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CyrusOne Inc. (NASDAQ:CONE)

Q3 2013 Earnings Call

November 6, 2013 5:00 PM ET

Executives

Anubhav Raj – VP, IR

Gary Wojtaszek – President and CEO

Kimberly Sheehy – CFO and Treasurer

Josh Snowhorn – VP and General Manager, Interconnection

Analysts

Stephen Douglas – Bank of America Merrill Lynch

Barry McCarver – Stephens Incorporated

Vincent Chao – Deutsche Bank

Frank Louthan – Raymond James

Jonathan Schildkraut – Evercore Partners

Operator

Good evening ladies and gentlemen. Thank you for standing by. Welcome to the CyrusOne Third Quarter 2013 Earnings Conference Call. My name is Gary 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 given instructions at that time. As a reminder this conference call is being recorded.

I would now like to turn the conference call over to Anubhav Raj, Vice President, Treasurer and Investor Relations. Please go ahead, sir.

Anubhav Raj

Thank you. Good evening everyone and welcome to CyrusOne’s 2013 third quarter earnings call. Today I am joined by Gary Wojtaszek, President and CEO; and Kim Sheehy, CFO.

Before we begin I would like to remind you that our third quarter earnings release, along with the third quarter financial tables are available on the Investor Relations section of our website at cyrusone.com.

I would 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 and 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 Investor section of the company’s website.

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

Gary Wojtaszek

Thanks, Raj. Welcome to CyrusOne’s third quarter 2013 earnings call. I will focus my discussion today on some of our highlights and key initiatives of the quarter and afterwards Kim will discuss our quarterly financial results in more detail. CyrusOne had another great quarter which is a continuation of the success that we’ve been able to generate and build upon over the past year.

It’s only the second inning of this enterprise outsourcing ball game and while it’s great to take at this moment to admire the score, I want to thank all the team members at CyrusOne with whom I have the pleasure of working with every day and who make this company a fun place to work.

Our focus on customer service continues to be our competitive advantage and the key driver to earning the trust of large enterprise CIOs. As we strive to earn our customer’s trust everyday it is a singular focus which creates the necessary confidence for Fortune 1000 CIOs to entrust our critical infrastructure to CyrusOne. Additionally our flexible product offering allows us to offer our customers customized solutions which can range from a single rack to a 50,000 square feet datacenter deployment.

Lastly our massively modular design approach enables us to build at a lower cost and with a faster time to market than many in the industry. This strategy continues to deliver excellent results as evidenced by our highlights for the quarter found on slide three. This was our highest leasing quarter ever with 62,000 colocation square feet signed, including the lease we previously announced on our last call for 19,500 square feet which fully leases up our San Antonio facility.

This was more than five times what we leased last year and a 68% increase in Q2. The team and I are amazed by this quarter’s result because it wasn’t that long ago when we were really proud and excited about leasing 50,000 square feet of space in a year, let alone in the quarter. With our national platform of datacenters and our focus on product innovation and customer service we have been able to capitalize on the strong enterprise demand for datacenter space.

Although we are very proud of our accomplishments this quarter I would not call this quarter normal indicative of our future leasing velocity. We continue to gain momentum and are beginning to reap the benefits of the investments we made in our sales and marketing efforts. But I would expect leasing velocity to return closer to the level we have seen over the past three quarters.

I also do not want anyone to misinterpret that it’s getting any easier to lease to enterprise customers. Many of the customers that we signed this quarter we were in conversations with for the last two or three years. The sales cycle has not shortened and it’s still very difficult to sell and service enterprise customers.

This is no different for us because we’ve been doing this for the past decade as enterprise customers have been our primary focus. Third quarter revenue increased by 19% over last year and 6% sequentially. Many were concerned after last call about CyrusOne achieving our 2013 guidance and hopefully these results will calm some of those fears. We also saw growth in normalized FFO and AFFO in excess of 40% and adjusted EBITDA growth of 21%.

Importantly as we discussed last quarter we expected improved profitability this quarter as costs were incurred in certain facilities in Q2 prior to leasing. As you can see the revenue growth this quarter drove significant increases in our profitability metrics and highlights the operating leverage we have in our business.

In the quarter we also launched the CyrusOne marketplace which is an innovative online tool where customers can select a specific datacenter, view the existing floor layouts and availability and pick their desired space. For small and medium business customers we have created a standardized product called the CyrusOne Express which offers three configurations to meet their needs.

Our goal with these products in the National IX is to remove potential stumbling blocks or barriers that our customers encounter when evaluating a datacenter provider. We want to make the decision and transition to CyrusOne to be as easy as possible for our customers. Ultimately we are removing the significant stress and complexity that moving in a datacenter can create.

Lastly we added six new Fortune 1000 customers to our portfolio, bringing our total to 128 of the Fortune 1000 or equivalent size customers. These Fortune 1000 customers account for approximately 75% of our annualized rent today and as some of these customers ramp this percentage should increase further illustrating our focus and desire to be the preferred datacenter provider to the Fortune 1000.

Turning to slide four, these statistics are consistent with what we shared last quarter and illustrates our consistent focus on our business model. We continue to have a sweet spot from the energy vertical but growth from other verticals like IT has reduced our energy concentration by 400 basis points from a year ago.

Our mix of metered to full service is still roughly half and half but as we expect that we are executing more metered power leases so there is a shift in the total reward, total towards meter power which we expect to continue. We also had another low churn quarter of 1% which ups our growth trajectory as new customer growth is almost entirely additive to the base.

Slide five shows the growth in our customer base from a year ago with total customers and Fortune 1000 customers growing up almost 20% each from last year. Our customer strategy is a simple one. We are focused on attracting and retaining profitable customers. We continue to bring in new names every quarter, growing our customer base and we focus on driving higher levels of customer satisfaction with our existing customers because we know that initially customers only outsource a portion of the datacenter needs.

Once we earn the trust of our customers they continue to outsource more with us. This represents a significant amount of embedded growth at CyrusOne today. In fact growth from our existing customers account for 46% of our year-over-year rent growth in Q3. We continue to see enterprise customers moving more of their business to a digital and Internet-based platform and we are actively helping them accelerate that adoption.

Before I discuss slide six I would like to take a moment to discuss this notion that there is a retail or wholesale datacenter product. Typically our customers are trying to solve a specific datacenter problem. We offer them a variety of solutions and services that meet their space, power, cooling, connectivity, capacity, resiliency and service needs in a timeframe that meets their requirements. Our customers are focused on deciding which applications they need to be deployed at what facilities based on that application’s vacancy requirements and the criticality of that application to their business in terms of resiliency and security.

We spend a lot of time learning about and understanding our current and future challenges which is the genesis of the products that we are developing for the market. Certain edge applications are highly network and latency dependent. Some are high compute applications requiring dense power configurations, some applications are for DR purposes and other important needs.

I have never once had a customer approach me for wholesale datacenter or retail datacenter. Although we discuss our business in this way to help our investor audience understand our company, we do not fundamentally think about the products in this two simple two state way because our customers don’t. In fact pricing varies widely based on the configuration and combination of these factors and many others.

Turning to slide six, we launched two products this quarter as we continue to develop creative new solutions for customers. The CyrusOne marketplaces and innovative products that customers can use to quickly and efficiently identify space and with a few clicks they can reserve the space and be ready to move in. This reduces the time and effort that we spend speaking with them servicing smaller customers. And the customers enjoy it because it makes business simpler.

The other product we launched this quarter is CyrusOne Express. CyrusOne Express is an innovative product because it standardizes a product and streamlines it with a month-to-month contract that is specifically targeted to the do yourself SMB customer who previously has chosen to convert a portion of their office space into a datacenter.

The product is competitively priced and the month-to-month contract ensures CyrusOne will earn their business every day. From a business perspective these products allow us to create new distribution and leasing channels that will enable us to attract more customers and accelerate our growth. Over time as our experience has shown our customers continue to grow with us so we expect that many of these smaller customers can become similar to the large enterprise customers on which we have built the success of our business.

Additionally by leasing these one and two rack configurations we are able to increase the yield of our facilities by leasing the more difficult odd-lot configurations that many enterprise customers do not use. The initial interest in these products has been great and we have already closed a few deals.

The National IX has been a tremendous success in its first two quarters operations in our markets. We have seen many customers that use our platform as second datacenters within the CyrusOne portfolio bringing more of their infrastructure into our family of facilities. As we add in our other U.S. markets to the National IX in 2014 we expect an even stronger volume business supported by this unique platform.

CyrusOne is also a strong supporter of the open IX imitative. We were honored two of our executives serving on the Datacenter Standards committing and the Internet Exchange Standards Committee. OIX is an industry association made up of member participants whose goal is to create an alternative connection point for the exchange of traffic in core markets and eventually edge markets, where pairing traditionally did not take place.

The association hopes to de-central and de-centralize and economize the interconnection of Internet traffic amongst content and [iBall] networks in North America. OIX is not competition to CyrusOne, it is actually a tremendous benefit to our Fortune 1000 client base. As our datacenter and exchange points becomes certified the OIX will bring in more content, cloud providers and networks for our ecosystem.

Given our enterprise focus there is no other provider in the market who we are in competition with that can compare to our platform of services and adding in OIX participation gives those enterprises access to services directly rather than through an intermediary. We plan to seek certification from the OIX board as soon as the standards are finalized in the fourth quarter of 2013 or first quarter of 2014.

On slide seven we discussed the return profile of our portfolio. We take a look across our entire portfolio, our development yield is approximately 17% without excluding properties that have not yet stabilized. This is an increase from last quarter but a decrease from last year which was approximately 20%. This is a result of the significant expansion we’ve made at the facilities, such as Carrollton, Phoenix, our second Houston facility. We expect the development yield of our total portfolio to improve as these facilities continue to lease up.

Excluding facilities that have not yet stabilized our development yield this quarter was 22%. This quarter we wanted to put a quick spotlight on our San Antonio facility where we first commissioned space in July of 2012 and which was fully leased within one year, a full year ahead of plan. By our estimates we expect this faculty to have a stabilized development yield of 15% with which we are very pleased for several reasons.

First, we strategically entered the San Antonio market with a small datacenter to ensure that our read our market demand was accurate, developing a smaller facility resulted in a slightly higher build cost per megawatt than our normal target. We also have lower operating leverage of the smaller facility as certain expenses don’t scale proportionately with the size of the facility. The operating leverage is why we chose to deploy larger footprints in high demand markets to achieve better return through scale.

Secondly we’ve made the strategic decision to lease most of that facility to one customer at a price that is considerably lower than the average across our entire portfolio. We feel this is a good trade off at the speed at which this facility became fully leased and the expected return is still above average compared to other peers in our industry. In addition having a fully occupied and operational facility in a market that strategically is very important from a sales and marketing perspective as it provides customers with comfort that CyrusOne can successfully design, build and operate an enterprise datacenter in particular region.

I point this out because there were some misperception in the marketplace that any real-estate developer can build and operate a he datacenter and convince Fortune 1000 companies to trust them with their mission critical gear. The company would have to sign a lease agreement first in order to begin construction and this approach is far from reality and we’ve seen it across multiple markets. We are only successful after we invest and deliver the product to show our customers that they can entrust their sensitive infrastructure to us. Without a completed product you are just selling waferware and anyone can do that.

On slide eight you will find an update on our portfolio. Despite my wishes [Timmons Rohadios] cannot find 8,000 more feet by the end of the quarter across the one million square foot mark but we’ve got there in October with the second data hall in Carrollton. Our utilization has increased to its highest point in the year to 85% at September 30th. As a reference point our footprint is 24% bigger than it was at the end of Q2, 2012 when it was last at 85%.

This quarter we commissioned the remaining space and power at our San Antonio facility and commissioned 20,000 square foot data hall at our Cincinnati facility in West Seventh Street location. As in this call we now have more than 1 million square feet across our portfolio which is the size of 13 football fields and we are looking forward to passing the 2 million mark in a few years.

Before I hand it off to Kim I want to address the frequent questions I receive regarding Cincinnati Bell’s ownership. As you know Cincinnati Bell owns about 69% of CyrusOne in the form of operating partnership units in common shares worth approximately $850 million at the end of September. And the lock up on their equity expires in January although self-registration for CyrusOne is expected in March. We are in frequent communication with the Cincinnati Bell management team Cincinnati Bell has been consistent in their message that any sale of CyrusOne equity will be carefully balanced with Cincinnati Bell’s need for cash in the current marketing environment.

As the largest stake holder in CyrusOne Cincinnati Bell’s has interest in maximizing value and the balance sheet flexibility to be patient and we expect that they will act reasonably when approaching potential monetization. Their earnings call is tomorrow morning and we would expect that their commentary will be similar in line with ours.

In closing I am very pleased with our growth in financial results this quarter. My team and all of CyrusOne is working very hard to continue this great growth story and I think we are on our way.

I’ll now hand it over to Kim and she will to talk about our financial results in more detail. Thank you.

Kimberly Sheehy

Thank you, Garry good evening everyone and thank you for joining us today. As Gary mentioned we had a great third quarter and I will provide additional color on our financial results. Starting with slide 10 revenue for the third quarter was $67.5 million, an increase of $10.8 million or 19% from the third quarter of 2012. The year-over-year growth was driven by a 24% increase in lease co-location square feet with both new and existing customers. As of the end of the quarter our customer base stands at 598 customers, an increase of 16% over last year. And we continue to receive strong demand from our existing base of customers, which provided 46% of our rent growth. We also added six Fortune 1000 customers in the quarter bringing our total to 128.

These customers accounted for 75% of our annualized rent, highlighting our continued success and focus on the Fortune 1000. We had a record leasing this quarter with approximately 62,000 co-location square feet leased compared to 11,000 in the third quarter of 2012 and 37,000 last quarter. The leases signed were for 12.8 megawatts of power primarily at our San Antonio and Houston West facility, which includes the 5 megawatts from the lease signed in July as announced in our second quarter call. The weighted average term of this quarter’s executed leases was 57 months and approximately 86% were leased to metered power customers. 78% of the new leases had escalators at a weighted average of approximately 2.9% annually.

While we are very pleased with our leasing this quarter, this quarter included several large leases which may not repeat in future quarters. As Gary spoke earlier our pipeline and funnel of future leasing is very robust and CyrusOne is well positioned to succeed. However this quarter was particularly strong and the leasing velocity may not continue at this rate every quarter.

This quarter we focused on reducing between lease execution and lease commencement. In the third quarter we recognized approximately 20% of contracted revenue for leases that were executed during this period. In the fourth quarter we estimate that we’ll recognize approximately 91% of the revenue run rate for lease signed during the third quarter as most of these leases will have commenced by October.

Remainder of the revenue associated with this quarter’s executed leases will be recognized in the first quarter of 2014. It’s important to note that this is partially a function of the specific leases signed this quarter and future commencements may not follow so quickly after signing. With respect to the second quarter’s new leases we recognized approximately 65% of the contracted revenue run-rate in the third quarter and expect to recognize almost 100% in the fourth quarter.

The CyrusOne National Internet Exchange continues to attract new customers and to provide additional value to existing customers. Of the new leases signed this quarter 75% included IX services which increased their monthly rent by approximately 29%. Total interconnect revenue for the quarter was consistent with past quarters at 4.4% of total revenue which is in line with our expectations as the IX product is expected to attract new customers and drive additional colocation leasing.

We expect interconnect revenues will remain in the 4% to 5% range of revenue in the near future. Our revenue churn was 1% in the quarter which compares favorably to the 1.5% churn we experienced in the third quarter of 2012. In the quarter we renewed leases for 8,550 square feet and 2.9 megawatt of power. 94% of these renewals have escalators with the weighted average rate of 2.95%. The renewals in the quarter consist of contracts relating to 16 customers. 14 of these customers renewed at their current level of service and pricing on an average rent per kilowatt basis for these customers remained flat.

The remaining two customers significantly increased their footprint and in turn received volume discount. The first customer a large Fortune 20 customer more than doubled their footprint increasing their monthly recurring rent by 118% and the average rent per kilowatt decreased by 15%. The second customer increased their contractual kilowatt by 56% in addition to the significant increase in their footprint they switched from a full service to a metered power contract. The average rent per kilowatt on the renewed services for this customer decreased by 50%. It is important to note that the rent on the prior contract is inclusive of power. However the rent on the renewed contract does not include power. When our customers increased at this scale their pricing is reviewed and adjustments are made due to volume or product mix compared to their previous rate.

Although the customer may be increasing their monthly rent, their average rent per kilowatt or per foot in some cases decreased. From a return perspective the decrease in rate is offset by higher asset utilization, an extension of their lease term and an increase in their overall data center spend with CyrusOne.

Moving to slide 11, our net operating income was $43.3 million for the third quarter of 2013, an increase of $6.6 million or 18% from the third quarter of 2012. Our NOI margin was in-line with last year at 64%. SG&A expenses were up slightly compared to last year due to higher non-cash compensation and public company cost.

Adjusted EBITDA improved by $6.4 million or 21% to $36.5 million as compared to last year. This quarter is the first quarter in over a year where our adjusted EBITDA growth has exceeded our revenue growth. We’ve been investing in our corporate structure and sales and marketing platform to support our growth and we are now approaching the scale where our adjusted EBITDA growth should be more in line with our revenue growth.

Normalized FFO for the third quarter was $21.9 million, an increase of 44% from the third quarter of 2012. The increase was primarily driven by growth in adjusted EBITDA and lower interest expense as the company is not borrowing to invest but rather using cash from the IPO to fund capital investment. Our AFFO for the quarter was $19.3 million, an increase of 46% from last year.

Slide 12 is similar to the previous slide except that it compares our performance on a sequential basis. Revenue increased $3.9 million or 6% from the precious quarter with NOI increasing by $4.3 million, as property operating expenses were 2% favorable over the prior quarter. This is consistent with what we expected and what I said on the call last quarter. While certain operating expenses such as utilities can fluctuate other costs like payroll facility and maintenance are relatively constant once the facility is brought online.

Adjusted EBITDA margin of 54% was 6% greater than prior quarter as SG&A expenses decreased by $1.2 million from the second quarter of 2013 on lower marketing consulting and legal expenses. We expect slightly higher sales and marketing expenses in the fourth quarter due to the timing of certain marketing events and general administrative expenses in-line with our prior quarters of 2013. Both normalized FFO and AFFO increased by 37% and 30% respectively due to the increase in adjusted EBITDA for the quarter.

On slide 13 capital expenditures were $64.3 million for the quarter compared to $41.6 million last year. Approximately $15 million was spent building out the remaining power and colocation square feet at our San Antonio facility, which was fully leased in only 15 months.

We also acquired 22 acres of land for $7 million to build our next facility in San Antonio. The first data hall in the new San Antonio facility is expected to be commissioned in the third quarter of 2014. We spent approximately $16 million in Houston where our larger projects included adding power to our Houston West 1 facility to support one of the larger leases signed this quarter and finishing construction and power for the first phase of our Houston West 2 facility.

In Dallas we spent approximately $15 million, of which approximately $11 million was related to construction of the second data hall at Carrollton and approximately $2 million was to add incremental power to our first data hall. The second data hall in Carrollton was commissioned in October. Lastly we spent approximately $7 million to add 20,000 co-locations square feet to our downtown Cincinnati facility.

In the fourth quarter in addition to the mentioned completion of the second data hall in Cincinnati we expect to begin construction on our second San Antonio and Houston metro national facilities. We will also begin construction of additional space and power at Houston West 2 and provide additional power to our Phoenix and Carrollton facilities.

Slide 14 shows our net debt and market capitalization, our cash balance has decreased from the end of June by $54 million primarily due to the capital that has been invested but our leverage has held at 2.3 times due to our growth in adjusted EBITDA. We have approximately $438.2 million of available liquidity. On October 15th we paid a cash dividend of $0.16 per share on the company’s common shares and common share equivalents for the third quarter of 2013 which is a dividend yield of approximately 3.4% based on September’s ending stock price.

Slide 15 shows our outlook for the full year 2013. We have narrowed our guidance range for revenue to $260 million to $265 million for the full year 2013 based on executed leases through the third quarter and expectations for the fourth quarter. We will provide official guidance for the full year 2014 on our fourth quarter call. However revenue growth for 2014 will likely be similar to the rate of growth experienced this year. Adjusted EBITDA on normalized FFO per share growth estimates will be provided next quarter as we are currently finalizing our expansion plans for the year.

In closing this was a significant quarter for growth and execution. We continue to add new customers and are on the path to becoming preferred global datacenter provider to the Fortune 1000. This launching of the CyrusOne marketplace is a testament to our innovation as we strive to provide more value to our customers.

Thank you for your time today. This concludes our prepared remarks. Operator, please open the lines for questions.

Question-and-Answer Session

Operator

(Operator Instructions) The first question comes from Stephen Douglas of Bank of America Merrill Lynch. Please go ahead.

Stephen Douglas – Bank of America Merrill Lynch

Great, thanks for taking the question. First one may be for Kim just kind of doing the math on the guidance it looks like you are expecting a step down in margins for 4Q and I know you talked about the increase in the marketing expense but you’ve been looking back to last year it’s a pretty big step down in 4Q just wondered if there is anything seasonal on the cost side that we should be thinking about?

And then second now that we are kind of approaching the one year anniversary of the IPO what’s kind of the best framework for us to use to think about dividend growth from here? Is it FFO growth just may be how should we be thinking about that? Thanks.

Kimberly Sheehy

Thanks, Stephen. In the fourth quarter we would expect some marketing to be higher because there are some events that are seasonally in the fourth quarter. So I think if you look at the sales and marketing expenses, I think it was second quarter of this year and even fourth quarter next year, it’s going to be in that range. As far as the AFFO we’ll clearly be looking at that as we finalize our plans for 2014 but we will continue to look it as a percent of our AFFO. So I think it will be fairly consistent with what we did this year.

Stephen Douglas – Bank of America Merrill Lynch

Okay, great. Thank you.

Operator

The next question comes from Simon Flannery of Morgan Stanley. Please go ahead.

Unidentified Analyst

Hi, this is [Liz] for Simon thanks for taking the call. Can you talk a little bit more about how you are looking at CapEx for 2014 and whether you would considered taking up your leverage a bit to account for any additional CapEx?

Gary Wojtaszek

Sure, well we will give forward guidance at the next earnings call. But I think you should expect capital to be in a consistent range that we have this year. And as far as leverage goes I mean that will naturally increase as our cash on our balance sheet goes away.

Unidentified Analyst

Is there kind of a target ratio that you are looking at?

Kimberly Sheehy

I mean we’ve said many times that 4% to 5% is sort of where we’re comfortable. So we haven’t changed anything on that.

Unidentified Analyst

Okay. Thank you.

Operator

The next question comes from Barry McCarver of Stephens Incorporated. Please go ahead.

Barry McCarver – Stephens Incorporated

Hi, good afternoon guys and great quarter.

Kimberly Sheehy

Thanks.

Gary Wojtaszek

Thanks.

Barry McCarver – Stephens Incorporated

Kim back to the question real quick on the dividend. When you say similar to what are doing now I am assuming you meant a percentage payout of AFFO, is it the way to think about modeling the dividend going forward, is that right?

Kimberly Sheehy

Yes, that is what meant.

Barry McCarver – Stephens Incorporated

Just wanted to clarify that. So Gary I know you hate talking about pricing so I am not asking a specific question but you pulled out several large customers you signed during the quarter and of course the one that went live. I am just curious it looks like pricing probably held up pretty well may be even was up a little bit. Any comments around kind of the directionally what you are seeing from pricing and demand?

Gary Wojtaszek

Yeah, it’s been pretty much unchanged. If you look at the price for each of the products that pricing for the product is basically unchanged. The only difference is that our mix is getting skewed more towards the larger deals which come at a lower price. So from a mix perspective you will see some pricing degradation but all-in-all if your denominator in this quarter is, in terms of like square footage or sold versus the revenue that we generated on that you mean our all-in margin, I mean all-in prices held up really well.

But the one thing I did point in my commentary about the San Antonio facility so one customer did take down 20,000 square feet and currently got a better deal. That lower price that we offered them was basically responsible for taking our return margins there down to 15%. So 15% is still I think an industry leading type of return metric but the lower pricing that we afforded that one customer as well as a fact that, that was a sub scale facilities we are not hitting our cost per megawatt metrics there I mean we delivered that for slightly over $7 million. We are targeting below that in our scale facilities, and that was the reason for the 15% return on that facility.

Barry McCarver – Stephens Incorporated

And then looking at that table breaking out your top 20 customers I noticed that your largest customers was up quite a bit in annualized rent again this quarter you mentioned adding I think 20,000 square feet to the Cincinnati datacenter. Anything to read into that, is that a bigger step up for that customer?

Gary Wojtaszek

No, there was no change at all in that customer.

Barry McCarver – Stephens Incorporated

Okay, that’s my question. Thanks a lot guys.

Gary Wojtaszek

Okay.

Operator

The next question comes from [Tio Okosania] of Jefferies. Please go ahead.

Unidentified Analyst

Hi, good evening. Also let me add my congratulations on a great quarter. Quick question, could you just discuss a little bit about the overall backlog and leases that have been signed and haven’t commenced how much that is and I know you talked a little bit about some of the stuff you signed in 3Q how it’s going to show up in 4Q and also in 1Q of ‘14. But is there any other kind of piece of the backlog we should be thinking about and how that would expect that to show up in 2014?

Gary Wojtaszek

Yeah basically of the deals that we signed in the first quarter 20% of those began earning revenue for us through the end of the third quarter, 90% of those deals will begin revenue recognition for us at the end of the fourth quarter this year and the other 9% or 10% will go through probably by the first quarter of ‘14.

As for the deals that closed last quarter just about all of that, I think may be 20% is left is going to get recognized in the fourth quarter of this year. And so I guess that’s where you are talking to how that will flow through. In terms of more broad, what we’re looking at from a market perspective our funnel remains just as strong as it was last quarter I mean we are still sitting on a really, really healthy pipeline.

We are getting a number of different opportunities to talk with customers that we’ve never really spoken to previously. So we feel really good about where we’re sitting from a sales and marketing perspective.

Unidentified Analyst

Okay. But is there would you get like a dollar figure around the backlog and kind of some sense of how that going to roll into 4Q and as well as 2014?

Gary Wojtaszek

I don’t think we’ve provided that. But it was a record quarter, it was very good.

Unidentified Analyst

Okay. Then Kim I just want to clarify a comment earlier on where you guys are not providing 2014 guidance yet but I believe you made comments in revenue growth in ‘14 you would expect to be on a similar trajectory as 2013 is that correct?

Kimberly Sheehy

That’s right.

Unidentified Analyst

You would expect the kind of like high-teens type revenue growth in ‘14 as well?

Kimberly Sheehy

That’s right.

Unidentified Analyst

Okay. That’s helpful. And then one more for the road, the legal charge in the quarter could you tell us what that was about?

Kimberly Sheehy

Sure there was a lawsuit that we had against a former employee that went back several years, that finally came to head this quarter there was an arbitration and other things that went on that’s where legal expenses. That is now completed and we got a ruling or whatever it is call that the arbitrator provides. And so that is what that’s related to.

Unidentified Analyst

Okay.

Gary Wojtaszek

We had a favorable rolling on that for about $12 million.

Kimberly Sheehy

All right. I wasn’t going to say that.

Unidentified Analyst

Well I guess it was a worth that than. All right, that’s it for me. Thank you.

Gary Wojtaszek

The other legal charges in there that was also associated with diligence work that we have performed on a larger sale lease-back transaction with a large corporate which we’re seeing more and more of and that was something that ultimately we decided was not in our best interest to pursue and that’s the other portion of those expenses that you’ll see in there as well.

Unidentified Analyst

Got it

Kimberly Sheehy

So just to clarify on that the settlement that he is referring to we did, he is right but we’ve not received anything and there is nothing recorded for any kind of gain on that or anything.

Unidentified Analyst

Yeah got it. Thank you.

Operator

The next question comes from Vincent Chao of Deutsche Bank. Please go ahead.

Vincent Chao – Deutsche Bank

Hey guys. Just wanted to go back to the guidance here on the CapEx side that went up a little bit from last quarter the in-progress pipeline is down a little bit in terms of total investment but then you talked about a few projects that are going to start in the fourth quarter, I think it was some additional space in tower in Phoenix and Carrollton, Houston West and then also the San Antonio facility. I was just wondering if you could provide a little bit more color around the size of those projects and what the total investment expected is at each of those projects.

Kimberly Sheehy

Sure I don’t think the total of the guidance changed. We did recast it a little bit in the categories that it was being spent in but we kind of [clapped] – I think we clapped the land we kind of just made it....

Vincent Chao – Deutsche Bank

Okay. Yeah that is going to answer the 20% to 35% there is land acquisition so that just got rolled into CapEx.

Kimberly Sheehy

Yeah, I am sorry if we did not give it here, but...

Vincent Chao – Deutsche Bank

So no change there, okay. Well, I guess could you also just provide some additional color then on just the total expected investments on those additions?

Kimberly Sheehy

Yeah I don’t really have specific dollars here per project but the large part of that will be finishing the data hall that came online here in October. Most of that was not paid for in September. And then we have the projects we are talking about in Houston that are in the kind of the design space. So those won’t be large but I mean I think the guidance that we’ve provided on CapEx is still good. You should expect thus to turn back that on either improvements but in additional power build cap the square footage that’s coming on and/or the designs and prepping for the new projects that will be going on next year.

Gary Wojtaszek

The 250 total number is a good number basically all the incremental spend that we do in the fourth quarter is going to be for development.

Vincent Chao – Deutsche Bank

Okay. Then on the revenue guidance just the top end got brought into just a little bit there $5 million but EBITDA guidance is the same. Just curious what if any impact is coming from sort of leasing activity expectations versus may be the mix of full service versus meter power and may be some tenant reimbursement revenues that may be come in later if you are saving money on OpEx just trying to get a sense of what drove that?

Gary Wojtaszek

Yeah I mean what just drove it is just time right we are smarter now than we were at the beginning of the year and we got more insight in terms of what we call as an anniversary quarter. So I mean we are feeling pretty comfortable where we sit today, that we delivered that our EBITDA’s good and as Kim mentioned we feel good about next year as well.

Vincent Chao – Deutsche Bank

Okay. And just last question for me just in terms of the initiatives that you guys talked about you announced some inter quarter but you just talked about here today, on the CyrusOne Express with the month-to-month leases just curious I know it’s early days but how much of the portfolio do you think you would be willing to have on a month-to-month. Obviously you would like to convert them to longer term I would think but this sort of getting into the door but just curious how much of the portfolio do you want to commit sort of this month-to-month part?

Gary Wojtaszek

Well I mean our approach there is how do you attack a section of the market that is very reluctant to outsource today. And that section of the market is really large I mean if you look at I guess where you were right and you look at all the buildings that you are next to Downtown Manhattan and each one of those skyscrapers has probably 20,000, 30,000 square feet of easily collective datacenter space in each of those buildings.

So when you look at of that there is a tremendous opportunity to kind of dislodge that. And the way thought about this product is how do you make this as least risky as least evasive as possible, because what you are trying to sell against is free. And free being that the way they look at this is the third data center today that’s housed in that office building is essentially costless too.

And I know that doesn’t make any sense right even on a phone you are all smart financially savvy investors. However the IT director that’s running that deployment in that office building sees it as essentially free. Because he is not really properly allocating the cost on expenses associated with his IT gears, electricity clauses, power, cooling all that stuff. So what we thought about this product what we’re trying to do is saying how do we make this easy. So we want to price it as a very competitive price point to basically competing against free and we also from a contractual perspective want to take away that.

The other biggest furlough that that these guys have is that the risk of the unknown, the risk of signing up for a five or 10 year contract, and not know what’s going to happen in their business. And so we’re focused on having new contract there because we want them to really understand, we want to earn the business every day. We want to basically show them that they could move out at any point in time and the onus is on us to basically provide them a great level of product and service and make sure that they don’t do that.

In answer to your question, what you will see over time is that as customers become comfortable with that product, they will absolutely want to go in longer term contracts because they are going to be scared that we also have the ability to not renew that contract every month and our hope is that eventually as they become comfortable with us as service providers and we establish a really good relationship with them that they will act and feel like every other large enterprise customer that we deal with and we want the security of the longer term commitment as well as with an SLA.

In those contracts that we’re providing to those folks we’re not giving them an SLA. We’re giving them a very different product than we would do with our different enterprise company. And the reason for that is the product and services that we’re wrapping around that are very different than what we offer our premium customers. And eventually we expect that they will morph and they will grow into same type of contract as an enterprise customers will. And so over time we would expect that many of those folks would sit in that month to month contract because it’s very risky for them to do so.

Vincent Chao – Deutsche Bank

Okay, thanks.

Operator

The next question comes from Frank Louthan with Raymond James. Please go ahead.

Frank Louthan – Raymond James

Great, thanks. So following up on the last detail on slide six there is a couple of new sales verticals there, how are we going to be approaching that from a market, how are you selling the Express product and the other products? What’s going to be different from your sales approach? Then over time how do you expect to factor the Express customers in the churn? Is that going to be a separate category? Do you think they’re going to churn at higher rates just given their size, how should we think about that?

Gary Wojtaszek

Good question. So this was specifically set up as a way to high volume low customer touch transaction sales as we intend to satisfy through an internal call center type center where we can close a lot of these deals, get them in and so our contract on this is really clean. We’re just going to show our space here it is we got it. Here’s a contract, give us a check you are in and you start deploying.

So the whole goal here is not that we’re going to be tying up a lot of our internal resources on closing these deals but it does give us a lot of touch points with customers. So if you went on online on our website you can go through the tools, you can pick that space and you can get it all handled and you can be up and running in a day. So it’s rather quick.

Frank Louthan – Raymond James

Okay. And what’s the difference between sort of the SMB target market and the Express product, can you give us in terms of targeted floor and sort of what’s the cut-off point where you might push somebody to those smaller products?

Gary Wojtaszek

Yeah, so there is two things so the marketplace tool what that is and that’s kind of like equivalent to ordering your airline seats on Expedia. Right it’s a an ability to kind of use an interface that’s easy to use and convenient, kind of quick through and get that space. So that’s more of the marketplace is more of like a tool type concept. The Express is a separate product line associated with pre-determined packages of different parts of the solution there, that we will sell at different price points, there is no negotiation, there is no change, there is no offering, there is no customization.

And that is targeted, that one is targeted at the small SMB type customer, that’s looking for a low cost easy to use solution. So the marketplace product is something that eventually we expect that we’re going to be offering different types of services and products in the marketplace and it’s kind of just the online front end tool to make business with us easier. The CyrusOne Express is like a product line offering this is our first quarter into this.

Frank Louthan – Raymond James

Great, thank you.

Operator

The next question comes from Jonathan Schildkraut with Evercore. Please go ahead.

Jonathan Schildkraut – Evercore Partners

Great, thanks for taking the questions here. Three if I may. The first is in terms of the activity in the quarter, in prior quarters you sort of talked about building up your indirect channel as well as building up your internal sales and just wondering, where you came out in the quarter in terms of those two sales channels and how we should think about your delivery to market going forward?

Second question has to do with your Interconnect product or your IX product rather, based on our channel check there is a pretty big difference between what you guys are doing with your connectivity between datacenters and what some of the other peers are out there doing although sort of getting bucked into the same group and I was wondering if you might take a minute and sort of distinguish the two products?

And then finally on the small and medium business product that you just been discussing, I was just wondering how you bill in for that, how you are sort of de-risking it from a credit perspective, are you taking an upfront payments to hold or you are billing in advance? Thanks.

Gary Wojtaszek

Sure, let me take those in kind of let me go three, one and two. As a special guest speaker today we have Josh Snowhorn, who is here who runs the IX business. And he can go into detail about that. So let me take these in reverse order then at the end of this I’ll hand it over to Snowhorn and he can give you his insight.

So in terms of the SMB product and how do you handle that from a credit perspective, so yeah we get an upfront check from the folks a month in advance and they pay us upfront. So we kind of minimize it that way. But the way we are seeing so that if you look at our churn profile I mean we were talking about this kind of [California] for a long time now and that Hotel California is still in effect. Once customers check in they don’t leave and as long as you provide them with a great quality product and a good level of service and commitment to them they just continue to be your customers for years and they grow.

So we don’t, so we’re not overly concerned about the credit exposure here, particularly because at the end of the day I mean the reality is this is never going to be like a huge part of our business. We expect that is going to be a fairly small amount of our business but it just gives us another opportunity to establish another channel which is really important.

In terms of your other question on the breakdown for the indirect channels I don’t have the specific breakdown for the quarter in terms of what deals close and which but what I can say is that we have added more customer or more partners to that ecosystem. We didn’t put it on this call because we’ve been talking on the last couple of and a lot of people said my push on the speech was too long today. So that was one of the things that we cut out but if there is interest in that we will report that information. We signed up more channel partners and we’ve signed up some more customers through that. So Kim do you have specifics?

Kimberly Sheehy

Not by channel, we know that it’s about 50-50 from direct and partners and channels, for the quarter.

Gary Wojtaszek

Well so everyone got that so 50-50 roughly speaking in terms of the deals that we closed this quarter came through indirect and the other 50 was on a direct basis. So then the last question that you had Jonathan was the IX product. And I will turn it over to Josh Snowhorn and he can give compare and contrast in terms of what we’re doing versus what some of the other competitors are doing. And by way of background Josh has been with us for almost two years now. Previously he was with Terremark. He was one of the employee number five or six at Terremark. So we are really happy to have him join the party at CyrusOne here. And he can give you an overview of our product offering.

Josh Snowhorn

Hi, Jonathan. So the CyrusOne Internet exchange is really an ecosystem platform that is designed to allow our enterprises to interconnect to carriers and cloud service providers across the metro markets where we have enabled including Dallas, Houston, Austin San Antonio and Phoenix as well as new markets we’re bringing on next year in 2014 plan.

The idea is that these enterprises might want a specific carrier or specific partner and they can them closely within our datacenter. In addition we have services interconnecting our datacenters using our carrier partners city-to-city using either optical waves or MPOS as well as our IP product which is used by very large percentage of our customers. And comparing that other entities large providers like Equinix are Terremark are going to have a single site Internet exchange where they just have partners interconnect [unit] across chassis within the facility. And we’re seeing some of the other competitors in the industry coming up with metro dark fiber options or cross connect services. But really nobody doing anything like we’re doing.

The only thing that might be similar is the Open-IX initiative but that’s actually being enabled by Internet exchange partners European operators, sometimes multiples in the same market and it’s going to be interesting to see how they succeed as they bring on new peers. It’s really a benefit of multiple providers on that platform. The more you have, the more you succeed on that platform.

Jonathan Schildkraut – Evercore Partners

Thanks, Josh.

Gary Wojtaszek

Yeah just the one thing I mean just to kind of add a little further color to what Josh was saying and I am not nearly as technical as him. But from a simple perspective what we’re basically trying to do is create a virtual datacenter platform that interconnects all of our datacenters together which basically then is enabling us from replicated datacenter platform that all of the Fortune 500 companies have built over the last two or three decades.

So all of the Fortune 500 companies generally have at least a three datacenter architecture solution whereby they put their key applications in one of those three facilities and they transfer data back and forth depending on the latency requirements of the application as well as the criticality of the application and the DR of benefits. What we’ve done there is basically by connecting all of our facilities together, we’ve enabled our connectivity solutions to be just as robust as none of our solution as our, as our datacenter assets are.

This is completely unique in the industry. No has done this, no one is thinking about the business this way. What we’re trying to do in this effort is bring the same economies of scale that we’re doing on the infrastructure datacenter side to the connectivity solution.

Because if you look at some of Cisco’s recent forecast what you are going to see is that the datacenter to datacenter transport as well as the inter-datacenter connectivity is going to be growing at ridiculous CAGR, 60% or 80% CAGR over the next several years. And so while we feel really good about the benefits of the broad growth in the datacenter outsourcing trends, the shift towards interconnectivity, interconnectivity solutions of this is probably going to be even a faster growth. And it’s the number two cost that all enterprises incur when they look to outsource.

So the number one is the cost associated with the datacenter and next cost is the associated cost with connectivity. And I think there is some more Internet proverb out there this says a datacenter without connectivity like a car without wheels and that’s a proverb that we subscribe to.

Jonathan Schildkraut – Evercore Partners

Thanks for the extra detail.

Gary Wojtaszek

Sure, Jonathan.

Operator

The next question comes from [Tio Okosania] of Jefferies. Please go ahead.

Unidentified Analyst

Hi, guys just a quick follow up question. I think we kind of, most of us have a fairly good handle on the Texas market but I think some of us are still struggling with Cincinnati, hoping you could just kind of give us an update on that overall market and what you are kind of seeing in Cincinnati?

Gary Wojtaszek

Sure I mean look Cincinnati we just killed it there right. I mean, my goal would be ideally if we could replicate the success that we’ve had in Cincinnati in the other markets that we compete in we would be just phenomenally successful. We’ve got about 400,000 square feet of datacenter space in Cincinnati, that’s twice as big as our next largest markets. So we’ve got phenomenal market share there.

The reality is that the pace of relative growth there is relatively small, I mean we’ve got such a big dominant market share position that we’re growing at a slower pace than we are in the rest of our portfolio. So you just saw recently that we built out 20,000 square feet of space in our Downtown facility. So I wouldn’t expect that on a go forward perspective that you should assume that there is going to be any significant growth in the Cincinnati market. So when you do your remodeling you should assume that, that’s going to grow at relatively lower rate of growth. Most of the growth that we’re talking about percentage wise is going to be in the other newer markets that we’re in rather than in the Cincinnati area.

Unidentified Analyst

But what are kind of – what are price point, what is pricing kind of thought like in that market, where is the demand coming from?

Gary Wojtaszek

Yeah, the pricing there is basically the same but if you look at some of our disclosures in there you also have to look it from a perspective of some of these things, particularly in some of the Seventh Street buildings if you do some quick math they you will see average pricing in there are significantly lower and that’s because we’ve got some customers in there that are been there for 20 or so years that are really kind of using very, very old datacenter space that comes with really low cost.

But that market is the same as elsewhere I mean the price per kilowatt per foot is pretty much inline everywhere. I mean to the point where we feel comfortable with customers, offering them complete flexibility and capacity across our portfolio.

So earlier in the year, Tesh who joined the party last year came up with his idea of this Pass-Port concept so its CyrusOne Pass-Port and what that is that it enables customers to get bigger block purchasing of capacity where they can basically satisfy their needs across anyone of our datacenters in the portfolio. And so that Pas-Port product is something else that we’ve been selling and that’s also been something that’s been pretty well received by the market as well.

Unidentified Analyst

Great, thank you.

Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Gary Wojtaszek for any closing remarks.

Gary Wojtaszek

Thank you everyone for taking the time to speak with us. Today we’re really excited about the quarter’s results and look forward to bringing in the year and our next earnings call with you all. Thanks a lot and have a nice Thanksgiving. Bye.

Operator

The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.

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