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CyrusOne Inc (NASDAQ:CONE)

Q2 2013 Earnings Conference Call

August 7, 2013 5:00 PM ET

Executives

John Caulfield – Vice President and Treasurer

Gary Wojtaszek – President & Chief Executive Officer

Kimberly H. Sheehy – Chief Financial Officer and Treasurer

Analysts

Lisa Lam – Morgan Stanley & Co. LLC

Jordan Sadler – KeyBanc Capital Markets

Operator

Good evening ladies and gentlemen, thank you for standing by. Welcome to the CyrusOne Second Quarter 2013 Earnings Conference Call. My name is Kevin, and I will be your conference operator today. At this time all participants are in a listen-only mode. After the prepared remarks, the management from CyrusOne will conduct a question-and-answer session and conference participants will give instructions at that time. As a reminder, this conference call is being recorded.

I’d now like to turn the conference over to John Caulfield, Vice President and Treasurer. Please go ahead, sir.

John Caulfield

Thank you, Kevin. Good evening, everyone, and welcome to CyrusOne second quarter 2013 earnings call. Today I’m joined by Gary Wojtaszek, President and Chief Executive Officer; and Kim Sheehy, our Chief Financial and Administrative Officer.

Before we begin, I would like to remind you that our second quarter earnings release along with the second quarter financial tables and presentation are available on the Investor Relations section of our website at cyrusone.com 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 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 cyrusone.com. 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 contain non-GAAP financial measures. You can find reconciliations of those measures to the most comparable GAAP measures in the earnings release and financial tables which are posted on the Investor section of the website.

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

Gary Wojtaszek

Thanks, Caulfield, and good evening, everyone, and welcome to CyrusOne second quarter 2013 earnings call. I will focus my discussion today on some of our key initiatives and highlights of the quater. And afterwards Kim will discuss our quarterly financial results in more detail.

Before I begin, I’d like to point out right about two weeks ago, CyrusOne marked its six-moth anniversary as a public company. As we’ll discuss shortly, we are continuing to execute the differentiated strategy that we talked about on our initial public offering road show. For those of you on the call today who maybe new to CyrusOne, our focus is on selling solutions to Fortune 1000 enterprise companies.

In fact, Fortune 1000 and similarly-sized private and foreign customers account for approximately 75% of our revenue, which differentiates us from competitors. Our focus on the customer combined with a flexible product offering that enables us to offer company solutions from a single rack to a large 50,000 square foot deployment has contributed to the company’s fast rate of growth and allowed us to command premium pricing relative to companies who just sell wholesale products. Additionally, our massively modular design approaches enabled us to build at a substantially lower cost and with a faster time to market.

Starting with Slide 3, our revenue growth of 18% over last year demonstrates that we continued to convince the enterprise customer to trust their data center needs to CyrusOne. For those of you who follow the industry closely, you understand that is very difficult to execute a sales strategy focused on selling the enterprises given that enterprises are typically very conservative or reluctant to outsource their mission-critical IT deployments.

During the second quarter, we signed 31 new logos three of which are Fortune 1000 customers and signed leases for 37,000 square feet. This compares to 19,000 square feet leased in the second quarter of 2012, an increase of almost 100%. In addition to this, we are also pleased to announce that in July, we preleased the rest of our San Antonio facility to one customer who also took additional space in our Houston and Phoenix facilities in order to take advantage of the new IX product that we launched, which I’ll discuss in more detail shortly.

Once construction is completed, we will have sold out the facility in 15 months, exceeding our initial expectation as a result of our massively modular deign methodology completion will take approximately 12 weeks. This increased leasing velocity is a direct result of our key initiatives that increase our sales and marketing presence and increased interests we are generating from the CyrusOne National Internet Exchange.

This quarter the CyrusOne National Internet Exchange has received terrific market acceptance of 68% of our new leases included incremental services resulting in an increase of their average monthly billings by 23%. This is just the start of our sales force, spent more time educating new and existing customers on the IX product.

Lastly in this slide, we completed the acquisition of three leased properties we spoke about last quarter, increasing our percentage in NOI from own facilities to 70% for the quarter, which equates to 77% of our colocation square footage. Over time, we would expect that we will grow the percentage of NOI from our own facilities. Almost 100% of our incremental capital investment over the past 18 months has been made in properties that we own. Kim will speak more to this in a bit.

Turning to Slide 4, our goal of CyrusOne is to be the preferred data centre provider to the Fortune 1000. Our targeting of the Fortune 1000 and current penetration into this group is a significant differentiator for us, and will ultimately benefit us into the future as more industrial enterprise companies shift more of their business models to a digital footprint, which should cause their deployments to grow in our facilities.

As I’ve spoken about in the past, the broad secular trend of explosive data growth continues. This trend is increasingly pressuring enterprise COIs to not only reconsider how they manage this long-term growth challenge, but how to manage in a cost effective manner.

Corporations are being forced to reevaluate the data center strategies and consider the cost effective solutions provided by outsourcing. This trend to outsource is at an early stage of approximately 80% to 90% of enterprise data centers are managed in-house today. The conversations we are having with existing and potential customers signal to us that this trend is currently in place and more importantly represents a significant market opportunity for CyrusOne.

It’s important to understand that outsourcing is an extremely important decision for a customer to make, which in turn causes the sales cycle to be very long. And as a result also makes it difficult to predict exactly in which quarter a lease will be signed. We have been very fortunate for the past several quarters to be able to consistently execute on our sales objectives. But no one should assume that the sales cycle has been reduced, or is any easier to predict.

For instance, the large lease that was executed in July for San Antonio was a deal that we were working on for almost nine months, and were supposed to have closed in early June, but slipped by one month to July. We work hard to understand our customers’ needs and cultivate deep relationships with them. This level of engagement creates a long sales clinical, but provides returns over the long-term.

Our success in penetrating the enterprise comes from our relentless focus on our clients and their needs. The CIOs decision to outsource revolves around security, reliability, and understanding of their needs as it relates to their future data center growth. Understanding these needs, earnings the trust of the CIO and delivering flexible solutions is the key to winning new enterprise business.

The process of getting to know our future customer can extend the sales cycle to two to five years. Most importantly, what makes CyrusOne special is our commitment to deliver high level customer service to all of our customers irrespective of size. This is what truly separates CyrusOne from our competitors and the one thing that I consistently hear from all of our customers that I speak with.

This is the reason why we recently adopted a rich calls in training program for everyone in the company in which we try to understand and emulate what is arguably one of the best service brands in the industry. Critical benefit to our focus on customer service is the partnership which we developed with clients.

This partnership is not just on the initial deployment into our data center, but also on the future IQ road map. This experience offers a wealth of insight and expertise which we can share across our entire customer bas. This elevates our business from selling data center space to that of a trusted partner. Proof of our excellence in customer service can be seen in our industry leading churn of 1.2% this quarter. Our customers grew with us and expand with us. Today, we service almost 575 customers including nine of the Fortune 20, 122 of the Fortune 1000.

Looking forward, we have spoken for several quarters about investing in our sales and marketing. And Slide 5 shows how we’re working to develop our direct and indirect sales channel to ensure our long-term growth. On the direct side, we have doubled the size of our sales force over the last year and beginning to see the benefits as the sales force begins to get traction.

That has been our experience that a salesperson can take up to a year to become fully productive as they build relationships and better learn the product. For this reason we are trying to recruit up and down the value stack, whether it would be from software companies, hardware manufacturers, telecom providers, or other industries as we try to lessen the learning curve.

We began developing a formal indirect channel program about 18 months ago in order and leverage our existing sale force, which has been developing well, and they account for approximately 15% of our revenue growth in the quarter.

This slide highlights our different channel categories and provides a few examples of our partner base. At the end of the quarter, we had 64 different partners that will all help to funnel business to CyrusOne as part of their own business strategies.

In marketing, we continued to see the benefits of our diverse marketing campaigns as the CyrusOne brand is gaining broad market recognition, acceptance, and many awards. This creates credibility for our sales personnel and partners as they approach prospective customers and is also driving an increase in both the volume and quality of sales lease.

As I mentioned on the last earnings call, the combination of these initiatives has been tremendous. We’re looking at the largest pipeline in our industry and more importantly are closing deals at a record pace. This quarter we saw 200% increase in bookings compared to last year’s quarter, and our late-stage pipeline is up also over 200% compared to last year. Also, our lead generation funnel is up over 400% when comparing with trailing eight months from the end of June versus the eight months at the end of October.

No one should refer by my comments that our revenue will be increasing to this degree, because we all know the adage that 50% of every marketing dollar is wasted, we just don’t know which 50%. However, I’m mentioning this to point out that our overall trajectory from what we’re seeing in our bookings, sales funnel, and lead generation is absolutely heading in the right direction.

This quarter we successfully launched our IX program, which has taken about 18 months to design and develop and be implemented. Before I discuss the quarterly results, I think it is important to point out that our strategy towards developing and deploying our IX product is completely different than what other companies are doing.

We look at the IX product as a way to create the data center platform that virtually connects all of our data centers together. CyrusOne’s solution provided customers with a high-quality enterprise data center and which is now complemented by high quality enterprise connectivity solution for a price an enterprise company simply cannot achieve on their own.

This is a very different strategy than what other companies have been discussing, which is predominantly focused on developing an ecosystem of single-point, cross-connect solutions in a particular building. Our solution provides a holistic means for enterprise companies to architect and replicate their existing data center platform, which generally is deployed in three or more facilities.

We believe our strategy will ultimately translate into success for our company as these platforms are difficult to replicate and create significant barriers to entry. Currently, about 50% to 55% of our revenue is generated from customers who are deployed in multiple facilities. We expect that ultimately this figure should increase towards a 100% as customers become more comfortable with their outsourcing decision and look to holistically replicate their existing multi-site data center architecture by choosing to go with CyrusOne.

As shown on Slide 6, the second quarter represents the first full quarter of operation for the CyrusOne IX platform, and the customer response has been very positive. 68% of new leases in the quarter included incremental services related to our national IX and their monthly recurring revenue was 23% higher because of it. This platform represents a true paradigm shift in the way companies store, manage, and exchange traffic for the enterprise customer. We anticipate it will continue to take time to educate and penetrate our base of customers, but the impact of the IX is still very tangible.

Through the first six months of the year, we have already deployed about 75% of the cross-connect as deployed in all of last year, which is significant considering that we just launched our IX product this quarter. In addition to basic cross-connect and bandwidth growth, we are gaining customers increasing our data center sales because of the IX.

During this quarter, one Fortune IT services customer need access to specific carriers that were not available at a particular data center. The IX made it possible for this customer to connect to those carriers co-located at our Carrollton facility. Another example is an oil and gas customer that expanded from one of our data centers that was full for one of our data centers in the same metro area connecting between the two and creating an active-active solution in the same metro area for only the price of their cross-connects. The customer also decided to add another site in a different metro area for disaster recovery purposes.

And as I mentioned earlier, the customer that took the rest of the space in our San Antonio facility also took additional space in our Houston and Phoenix facilities in order to take advantage of what the IX can offer. These are just a few of the examples that were implemented in the quarter but which provide some color on the powerful platform effect of the solution we engineered.

Turning to Slide 7, we increased our available square footage by 49,000 square feet in the quarter to 970,000 square feet across 25 facilities. This represents an increase of approximately 169,000 square feet or 21% growth from a year ago. Specifically, we added 42,000 square feet in our New Houston West facility, as well as space in Cincinnati and Dallas.

Utilization in the quarter was 81% compared to 85% in the same period of last year and flat sequentially. At June 30, we had 806,000 square feet of power shell available for incremental development across all of our markets, as well as 172 acres of land held for development.

We are expecting to complete construction on our existing San Antonio facility and also announced today that we are acquiring 22 additional acres of land to begin construction on the second San Antonio facility, which will be our newest expansion facility. San Antonio is a great example of our massively modular approach to building data centers allows us to cost effectively deliver space in record time.

We have developed an expertise in design, supply chain management, and construction logistics and have turned it into a very reputable process, which then enables us to continue to reduce our investment in each new iteration of the design we deploy.

To conclude, we were pleased with the results of the quarter and our focus on being the preferred data centre provider for the Fortune 1000. Our relentless focus on customer service, which permeates our entire company and at all levels of employees, has allowed us to crack the code on the enterprise. I will spend time today providing additional information on how we’re approaching the market. And the area that we’re focused on. Taking together we believe that we have a long runway for growth as the enterprise increasingly looks to outsource. And our development expertise should enable us to generate sustained capital returns. Lastly, the initial reaction to launch of the National IX are promising. And I’m very excited to see how this supports and impacts our business over time.

With that, I’ll now turn the call over to Kim

Kimberly H. Sheehy

Thank you Gary, Good evening everyone. And thank you for joining us today. My comments this evening will speak to CyrusOne’s results for the second quarter of 2013.

Slide nine shows revenue for the second quarter of $63.6 million, an increase of $9.6 million or 18%. The growth in revenue was fueled by the addition of 80 new customers over the past year, growth from existing customers in our legacy markets and success in new markets. We grow our customer base 3% from the first quarter of 2013 and 16% over the prior year.

As of end of the quarter, our customer base stands at 537 customers and we added three portion of 1,000 customers in the quarter bringing our total 122. These customers accounted for 76% of our annualized rent. We continued our momentum of strong leasing from the first quarter of 2013 with approximately 37,000 co-locations square feet leased in the second quarter compared to 19,000 for prior year quarter and 31,000 in the first quarter of 2013. The leases signed were for 3.8 megawatt power primarily across our Carrollton, Austin and Houston West facilities.

Based on square footage, the weighted average term with these leases were 65 months and approximately 65% was leased to metered power customers. 78% of these contractors are escalators at a weighted average of approximately 1.5% annually. As Gary mentioned earlier, the Cyrus National Internet Exchange attracted new customers. Of our new leases this quarter, 68% included IX services, which increased our monthly rent by approximately 23%.

Total interconnection revenue for the quarter was consistent with past quarters at 4% to 5% of total revenues. In the second quarter, we recognized approximately 20% of revenue for the leases that were executed during that period. We estimate that we will recognize revenue on approximately two-thirds of the leases signed during the second quarter and the third quarter of 2013 with the remainder being early in the fourth quarter.

This trend is consistent with last quarter as we recognized in the second quarter approximately two-thirds of the revenue from the leases signed in the first quarter with the remaining third ramping in the third quarter.

Our revenue churn was 1.2% in the quarter, which compares favorably to the 1.8% churn rate we experienced in the second quarter of 2012. Pricing on renewed contracts in the quarter remained flat compared to previous rates overall with a weighted average duration of our renewals in the quarter being 37 months and about 80% of those renewals have escalators with a weighted average of 2.2%.

On Slide 10, our property net operating income was $39 million for the second quarter of 2013, an increase of $3.1 million or 9% from the second quarter of 2012. This was driven by organic revenue growth at existing and newly constructed facilities. Higher property operating expenses in the period decreased our NOI margins 61% for the second quarter compared to 67% for the second quarter of 2012.

Almost half of the expense increases related to newer facilities that just began leasing in the past few quarters. The remaining increases from higher electricity usage at existing facilities, costs related to our new interconnection platform, maintenance and other costs.

Looking forward, we anticipate that this will be the low point in the year for our NOI margin, as revenue ramps up at our new facilities and operating expenses are expected to remain relatively flat. Our return on invested capital this quarter, which is calculated as our net operating income for the last quarter annualized divided by our growth fixed assets, excluding construction in progress was 16%. When excluding the properties that has been opened for one year or less, our return on invested capital was 22%.

Our sales and marketing costs are approximately $1million higher than the prior year, as we have doubled our sales force and expanded our marketing outreach as Gary mentioned earlier. General and administrative expenses are also approximately $1 million higher from the higher non-cash compensation costs, incremental head count and other costs to support being a public company.

These were partially offset in the quarter by lower consulting and legal expenses. This resulted an adjusted EBITDA of $30 8 million in the quarter, as compared to $28.5 million or an increase of 8%.

Before I speak to normalized FFO, I would like to mention that we have modified the definition of normalized FFO to exclude the impact of gains and losses on extinguishment of debt to provide a clear metric that better illustrates profitability of ongoing operations.

In the second quarter of 2013, we reported a $1.3 million loss on extinguishment of debt associated with the acquisition of our Austin 2 facility. The lease liability for this facility was recorded on our balance sheet as another financing arrangement and GAAP requires that any payment that exceeds the liability on the balance sheet, even if the purchase is at fair market value, be presented as a loss on extinguishment of debt.

Normalized FFO for the second quarter was $15 million, a decrease of 22% from the second quarter of 2012. The decrease was primarily driven by a $4.6 million tax benefit recorded in the second quarter of 2012, as CyrusOne was a C-corporation. Excluding that tax benefit in the prior year, normalized FFO was flat to 2012. Our AFFO of $14.8 million was slightly better than last year.

Slide 11, is similar to the pervious slide except that it compares our performance on a sequential basis. Our NOI decreased by $1 million in the first quarter of 2013 as higher property expenses exceeded the increase in revenue. Approximately $1 million of the expense increase was due to be expenses at new and growing facilities that approximately $1.5 million of the increase from seasonally high electricity expenses at existing facilities. The remaining increase was associated with costs to support our interconnection platforms, maintenance costs, and other expenses.

Again, we anticipate our NOI margin this quarter to be the low watermark for the year as we see ramps at our newer facilities. SG&A expenses were consistent with the first quarter as higher non-cash compensation expense was mostly offset by lower consulting and legal expenses.

On Slide 12, capital expenditures were $49 million in the second quarter of 2013, or about $3 million less than the second quarter of 2012. In the quarter, we finished construction and commissioned our second facility at Houston West. The first data haul has approximately 42,000 of colocation square feet with a total footprint in excess of 150,000 net rentable square feet.

In the quarter, we also added 5,000 square feet of space at our Lebanon facility in Cincinnati. At our Phoenix facility, we commissioned 36,000 square feet of available office space. We began building the next data hall at our Carrollton facility, a data hall at our West Seventh Street location and continued construction of more power at our Houston West facility.

In addition we began construction to build out the remaining power shell at San Antonio for the customer lease executed in July and we anticipate that we will finish construction within the third quarter.

Reoccurring capital expenditures for less than $0.5 million for the second quarter of 2013. Also, as mentioned before in the quarter, repurchased three of our leased data center facilities in Florence, Kentucky, Lombard, Illinois, and Austin, Texas for a total of $28 million. These facilities represent almost $21 million of annualized rents of June 2013 and approximately 107,000 square feet of colocation square footage. These acquisitions improve our property net operating income and colocation square footage from own facilities to 70% and 77% respectively.

We are committed to owning our real estate in the future and continue to review our existing portfolio for opportunities to purchase when it makes economic sense. These lease were previously accounted for capital leases and other financing arrangement on our balance sheet. And the accounting presentation of the purchases on the cash flow statement were only reflect $8.4 million of this purchase of capital expenditures, $19.8 million is shown as payments and capital lease and other financing obligations.

The next slide highlights legislation of CyrusOne sponsored in Arizona and Texas that will provide tax release organizations for the purchase of servers, network here and datacenter infrastructure. The exemption in Arizona as for a period of at least 10 years and can provide customers with sales tax savings of almost 8%, when they leased at least 500 kilowatt.

Customers spend million of dollars over this period on hardware purchases, while benefit from locating in an area of country with a low rate of seismic activity access to a robust fiber network a highly educated technology work force and low-latency connectivity to West Coast cities.

The Texas legislation is similar except that requires higher amount of capital investment and later to be made, both of these measures represent material savings opportunities for our customers.

Slide 14 shows our net debt and market capitalization. Net debt increased by $15 million from last quarter, due to a $16 million decreasing cash for capital expenditures, and the acquisition of our three leased facilities, which reduce our capital lease obligations by $10 million, we have approximately $492 million of available liquidity, including over $250 million in cash. Our net leverage is 2.3 times our annualized adjusted EBITDA.

We also want to take a moment to remind investors of our brief structure, where approximately two-thirds of equity value, it’s held in the partnership units which are considered to be common share equivalents. Our equity value at June 30, was approximately $1.3 billion. On July 15, we paid a cash dividend of $0.16 per share on the company common shares and common share equivalents for the second quarter.

Slide 15, shows our outlook for the full year 2013, where we are reaffirming our guidance. We expect our full year revenue to be between $260 million and $270 million, and our adjusted EBITDA will be between $133 million and $137 million. We also expect normalized FFO per diluted share and share equivalents to be between $1.15 and $1.25.

Assuming the shares were outstanding for the full year in 2013, our guidance on capital expenditures were also unchanged, however we would like to clarify, that our estimate for the acquisition of leased facilities is for the full purchase price of facilities, regardless of the presentation on the cash flow statement. We don’t anticipate purchasing additional lease facilities during the second half of the year.

In closing we are very pleased with the growth achieved in our new markets the continued expansion of our customer base and the launching of the internet exchange. We continue to be optimistic about our future performance and our ability to execute our strategies. We want to thank you for your time today. And this concludes our prepared remarks. Now operator, can you please open the line for questions.

Question-and-Answer Session

Operator

(Operator Instructions) And we’ll take our first question from [Vincent Chao].

Unidentified Analyst

Hey, good afternoon everyone. Hey, Gary, you said some time early on in your comments talking about the sales cycle, not getting any easier to predict or shortening. I’m just curious, I mean is it getting any longer or is it getting any tougher given the current environment?

Gary J. Wojtaszek

Well, it’s basically been unchanged. So we’ve had really strong results over the last three quarters. In fact, the first half has been our strongest half ever in terms of sale and I don’t want to mislead anyone thinking that things are getting easier. It’s just as difficult as it has been. It hasn’t linked up any, but it’s not gotten any more difficult either. The one thing that we have been benefited by is that our name recognition is absolutely improving a lot. Our marketing leads are up 400% and that seems to help at least kind of get the name out. It’s no longer Cyrus who as opposed to CyrusOne.

Unidentified Analyst

Okay. Thanks. And just, going back to the comments about two-thirds of the assigning in the second quarter expected to commence in the third quarter, can you just tell us what the actual level of commencement was in the second quarter in total?

Gary J. Wojtaszek

It was two-thirds of the first quarter or so.

Unidentified Analyst

Okay. So there was nothing that was signed and closed in the quarter?

Gary J. Wojtaszek

A little bit. Not much. It was like 20%...

Kimberly H. Sheehy

20%, yeah. About 20%, Vincent, signed and recognized in the same quarter.

Unidentified Analyst

Okay. Thanks. Maybe just a broader color that if you could provide just on the competitive environment out there and seems like pricing held in for you guys on the renewals, I think you said it was flat and you did see a pickup on the Internet Exchange driven leases. But just maybe taking a step back in for Phoenix and for Texas, has there been any noticeable change in the competitive environment for you guys?

Gary J. Wojtaszek

No, I mean, well, we are actually involved in some larger deals and that’s kind of new for us, so that’s a little different and the pricing on that is obviously tighter than the smaller deals. But that’s kind of consistent with our business model and being able to sell whole, portfolio products to customer. So when you look at each of the piece parts of the size of the customer, the land term, all that you factor in that, it’s fairly constant.

Unidentified Analyst

Okay. And just one last one for me, just on the direct sales side, the 34 folks that you have now in place, is that – are you guys done with the hiring at this point or you anticipate continue to grow that number?

Gary J. Wojtaszek

I hope not. I think that, our plan is as we continue to scale the business we’re going to be adding more sales and marketing, but we don’t want to get too far out ahead of ourselves. I think this year we are pretty much done and we’re going to add a couple of more heads here and there. But the longer-term plan is to basically increase how many folks we’ve got deployed doing that.

Unidentified Analyst

Okay. And when you think that the current guys will sort of reach that full productivity level? I know it takes 9 to 12 months by just without knowing exactly when it was started. I mean, do you think by the end of the year you will sort to be at full productivity level?

Gary J. Wojtaszek

Yeah. Well, I mean theoretically, I mean not everyone is going to perform exactly to that, but by the end of the year they should, I mean what we could, I give you some flavor on, we have twice as many people that are above their quote as we had last year. So the efficiency of our sale force has improved versus where we were last year, as well as the volume of the sales force.

Unidentified Analyst

Okay, great. Thank you.

Gary J. Wojtaszek

Yeah, sure.

Operator

We’ll take our next question from (inaudible).

Unidentified Analyst

Great. Thank you. Can you give us idea on some of the trends in the verticals beyond energy, how are you taking that model and being able to expanding into some other verticals? And give us update on international expansion, particularly thoughts on Brazil, I apologize if you had that earlier in the call, I may have missed that. But if you can touch basically on that, it will be great.

Unidentified Company Representative

Sure, sure. Hey (inaudible) thanks for your question. I mean, we don’t necessarily think about our product has been so vertically dependant on a particular history. I mean when you look at the Fortune 500 CIO, we’re basically focused on selling to 98% of what keeps that one or that guy up at that night. It’s basically the same. So, whether you work at P&G or Procter or Exxon or Dell, I mean the CIOs job is relatively the same. So, our focus is really not much industry dependent, it’s more focused on providing a little level of service and quality that would meet the needs of the enterprise CIO. That’s a little different than what so many other folks have done in the industry which are much more focused on a particular size of the applications that the Fortune 500’s deploying in the highly network down facilities. That type of sales approach doesn’t seem to be as helpful to us, just given that what we’re selling to them is much more boarder base than what so many other folks are offering.

With regards to the international expansions as we talked about before we spend a lot of time in Brazil, we’re working up our business model there with the goal of presenting that to customers and get that to sign. Sign up for that capacity before we actually build out space that we recognize that. That the risk profile going into emerging market like Brazil is a little different than on our own backyard and some of the other developed countries London versus (inaudible). So we’re going in there with the little better approach from the rest perspective.

Unidentified Analyst

Okay, great. Thank you. And just follow-up, who do you think that you’re taking share from where do you think you’re getting the customers, and this is largely coming from in-house or you think you’re winning incrementally from some of the other multicenter data center guys out there?

Gary J. Wojtaszek

Yeah, no, I mean we never really try to ever this large customer from that does already decided to go someone else. We know how difficult it is to convince that customer to get out of the data center and there is really not much of an economic incentive, we don’t really focused on that. We focus on trying to convince those guys, who are just kind of new to this, to this whole outsourcing phenomena to basically get out in front of them be comprised, and convince them to go with us.

I mean from the vast majority of the customers that we’re waiting, these are kind of like direct sales on the result of our marketing and sales efforts. And we just spend a lot of time with them over years in some cases try to make sure they who we are as operators and people. And so that they can trust us when they ultimately make a decision (inaudible) will be pretty good year out of (Inaudible)

Unidentified Analyst

Okay, thank you.

Operator

We’ll take our next question from [Simon Flannery]

Lisa Lam – Morgan Stanley & Co. LLC

Hi, this is Lisa for Simon. Thanks for taking my question. I guess just maybe a comment a little bit more on your interconnection product. I know currently and you have product (inaudible) is there plans to expand us to your other facilities outside that state. And also is there particularly that’s really focusing in on this interconnection product and the other sense to maybe split up this revenue as a separate segment going forward?

Unidentified Company Representative

Yes, so I’ll take. Let me answer your last one first, yeah, eventually and what’s becomes material, we’re going to be breaking it out revenue lines. I mean, what we’ve said is going through, roughly 4% of revenue today. The other point of that is just being specific to taxes, it’s a little incorrect, we actually expanded this, so we’ve lengthened our Phoenix facility as well, that’s in there. But with regard to the bigger question about what type of customer this is for, I mean what we’ve done is we’ve architected data centre platform which is available for all enterprise companies, every single enterprise company that we are aware of basically has two and for the most part three or four data centers which they basically use for active type replication or inactive DR type replication.

So as we see the industry evolving, we think that as customers become more and more comfortable with outsourcing their mission critical data centre here to a company like us, we believe that the next step in that, is that they will ultimately replicate their entire data centre architecture that they’ve done themselves and we’ll do that on our platform. And we’re able to do that, because we’re making considerable capital announcement in all of the data centre themselves, but equally important we are putting a significant amount of capital investment building out the network and the reality is that the scale that we’re able to build that is just unachievable by the enterprises and the economic benefits that we provide by linking up the connectivity is really attractive to the enterprise companies.

So what we’ve developed is something that every single enterprise company is currently doing today themselves and we think tomorrow they’re going to basically look to replicate that on our platform.

Lisa Lam – Morgan Stanley & Co. LLC

Got it. Do you see those kind of new existing customers from picking up this product at a pretty similar rate?

Unidentified Company Representative

Yeah. This has been like a really great launch. We’ve been working on this for a long time and talking to our customers about it for some time. And for the most part, the enterprise companies do not really understand that the connectivity benefit is supported by this platform. So you can trace that with some of the digital companies out there the big larger scale internet companies, who were much more assuming to have a distributive data because it’s such a big platform.

This is a fairly new product for enterprise companies that we’re educating them on. They’re really coming up part of the learning curve on this. And it’s been very well received from – basically, every deal, that we’re involved in now from a product perspective has this as a component and the big part of the conversation.

In addition to that, we’ve got a number of wins from existing customers this quarter that are looking at taking that service. And one example, I had given in my talk notes was the customers that was in one of our facility in Houston, it was the facility that was full and wanted to grow. They expanded into our other facility within Houston, so they were virtually able to expand out of one data center into another data center with just with prices that cross connect. That is really attractive to it because then what we’ve been able to do that enabled them to replicate between two data centers for free within the same metro area.

In addition to that, a customer likely said they actually – the ideal customer, they’ve put another, they took some additional space from us in Houston, so as they are actively replicating between two sites within the same metro area and then they deployed in our Austin facility as well and that’s the type of customer that we think eventually everyone is going to morph into.

Lisa Lam – Morgan Stanley & Co. LLC

Great. Thanks for that.

Operator

We’ll go next to Jordan Sadler.

Jordan Sadler – KeyBanc Capital Markets

Good afternoon. I was hoping to get a little color if possible on the backlog. I know Kim in terms like, you gave a little bit of detail there in terms of what’s commenced, but maybe it might be helpful to have a little bit of sense of what the backlog maybe if signed but not yet commenced leases, so we might be able to model the second half a little bit better. So, in total not just, well assigned in the second quarter.

Unidentified Company Representative

I mean we just, we obviously haven’t given out kind of the growth numbers out of way. I mean, I think what you should look at is the trends that you’ve seen, the increase in the last two quarters, and we would expect to say, kind of on that same trend. That’s probably the best I can give you right now.

Jordan Sadler – KeyBanc Capital Markets

Well that’s exactly going to that’s a great because there wasn’t actually an increase sequentially in terms of adjusted EBITDA and FFO, and I’m just trying to figure out. Is there any other sort of down side and I assume that as a result that some of the things you talked about of course new facilities coming online expenses et cetera, but any other volatility you could point this to sequentially that would or should from here on in we see a more normalized and a sequential up tick in those metrics.

Kimberly H. Sheehy

I was speaking to Gordan, with the trends I was talking about the increase in revenue. What we said today and looking at the margins on the NOI and EBITDA flows, we are at the lowest point, we would expect this year. We think the expenses are going to remain fairly flat. For next two quarters and so we used to get a pick up in the margin, from the revenue increase.

Jordan Sadler – KeyBanc Capital Markets

Okay. So expense to say generally flat.

Kimberly H. Sheehy

Yeah.

Jordan Sadler – KeyBanc Capital Markets

That is helpful. And if in terms of the revenues specifically you had about almost 6%, 5.8% sequential increase in top line over 1Q. Is that pace also consistent for the back of the year the sequential uptick or would you think that would accelerate in 3Qor 4Q?

Gary J. Wojtaszek

Well, Jordan, this is Gary. We are on a really good trajectory right now and we mentioned in our first half, booking has been really solid. We’ve also signed a very big deal that actually close in the third quarter that enable us to sell our San Antonio facility. So we feel pretty good about the run rate that we are currently on that we should be drilling pretty nicely towards the second half.

Jordan Sadler – KeyBanc Capital Markets

When does that piece July lease commence?

Gary J. Wojtaszek

In September.

Jordan Sadler – KeyBanc Capital Markets

Okay.

Kimberly H. Sheehy

That the other things are I mean our guidance of the revenue I mean we still feel like we are going to forecast will come within that range for that certainly gives you some sense of what we expect to happen in the second half of the year?

Jordan Sadler – KeyBanc Capital Markets

Okay. Okay that is what I am trying to manage to little bit my model here I mean that right now I feel like 123.7 year-to-date is that’s a run rate of 246 or something, which is 247 when you add a little bit of growth in there, you could get to the almost a low-end of the range but it’s so far below. So I guess at some point there is some acceleration but maybe September lease that kind of kicks in, that might do it.

Unidentified Company Representative

Okay.

Jordan Sadler – KeyBanc Capital Markets

Okay, I mean similar question, is there any – there seems to be a little bit of a disconnect in terms of the FFO, but I guess because you got $0.52, adjusted EBITDA sort of seems to be tracking a little bit better, but FFO, per share, you had $0.52 in the $0.64, excuse me $0.68 that hit the mid point. So it looks like there is a little of bit of a back half ramp, but I guess it’s a similar phenomena on the sort of the fourth quarter, would probably be the peak?

Unidentified Company Representative

Right. I think it’s the margin that we would expect over the next two quarters in EBITDA right.

Jordan Sadler – KeyBanc Capital Markets

Right, I guess, so in terms of rent trends, anything you could speak to Gary, about what you are seeing in market rents, I know I saw the renewals, were done at consistent levels and I know that you are getting nice increases from the IX related business, but anything else, you could sort of speak to in terms of what the customers are looking for and what you are talking to customers about?

Unidentified Company Representative

I mean win-win has a similar type question, I mean what we are seeing is relatively unchanged, when you kind of level set for the different variables that go into pricing, the terms of sizing of the deal and length of the deal, resiliency all that, there has been no real difference in terms of the pricing that we are seeing across all the different components that we offer.

Jordan Sadler – KeyBanc Capital Markets

Okay, and last one is that…

Unidentified Company Representative

As you’re putting on renewals, they are basically flat. And the one thing that we have done and consistently are seeing is that the whole lease escalators has been in just about 80% of all the contracts that we’ve done, either new ones or renewals and the length of the term of the contracts that we’ve put in place. This quarter I think those average maybe 65 months, but the last two quarters have been around 70 months or 72 months. So consistent with what we have been telling everyone that we would expect over time as our footprint expense, our average lease mature [duration] should extend and we’ll have lease escalators in all of our contracts.

Jordan Sadler – KeyBanc Capital Markets

Okay. Last one is on San Antonio. I may have missed this. Was that a new customer and what’s sort of the nature of that customer?

Gary J. Wojtaszek

We don’t talk about customers, but that’s one that we’ve had previously that are big Fortune 50 type customer and they just expanded with us, not just in San Antonio, but also in Houston and Phoenix as well.

Jordan Sadler – KeyBanc Capital Markets

Okay. Thank you very much. Last one, just the rent related to the assets that were purchased during the quarter, the $28 million. I know it’s in an couple different buckets, but what was the total no cash flow yield related to that $28 million? How much were you paying in rent annually?

Gary J. Wojtaszek

It was roughly around – I don’t know what the average number. On a blended basis it was somewhere in the 9%-10% range on a blended basis, probably cash basis, but the expenses wasn’t going through the EBITDA [in] balance sheet.

Kimberly H. Sheehy

They were on the balance sheet.

Jordan Sadler – KeyBanc Capital Markets

Okay. Thanks, guys.

Kimberly H. Sheehy

Thank you.

Operator

We’ll go next to David (inaudible).

Unidentified Analyst

Great. Good afternoon, everybody. Just wonder if we can talk a little bit more about revenue growth, and maybe you can just gives us a little bit more detail about how we’re going to get from the annualized revenue number of about 250 to 260 to 270 in guidance, how much of that is going to come from lease up, how much is gong to come from interconnection revenues, any kind of color would be helpful.

Kimberly H. Sheehy

Well, I mean, our revenue is driven by three or four different things, David. So I mean, obviously, they are continuing to attract more and more customers like we have in the first quarter, that’s what we plan for this quarter as well. And that’s been accounting for a significant amount of our growth, but historically, again, even this quarter you see that the vast majority of the growth has come from existing customers that been with us that continued to grow just as their footprint expand.

And as we are talking earlier, as we renew customers, we’re putting in lease escalators in there, so those contracts are growing a little bit as well because of that. And then the success that we had in the first quarter for IX was really good. We saw a 20% plus lift in revenue because of it. We would expect that as more customers become familiar with that product and want to take advantage of it. That’s going to further accelerate the growth that we’ve experienced this quarter.

Unidentified Analyst

That’s helpful. I was just wondering, you said it was 4% of your rents today, what sort of the outlook for that going forward? What’s the revenue mix is going to look like?

Kimberly H. Sheehy

Well, it’s going to be skewed more towards the IX over the time, obviously since its’ a fairly new initiative that we have. I mean, ideally if we can get the big percentage of our business like, one of our business site, like one of our great competitors does in a phenomenal way, I mean, that would be ideal. We recognize that our approach is a little different than and if you kind of start, but I think just given the success that we saw in this quarter, we feel really good about the market acceptance for what we’ve just then provided them.

Unidentified Analyst

That’s helpful. And also look like you’re the tenant reimbursements as a percent of OpEx, came down during the quarter, is that mostly the result of more metered power leases signed during the quarter. And I guess going forward, should we expect to see more of those metered power releases versus full service?

Unidentified Company Representative

Yeah, we think, we said this quarter on the last 65% of the new leases for metered power leases. So, I’m not specific what number you’re looking at downward comps. So last couple of quarters is what we’ve announced it as the largest percent of our new deals are metered power deals.

Unidentified Analyst

Okay, thanks a lot guys.

Operator

Ladies and gentlemen that does conclude our question-and-answer session. I now like to turn the call back over to Gary Wojtaszek for any additional or closing remarks.

Gary Wojtaszek

Well, thanks everyone. We appreciate you taking the time and talking with us. And if you have any other questions definitely reach out to Caulfield, he is only standing by. Thanks.

Operator

And ladies and gentlemen, once again that does conclude today’s call. I would appreciate everyone participation.

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