. The other market that we’ve been focusing on, spending a lot of time on is Brazil and there its basically again following our customers, Brazil is the up and coming energy market of the world and with all of the new finds, that they are finding off the coast there creates a lot of opportunities for our customers and we are going to need to provide product that will enable them to do their exploration work off the coast of Brazil.

Zhi Zhang - Bank of America Merrill Lynch

Thank you.


Our next question will come from Frank Louthan of Raymond James.

Unidentified Analyst

Hi. Great. Thank you. This is [Mike Rowland]. Can you give us any sort of color on the buildout schedule, how many, over the next 12 to 18 months, we should be looking at for quarter and can you give us an idea on the sale side, what your current quota-bearing rep headcount. Where do you think that needs to go by the year end in order to kind of hit your goals?

Gary Wojtaszek

Yeah. I think that the way we are thinking about the investment is in terms of existing facilities is just trying to keep our head of customer demands, we have initial, so we have base level of inventory available on all our markets.

If you look that the majority of our capital investment this year, say half of it, is going to be year mark towards building our existing facilities that already underway in all the markets that we are currently out. The rest of it is going to be based on success base and we expect that, we are going to continue to sell out those facilities just as we have over the last several years.

And so, I wouldn’t expected to be that much different than this year, except for the fact that, this year we did have some land purchases and some shale purchases that give us ample room to grow within those locations. So we’re not going to have the heavy step up functions that we had, for instance we see in Dallas.

So this year in Dallas we purchased 30-acre parcel land there that has a 700,000 square foot shale on that, that something that we’re just going to be building out incrementally, so we’re not going to have that heavy upfront capital investment there. We’ve got enough inventory there hopefully the last -- for the next couple of years.

In terms of the reps current quotas, so as we mentioned both Kim and I speech, we did hire a bunch of folks in that organization. It does take a while for the reps to really become productive citizens of the company generally you are looking at six to nine months before they really can start bringing in deals.

However, I think, the folks that we have hired have all come from really big company background that are selling to enterprise companies, so lot of folks that have joined from Verizon, and HP, and EMC, so they are use to selling to enterprise customers in the long sell cycles.

So we would expect that by the end of next year. Our quotas are going to be substantially higher than that we are currently at today. We would expect that just given the success that we are expecting to generate from our marketing efforts that is really going to help make all of our sales folks way more productive as we come into the back half of 2013.

Unidentified Analyst

Okay. And last question, you commented on the cross connect business, where do you see that through ultimate percentage of revenue, is that more important to your current customer base, or sort of future customers as you sort of diversify out of the oil and gas sector a little bit?

Gary Wojtaszek

Yeah. It’s a good question. We see the connectivity portion of our business as a key instrumental product offering that will enable us to change the economics associated with just an individual asset to basically really develop a platform. And that IX business will do both of those things you mentioned.

So for our existing customers, what it does, it enables us to provide to them an entire platform solution which enables them to put their key applications in multiple data centers which are part -- which are required as part of their broad data center architecture strategy. So your typical Fortune 500 data center ideally is going to need at least three data centers. They are going to need two data centers on a close proximity to one another to do hot-hot or active-active replication of the application layer.

And then they are going to need a third data center that is between 100 and 300 miles away as part of the DR strategy. So when we lit up this network in Texas, what we’ve then done is provided the entire solution set to our customers, where we fought through and provided both the enterprise quality data center assets they require as well as the interconnectivity piece that is equally as important in their TCO calculations.

So we’re expecting that, we’re going to drive significantly more growth in our existing customers as part of that. However, the other thing that this does just as importantly is it opens up that same product set to many other verticals that we don’t do any business with today that are eagerly trying to sell the products and services to our Fortune 500 customers.

So if you look at all of the digital media, the content guys, the ecommerce guys, they have all strategies where they are trying to penetrate the enterprise customers. And that’s our customer base currently. So we’re going to make those customers available to these other digital folks that we don’t really do any business with today currently.

And in addition to that, if we drew a circle around the four metro areas in Texas that we’re operating in, there is roughly 18 million eyeballs. Those 18 million eyeballs are usually valuable to all of the folks that are trying to push products and services to the consumers to the edge of the networks.

So we think that’s going to be another big draw to the same folks. So we’re going to get many different benefits out of this. Expansion in new vertical, we don’t have additional penetration of our existing enterprise base. And the economics are really quite compelling. I think if we just looked at this as a standalone product offering, it would be phenomenal.

I think there’s a couple of our competitors in the market that have just done a phenomenal job in terms of driving tremendous shareholder value. We think that there is opportunities for replicating some of the success out there. And we think with the base of enterprise customers that we have, this is something that is uniquely differentiated and something that they are generally not even aware of, of the possibilities we’re taking advantage of something like this. So it’s pretty exciting opportunity for us.

Unidentified Analyst

Great. It’s very helpful. Thank you.


Our next question will come from Vincent Chao of Deutsche Bank.

Vincent Chao - Deutsche Bank

Hey everyone. Hi. Vincent Chao of Deutsche Bank. Thanks for taking my question. I just wanted to round back to Phoenix. I know it has been open for very long. But can you just maybe extend upon your comments about seeing some pretty good activity there, may be in terms of tours or they might frame it but just some additional color on how demand is trending there?

Gary Wojtaszek

Sure. Sure. So when we went into the Phoenix market, we did so with the goal of using that as the base in order to attack the West Coast market, particularly California and also as an opportunity for a lot of the enterprise companies that are looking for an attractive location for DR perspective.

So Phoenix is great from an environmental perspective. It saves seismically. There is no storm. It’s just a great location from an environmental location to be located in. So it developed as exactly as we thought it would. And that we’re getting a tremendous amount of demand from customers, doing tours, from California and from bigger enterprise companies, looking at DR locations.

And we’re in discussions right now with the number of big customers there that we’re looking at taking fairly large pieces of space with us. We had an opportunity earlier, towards the end of last year that we were feeling really bullish about that was a company that you would be excited to have.

Unfortunately, the customer didn’t believe that we’d be able to build that space out as quickly as we thought. When we were touring them in the facility, they didn’t think that we can take piece of their return into an enterprise class data center by the end of the year. And they weren’t willing to risk their critical assets based on our construction timeline.

So we missed a great opportunity with a really good customer but I think it just validates what we initially thought when we run into that investment.

Vincent Chao - Deutsche Bank

Okay. And just in terms of, type of demand that you are seeing. Is there any preference in terms of size and it sounds like that customers are little bit larger but are you seeing more demand from smaller deployments or larger deployments?

Gary Wojtaszek

Yeah. It’s pretty much the same. We sell across the board to anyone that want space. So we’re not -- we pride ourselves of being really flexible. And so all of our efforts are geared towards continuing to tap the entire market from the retail, smaller one cabinet type deals up to 20,000, 30,000, 40,000 square foot wholesale type deployment.

Our goal there was when we design that facilities is that we can minimize the capital deployment and get that online very quickly and that works into ourselves from an investment perspective to make sure we get high utilization of the assets that we’re deploying there.

Vincent Chao - Deutsche Bank

Okay. And should we think about the sort of 80% utilization rate before you start the next phase?

Gary Wojtaszek

Yeah. That’s a good metric. And we continue to try to whittle that down. We can -- like in a facility like in Dallas, and that Carrollton facility, we believe that we can bring down our next phase of that and deliver facility online in about 10 weeks time. So conceivably you can run that higher utilization. So we continue to streamline our supply chain in the way we think about the process associated with designing and delivering those assets.

Vincent Chao - Deutsche Bank

Okay. And just maybe, just going back to the CapEx, roughly $200 million or so for this year expected, I mean, some one asked earlier about this quarterly square footage. I mean, just from a total $200 million CapEx. I mean, how much square footage do you think that add in terms of colo?

Gary Wojtaszek

It’s going to be roughly about 160,000 square feet of additional space that comes online but that $200 million number isn’t exactly for all of that space. So I mean, our general metric is, we’re delivering less than $1000 a foot but that gives you a rough idea of how much space we’ll be delivering online.

Vincent Chao - Deutsche Bank

Okay. And just maybe -- we haven’t really talked about too much in terms of the 41,000 space that was leased. Can you talk about sort of pricing trends that you’re seeing? Are you seeing pricing pressure in any of your particular markets or are you seeing things improving?

Gary Wojtaszek

We’re seeing consistent pricing trends. What we signed on in the quarter was pretty consistent with what we saw in the past. And even in terms of the renewal that we had in the quarter, what you had seen on the road show through the third quarter was that -- through the third quarter we saw like a 2% net price reduction through the third quarter, our fourth quarter renewals, we actually saw a 2% price increase in the quarter.

So it’s been pretty flat on renewals as well. The only thing that we are intentionally doing, have been doing for last couple of months now is deliberately putting in 3% price escalators into our contracts that something that historically we’ve never done.

This quarter, little over two-thirds of the contract that we entered into at price escalators and about 80% of the contracts that we renewed in the quarter had price escalators put into which weren’t there previously so. So we expect over time, we should probably get some pricing lift on a comparable basis because of that.

Vincent Chao - Deutsche Bank

Okay. Thanks, guys.


And our next question will come from Sergey Dluzhevskiy with Gabelli & Company.

Sergey Dluzhevskiy - Gabelli & Company

Good evening, guys. Congratulations on the success of IPO. Two questions. First of all, obviously you have significant runway in terms of organic growth but could you talk maybe a little bit about your M&A philosophy? And as you look at the growth opportunities for CyrusOne, how much of it would come from organic growth and how much would come from acquisitions, and what are your main criteria when evaluating potential acquisition opportunities?

And also second question. Maybe you can talk a little bit about your dividend policy. Obviously you just said, a dividend is about $0.64 per share, so how should I think about dividends going forward in general?

Gary Wojtaszek

Sure. I’ll turn the second question over to Kim, first because she hasn’t had a chance to answer yet.

Kim Sheehy

Thanks, Gary. All right. We did state the $0.64 dividend policy through the IPO process and right now that remains a part of our policy. As you know that number or that amount is greater than what we are required to distribute under the REIT rules and we think it is probably something we are going to stay with this year, but then we will continue to evaluate at that point.

Gary Wojtaszek

Right. Yeah. With regard to and I don’t know, Sergey, if the operator would butcher your name or my name more so. But I think we could bode these a couple of vowels.

Sergey Dluzhevskiy - Gabelli & Company


Gary Wojtaszek

But, hey, with regard to the M&A opportunities, so I mean that is -- our base strategy does not include any M&A. We’ve build our plan up with going organically and focused on our sales and marketing program in that, and the variation improvement in our product launch in terms of Massively Modular and the IX program is just a peer organic base plan, which we think we can do really well as we have over the last couple of years.

However, I think the M&A opportunity is going to be a real one. We are going to look at this very selectively and the way we are thinking about this is three fold. One is, we are looking at opportunities that can potentially give us geographic expansion in the markets that we are currently not there and currently where we need we need, where we need to provide a product to provide for the latency requirements of the applications that our customers are requiring.

So there is something on the East Coast, something in West, Upper West, Pacific Northwest area would be something that we’d look at. The other thing that we would consider as part of that is access to the customers that we are going after. We are targeting the Fortune 1000 customer base. So that’s what we would look for in terms of the opportunities for expansion.

I do think that this industry is going to become more and more bifurcated, between those companies that have access to a capital and those companies, probably even more importantly that are platform placed. You will slowly find yourself if you’re not part of a platform in this industry I believe anyway, the odd man out. This is a really ubiquitous heavy asset in terms of business and I think you need to have that ubiquitous global platform to do that.

So, I think over time we are going to be able to use our strong balance sheet and we are very lowly levered less than two times and on a debt to enterprise value like 13%. So we’ve got a lot of flexibility there. But I think having access to this form of currency to CyrusOne currency is going to be pretty attractive to a lot of potential partners as we build out that platform. So we are going to continue to look at different opportunities there and see if we can make something, make sense for our shareholders.

Sergey Dluzhevskiy - Gabelli & Company

Thank you, guys.


And our next question will come from Jordan Sadler of KeyBanc Capital Markets.

Jordan Sadler - KeyBanc Capital Markets

Thank you. Good afternoon. I just wanted to -- I appreciate that you guys are a recent IPO obviously in the quarter, so congratulations on that and not necessarily looking to give guidance here. But maybe just maybe a little bit more context around the leasing. I know there were some questions. It’s unclear to me, whether or not the pace you saw in the fourth quarter, the 41,000 was a sustainable pace or not? Are you saying that is a sustainable pace?

Gary Wojtaszek

No. I think we didn’t answer that directly. I think what I did say was that we believe that the results that we were able to deliver in 2012 is something that’s sustainable into 2013. But I mean this quarter was three times -- was bigger than any other quarter by far if I recall that correctly. You’re exactly correct.

Jordan Sadler - KeyBanc Capital Markets


Gary Wojtaszek

And that I was talking about to Gey’s comment earlier, I think there was a lumpiness in terms of way these deals closed. I mean, ideally you’d like to have continued closings study and up into the right progression. But I think that’s the challenges of running this business. You are basically on your customers’ calendar and timeline to get deals closed. So, I think in aggregate if you look at our results over the year, I think we should be able to replicate that, whether they come in on a nice smooth trajectory or not, I doubt that.

Jordan Sadler - KeyBanc Capital Markets

Okay. We wouldn’t be well served if you used that our fourth quarter as our baseline.

Gary Wojtaszek

No. No. I wouldn’t use that as the baseline.

Jordan Sadler - KeyBanc Capital Markets

Okay. That’s helpful. Thank you. On the interconnection side, what was the interconnection revenue for 4Q and for 2012, Kim?

Kim Sheehy

We don’t separately state that. I mean, on an annual basis that revenue right now was only about 4% of our revenue.

Jordan Sadler - KeyBanc Capital Markets

4% revenue. Okay. And would you expect that growth rate given the -- obviously, the interconnection initiative in 1Q ‘13 that we’ve discussed here, would you expect that that growth rate would may be outpace the growth rate?

Gary Wojtaszek

Yeah. Absolutely.

Kim Sheehy

Right. I mean on a small number, right?

Gary Wojtaszek

We’ve got a smaller number relationship issue and that revenue trajectory will be significantly higher than the rest of the company. So, I mean it’s still probably not going to make a material difference. But in terms of our absolute numbers this year, but from a percentage change it’s going to be substantial.

Jordan Sadler - KeyBanc Capital Markets

Could that be double in size by the end of the year and the number in terms of the percent of revenue?

Gary Wojtaszek

We don’t want to give out any projections. We think that it’s going to be very -- it is a great business, right. I mean, having a platform and being able to connect them up is going to drive a tremendous amount of growth in that product line.

Jordan Sadler - KeyBanc Capital Markets

Okay. That’s helpful. And then the sales force that you discussed your, Tesh’s reorganization of the sales force into a global as opposed to a regional one, does that include a vertical focus or it’s still ultimately geographic?

Gary Wojtaszek

No. I mean, there is no vertical focus. I mean, here is the way we look at it. We look at there are -- the enterprise companies that we’re going after whether it’s big oil and gas company or an industrial company or an IT manufacturing company. I think at their base what we’ve seen is that 95% of what they’re doing in terms of their IT deployments are very common throughout.

So, when we think about the verticalization of that, I think there are -- there is benefit to doing that on the margin. But conceptually, the bigger focus area that we’re trying to attack is just 30 years of baggage in history trying to get that Fortune 500 CIO to break from the past and show him that there’s another way of doing this and that is to outsource his primary infrastructure to a company like us.

That type of cell is common to whether he works in oil and gas company to, he works in the semiconductor fab or anything. I mean, it’s very common in terms of the IT applications that they’re running. There have been certain types of applications that are very unique, particular some of the edge applications, low latency things that some of the other folks are focusing on from a vertical perspective that I think makes a lot of sense for their business.

But when we thought about it now, we didn’t think that that made a whole lot of sense for us at this point. Maybe over time, we would morph our business more to that model but when we think about our coverage now, it’s really just trying to get your name recognition out there in front of those customers, recognizing that the sale cycle for these guys can run upwards of three or four years.

And what you’re trying to do is make sure that you are top of mind so that they know this product is available when they do try to make that decision. They know that you are a trusted provider to a lot of their other brethren in the space and that’s where we’re trying to focus our efforts.

And when we think about the nationality of this as a platform, what you see is if you look at lot of our customers, for instance, like a lot of customers that we just signed up this past quarter. They’ve come from all different parts of the country. So it’s not regional play in that. They are predominantly just being generally at a particular region.

A good part of the company is that we’ve been successfully able to win, have come to us from other parts of the country and what we’re trying to do is develop a broader effort to transform our company’s marketing and sales strategy from a regionally focused one to national platform. And that’s some of the other broader economies of scale you get that I was alluding to in terms of when you building out a platform -- a platform franchise.

Jordan Sadler - KeyBanc Capital Markets

Okay. Last one quickly, we talked quickly but the Phoenix on the call. I’m curious about the competitive landscape there a little bit. If you could flush it out, I know next board has a project going on and just maybe vis-à-vis DLR and IO in the market where -- I know it’s early days for you guys. But how do you sort of compare, contrast you bumping up against them?

Gary Wojtaszek

Yeah. I mean we’re in the markets that we’re going to -- we’re going too bump up against all of those guys. I think every player there is offering a different solution to customers. And it’s going to ultimately be whose solution is the best for what the customer needs at that point in time.

That said, I feel really comfortable that we have a world-class product. We have a customer service delivery organization that is just second to none. And when we’re selling into the Fortune 500, we look at that relationship with the -- with that customer as we are critical IT service provider to them. We don’t look at them as we’re just providing them a capital solution.

We are providing them a service that is focus on solving their long-term IT data center architecture needs. And we think we’re positioned very well with the basic customers that we are going after.

Jordan Sadler - KeyBanc Capital Markets

Thank you.


And we’ll take a follow-up question from Jamie Feldman, Bank of America Merrill Lynch.

Jamie Feldman - Bank of America Merrill Lynch

I just to follow up on the question earlier in terms of pricing, if I heard correctly 46% of the leases you signed was for the full-service customers and 54 to meter power. Can you just give us a sense of what the average price per square foot or price per kilowatt was for those two types of customers?

Gary Wojtaszek

Yeah. In our -- in the road show presentation, we have provided some rough pricing per foot in terms of the stratification across the different size customers. And I think you can use that as a proxy for estimating that. It hasn’t really changed this quarter from what we’ve done historically.

Jamie Feldman - Bank of America Merrill Lynch


Kim Sheehy

He’s talking about the lease distribution table. It’s also in the data we file today.

Gary Wojtaszek

Okay. It’s in the data today.

Jamie Feldman - Bank of America Merrill Lynch

Thank you.


And it does appear there are no further questions at the time. I’ll turn the conference back over to Gary Wojtaszek for any additional or closing comments.

Gary Wojtaszek

Well, thanks guys. This has been a great meeting. We’re pretty excited about getting the IPO behind us and getting down to work. We’re really bullish about 2013 and look forward to the next call. If you do have any follow-up questions, definitely reach out. We are going to try to make these things very helpful for all of you and try to give you as much insight into our business as we look at it that can help you in the work that you’re doing. So have a great day. Have a great week. Take care.


And that does conclude today’s teleconference. Thank you all for your participation.

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