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CyrusOne Inc. (NASDAQ:CONE)

Q2 2014 Results Earnings Conference Call

August 6, 2014 12:00 PM ET

Executives

Anubhav Raj - Vice President, Treasurer and Investor Relations

Gary Wojtaszek - President and CEO

Kim Sheehy - Chief Financial Officer

Analysts

Ross Nussbaum - UBS

Jordan Sadler - KeyBanc Capital Markets

Simon Flannery - Morgan Stanley

Barry McCarver - Stephens, Inc.

Jonathan Schildkraut - Evercore Partners

Frank Louthan - Raymond James

Vincent Chao - Deutsche Bank.

Sergey Dluzhevskiy - Gabelli & Company

Colby Synesael - Cowen & Company

Ana Goshko - Bank of America

Operator

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to the CyrusOne Second Quarter 2014 Earnings Conference Call. My name is Kate, and I will be your conference operator today. At this time, all participants are in a listen-only mode. After the prepared remarks, the management from CyrusOne will conduct a question-and-answer session, and conference participants will be given instructions at that time. As a reminder, this conference call is being recorded. (Operator Instructions)

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

Anubhav Raj

Thank you, Kate. Good afternoon, everyone. And welcome to CyrusOne second 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 second quarter earnings release along with the second 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 afternoon contain non-GAAP financial measures. You can find reconciliations of those measures to the most comparable GAAP measures in the earnings release which is posted in the Investors section on the company’s website.

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

Gary Wojtaszek

Thanks, Raj. Good afternoon, everyone. And welcome to CyrusOne second quarter 2014 earnings call. Before I begin with my prepared remarks today, I would like to welcome all the new investors who decided to purchase our shares on June 25th and for making our secondary equity offering so successful.

We know how hard it is to decide where to invest your capital given all the choices you have and we really appreciate you taking the time to understand our company, its business model and getting to meet the management team.

On behalf of the entire team at CyrusOne, we just want you to know that we appreciate your support and commitment to us and our company. I think we have an attractive and easy to understand business model and I look forward to talking more about our Q2 results with you.

With that, I’ll begin my prepared remarks. This marks the sixth consecutive quarter in a row of delivering strong leasing results as a public company. Through the first half of this year, we have leased almost as much space as we did in all of last year, which sets us up well for a strong 2015.

Unique to our results this quarter is the pre-lease of 30,000 colocation square feet for our new Phoenix facility that is currently under development. This is the first time in the company's history that we were able lease facility where the shale has yet to be built.

As always, I want to thank all the team members at CyrusOne for their hard work and producing these results quarter-after-quarter and for their commitment to meeting the needs of our customers.

After I review some of the highlights for the quarter, I am going to talk about the business in the context of the framework we introduced at the beginning of the year. Kim will then discuss our quarterly financial results in more detail.

Beginning with slide three, the strong growth trends that we have seen across our key financial metrics since becoming a public company continued in the second quarter. Revenue was up 28% compared to the second quarter of 2013, normalized FFO and AFFO were up 60% and 71%, respectively over the second quarter of 2013 and adjusted EBITDA was up 32%.

We leased 59,000 colocation square feet in the second quarter, as well as 17,000 square feet of office space, which equates to about $27 million of annualized GAAP revenue inclusive of estimates of power, which is about the same level of bookings we generated last quarter.

I will talk more about some of the leasing in the quarter later in my remarks. Finally, we added four new Fortune 1000 customers in the second quarter bringing our total to 139 customers.

Turning to slide four, I just want to remind everyone of the four key organic growth drivers for CyrusOne, which include expansion by our existing customers, acquisition of new logos, development of new channels and products, and portfolio expansion.

We believe that level of success we have in each of these area, which I will discuss over the next few slides, determines the trajectory of our growth and in turn our ability to deliver value to our shareholders.

We believe that our ability to grow the business organically through our development and sales efforts translates into considerably higher returns that are well above our cost of capital. It is because of our ability to generate such great returns organically that we have not acquired any fully leased assets.

The returns we were able generate on even upper single-digit cap rate asset acquisition held comparison to mid to upper-teen returns we are able to generate organically. Furthermore, this enabled us to maintain low net leverage which provides the company with balance sheet flexibility.

Moving to slide five. The first key organic growth driver is our existing customer base. As those who follow us know we are focused on attracting Fortune 1000 enterprise customers and have built a high quality customer base with the Fortune 1000 representing approximately 70% of our annualized rent.

Existing customers are an important source of growth for us, accounting for approximately half of our year-over-year growth in annualized rent. As I said before, Fortune 1000 companies often come to our facilities with small initial deployments representing just a portion of their applications stack as they outsourcing for the first time. As the requirements grow, they increase the size of their deployments and take down space in multiple locations, which we can tie together with our National IX product.

In essence existing customer provide a growing annuity stream. In fact, we estimate that approximately 40% of the net present value associated with the customer comes outside of the first order.

As an example, if you look at the bottom left chart on the slide, you can see that of our 30 largest customers, 23 of them have been with us for three years and more, and have grown in compound annual rate of more than 20% over the past three years.

The chart in the lower right corner shows the trend in our rent mix has been towards longer term medium power leases, which now account for more than 60% of our annualized rent.

Turning to slide six, new logo acquisition is one of my top priorities as getting customers and the door creates the opportunities for the growth that I talked about on the last slide. We have been quite successful on this front as our overall customer base increased to 648 as of the end of the second quarter, up from 630 as of the end of the first quarter and up 13% from last year. The number of Fortune 1000 customers is also up around 14% from last year as we have added 10 new logos in the first half of 2014.

Across the bottom of the slide we show some stats by highlight the underlying secular trends that are driving our company's success. As the second chart shows, the amount of data creating copied is expected to grow at an annual rate of nearly 40% over the next seven years. This is truly astonishing. When I first heard this statistic I had a hard time comprehending exactly what 44 zettabytes looked like.

One of my favorite way is to put this into context is that if the original -- if the digital universal represented by the memory and a stack of iPads. In 2013, we would have stretched two-thirds of the way from the earth to the moon. Assuming this growth rate by 2020 there will be more than six stacks from the earth to the moon, which implies us going to be a need for lot more data center space.

In a simple sense, data centers are similar to public storage companies that built the business around the human beings and ability to discard items. Our business provide a service to store all of those digital images that are even more difficult to discard.

Additionally, as I’ve mentioned before, it is estimated that a very small portion of data center requirements are currently outsourced. The outsourcing movement continues to accelerate driven by favorable economics and an increasing willingness by CIOs to entrust third-party providers with the mission-critical gear. It was not that long ago that the enterprise CIO who choose to outsource their organization data center needs was considered the crazy uncle by his peers.

However, that dynamic has changed considerably over the past few years and I believe that the enterprise outsourcing movement will continue to accelerate. These parallel trends create a huge addressable market for us and I feel we are well-positioned to capitalize as we continue to execute on our strategy.

Moving to slide seven, the third key growth driver is new channels and products. I am pleased with the result so far of CyrusOne Solutions. In the second quarter we signed a lease for 12,000 square feet of office space to house to the best of my knowledge the first ever collocated 9/11 dispatch center.

This customized build will include all of the mission-critical infrastructure required to run a 9/11 operation for a large area of North Texas. It will include data center space, call center workstations, meeting rooms, technology space and a highly reliable electrical mechanical systems to accommodate the newly formed North Texas Emergency Communications Center, which is consolidating 9/11 services for four communities in order to provide faster response times.

We're excited and honored to have the opportunity to host a critical part of the government security infrastructure for these local communities and believe this solution can serve as the model for other dispatch centers across the country.

Also in the quarter, we agreed to deliver another 11 megawatts of power capacity to support the power requirements for these solutions product we sold last quarter. As with the initial build the cost to add this capacity is below what we typically spend.

We continue to evaluate a number of opportunities leveraging the expertise of our design team as we work with customers to explorer creative ways to solve their unique requirements for large-scale deployments of mission-critical assets.

I also want to provide an update on our National IX platform as we have accomplished a lot in the year since it was launched. The National IX was developed to replicate data center architecture Fortune 1000 enterprises previously had to create in-house. We are able to deliver interconnection across states and between metro enables sites, allowing customers to connect multiple sites together at a low cost.

The platform currently links to dozen facilities across our Phoenix, Taxes and Midwest markets. 62% of our revenues from customers with deployments multiple locations and we expect to continue to see more and more customers add a second CyrusOne facility.

I wanted to provide some further color on the components of IX revenue. The two main components are connectivity, which a National IX target and bandwidth, which is a legacy product that is not a core focus. Currently, each contributes approximately 50% of total IX revenue. However, the growth rates are considerably different.

Over the last year the launch of our National IX product has led to a 45% increase in connectivity revenue, which outpaces our overall revenue growth during the same period. However, total IX revenue remains at approximately 4% as bandwidth revenue is only increased 13%.

The attachment rate of the National IX has grown from 68% in the quarter we launched to today’s steady-state level of higher than 80%. The national IX is the key part of our growth strategy as it enables colocation opportunities and increases the stickiness of our customer base by providing the platform that is not easily replicated by competitors.

Turning to slide eight, the final key growth driver is portfolio expansion. We have been aggressively adding capacity to meet strong demand in existing markets and expanding into new markets as we build out our platform.

Over the last six quarters we invested more than $325 million in the business, yet have been able to maintain unlevered development yields in the mid to upper teens throughout this period.

As I’ve discussed before, we are able to generate these returns in part because of the low cost we can build these facilities for and the speed at which we are able to deliver capacity, minimizing the amount of capital we invest.

Between 70% and 80% of our capital spend is discretionary within existing markets where we have a good line of sight into demand based on our late-stage sales funnel. From time to time I get questions from people asking if I'm concerned about potential oversupply in our markets, well, it’s something we are mindful of it in the longer term, in the short-term we don't really focus on that.

We're deploying the vast majority of our capital on a just-in-time basis according to near-term demand from our customers, minimizing the capital at risk and maximizing returns for our shareholders.

Our flexible and robust product offering from which customers can choose from a wide range of space, power density and resiliency options, as well as numerous ancillary products and services generates incremental revenue opportunities and allows us to maximize asset utilization and subsequently increase the return on the assets we deploy.

Also as shown in the slide the development yields of 16% to 19% that we are able to generate organically are well above the returns we would be able to generate if we were to acquire leased assets at current market cap rates.

Slide nine shows our new building in Phoenix. As I mentioned earlier, we have pre-leased 30,000 colocation square feet in this facility, which marks an important milestone for the company as it is the first time we have leased space in the facility before the shale has even been built.

Our experience has been that customer want to see raised floor before they will provide a commitment so this deal reflects trust based on our proven track record and delivering capacity when we say we're going to delivery it. We still believe that it is incredibly difficult to lease the vision of raised floor that is still merely a plot of dirt to our target Fortune 1000 enterprise customers.

On that note, we are in the number of discussions with potential customers in Northern Virginia. We have signed up four carriers and expect to have eight by the time the facility comes online, which we expect will occur in the fourth quarter. We will provide an update on next quarter’s call.

To close I am very pleased with all that we have been able to accomplishing in the first and a half as a public company, delivering consistently strong results as we build out our platform.

I believe we are well-positioned as we head into the second half of the year to capitalize on many opportunities in front of us and in turn create value for our shareholders, which will sets us up nicely for a good 2015.

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.

Kim Sheehy

Thank you, Gary. Good afternoon and thank you for joining the call today. As Gary highlighted, our strong second quarter financial results are a reflection of continued successful execution by the entire team at CyrusOne and we have been able to sustain the momentum built in recent quarters.

Continuing with slide 11, revenue for the second quarter was $81.7 million, an increase of $18.1 million or 28% from the second quarter of 2013. The year-over-year increase was driven a 37% increase in leased colocation square feet and additional IX service with both new and existing customers contributing significantly to our growth.

As Gary noted, we followed up on a record leasing quarter with another strong quarter in which we leased 59,000 colocation square feet and 17,000 square feet of office space, including the customized build for the North Texas Emergency Communications Center here at -- at our Carrollton location. The leases signed in the second quarter were about 17.4 megawatts of power primarily at our Phoenix, Houston West and Dallas facility.

Based on square footage, approximately 92% of the colocation square feet leased was to metered power customers with executed leases having a weighted average term of 91 months. 88% of the new leases on an MRR weighted basis have escalators at an average annual rate of approximately 2.9%.

Our rent churn in the second quarter was 1.4% in line with the churn rate in recent quarters. We renewed leases for 25,700 square feet and 4.1 megawatts of power in the quarter.

Moving to slide 12, the leases signed this quarter represent approximately $1.4 million in monthly re-occurring rent on a steady state basis or approximately $17 million in annualized contracted GAAP rent and excluding estimates for pass-through power. Including estimates for pass-through power charges, the leases signed this quarter represent approximately $27 million of annualized GAAP revenue once the customer has fully ramped in.

In the quarter, we recognized approximately 11% of contracted revenue for leases that were executed during this period. We estimate that in the third quarter, we will recognize approximately 57% of the contracted revenue run rate for leases signed during the second quarter with 78% being recognized in the fourth quarter and the remainder being recognized in early 2015.

Moving to slide 13, net operating income was $49.9 million for the second quarter, an increase of $10.9 million or 28% from the second quarter of 2013. The NOI margin of 61% was flat versus the second quarter of last year.

The impacts of higher electricity usage as well as higher property taxes were offset by reductions in other expenses as a percentage of revenue, primarily payroll and contract services, reflecting the benefit of operating leverage as we scale our facilities. Adjusted EBITDA increased by $10 million to $40.8 million, up 32% from last year, driven primarily by the increase in NOI.

The 2 percentage point increase in the adjusted EBITDA margin is a result of selling, general and administrative expenses, excluding non-cash compensation declining as a percentage of total revenue, a reflection of the benefit of scale as we were able to spread our corporate charges over our larger revenue base.

Normalized FFO for the second quarter was $25.6 million, an increase of 60% from the second quarter of 2013, driven primarily driven by growth in adjusted EBITDA. AFFO for the quarter was $25.3 million, an increase of 71% over the second quarter of 2013, driven primarily by the increase in adjusted EBITDA and lower cash payments for leasing commission.

Slide 14 compares our performance on a sequential basis. Revenue increased $4.2 million or 5% from the previous quarter. Approximately half of the increase was related to strong recent leasing, meanwhile the rest can be attributed to increased electricity usage pass-through on a metered-power contract.

As we had mentioned in the past, our base of customers is increasingly moving toward metered power. While the percentage varies from quarter to quarter, approximately 75% of our electricity costs are passed through to metered power customers. This results in higher revenue but also margin compression.

NOI was also impacted on a sequential basis by an increase in maintenance expense, primarily driven by the timing of maintenance work. We also experienced an increase in the expense for circuits for our IX products, which was not completely offset by an increase in revenue due to the timing of revenue recognition within the quarter.

As a result of these items, NOI was essentially flat by the increased revenue and the NOI margin decreased by 3 percentage point. We recognized bad debt expense of approximately $600,000 in the quarter to reflect a partial write-down of amounts due from a single customer and expenditures on advertising activities were up approximately $300,000 sequentially.

The slight decreases in our normalized FFO and AFFO were primarily driven by the lower adjusted EBITDA and timing of certain adjustments. The higher non-cash compensation expense in the second quarter is in line with our expectations for the remainder of the year.

AFFO was impacted by higher adjustments for leasing commission and straight line rent. As you may recall, in the first quarter, we mentioned that some of the AFFO adjustment were below expected trends mainly due to the timing of cash payments. We expect that the adjustment for leasing commissions and straight line rent in the third and fourth quarters will be relatively in line with the adjustments for the second quarter and that re-occurring capital expenditures will be higher in the second half of the year than in the first.

Slide 15 shows the market level snapshot of our portfolio at the end of second quarter in 2014 and ‘13. Utilization is up 5 percentage points compared to last year, even with the 23% capacity increase, reflecting particularly strong demand in our Texas and Phoenix market.

We commissioned a third data hall at our Carrollton facility in Dallas, adding 63,000 square feet of raised floor which drove a sequential decrease in utilization of 3 percentage points. The 30,000 colocation square feet lease in our new facility in Phoenix is not included in the percentage utilized as the capacity is not yet online.

Capital expenditures in the second quarter were $67.1 million, compared to $68.5 million last year. During the quarter, in addition to the raised floor, we added at our Carrollton facility 9 megawatts power capacity, including 6 megawatts for the new data hall and 3 megawatts for previously constructed data hall.

We also added 5 megawatts at our Phoenix facility to support the CyrusOne Solutions build at that location. Additional spending relates primarily to continued construction of our new facilities in Houston, San Antonio, Phoenix and Northern Virginia.

Slide 16 shows our net debt and market capitalization as of June 30. Our cash balance was $49.3 million, a decrease of $75.9 million from the end of March. The decrease in cash was primarily driven by investments of the capital in the business. Our net leverage is currently three times annualized second quarter 2014 adjusted EBITDA, up 2.5 times annualized adjusted EBITDA in the first quarter, up from 2.5.

As of the end of the second quarter, we had $274.3 million of available liquidity to fund our growth plans, including $225 million undrawn revolving credit facility. In June, we completed an offering of approximately 16 million shares of common stock using the net proceeds to acquire an equivalent number of limited operating partnership units in CyrusOne operating partnership from a subsidiary of Cincinnati Bell.

As a result of the offering, Cincinnati Bell effectively owns approximately 43.7% of CyrusOne. We were pleased with the outcome of the transaction as the shares were priced at a slight premium to the loss trading price prior to launching the offering. And we’ve seen a significant increase in the liquidity of our stock.

Moving to slide 17, we are reviving the guidance issued in February, moving the ranges up for revenue and adjusted EBITDA and tightening the range for normalized FFO per share. We expect revenue to be between $325 million and $330 million. We expect adjusted EBITDA to be between $165 million and $167 million -- $170 million and normalized FFO per diluted share and share equivalent to be between $1.58 and $1.63.

We've maintained our original guidance for capital expenditures. Assuming no new leasing in the second half of the year but taking into account estimated churn, we would expect to be at the low end of the guidance range for revenue based on the estimated phase-in of leases signed during the second quarter.

Based on the strong leasing in the first half of the year, we feel that there is upside to our original adjusted EBITDA guidance and thus far increasing the range. The slight decrease in the implied adjusted EBITDA margin, assuming the midpoint of the new revenue and adjusted EBITDA ranges is primarily driven by expectations of higher electricity usage based on recent trends, in addition, we will be bringing new facilities online in the fourth quarter, which will increase our property operating expenses as they will no longer be capitalized. Also impacting adjusted EBITDA on the second half of the year will be approximately $1 million of expense associated with our requirements to become SOX and COSO compliance, which was not contemplated in our original plan.

This was triggered by the recent common stock offering as issuers with an equity market capitalization of at least $700 million are deemed large accelerated filers and issuer that first meets this condition among others, as of the end of the second quarter in any fiscal year is subject to these compliance requirements as of the end of that same year.

As a result of this additional cost as well as the full period impact of expenses related to personnel brought on in the first half of 2014, general and administrative expenses and excluding non-cash compensation for the second half of the year is expected to increase by approximately $2 million over the first half. Based primarily on the increase adjusted EBITDA guidance, we are slightly increasing the midpoint of our normalized FFO guidance range while also tightening it.

I know that some of you may have been expecting a bigger lift to normalized FFO guidance, especially after last quarter's results. I want to take a moment to address why you're not seeing that. First, as I mentioned earlier, we anticipate non-cash compensation for the remainder of the year to be in line with our second quarter number.

The difference between this and annualizing our first quarter number is approximately $0.03 on an FFO per share basis. Furthermore, we will begin drawing on our revolver over the next week or two, which will increase our interest expense in the second half of the year.

In addition, given the current interest rate environment, we are planning to accelerate the financing of next year's capital plan. Conservatively, as we're still early in the process, we assume that this will be through $200 million to $250 million high-yield issuance at current market rates in the fourth quarter.

We are exploring all of our alternatives and if we were to finance next year's capital plans through floating rate debt, we would anticipate approximately $0.02 increase to our current 2014 FFO per share forecast. We will provide further updates as we finalized our financing plan.

I wanted to also quickly point out that our current $525 million 2022 notes are fixed rate. We estimate that if we were in a floating rate instrument consistent with the financing approach of some of our peers, our interest rate would be approximately 200 basis points lower, generating approximately $10.5 million in annual interest expense savings and increasing our annual FFO by a like amount. The downside of course is that we would expose ourselves to an increase in rates and introduce volatility to the P&L.

Slide 18 shows current plan development activity by market as we have several major projects currently in process. As noted earlier, in the second quarter, we completed projects at our locations in Carrollton in Phoenix. And we are continuing construction on four new facilities in Houston, San Antonio, Phoenix and Northern Virginia.

We expect each of these shells as well as the first data halls for the facilities to be completed in the second half of 2014 or early 2015. Construction of the Houston West 3, San Antonio 2 and Phoenix 2 facilities were triggered by demand. The Houston facility will consist of approximately 320,000 square feet of powered shell.

The San Antonio facility will consist of 124,000 square feet shell with 30,000 square foot of raised floor and 3 megawatts of power capacity coming online day one. The Phoenix 2 facility will consist of 105,000 square foot shell with 60,000 square feet of raised floor and 6 megawatts of power capacity initially coming online.

The Northern Virginia facility will consist of 129,000 square feet shell with 30,000 square feet of raised floor and 6 megawatts of power capacity coming online day one. In addition to the new facility built, we’ve begun construction on 21,000 square feet of office space at our Carrollton facility including the 12,000 square foot custom built for 911 Dispatch Center that Gary talked about.

We are still evaluating another new market entry and will provide an update in the coming months. However, given the strong demand across the existing market, we’ve prioritized our allocation of capital accordingly. With the projects currently underway or expected later in the year, we expect to end 2014 with approximately 1.3 million square feet of raised floor and 1 million square feet of additional powered shell available for future development.

In closing, we are very pleased with results of this quarter as continued strong financial performance, helping leasing trends and success in acquiring new customers highlight the attractiveness of our value proposition to enterprises. As always, our number one focus is on the customer as we recognize that outstanding customer service is core to our success.

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

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Ross Nussbaum of UBS. Please go ahead.

Ross Nussbaum - UBS

Hi guys. Two questions, first, I just want to be clear on the NOI margin for the guidance for the second half of the year. So you were at 61% in the second quarter. So where are you saying that’s going to be in the second half of the year?

Kim Sheehy

Ross, this is Kim. We would expect the second half of the year to be about at 60%.

Ross Nussbaum - UBS

Okay. And then the second question, just want to be clear on what you were discussing on high-yield issuance. Can you just review again the volume of that issuance and the exact pricing at least that you're anticipating at this stage on that offering?

Kim Sheehy

Yeah. So in our plan right now, like I said, we haven’t made any definitive decision on how we would raise the financing. But we have assumed that we would add on to our existing high-yield bond and in the range of $200 million to $250 million. And right now, the rate on that would be about 5.5% to 6%.

Ross Nussbaum - UBS

Okay. But that was not in your original FFO guidance. So I guess the higher -- while I guess, that explains the difference between why the EBITDA guidance is up but the FFO guidance is more flattish. Is that a fair characterization?

Kim Sheehy

Yeah.

Ross Nussbaum - UBS

Okay. Thank you.

Operator

Our next question comes from Jordan Sadler from KeyBanc Capital Markets. Please go ahead.

Jordan Sadler - KeyBanc Capital Markets

Thank you. I just want to follow up on that. So the assumption has this 5.5% to 6% debt rate in it. What’s the remaining term on that $200 million to $250 million -- on the existing facility?

Kim Sheehy

The remaining terms is about 8.5 years on that facility.

Jordan Sadler - KeyBanc Capital Markets

Okay. Is that consistent, the 5.5% to 6% consistent with market in terms of where you think that would trade today according to sort of packers?

Kim Sheehy

That’s right.

Jordan Sadler - KeyBanc Capital Markets

Okay. And then G&A piece, so I think you said G&A would be growing up by about $2 million in that because of SOX compliance, is that right?

Kim Sheehy

The $2 million is if you look at the first half of the year, in total compared to the second half, we’re saying that it would be up $2 million. And that’s some of that is about half is due to additional fees related to getting SOX implemented in audit and everything really is there in such a short timeframe because we’re already in August. And the rest is just personnel that we had hired early in the year, just payroll run rate being a full half on the second end of the year.

Jordan Sadler - KeyBanc Capital Markets

So should that carry forward into 2015 into full run rate, is $4 million of higher G&A or are there some one time items?

Kim Sheehy

No, I think the million for the, kind of -- is mostly one time. The other is, it’s already coming into the run rate into the second half of the year.

Jordan Sadler - KeyBanc Capital Markets

Okay. So if I increased your G&A by $1 million a quarter, would that be good for 2015 as well? I know you’re saying, I’m not following.

Kim Sheehy

If you look at where we’re for the third -- the third quarter, the $1 million is one time. So if you take that out, but the other million, if you look at our -- where we’re at from the payroll run rate coming into the third quarter is we’ll see that for a full year. So Q2s G&A is probably a fairly good number to use to estimate next year.

Jordan Sadler - KeyBanc Capital Markets

Okay. I think I got it. In terms of the Phoenix pre-lease, can you maybe give us a little bit more color around that? Congratulations on doing your first pre-lease. I’m curious is it about wholesale user and did you say it was a new or existing customer?

Gary Wojtaszek

Hey, Jordan, Gary here. Yeah. It was a pretty exciting deal to us. We’ve never done that previously. So this is a new customer, customer that we’ve been talking to over the last couple of years and we finally manage to convince them to go with us. They are taking down the fall 30,000 square feet, so it would be a larger type customer.

Jordan Sadler - KeyBanc Capital Markets

Okay. That's helpful. Go ahead.

Gary Wojtaszek

I had a little more color, Jordan, I mean, on that, what triggered this, I mean on that SOX requirement. If our financing was done in July, like if it was done in July 1st, rather than June 25th, we would not have to have incurred that additional expense for the remainder of this year. And it just because that deal closed a couple days prior to Q2 requires us now to basically amp up our efforts to basically be compliant by the end of this year. We had otherwise assumed that we’re going to need to be compliant by the end of ‘15. So a considerable increase there from a timing perspective.

Jordan Sadler - KeyBanc Capital Markets

Okay. The other question I had for you was just on markets, it sounds like you’re considering new market. Did you have a look at the Sun-Times building in Chicago on the radar?

Gary Wojtaszek

Yeah. That was an interesting property. We had looked at that a while ago, but we decided to pass on it. We’ve been focus on expanding into the East Coast and with Northern Virginia being our first market, one of the other market -- we had originally anticipated going into another East Coast market this year. But given the amount of leasing that we've been selling at such a fast pace.

All the capital that we had originally assumed to go into another new market, we’re basically diverting now to go build our existing facilities in space in our existing footprint. So we’re not going to be in another new market as currently contemplated in our plan this year.

Jordan Sadler - KeyBanc Capital Markets

Okay. So it’s going to be -- next new market would be ‘15?

Gary Wojtaszek

Yeah.

Jordan Sadler - KeyBanc Capital Markets

Okay.

Gary Wojtaszek

We didn’t want to go over our capital budget this year. And we want to live within that and then we’ll revisit this discussion next year as we develop our ‘15 plan.

Jordan Sadler - KeyBanc Capital Markets

That make sense. Thank you.

Operator

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

Simon Flannery - Morgan Stanley

Thanks a lot. Gary, you talked a lot about the healthy leasing environment. I wonder if you could just talk about some of the conversations that you’re having, what do you think is really driving this? Is it an improved economy where people feel more comfortable making long-term decisions? Is it more embracing of the outsourcing model as one Fortune 500 company, does it others get more comfortable?

Is it factors specific to CyrusOne, where you’re really taking share? Any thoughts you have around that would be great. And then sort of secondarily on pricing, Kim, you talked about the renewals? Can you just give us a little bit of color around the renewals and related to that what’s going on with churn? Is this -- it was a slight rise in trend, nothing to concerned about there? Thanks.

Gary Wojtaszek

Sure. Simon, I’ll take your first couple of question. So it’s kind of all those. I mean, our --when we kind of develop this strategy years ago as part of our Cincinnati Bell, what we always liked about or attracted to were just the broad secured trends associated with increasing data demand and explosion as well as a confer by CIOs to get more and more comfortable with outsourcing their colocation to provider like us.

Those trends have remained intact and I think if anything, there is all sorts of data points of explosion in data out there. But the thing that we are seeing more of is a much more better willingness from enterprise customers to outsource more and more to co-location providers like ourselves. That trend has been accelerating and that’s been really one of the things that’s been -- the biggest change in our business model from years ago.

And that only is it willingness to do something with us with the size of the deployments that they are willing to do out of the gate has also increased substantially as well. I mean, this quarter, I mean, you see our average leases were at 90 months. I mean, these are considerably bigger deals, longer term deals because enterprises are much more comfortable with outsourcing a bigger portion of their solution to a provider like us for a longer period of time.

The other thing that I think is very specific to us is that all of the investments that we’ve been making in our sales and marketing efforts over the last several years have really being paying off dramatically for us. I mean, our current funnel on what we sit on now is about the same size as it was last quarter, which is really good, considering that we had just another phenomenal quarter.

I mean, we sold about $27 million of annualized bookings this quarter, consistent with next quarter and our funnel remains unchanged. So it gives you a sense for the amount of ability, we’ve generally in terms of filling up the funnel. If I look at that relative to say where we were six months ago or nine months ago from last year, we’re up about 50% more from the funnel perspective.

So those metrics, they are all I think, specifically related to the efforts by our sales and marketing team. We’re really doing phenomenal job and just creating more and more brand awareness for us. I’ll turn the last question over to Kim.

Simon Flannery - Morgan Stanley

Thanks. That’s helpful.

Kim Sheehy

Sure. Just real quick, I think, I mentioned, we did renew about 26,000 square feet during the quarter for little over 4 megawatts. The pricing on that across looking at all of them combined was down about 1.8%, kind of in line with what we’ve seen and that would be included in the churn that you’re seeing at 1.4% for the quarter.

Gary Wojtaszek

And that’s a cash number.

Kim Sheehy

Yeah.

Simon Flannery - Morgan Stanley

Okay. And is there anything -- this might be slightly be different in the second half on that?

Kim Sheehy

On the renewal?

Simon Flannery - Morgan Stanley

Yeah. Renewals, churn, et cetera.

Gary Wojtaszek

Yeah. We are expecting one customer is going to churn out. And it’s a customer that we signed up recently that isn’t working out and we expect that that’s going to increase our churn 1%, but that is all factored into our guidance number for the year.

Simon Flannery - Morgan Stanley

What quarter does that hit?

Gary Wojtaszek

Probably, third quarter.

Kim Sheehy

Third quarter.

Simon Flannery - Morgan Stanley

Okay. Thank you.

Operator

Our next question is from Barry McCarver from Stephens, Inc. Please go ahead.

Barry McCarver - Stephens, Inc.

Hey, good morning guys and thanks for taking my questions. I guess, first off, looking at the little over 165,000 square feet of leases commenced in a quarter. Could you provide some color on some of the larger deployments from customers in that number?

Gary Wojtaszek

Well, that commenced or that were sold, are you talking just what we sold rather then commenced?

Barry McCarver - Stephens, Inc.

I was talking about leases that commenced during the quarter?

Gary Wojtaszek

Are you talking that chart, the step-through chart?

Barry McCarver - Stephens, Inc.

Yes.

Gary Wojtaszek

And maybe you can walk through that chart. For those of you who haven’t paid attention to the press release, we had PowerPoint presentation, what we try to do this quarter was provide a good overview or the walk through in our MRR progression from the contracts that were sold and as I started going through our P&L.

Kim Sheehy

The chart Gary is referring to is chart number 12. What we’ve tried to lay out on the top of the slide is of the monthly amount that was executed into leases this quarter. This is how we see those leases commencing meaning installation. So that we would trigger revenue recognition over the next few quarters. And then we have tried to estimate in the second half of that chart, the amount of GAAP revenue that would actually be in our results as those installations occurred. Is that your question, Barry?

Barry McCarver - Stephens, Inc.

Well, I guess, what I was getting at during the quarter is that I’m just taking a stab at overall pricing of capacity. And it look like it came down a little bit quarter-over-quarter. And I suspect there were some large customer contracts that kicked in during the quarter, which is why that. And again I know it’s just an average pricing number, so on an absolute basis doesn’t (indiscernible)

Gary Wojtaszek

I’m not sure. I mean, just roughly speaking Barry, like last quarter we sold about $27 million in annualized GAAP revenue and that was based on a 100,000 square feet of deals that we sold. This quarter we sold same thing for $27 million of GAAP annualized revenue, 59,000 square feet of colo space and another 17 of office space, 12 of which was for that 9/11 deal that I talked about. So I’m not sure the way you’re looking at it but just on a high level number, it would go up relative to last quarter.

Barry McCarver - Stephens, Inc.

Okay. Fair enough. And then I guess, just secondly back on the margins again. I think, I understand sales and marketing and general and administrative but it sounds like you’re indicating that property operating expenses are going to remain at a pretty high level for the remainder of the year. Is that just mostly because of the amount of capacity in development programs we have underway? And if so, should those margins trend higher in 2015?

Kim Sheehy

Barry, I think as we have more facilities operating and revenue being generated that certainly would expect to see the margins improve. But what you’re seeing in the second half or the first half, we would expect operating expenses to pretty much be flat with the exception, if our metered power customers ramp-up their power usage, you would see an increase in the power expenses as well as the revenue.

Barry McCarver - Stephens, Inc.

Okay. Thanks a lot guys.

Kim Sheehy

Okay.

Operator

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

Jonathan Schildkraut - Evercore Partners

Thanks for taking the questions, the few if I may. I just want to start out a little bit about what’s going on from a leasing perspective. If you give us a little bit more color on whether your deals that you’re winning are competitive deals, responsive to RFPs, more of these are sort of lead generated deals that have been matured over time. And whether you’ve gotten any feedback from those customers as to why they’re choosing you versus maybe some of the other options, whether it’s the shared infrastructure, the national IX or the potential to multi tier.

And then I guess it was a derivative question, one of the things that we’ve been talking about with you guys has been improvements in sales force productivity. And maybe if we get a sense as to how that productivity has been trending over quarter, it would be helpful. And then I have a follow-up with the separate question. Thanks.

Gary Wojtaszek

Sure. In terms of the deals that we closed this quarter. I think it was about 3% of our deals came through, call it, broker channels where there were RFPs in there, so really small. And last quarter none of our deals came through that channel. So all the stuff that you’re seeing is really the result of just kind of our basic sales and marketing efforts in terms of driving direct business out of customers.

I mean, a lots of customers say, they choose us for CEOs good looks, but I question that. I think what they generally like is just what we’ve been talking about historically. We are really flexible. I think we’re focused on trying to come up with solutions that are addressing their needs. We’re underwriting these deals to the same returns that we have historically. So our underwriting standards have really changed on them. And it’s just in general, I think they just like working with us.

And as the business expands and more customers come with us you get that networking effect associated with Simon’s questions earlier about the more people do business with you, the more they feel comfortable with you than they tell others and that kind of feeds on itself.

Jonathan Schildkraut - Evercore Partners

Great. And in terms of the productivity of the sales team?

Gary Wojtaszek

I actually been looking at that number, Jonathan. My guess is that it is up pretty dramatically. I don’t know where we stand on that number for the quarter.

Jonathan Schildkraut - Evercore Partners

Okay. All right. And then I guess my other question, little bit of our guidance. First, if you give us a little bit more color on this one customer churn. You said it was a reset customer, so I’d be interesting to get a little bit more colors as to why that didn’t work out. And then specifically as to the commentary about the financing, that is now in your guidance. If you assume, I guess, the beginning of a quarter like so it would be in for the full fourth quarter Kim. I’m coming up with about a nickel drag from that relative to the prior expectation. Is that the way you would have think about it or is it a mid quarter convention the more appropriate way…

Kim Sheehy

The mid quarter is probably more, it would be in with what we are looking at.

Gary Wojtaszek

Yeah. In terms of the customer Jonathan, this is the customer that we put in on our end power solution so not are basic, not the premium product that we sell to our customers, this is more of an opportunistic sale that we did for a particular customer, which is -- we look at is basically all upside. That customer didn’t work out from a product perspective. I don’t think that their understanding of that was as robust as it needed to be and I think the applications that they are running weren’t applicable to that application.

Jonathan Schildkraut - Evercore Partners

That’s very helpful. Thanks a lot for taking questions.

Gary Wojtaszek

Yeah.

Operator

Our next question is from Frank Louthan from Raymond James. Please go ahead.

Frank Louthan - Raymond James

Great. Thank you. Just wanted to circle back on the pre-lease, was that facility in Phoenix, are you breaking new ground for another data haul or is that just building out some of the space that you already have under roof there?

Gary Wojtaszek

Yeah. That’s -- it’s a brand new building. That exact -- that existing building that was initially that we built last year was sold out as of last quarter and that both spaces of that building. This deal is the new building that we just start a construction on just within the last month. So that will be commissioned by the end of this year as well.

Frank Louthan - Raymond James

Okay. Great. And then going forward, how can you -- can you characterize the size of your sales force, I mean, with the new expansion, is it you are getting leverage with your sales force, you see need to hire more direct sales folks and what markets in particularly are you forcing on the new hires?

Gary Wojtaszek

Yeah. We’ve added people in California, Chicago, Northern Virginia, where we are expanding, we are putting resources in those ground to kind of work those accounts there. The way we think about broadly as we do expansion, because every new market that we go in to, generally we’re assuming that there is going to be about four additional sales and marketing people for per new location.

Frank Louthan - Raymond James

Great. Thank you.

Operator

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

Vincent Chao - Deutsche Bank.

Hi, everyone. Just a question on the 9/11 deal. Just curious how you guys think about returns on those types of deals where its most like a mixed use kind of things where you get some office in some other non-technical product that’s included? And also how you think about allocating net rentable square foot between your offices pieces of it or the non-data center pieces and the date center portion?

Gary Wojtaszek

Yeah. We are underwriting those then on consistent type deals that we are getting in the rest of our business. So we making really nice return on that and not only are we getting the nice return on that on the standalone basis, but we get really great amount of marketing and sales benefit associated with it, because now we are going to have a bunch of the critical infrastructure for those towns that are going to be located here, the police fire, emergency and medical services dispatched out of this facility. So from a marketing perspective that shows really well to our potential customers. So we think we are getting at a lot more sales benefited out of that.

In this facility in Carrollton, I mean, if you have been here, I mean, it’s a 700,000 square foot building. So we’ve got a pretty large sandbox to play in. So we could be pretty creative in terms of how we give you up critical infrastructure space versus office space and the goal is really just making sure you are underwriting to get a return that’s very attractive.

Vincent Chao - Deutsche Bank

Okay. That’s helpful. And then sticking Dallas, I know you guys just delivered some space there and you did have some lease up it looks like, but just relative to some of the chunky deals that you are pulling off in some of your other markets particularly in Phoenix. Just curious of the leasing the process where you at in Dallas there is meeting your expectation or if there is anything going on in that market in particular given the amount of supply that is sort of coming on there?

Gary Wojtaszek

Yeah. Yeah. Absolutely. I mean, the reason that we -- that we move the headquarters to Dallas. There are couple of different reasons. The airport is great here and made a lot of sense from a corporate perspective. But also I’ve always thought that our ability to sale in Dallas was way underrepresented given success of this company has been able to generate in Cincinnati and in Houston.

And I have always thought that the reason for that was because of lack of strong executive presence here. And since we move the headquarter here, we put a lot more focus and effort on this. This is actually been our fastest growing market over the last year and it’s kind of developed exactly as I had hoped it would and so our demand funnel here is just as strong as it ever been.

Vincent Chao - Deutsche Bank

Okay. Thanks guys.

Operator

Our next question comes from Sergey Dluzhevskiy from Gabelli & Company. Please go ahead.

Sergey Dluzhevskiy - Gabelli & Company

Good afternoon, guys. A couple of questions if I could. First for, Gary, on inorganic growth opportunities, I guess, recently you had another deal on the data center space agreed to acquire via, via for about 13.5 times EBITDA. So maybe you could give us your thought on potential inorganic opportunities, do you see any companies out there that could potential expand your platform or enhance your growth prospects and what are the main factors that are most important in evaluating M&A targets for you guys?

Gary Wojtaszek

Sure. Sure. I think, Sergey, so that 13.5 times number that you reference. That was probably with the headline number, the actual number if you compared to a public company like us it would be probably closer to about 15, 15.5 times EBITDA multiple.

Clearly, well about where we trade at currently, right. We still are the lowest traded EBITDA multiple company in this space. So I think that bodes well for us in general. What I think about paying a premium for assets like that versus where we trade at that would be difficult for me to do in terms of justifying why we should pay a premium for that.

I think in general that was a good sign for the market that asset traded for the value it did. It was also interesting in that Canadian company came into the market and pay that multiple, because I think some of those larger enterprises are clearly seeing the benefits of this assets class. You can’t help but notice the Windstream deal on what Jeff was able to do with that company.

Really interesting transaction taking advantage of the restructure. So I think in general those two deals and the recent sale of (indiscernible) I think bode very well for the industry. We think that we should trade at a higher price just giving some of the financials that we’ve been able to consistently put up and we will continue to looking at numbers but we won’t do anything that, that doesn’t make sense from the return perspective.

Sergey Dluzhevskiy - Gabelli & Company

Okay. And one question for Kim, you provided, obviously, a lot of details about variability in cost in the second half of the year compared to the first half of the year. Would you talk in general about some of the efforts or initiatives that you guys have to improve margins in general? Obviously, with the great revenue base and leveraging the systems, there is going to be some margining improvement as the company grows, but also what are some of the efforts that you are making to cut cost in certain areas?

Kim Sheehy

Thanks, Sergey. And as far as effort, I mean, you think at this point, this past year, we really built the team from a G&A perspective, just being a new public company. So, I mean, like you said, a lot of it is just going to be as our topline growth, we are able to leverage that. We are always looking at operating efficiencies. I don’t have specific opportunities to communicate but the construction folks and the operation folks are always looking at efficiencies and how they design from a power perspective, as well as just in general how they operate the facilities. We kind of tackling all the basis stuff, so I’m not sure that there is anything specific to share.

Sergey Dluzhevskiy - Gabelli & Company

Okay. Thank you.

Operator

Our next question comes from Colby Synesael from Cowen & Company. Please go ahead.

Colby Synesael - Cowen & Company

Great. I guess to follow on that. So we are obviously seeing a trend towards metered power which is started a few quarter ago and obviously, you continue to see strength in National IX? Can you just trying to get sense of what the impact of those things will be end margins? Can you talk about what you think the typical EBITDA margin would be on a facility that’s fully utilized using the previously in terms of power and then kind of what the margin profile would be now that you are using the metered, looking at the sense of what the, I guess, the fundamental change in margin is going from one to the other maybe it’s a good way of kind of explaining that?

And then also what the impact would be as it relates to the National IX? And then the other question I just have is, I am sure you could answer it, about Cincinnati Bell, sounds its share, I guess, as the stock continues to work up, the natural cohort question will, could they sale again at the higher level? So you have any context or color whether or not they have any intension of selling certain share at a certain price or what’s your general thought are in terms of when we might be able to see another slug come through? Thanks.

Gary Wojtaszek

Sure. Yeah. Think of the margins. Those are really good questions, Colby. Think of the margins. At the assets level as, if you were a fully -- if you are fully metered customer engagement, you are roughly looking at NOI margins which are a good proxy for EBITDA margin at the asset level of roughly 70%.

So that's where you would, that is kind of like Nevada, in terms of where you would kind of come in to in terms of everything was that level, because every dollar of incremental revenue for that customer, as Kim was mentioning, 75% of that is flowing through as expense to the costumer, right.

So you think about it from that perspective, you layer in some additional expenses for some of the property for property expense on this facility, some of the maintenance items on there and you come down 4% or 5% below that number.

So if you look at some of the pure operators in the space, so say like a DuPont, those guys that have almost triple net deals, those margins at their able to get at their level that’s probably where the (indiscernible) of this would go to, right.

And so the -- and so at the EBITDA level down below, I mean, then it’s a question of how much are you going to be allocating of your corporate, your sales and marketing expanse to basically operate those facilities or continue selling into those facilities, right. So it would come down from, if you were a purely retail-only -- if you had a purely retail-only base and there those margins are considerably higher than what would get in -- on the wholesale side. Does that explain it.

Colby Synesael - Cowen & Company

Yeah. I mean, basically 70% stability that we are driving toward centers.

Gary Wojtaszek

No. You are probably looking at, 70% just with the pure power, if you layer in like the additional operating expense there, you are going to get about 65% level at your -- at the asset level when you factoring everything else from at the gross margin level.

Colby Synesael - Cowen & Company

Okay. And then, I guess, on Cincinnati.

Kim Sheehy

We have really nothing we can share that point on that. I mean, you are absolutely right, I mean, in the future they will sale more but there is no plan immediately. Their original plan was for this to be sale down over several years and nothing changed at this point.

Colby Synesael - Cowen & Company

Okay. Thank you.

Operator

And the next question comes from Ana Goshko from Bank of America. Please go head.

Ana Goshko - Bank of America

Hi. Thanks very much. Some additional debt questions for Kim. So I just wanted to understand, Kim, because in your prepared comments you did talk a lot of about floating rates, so what your planning is in the next couple weeks to access the revolver? And the you would plan to pay down the revolver with the fixed rate, is that how I should interpret that?

Kim Sheehy

The way we -- what we referring to is how we forecasted and planned, would be that we go ahead and raise the fund to fund next years capital plan at fixed rate. And the revolver is, it’s kind of like, not really -- don’t combine the two. I mean, that’s sort of what we planned. We’ll be drawing on the revolver until we would raise that cash. So its not -- I guess the answer to your question is yes just by the math but…

Gary Wojtaszek

Ana, I mean, we’re kind of going through that whole analysis of fixed and floating rate. I mean, what we have assumed for conservativism is that we have assumed it to be a bond offering at 5.5% to 6% rate later this year to the extent that we didn't do that. And we did everything on a floating-rate basis on revolver. We would have a pick up to our FFO because of that.

But we’re just trying to take internally about the choice that we’re making there given what our expectations are going to be in terms of increasing interest rates over next several years and whether one trade versus the other is more appropriate for us. Right now, everything is 100% fixed in a bond that we chose eight years form today.

We don’t know -- that may be -- that may be too conservative, we’re not sure. But from our forecasting purposes, we’ve assumed it just continues -- we assume that same -- same type of debt.

Ana Goshko - Bank of America

Okay. And then the $200 million to $250 million, should we assume that that would take you through your 2015 plans?

Kim Sheehy

Yeah, it would be actually be longer than that with the revolver that we would have in place.

Ana Goshko - Bank of America

Okay. But with the revolver, there still be some potential that if you need to access revolver in 2015?

Kim Sheehy

Yes. What we would look at is -- so we would look at financing through ‘16 with the revolver that would have in place as well as the debt that we would raise.

Ana Goshko - Bank of America

Okay. And then you had a pretty complicated, very complicated maintenance of total unencumbered assets coming in. So it sounds like even with the new debt rate, you don’t have any problems under that covenant and you would assume to have full access to the revolver, even if you put a bond in place?

Kim Sheehy

That is right.

Ana Goshko - Bank of America

Okay. Great, okay, thank you so much.

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

Well, thanks every one. Please let us know if you have any additional questions. And we look forward to delivering a really strong second half of the year. Thanks. Have a good day.

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 Q2 2014 Results - Earnings Call Transcript

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