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CyrusOne Inc (NASDAQ:CONE)

Q1 2014 Earnings Conference Call

May 7, 2014 5:00 PM ET

Executives

Anubhav Raj – Vice President-Treasurer and Investor Relations

Gary J. Wojtaszek – President, Chief Executive Officer and Director

Kimberly H. Sheehy – Chief Financial Officer and Treasurer

Analysts

Stephen W. Douglas – Bank of America Merrill Lynch

Jordan Sadler – KeyBanc Capital Markets, Inc.

Tayo T. Okusanya – Jefferies LLC

Colby A. Synesael – Cowen & Co. LLC

Lisa Lam – Morgan Stanley & Co. LLC

Vincent Chao – Deutsche Bank AG

Barry L. McCarver – Stephens, Inc.

Frank G. Louthan – Raymond James & Associates, Inc.

Operator

Good afternoon, and welcome to the CyrusOne First Quarter 2014 Results Conference Call. All participants will be in a listen-only mode. (Operator Instructions). Please note this event is being recorded.

I would now like to turn the conference over to Anubhav Raj. Please go ahead.

Anubhav Raj

Thank you, Amy. Good evening, everyone, and welcome to CyrusOne’s first quarter 2014 earnings call. Today, I’m joined by Gary Wojtaszek, President and CEO; and Kim Sheehy, CFO. Before we begin, I would like to remind you that our first quarter earnings release along with the first 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 contains 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 Investors section of the company’s website.

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

Gary J. Wojtaszek

Thanks, Raj. Good evening everyone and welcome to CyrusOne’s first quarter 2014 earnings call. I am excited about all that we were able to accomplishing the quarter with record leasing, the launch of a new product CyrusOne Solutions and continued progress in expanding our targeted Fortune 1000 customer base.

I’ve mentioned before that it wasn’t that long ago, while we were proud about leasing 50,000 square feet in an entire year. And we just double that in a single quarter. We continue to see strong growth across the board on all of our key metrics. I believe we’re well positioned to have another great year.

As we continue to execute on our strategy and most importantly keep our focus on the customer. As always I want to thank all the team members at CyrusOne who I have the pleasure of working with every day, and who make this a really fun and enjoyable place to work, and who provide a great level of service to our customers. That continues to contribute to our success. Last quarter we introduced a framework that summarizes what we think drives growth for CyrusOne, and ultimately enables us to deliver value to our shareholders.

After I head on some of the highlights for the quarter, my discussion will be focused on the business and the context of these growth drivers. Afterwards Kim will discuss our quarterly financial results in more detail.

Beginning with slide 3, you can see the CyrusOne continues to deliver great financial performance. Our first quarter revenue was up 29%, compared to the first quarter of 2013. Normalized FFO and AFFO were up 58% and 57% respectively over the same period of last year. And adjusted EBITDA was up 32%. We also launched CyrusOne Solutions, our new product line tailored to delivering customized solutions to customers that require a large scale and cutting-edge deployments. I will talk more about this later. We leased 100,000 colocation square feet in the quarter, including 41,000 square feet with a custom CyrusOne Solution build at our Phoenix location.

Two quarters ago, we hit an important milestone with 1 million square feet of space available on our portfolio, and more importantly in this quarter we crossed the 1 million square feet of sold space. Finally, we added six new customers. Six new Fortune 1000 customers bringing our total, as of the end of the quarter to 135.

Turning to Slide 4, I just wanted to remind everyone of the elements of our strategy that have been responsible for CyrusOne strong growth and for enhancing value to our shareholders, and what we expect to continue to be responsible for our growth resulting shareholder value going forward. These drivers include expansion by our existing customers, acquisition of New Logos, development of new channels and products, and portfolio expansion. Over the next few slides, I’ll talk about our progress in each of these areas.

Moving to Slide 5, the first key growth driver is our existing customer base, which continues to account for a healthy percentage of our year-over-year growth in annualized rent. We have a high quality customer base which includes 135 Fortune 1000 companies, representing approximately 74% of our annualized rent. The energy vertical continues to generate approximately one-third of our rent. Lastly, we have a good mix of metered power and full service customers. Our rent mix continues to shift towards longer term medium power leases as customers grow with CyrusOne and increase the size of their deployments.

Turning to Slide 6, new customers are our second key growth driver. Our overall customer base has increased to 630 as of the end of the first quarter, a 14% increase over last year. We made a lot of progress going on core Fortune 1000 customer base this quarter adding six new logos pushing our total to $135, which is a 13% increase from last year.

Fortune 1000 companies form the core of our customer base and getting them in the door represents a significant opportunity for us Fortune 1000 companies are often coming into our facilities with initial deployments representing just a portion of their overall needs. It can take a long time to convince these CIOs to entrust the third party provider with our mission-critical IT assets. We are completely aware of this and work diligently to alleviate any concerns that CIO may have in letting go of any perceived control over their critical assets.

One way we do this as ensuring we employee industry leading standards to protect these assets. Of that note I wanted to mention that we added to our existing list that physical and information security certifications recently receiving the globally recognized ISO 27001, information security certification at 18 of our data centers. The physical security that we provide to protect these service and data we house in our facilities is top notch, and this certification formally recognizes it.

As these companies dip their total to the water and experience the security first hand and exceptional customer service that CyrusOne provides. They become more comfortable moving additional components of their IT stack into our facilities. An added benefit for us is that as a potential customer sees that we have done this 135 for Fortune 1000 companies. They gain comfort knowing that CyrusOne understand their service needs in the critical nature of the assets they are seeking to place in our facilities, making them more comfortable in selecting us.

I want to talk a little bit more on the next slide, especially about one area of customer growth in particular that we receiving.

Moving to Slide 7, while we continue to see strong demand from Fortune 1000 enterprises, we have also added more than 25 cloud providers in the past year. This is a group we had never really pursued before, but that is now attracted to our facilities and the ability to sell their services to 135 as the largest enterprises in the world.

As we’ve discussed before, our enablement platform for the Cloud, which we refer to as the Sky for the Cloud, provides a home for the Cloud in our facility. As we continue to add Cloud vendors along with network and content providers in our core base of Fortune 1000 enterprises, we can create an ecosystem to which everyone is working together in mutually beneficial relationships.

Multiple locations are been tide together with our National IX platform, while the 60% of our revenues attributed to customers that have multi site deployments. On the topic of the Cloud I want to briefly touch on the question that I get from time to time as to whether this potentially represents a threat to CyrusOne.

It can take years to convince a CIO to entrust us with their gear, and all that we are providing is space, power, core and connectivity. We believe it is highly unlikely than enterprise is suddenly going to deploy the majority of their applications many of which are critical to their core business in a public cloud environment. Clearly companies are evaluating, which components of their IT stock makes sense to migrate to the cloud, such as test from development applications or non-critical mass storage.

The explosion of data and consequently the growth in data center requirements are absolutely staggering. For example, 90% of the data that exists has been created over the past two years. There are many more similar statistics that underscore the growth of data and our representative of the information age that we live in today.

When we combine this with the acceleration of outsourcing by enterprises CyrusOne stands in a very strong position to capitalize on this growth, and I envision that continuing to increase the amount of business we directly do with our customers. CyrusOne also recognizes that there will be certain non-core applications that a public or hybrid cloud maybe the most appropriate environment for. The leases with our cloud providers are allowing CyrusOne to also benefit from the growth in cloud as these environments ultimately reside in the same data centers.

Moving to Slide 8, the third key growth drivers new channels and products as I mentioned earlier we’re excited to announce the launch of CyrusOne solutions our new product line tailored to solving unique customer requirements for large-scale and cutting edge deployments of mission-critical IT assets through innovative engineering solutions

Customers can use either their own design or work with CyrusOne’s experienced design team to build a customized solution. The product leverages the expertise of our team in delivering creative solutions for projects ranging from 30,000 to 100,000 square feet of raised floor to an entire green field data centre build. It was created response to the growing number of request we have been receiving for large-scale and innovate, built-to-suit deployments. We can offer the flexibility and engineer solutions on a range of power densities and resiliency levels with robust connectivity options to meet their specific business requirements.

CyrusOne Solutions highlights our technological progress such as the ability to deliver high-performance compute solutions, like the geophysical computer setting of excellence at our Houston West campus, which has ultra-high density infrastructure supporting up to 900 watts per foot. As I mentioned earlier, in the first quarter we completed 41,000 square feet data hall build at our Phoenix location, here we delivered an environment that supports specific requirements for customers deployment that uses liquids submersion technology to achieve remarkable power efficiency.

The customer do not require the same resiliency as traditional deployment. One of the key engineering challenges we were presented with was how to achieve the lowest operating expense possible for the customer. Our engineering teams work closely with the customer and suppliers to determine the most economical way to produce a solution that provided the required resiliency without wasting any dollars on unnecessary resiliency. As a result we were able to deliver the environment for less than $1.5 million per mega watt as we have stated in the past we deliver environments that support data center requirements at multiple resiliency levels.

Each of these builds as a different level of capital investment and when we evaluate pricing for a specific deployment we take into account the amount of investment as that is an important factor and allowing us to achieve our target IRRs and development yields. We’re currently exploring a number of opportunities with customers as we offer a variety of creative solutions to meet their needs for large scale deployments of mission-critical gear.

Turning to Slide 9, the final growth drivers portfolio expansion as I’ve said before, we achieved strong consistent yields in no small part, because of the way we engineer our product and the speed at which we deliver it. Once we have constructed a power shell, the incremental cost to build it out drops significantly. We estimate that the cost per megawatt for incremental build is approximately 30% lower than our average cost of build due to upfront investments for the shell of land.

Given that we’re able to construct a data hall within 12 weeks to 16 weeks we can respond to demand signals on a just in time basis, which ensures that we minimize the amount of capital we are investing.

As the slide shows, our unlevered development yield has consistently been in the high-teens, each of the last six quarters. We’ve been able to maintain the yields at these levels, even as we continue to invest substantially in growing the business. Our current development yield of 18% is identical to our development yield from six quarters ago, despite a 32% increase in capital investment which we did without any acquisitions, on the stabilized property in the portfolio we are generating a 22% unlevered development yield. I also want to remind everyone that the significant operating leverage associated with our business when we bring a new facility online we will often see a dilutive impact on our overall margin as revenue does not cover fixed operating cost.

However as we continue to lease up a facility and add data halls we benefit from high operating leverage which is why we chose to deploy larger footprints and high demand markets to achieve better returns through scale.

The scale benefit is also evidenced in our SG&A expense which improved 300 basis points on an expense per revenue basis versus last year. To close I am very pleased with our accomplishments in the first quarter, we are continuing to deliver on our financial and operational objectives and I feel really good about that momentum we have generated. Given the strong execution solid business fundamentals and low average we are well-positioned to capitalize on a number of attractive opportunities to maintain our current growth trajectory. Given all these factors I cannot help, but notice the significant discount our stock is trading relative to the broader universe and industry peers on a forward EBITDA multiple basis. We are focused on executing our plan, and in time if we continue to execute I believe the valuation will take care of itself.

I will now turn the call over to Kim, who will provide more color on our financial performance and speak to our outlook for the remainder of 2014. Thanks.

Kimberly H. Sheehym

Thank you, Gary. Good evening everyone, and thank you for joining us today. As Gary highlighted, we have carried strong momentum into 2014, which is reflected in our first quarter financial results.

Continuing with Slide 11, revenue for the first quarter was $77.5 million, an increase of $17.4 million or 29% from the first quarter of 2013. The year-over-year increase was driven by a 34% increase in leased co-location square feet and additional IX services with both new and existing customers contributing significantly to our growth.

Similar to prior quarters existing customers contributed 55% of the year-over-year increase in annualized rent. IX revenue continues to be approximately 4% of total revenue as IX services continue to drive additional co-location revenue. As Gary said, we had a record quarter in which we leased 100,000 co-location square feet including the custom deployment of 41,000 square feet at our Phoenix location.

The leases signed in the first quarter were for 16.1 megawatts of power, primarily at our Dallas, Houston West and Phoenix facilities. Based on square footage, approximately 93% was leased to metered power customers with executed leases having a weighted average term of 64 months.

Excluding the CyrusOne Solutions lease in Phoenix, 72% of the new leases have escalators at a weighted average annual rate of approximately 2.7%. Including estimates of pass through power charges, the leases signed this quarter represent approximately $27 million of annualized contracted revenue.

Excluding estimates of pass through power the annualized contracted revenue was $18 million for leases signed during the quarter. In the first quarter we have recognized approximately 19% of contracted revenue for leases that were executed during this period. We estimate that in the second quarter we will recognize approximately 74% of the contracted revenue run rate for leases signed during the first quarter, with the remainder being recognized by the third quarter.

For leases signed during the fourth quarter of 2013, approximately 96% of the contracted revenue run rate was commenced by the end of the first quarter. Our revenue churn in the first quarter was 1.3%, in line with the churn rate in recent quarters. In the quarter, we renewed leases for 15,500 square feet and 1.7 megawatts of power.

Moving to Slide 12, net operating income of $49.8 million for the first quarter of 2014. An increase of $9.8 million, or 25% from the first quarter of 2013. Our NOI margin of 64% was down 3 percentage points from last year, in large part driven by higher electricity usage and rates compared to the first quarter of 2013.

Adjusted EBITDA increased by $10.2 million to $41.7 million, up 32% from the last year, driven primarily by the increased in NOI. The 2 percentage point increase in the adjusted EBITDA margin is a result of selling, general and administrative expenses declining as a percentage of total revenue. These expenses represented 13.3% of revenue for the first quarter of 2014, down 2.8 percentage points from the first quarter of 2013.

Normalized FFO for the first quarter was $27.2 million, or $0.42 per share an increase of 58% from the first quarter of 2013. The increase was primarily driven by growth in adjusted EBITDA. Our AFFO for the quarter was $27.5 million also $0.42 per share, an increase of 57% over the first quarter of 2013.

Slide 13 compares our performance on a sequential basis. Revenue increased $5.2 million or 7% from the previous quarter, with NOI increasing by $1.8 million and property operating expenses were $3.4 million higher compared to the prior quarter.

The 2 percentage point decrease in the NOI margin is driven primarily by an increase in property tax assessments for the capital deployed in 2013, as well as an increase in electricity usage and prices. The adjusted EBITDA margin of 54% was down 1 percentage point from the fourth quarter driven by the lower NOI, partially offset by flat selling, general and administrative expenses excluding non-cash compensation expense.

Normalized FFO increased by 15% primarily driven by higher adjusted EBITDA, AFFO increased by 32% or $6.7 million during the same period primarily driven by higher adjusted EBITDA and lower adjustments for leasing commission and reoccurring capital expenditures. It is important to note that in this quarter leasing commission and recurring capital expenditures were significantly below recent trends, a total of $2.6 million lower than in the fourth quarter due to the timing of cash payments. We expect that in the future quarters these categories will be more in line with prior trends.

Slide 14, shows a market level snapshot of our portfolio as of the end of the first quarter in 2014 and 2013. Utilizations up 8 percentage points compared to last year even with a 23% capacity increase, reflecting particularly strong demand in our Texas and Phoenix markets.

Utilization also increased 4 percentage points sequentially despite a 7% increase in capacity. New data hall is commissioned in Phoenix and Houston in the quarter. This was primarily driven by the CyrusOne Solutions custom build in Phoenix, as well as the lease up of the new 60,000 square foot data hall, at our Dallas facility that was commissioned in the fourth quarter.

Capital expenditures in the first quarter were $49.7 million compared to $52.6 million last year. During the quarter, we completed the construction of 37,000 square feet of raised floor and added 6 megawatts of power capacity to our Houston West Two facility.

In Dallas, we are essentially sold out of our current inventory based on strong first quarter leasing. And have begun construction on the third data hall in our Carrollton Facility. We also recently completed our power capacity addition to our second data hall at this location.

In Phoenix, we constructed the CyrusOne Solutions custom data hall for our customer and lastly in San Antonio we begun construction on our second facility, a project we expect to complete in the second half of 2014.

Slide 15, shows our net debt and market capitalization as of March 31. Our cash balance was $25.2 million, a decrease of $23.6 million from the end of December. The decrease in cash was primarily driven by investments of capital in the business. Our net leverage is currently at 2.5 times annualized first quarter 2014 adjusted EBITDA the same as our net leverage as of the end of 2013. As of the end of the first quarter, we had $350.2 million of available liquidity to fund our growth plans.

On April 15, we paid a quarterly cash dividend of $0.21 per share on the company’s common stock and common stock equivalent, which is an annualized dividend yield of 4% based on the March 31, closing stock price. We have also announced the second quarterly dividend $0.21 per share to be paid in July of 2014.

Slide 16, shows our outlook for the full-year 2014, we are reaffirming the guidance issued in February. We expect revenue to be between $305 million and $315 million. We expect adjusted EBITDA to be between $160 million and $165 million, and normalized FFO per diluted share and share equivalent to be between $1.55 and $1.65. We expect capital expenditures to be in the range of $280 million to $310 million with development capital in the range of $275 million to $300 million, and recurring capital between $5 million and $10 million.

Given our first quarter performance we are trending towards the upper end of the guidance range on our financial metrics. However, please remember that margins will be impacted by seasonality and electric usage and rates, higher sales and marketing expenses in the second half of the year and the effect of new property is coming online in the second half of the year. It is so early in the year and we will provide further information on next quarters call. I would like to provide an update on our 2014 development activity which we shown on the next slide.

Slide 17, shows current and planned activity by market. We have several major projects currently in process or scheduled to begin in the near future. As I mentioned earlier, we have begun construction on the third data hall at our Carrollton Facility in Dallas, and expect to complete the project in the second quarter. The data hall will consist of 60,000 square feet of raised floor and have six megawatts of power capacity. We also completed the addition of 3 megawatts of power capacity in the second data hall and its facility, at the beginning of the second quarter. Also early in the second quarter, we completed the second five megawatt power capacity addition to support our Cyrusone Solutions build in Phoenix. This build has triggered the need for another facility in Phoenix, which will consist of approximately 110,000 square feet of powered shell, and is expected to be completed in the second half of 2014.

Additionally, since the beginning of the year, we have broken ground and began construction on three new facilities and we expect each of the shell’s as well as the first data halls for two facilities to be completed in the second half of 2014. Construction of the San Antonio 2 and Houston West 3 facilities where triggered by demand, the San Antonio facility consists of 115,000 square foot shell, with 30,000 square feet of raised floor and approximately three megawatts of power capacity coming online day one. The Houston facility will consist of approximately 320,000 square feet of powered shell. The third build is our facility in Northern Virginia, which consists of 115,000 square foot shell with 30,000 square feet of raised floor and six megawatts of power capacity coming online at the onset.

We’re still evaluating another new market entry and we’ll provide an update in the coming months. With the projects currently underway are expected later in the year. We expect end 2014 with approximately 1.3 million square feet of raised floor and 1.1 million square feet of powered shell available for future development.

In closing, we’re very pleased with results of the first quarter, as the continued strong financial performance as refection on the teams hard work and unwavering focus on the customer.

Thank you for your time this afternoon. This concludes our prepared remarks. Operator please open the line for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question comes from Stephen Douglas of Bank of America Merrill Lynch.

Stephen W. Douglas – Bank of America Merrill Lynch

Great, thanks for taking my question. Congrats on the quarter guys. So first you know obliviously Gary you expressed some frustration with where the stock has traded. I am wondering I guess interested in how you evaluate a benefits of a potential share repurchase program versus maybe the incremental liquidity for the stock as it relates to Cincinnati Bell potentially selling down some of those stake in the near future. And then second just may be a question on the renewal rate just wonder if you can provide any kind of color there in terms of what the spreads were both on a cash and GAAP basis? Thanks

Gary J. Wojtaszek

Sure. I think the current stock prices – that’s probably might biggest (indiscernible) in terms of performance generally for the company. I think it just doesn’t reflect the underlying financial performance that we’ve been able to put up over the last five or six quarters. But that said I think its probably related to the overhang issue associated with Cincinnati Bell and their intention to sell down and monetize the piece of their holding for us.

And you actually see that worsening our share price performance worsening after we file the shelf registration basically notifying the market that this is something that they can have variability to execute on pretty quickly. So I think there is a temporary overhang for it. I think share buyback, would it make sense for us at the current time, just giving that one of the challenges that we have is the lack of flow in our shares. And I think just as always we continue to stick to our netting focus on delivering the same types of numbers eventually its going to have to respond and I think as our stock price comes up I think our share our larger shareholders going to be much more willing to monetize a piece of their holdings.

In terms of the renewals basically if you exclude one contract all the renewables that we had in the quarter were basically flat is actually down about 2%. So there was about 20 contracts that came up for renewal 19 were basically flat. There was one customer that was basically responsible for the slight pick up that you see in our churn metric which went up to 1.3% that customer had a fairly significant write-down in terms of the price on that. That was about a 30% write-down from where there, wasn’t that material in the overall companies results for the quarter, but it was a substantial write-down, that was the company that we had in place for about dozen years or so, so they have around for a very long time.

Stephen W. Douglas – Bank of America Merrill Lynch

That’s helpful. Thanks for the color guys.

Operator

Our next question comes from the Jordan Sadler at KeyBanc Capital Markets.

Jordan Sadler – KeyBanc Capital Markets, Inc.

Thank you good afternoon.

Gary J. Wojtaszek

Hi, Jordan.

Jordan Sadler – KeyBanc Capital Markets, Inc.

Hi, I thought obviously the volume here surprise significantly to your upside, it sounds like you guys were surprised a little bit as well in terms of how good the quarter came in volume wise being a record quarter for you guys. So congrats on that, but I just wanted to sort of get some color on momentum and what you see driving the acceleration?

Gary J. Wojtaszek

Yes, good question. So, yes, we’re really pleased with the results for the quarter and it’s just kind of a continuation of all the different initiatives that we’ve been put into place over the last two years. So whether it’s developing a broader sales force that’s more geographically focused, whether it’s getting those folks up to speed quicker and having them become productive citizens, and all the different marketing initiatives that we’ve been doing, they’ve all been trying to contributing to the fact that we’ve been continuing to put up bigger and bigger numbers for us.

And by no means should anyone assume that this type of quarter’s performance is repeatable. We do not have that in our model yet all, this was a great quarter, we love for this to repeat, but no one should model that in the numbers at all. To give you some flavor on our frontal I mean our sales frontal has been building up really nicely. So like last year at this point we talked about our sales frontal that was about four times larger than it was in the prior year. Currently we are looking at a sales frontal that was up about 27% greater than it was same time this year and up 6% to 7% sequentially from where we ended the fourth quarter.

That said I think if anything what we’ve earned over the last decade in this business is that – these deals are very, very difficult to forecast when they going to close, we had a number of deals this quarter that really talking to customers for three years and we manage to close in this quarter, but that was a customer that we assume that was going to close last quarter. The reality is you just don’t know, that’s why we try to focus on building up really large frontal coverage, so that we can ensure that if you have a bunch of deals in the hopper, you are going to continue to knock down a few every quarter and continue to put up kind of consistent consecutive growth.

Jordan Sadler – KeyBanc Capital Markets, Inc.

Okay, I understand the reluctance to just the first quarter number and the model for the rest of the year. The question I have just as a follow-up though is even as a result of the first quarter leasing based on sort of the progression of the commencements that Kim described, it’s almost hard to not hit the top end unless you have some expected move outs.

Gary J. Wojtaszek

Yes, we…

Jordan Sadler – KeyBanc Capital Markets, Inc.

So you did $77.5 million that’s the midpoint – if you do that for the next three quarter that would be the midpoint of the current guidance, right, and you have $18 million revenue side in the quarter it’s going to start between 2Q and 3Q that’s a meaningful contribution that’s going to put you to the top end. So can you bridge the gap for me there?

Gary J. Wojtaszek

Sure, sure, yes. So astutely analysis there, we feel really good about where we sit for our guidance this year as Kim mentioned in her talking points. We feel very comfortable that with the high end of our guidance range right now come at the end of the next quarter we will revisit what our guidance is going to be for the year, but we feel very good where we sit right now.

Jordan Sadler – KeyBanc Capital Markets, Inc.

Okay. In terms of your prepared remarks, Gary, you made the comment discussing I guess maybe it was discussion with solution or some of things you’ve been doing for certain customers in terms of that you’re trying to limit the overall cost of occupancy with the tenant and used a phrase, unnecessary resiliency. And I’m kind of a curious technically what that means?

Gary J. Wojtaszek

Sure, yes and this is something that we’ve been doing for a while and the more and more if we get involved with customers and really kind of understanding their needs from a data center architecture perspective. Particularly as it crosses multiple data centers. What we found is that you have to go down to the application layer. And once you really kind of pull back the onion in customers and you really understand what’s critical to their needs, what is that that they’re trying on the software on the TCO basis and once you educate them on the different capabilities that are available in terms of the solutions that we can provide to them what we’ve been success outdoing is educating customers and teaching them that not all applications need the Ferrari type solution, that there are some applications that don’t require the high resiliency solution, which isn’t critical to their business and so as long as they’re comfortable in a solution that is not nearly as robust from a number of non-reliability perspective, we can engineer them solutions that will meet the resiliency requirements they need for their business at a significantly lower price point.

But on the back end of this, I mean the significantly lower price point also has significantly less capital involved in that as well. And then my talking points, we were talking about this solution where it was about 1.5 megawatts, I mean $1.5 million per megawatt for this particular solution. So substantially below the $7 million that we would typically do for a high-end, high availability [5-9s] (ph) of type solution. But you can only have those conversations when you are really with customers on the day-in and day-out and really kind of understanding what their needs are and coming up for a solution that’s really appropriate for them.

Jordan Sadler – KeyBanc Capital Markets, Inc.

So just to clarify, that’s not operating cost in terms of rent et cetera? That’s the development cost you’re able to give?

Gary J. Wojtaszek

Yes. That is the cost to deliver a megawatt of capacity, but in conjunction with that the operating, I mean, this solution is extremely energy efficient. We almost reached a 1.0 PUE. So this is a phenomenally efficient solution. It doesn’t work for everyone, but for this particular customer it worked really well for their needs.

Another example, I mean we’ve done like really dense. Last quarter we talked about a little bit in some of my prepared remarks, but we talked about really dense power solutions where we put together a solution for a customer that was 900 watts a foot. So I think it was roughly like 8 – it was 9 megawatts in 10,000 square foot type, like this is just incredibly dense capacity for a particular application that that customer needed to deploy. So these are things that you can all achieve when you really spend lot of times with customers understanding what they’re really looking for and coming up with a creative solution.

Jordan Sadler – KeyBanc Capital Markets, Inc.

Okay. I’m going to make one more question plus a comment and then I’ll get off the call. But I guess what I’m trying to bridge the gap and I understand you’re frustrated with the stock price. Investors that I talk to are frustrated with the space overall in general because they feel they don’t have visibility into pricing and growth in rents over time and so from an investor perspective that horizon doesn’t necessarily seem that robust. When I hear about engineering solutions like this to add a cost effectively, a construction cost that’s 20% of what your typical applications look like, I’m concerned. So that could potentially be extremely deflationary in terms of rents. So how do you think about that?

Gary J. Wojtaszek

Great question, and this is why we only need –see with pricing, pricing is not just a simple thing, right. I mean there are so many different flavors of price about how you come up with the price and the most important relationship is that price relative to the capital that you are deploying, which is really what’s generating returns and that’s why we’ve been trying to highlight to the investors about the relative capital investments that we are making in the business relative to the yield that we are generating. And the highlight in that we’re able to deliver the same type of development yield in spite of investing about 30 plus percent more dollars into the business. And what’s difficult to understand from the investors’ perspective and it’s one that we struggle with is that these are different solutions that we’re providing to customers that are achieving different outcomes that are very specific to customers needs, and this is why we have been very reluctant to say, look, what we don’t like giving a pricing in just a general sense because it’s not like we’re delivering the same things in our product that maybe someone else’s.

So we’ve get really leery about talking about price and that’s why we try to explain to investors that you can really the best measure for evaluating us is, what do I do with your capital. Can I put your capital to work and make a consistent returned for you that you should be happy with, and I think we’ve proven, and I think we’ve also proven that our top line growth has really kind of demonstrated the ability of this franchise have to continue put up really nice growth numbers. And so I think it’s a combination of those two that ultimately is what’s delivering value to our shareholders.

Kimberly H. Sheehy

But to his concerns, disappointment it’s specific to that customers needs and not everyone is going to producing that type of product.

Gary J. Wojtaszek

It’s a such a unique – you can never deliver like, I believe that we can deliver a megawatt of capacity at the highest resilient to that believe that we are that the lowest cost delivery that in the market today that’s my opinion only. You can never delivered the solution I am talking about here this customized design for that same $7 million price that we talk about rather a high end solution. So there are two entirely different products that we’re putting out there.

Jordan Sadler – KeyBanc Capital Markets, Inc.

Okay, thanks for the color.

Gary J. Wojtaszek

Sure.

Operator

The next question comes from Tayo Okusanya at Jefferies.

Tayo T. Okusanya – Jefferies LLC

Yes, good afternoon again congrats on a brilliant quarter. Back to guidance again two things, Kim I definitely get what you are saying about the operating expenses and timing and that piece of it, but when I just tickle it at the top line your revenues for the quarter was $77.5 million, you analyze that it’s 3/10 your guidance is 3.05 to 3.15. That seems to be implying that you’re not going to have any more revenue group for the rest of the year. So I am just wondering, are you expecting a big ramp, roll down, are you expecting a big move out and why that – why you are not seeing more upsides of the top line.

Kimberly H. Sheehy

Thanks, Tayo. We obviously will have some churn, we forecast 5% a year and we have that in our numbers. So that does have to be taken into account. And it’s really what Gary said, we do feel good about where are, we feel real good about delivering the top line of the guidance, but it’s early enough and we are not having inside into the contracts we sign here in the second quarter for us to update any numbers.

Tayo T. Okusanya – Jefferies LLC

That’s helpful. And then second thing is again not to beat a dead horse, but around Cincinnati Bell, the kind of this double edge sword the filing is out there, everyone is expecting them to sell. It’s pulling pressure on the sales. This year get cheap enough way it makes no sense for them to sell, because all it sort of becomes an expenses source of equity, so they don’t sell, then people have to waiting for them to sell. Is this kind of chicken and egg situation I’m just curious if you are getting any clarity from them about how they’re thinking about your spot of the source of capital.

Kimberly H. Sheehy

Now they are thinking a lot like you’re they’re – they continue to – they’re looking for appropriate price before they monetize, but the probably the best thing is to listen to their call in the morning and see what they say.

Tayo T. Okusanya – Jefferies LLC

Okay, that’s helpful. And then the entry into Northern Virginia at this point just kind of curious about pre-leasing prospects. How demand for that space is doing at this point?

Gary Wojtaszek

Yes, let me take that, Gary here. So we’ve had many conversations with different customers, no customer will commit to us prior to having that space available, but the conversations that we’re having with some of our existing customers and some of the discussion we had with new once that are looking for space there are ongoing, and we feel pretty good about it. I would point out those that the relative amount of capital that we’re putting at risk there in the Virginia is fairly limited and we do feel really confident about the product that we’re going to providing in that market relative to what’s currently available.

Tayo T. Okusanya – Jefferies LLC

Got it, okay. That is very helpful. That’s it for me. Thank you.

Gary J. Wojtaszek

Thanks.

Kimberly H. Sheehy

Thanks.

Operator

Our next question comes from Colby Synesael at Cowen & Company.

Colby A. Synesael – Cowen & Co. LLC

Great, thank you. Two questions if I may some what recycling, what’s already been talked about, but on the new solution offer that’s been discussed considering that is somewhat of a custom solution, I am just curious if you are asking for longer-term, then you might normally recognizing that might more difficult for you, we saw that space it was given back also trying to give sense how you are actually, pricing that, are you pricing it typically with – you talked about commentary that excluded that when you mentioned the escalators. So I am just wondering how you are thinking about your pricing that and then also just again on Ashburn, you mentioned during the quarter, that you are already working on another expansion in that market, without actually going and signing any preleases yet for the space its already was going to be coming on line, what gives you the confidence that you should be moving so aggressively I guess to go and build another phase if you will? Thank you.

Gary J. Wojtaszek

Sure, yes, so on. On your point about the return, so the returns that we’re getting in these customized solutions, you look at the same way that we look at all the investments that we’re doing. So, when we’re looking at some of these customized solutions, the pricing stuff that were breaking in there, comprehends the fact that some of this is specialized. And the likelihood that this customer can go away and what is our ability to repurpose that. So, when we think about the pricing there, what we want to make sure, that we’re not taking any risk on is the portion of that solution that’s very specific to the customer that we can’t get anything returned on. And then pricing the rest of that just on a basis of what we’d do normally in terms of our IRRs that we’re trying to solve for.

That said, I mean in this particular case, it was only like a five year deal. We feel very comfortable about our ability at the end of this to repurpose that space entirely of that customer were to leave. So we feel pretty good about it. Relative to Northern Virginia, so this is our first four way into Northern Virginia the reason that we were pursuing that market was based on interest that we had from existing customers and other customers over the course of the last two years or so.

That was the number one market that had continually come up from various customers wanting space in. And we think that the solution that we are going to be bringing to the market is something that is a little different than what is currently out there. But as I pointed out we are only bringing on 30,000 square feet of capacity online there. So its not a significant amount of capital that we are going to bringing into market.

The way we think about our capital deployment generally is basically that we were only building on additional capacity relative to the demand forecast that we see for customers. So the vast majority of our capital investment which is going into all of our existing locations is relatively lower risk than a brand new facility like Northern Virginia, but the demand that we are seeing from customers in Northern Virginia is very similar to the demand that we were seeing from customers when we decided to go into Phoenix, or San Antonio, or even Dallas couple of years on prior to that.

Colby A. Synesael – Cowen & Co. LLC

Great, thank you.

Operator

Our next question comes from Simon Flannery of Morgan Stanley.

Lisa Lam – Morgan Stanley & Co. LLC

Hi, this is Lisa for Simon, thanks for taking the question. Just wanted to get an update on –that you mentioned interconnections in your prepared remarks. I’m just trying to get an update on kind of how much of your revenues are made up of interconnection revenues and also whether you see any impacts from open IX and kind of how that’s helped you or so forth during the quarter? Thanks

Kimberly H. Sheehy

Yes, Lisa thanks the IX in it was about 4% of our total revenue which has been pretty consistent as the revenue continues to grow it’s growing at a good pace to keep up. I’ll let Gary answer the question on the Open-IX.

Gary J. Wojtaszek

Yes I mean so we’ve gotten certification on the Open-IX, I mean we think that is huge catalyst potentially for us to accelerate our growth. So more customers adopt that – the more customers that are trying to make that Open-IX initiative successful, we’ll ultimately lead into more data centers sales for us. So we are hoping that that consortium really takes off and the work we’re doing here we hope is going to benefit us.

Lisa Lam – Morgan Stanley & Co. LLC

Got it. And do you see opportunities for the interconnection revenues to grow given that you got to selling some more kind of cloud customers?

Gary J. Wojtaszek

Yes, I mean Kim just say I mean that the portion of our revenue that’s interconnection is 4% which is roughly what it was last year I mean it was, the base of businesses we’re growing very quickly in aggregate, but if you did piece marks within the IX portions of our business there is some pieces – particularly interconnectivity side are growing significantly faster, which is what we would have expected just given that we launched this last April. So we’re basically now a year into that product launch. So we would expect that that’s going to accelerate particularly as we sign up additional cloud customers. So I have to provide a little color about the different cloud customers that we signed up over the year about two dozen or so. Those cloud customers are going to require having your connectivity sharing and moving data amongst themselves the customers and we would expect that would be Open IX coming into our facilities, they are going to drive additional digital media and content folks as well.

Lisa Lam – Morgan Stanley & Co. LLC

Great, thank you.

Operator

Our next question comes from Vincent Chao at Deutsche Bank.

Vincent Chao – Deutsche Bank AG

Hey, everyone. Hopefully, last question on the Phoenix deal here, but last one or two. Just curious I mean you specifically mentioned sort of a liquids emerging technology as part of that deal and just curious what is the power and cooling provider you needed to deliver to make that happen?

Gary J. Wojtaszek

Basically it’s like in all these things, I mean, in every design we do we don’t own any of the underlying hardware, right we buy, we stitch it together and provided in a solution that customers essentially read from us. So there is – so whether it’s generators, PDUs, switches, chillers all those different things, our value add is how we pull that all together architecture into whether that solution to the customer. This is really no different, it just a different type of cooling technology that we’ve deployed here, but we probably have half a dozen different cooling technologies deployed across all of our different facilities.

Vincent Chao – Deutsche Bank AG

Okay, and I guess to your point that you don’t see repurposing as something it will be significantly difficult in this particular case.

Gary J. Wojtaszek

No, no.

Vincent Chao – Deutsche Bank AG

Okay, and then does the sales with CyrusOne Solution I mean is that require a different sales force, a different sort of focus for those guys or is it just part of their overall activities.

Gary J. Wojtaszek

Yes, I mean once you get in with the customer and you start talking right, there is certain levels of conversations that are general Cyrus folks can handle and we have a really technical sale force in general. So we can really kind to get down into the weeds, just our general business development managers. This type of sale though is we have those conversions at the sales level, but once its gets way more involved in terms of the engineering works, some of the cooling aspects, and then its, then we reach out we bring in, much more technical engineering folks that we’re basically using, that we work with daily in terms of covering the upward solution for ourselves. So that same group of folks that was kind of turn more outside looking and trying to help the customers achieve some of the things that they are looking at. But their day job is basically making to ensure that we can continue to improve our designs and efficiency in each iteration of the date centers we build now.

Vincent Chao – Deutsche Bank AG

Okay, that’s helpful and just without getting into pricing of specific deals which I know talked about on number of cases, but just curious if there any markets where you’re feeling hidden competitive pressures albeit given supply or any other reason – any markets where you are seeing some hidden competition?

Gary J. Wojtaszek

Yes. I mean there’s competition in all the markets that we’re in, but there is no change in the competitive profile in terms of what’s been going on for long-time there, and there has really been no change in pricing and you can kind of see that some what in fact that our yields have been basically flat for year and a half in that.

Vincent Chao – Deutsche Bank AG

Okay, thanks guys. that’s all I had.

Kimberly H. Sheehy

Thanks

Operator

Our next question comes from Barry McCarver at Stephens.

Barry L. McCarver – Stephens, Inc.

Hey, good evening guys, great quarter and thanks for taking my question.

Kimberly H. Sheehy

Okay.

Barry L. McCarver – Stephens, Inc.

First of I had echoed some previous comments about guidance, but I do understand that it’s very early in the early in the year. but in regards to margins, it became a question for you; you mentioned some of the seasonal pressures we get in the summer months on margins. I believe last year in 2Q and 3Q, there were some other kind of one-time items relating to connecting the data center with fiber that push margins down in the second quarter. Can you give us an idea of the magnitude of what you expect from seasonal pressures, I want to look at last year and I think necessarily that’s where margin are headed?

Kimberly H. Sheehy

Yes, I don’t recall specifically how much of the margins were affected by the connectivity last year. but I think on the seasonality of the electricity, it’s really hard for us to forecast, because it depends on the weather, and the usage, and rates and everything else. but I think the way I would look at it is, I mean I think that the margins this quarter, the EBITDA margin at 54%. If you look at what we’re putting out for the full year EBITDA margin, I think you’ll be able to kind of back into what we would expect as kind of the worst case. But I mean we can get into some detailed numbers, a little more with you off-line, if you’d like Barry, but I don’t have 1% to give you from an estimate on just electricity rates.

Barry L. McCarver – Stephens, Inc.

Okay, fair enough. And then, kind of back again on the energy vertical, it looks like for the first time, your number one customer slot is we used to plan it. The historical number one CBB with that energy customer, feel like every week we hear, read another article about the depend upon some data that that vertical is using in their day-to-day business, or using that broadly across that vertical some of your customers, I guess demand is still real strong, what do you think their CapEx budgets for colo is going to look like this year.

Gary J. Wojtaszek

Yes, hey, Barry, Gary here. Yes, I mean as long as oil stays above $100 and there is just continued exploration and fracking going on in this country, I mean that is just all spells goodness for us. I mean I don’t know specifically, how much their budgets are for colo, but I can tell you that’s like a non-event for the amount of capital that all of these oil and gas companies are spending, trying to find new reserves and get more oil and gas out of the existing wells.

so the return that they’re getting is really significant, I think that’s creating a lot of business. I think that the whole privatization of what’s going on in Mexico with the oil and gas industry is also going to be very beneficial for us as well. it’s that portion of our business is doing really, really well. the thing I would point out though is that the percentage of our business in the oil and gas house coming down, and it’s not because the oil and gas business has shrunk, it’s that we’ve been diversifying I think pretty effectively in other industry verticals.

Barry L. McCarver – Stephens, Inc.

That’s very helpful. Thanks a lot guys.

Gary J. Wojtaszek

Thank you.

Kimberly H. Sheehy

Thanks.

Operator

Our next question comes from Frank Louthan with Raymond James.

Frank G. Louthan – Raymond James & Associates, Inc.

Great, thank you. looking a little bit at market demand, you’re looking – what sort of your markets do you think, you currently have the best outlook and then specifically with some of the new facilities, can you give us a little more color on how you feel comfortable with the interest levels there and Northern Virginia is the Yahoo! space they are – they have announce, they’re going to sublease, what’s the impact in that in the market, how are you feeling that and how are your customers telling you that’s impacting pricing there?

Gary J. Wojtaszek

Sure. Hey Frank thanks for joining the call today. In terms of the markets I mean we are seeing really strong demand in Dallas, Houston, Phoenix, San Antonio and basically if you look at us and you see we are investing our capital in order to bring up additional capacity, our capital investment is really kind of derivative of the customer demand that we are generally seeing in those existing market. And so the way we think about that is we see how much inventory we have in a market relative to the late stage customer demand, that we’re hunting for currently and we want to make sure that we don’t want out of space and we’ve got to bring on additional capacity to meet the demand that we’re seeing in the frontal.

So, have you ever see where we’re spending capital and building up new capacity, that’s a good indication that, we’ve got a really strong frontal their from customers. Relative to Northern Virginia, on the Yahoo issue I don’t know I mean it would be really difficult I think for Yahoo to go sublease that space out to someone else, given that I don’t know that base is up in just a couple of years time. I mean, you’re not going to do a big deployment in some space that you’re not going to be able to have good visibility and to be able to control that space for many years. So, I don’t think it’s – that realistic that they’re going to be able to lease that out to someone. I think that’s created a lot of churn in the – or concern in the industry relative to that, but I don’t see that as a big issue now.

I think potentially in three years from today whenever that comes up for maturity I think – then it could be an issue on the market. Relative to Virginia in general, I mean, our decision in going into it has not changed, I mean, we went into it because that was a market – that was a number one market that we’re getting the most demand from customers, existing customers and new customers now approaching us to go there. We’ve had many conversations with customers, particularly since we announced this publicly. So the level of interest is definitely increasing a lot of the folks that we never really have relationships with that are in that market and have been reaching out towards understanding what it is that we do, but like and all these deal I mean the Russia have product available to physically show some one and walk him through, and give him – of the facility and it’s completed. You really can’t sell anything I mean no one – none of the customers that were going after really want to put any part of their business at risk going into something unless it’s already up in running, it just too much risk for them. So we feel pretty comfortable about this hopefully, as we get further along to commissioning this we’ll be able to give more insight in terms of actual customers are going to be taking it, but at this point we don’t have a assigned customer for any of that space yet.

Frank G. Louthan – Raymond James & Associates, Inc.

Okay. Great, thank you.

Kimberly H. Sheehy

Thanks, Frank.

Operator

At this time I’d like to turn the conference back over to Mr. Wojtaszek for closing remarks.

Gary J. Wojtaszek

Well, thanks every one. I appreciate you taking the time and joining our call today. I think as you see by our results in the first quarter, we feel really good about the business. I think the team of all 275 of us performing at a phenomenal level. This is a great way to start 2014. We feel really good about the year. As Kim mentioned, we feel very confident that we are going to be at the high end of the guidance range that we had shared and we’ll update that based on our second quarter results. But as we sit here right now, we feel really good about being able to put up really big numbers for 2014, consistent with what we did, we did last year. Thanks again everyone, I appreciate your time and look forward to talking with you again. Take care. Bye.

Operator

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

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Source: CyrusOne's (CONE) CEO Gary Wojtaszek on Q1 2014 Results - Earnings Call Transcript

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