CyrusOne Inc.
Q3 2018 Earnings Call Transcript

Published: 31 Oct 2018

[Operator:]

Good day and welcome to the CyrusOne Third Quarter 2018 Earnings Call and Webcast. All participants will be in listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Michael Schafer. Please go ahead.

[[0FQ4TF-E Michael Schafer]:]

Thank you, Austin. Good morning, everyone, and welcome to CyrusOne's third quarter 2018 earnings call. Today, I am joined by Gary Wojtaszek, President and CEO; and Diane Morefield, CFO. Before we begin, I would like to remind you that our third quarter earnings release along with the third quarter financial tables are available on the Investor Relations section of our website at cyrusone.com. I would also like to remind you that comments made on today's call and some of the responses to your questions deal with forward-looking statements related to CyrusOne and are subject to risks and uncertainties. Factors that may cause our actual results to differ from expectations are detailed in the company's filings with the SEC, which you may access on the SEC's website or on cyrusone.com. We undertake no obligation to revise these statements following the date of this conference call except as required by law. In addition, some of the company's remarks this morning 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 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, Schafer. Howdy, everyone, and welcome to CyrusOne's third quarter earnings call. This was another very strong quarter with many significant accomplishments. The U.S. business continues to do very well, and I am very excited about what we're doing to serve our customers globally, positioning the company to take full advantage of the significant growth opportunities ahead of us. Slide 4 summarizes the key takeaways for the quarter, and I'll adjust those slides, highlight a few of those here. We released 15 megawatts and 114,000 colocation square feet totaling $27 million of annualized GAAP revenue. Revenue signed through the first 9 months of this year is 26% higher than our total for all of last year, and we still have one more quarter of selling to do. With regard to expansion, we filled the last remaining significant gap in our U.S. portfolio with the acquisition of 15 acres of land in Santa Clara, giving us a presence in a key West Coast market. We also acquired land in Northern Virginia and Allen, Texas to support our continued growth in those markets. We closed Zenium and, subsequent to the end of the quarter, announced the strategic partnership with an investment in ODATA, a leading data center provider in Brazil as well as another partnership with Agriport to build the largest data center campus in Europe. Moving to slide 5, the $27 million in annualized revenues signed was at an average price of nearly $150 per kilowatt, 23% higher than the prior four-quarter average. This is primarily a function of the mix of smaller, higher-priced enterprise deals which represented about 43% of our bookings this quarter compared to the larger, lower priced hyperscale deals that we have signed over the past few quarters. We signed 500 leases across 9 verticals and 10 markets, and the number of lease assigned was 14% higher than the prior 4-quarter average. We also signed three new Fortune 1000 customers and gained four more through the Zenium acquisition, bringing our total to 208 Fortune 1000 customers. The GDS partnership again contributed to our leasing and we signed 4.5 megawatts with the Chinese hyperscale company. This has been a very productive and successful relationship with both companies seeing deals and I couldn't be more pleased with the results over the last year. The $150 million in revenue signed over the last four quarters is equivalent to 22% of base revenue over that same period and our backlog of $90 million represents over 10% embedded revenue growth heading into 2019. Turning to slide 6, while we have discussed this before I don't think everybody fully appreciates the extent to which the hyperscale companies will provide a tailwind to the industry over the coming years. Despite the recent share price volatility, the underlying trends remain very strong. Our sales funnel is up significantly and is again at a record level, primarily driven by hyperscale demand that is well above the level we had previously been tracking to. We expect this demand to continue for years to come and, in fact, accelerate globally and the discussions we will be having with our customer support this trend as well. Just last week, I spoke with two Fortune 100 companies that are just starting to outsource their internal IT infrastructure to the cloud and plan to pursue a hybrid cloud solution. I also met with a cloud company that shared some of the challenges they face in helping enterprise companies migrate to the cloud. All of these experiences further support the 5 gigawatts of demand coming over the next five years that I have been hearing from customers since the beginning of the year. AWS continues to put up growth rates in the mid to upper 40% range, even as the business has grown significantly and is now at nearly $30 billion on an annualized run rate basis. Azure, Google Cloud, Alibaba and the list goes on of cloud companies that are experiencing tremendous growth and that is translating into strong demand for our sector. Capital spend by Amazon, Facebook, Google, and Microsoft through the first half of this year totaled $35 billion which was up nearly 60% compared to the same period last year and far surpassed the CapEx investment of some of the traditional CapEx heavy customers in oil and gas, industrials, and auto manufacturing. Based on everything we are seeing and what our customers are telling us, we feel really good about how things will play out over the coming years. Slide 7 provides an update on our interconnection business. We had another very strong quarter of bookings signing $2.7 million in interconnection revenue. We added 700 cross connects in the quarter and are up to more than 18,000 across the portfolio. Total interconnection revenue was up 14% with growth continuing to be driven by the deployment and growth of ecosystems within our data centers. We are seeing more and more customers acquire access to clouds via SDN solutions like what Megaport offers which enable customers to bypass the need to establish a point of presence and very expensive traditional network hubs. Our business with Megaport has nearly tripled over the past year highlighting this powerful trend. This slide also provides an update on several other key operating metrics that we track. These are indicators of the quality and durability of the customer base and lease portfolio. The vast majority of MRR signed each quarter includes escalators generally in the 2% to 3% range annually, although for some of the cloud deals they may be slightly lower. Overall, 65% of portfolio rent includes escalation and this percentage has continued to steadily increase over time. The weighted average lease term for bookings year-to-date is nearly nine years and the remaining average duration of the portfolio is nearly five years, up six months from the end of 2017. A few years ago, the duration was just over two years but we have pushed out terms significantly as customers prefer to sign longer-term leases. We have a high-quality customer base with 72% of rent from investment-grade customers, which is very high compared to what you generally see across other REIT asset classes. Additionally, 73% of rent is from customers that are in more than one location, which is a result of their expansion into other locations as they grow with us, highlighting the ecosystem benefits that we are providing to our customers. Moving to slide 8, we have been very active domestically with site acquisitions across key markets to ensure we have the capacity to support our continued strong U.S. growth. As we have talked about for some time, Santa Clara was the one important location in the U.S. where we did not have a presence. This market has been supply constrained which has been supportive of healthy pricing, particularly for larger hyperscale deals. We will deliver 100 megawatts of capacity at this location in the early part of 2020. And as I mentioned earlier, this property is unique as it is the only data center with an on-site power cogeneration plant in the Santa Clara market. We have also acquired additional sites in our existing markets. In Northern Virginia, we recently purchased a 40-acre parcel with capacity to deliver an estimated 120 megawatts of power. This is in addition to the 154,000-square-foot shell we talked about on last quarter's call which will deliver another 30 megawatts of power. Inclusive of our existing Northern Virginia sites, we will be able to deliver over 180 megawatts of capacity into that market which we estimate is enough capacity for the next few years. To support continued growth in the Dallas market, we acquired a 24-acre parcel adjacent to our existing location in Allen that will deliver nearly 100 megawatts of power capacity. Across the portfolio, we have significant capacity to grow with approximately 600,000 colocation square feet currently available for lease or under development. 2.3 million square feet of powered shell and nearly 500 acres of land, the shell and land will allow us to add an estimated 1.4 gigawatts of leasable power capacity once fully built out. Turning to slide 9, I am very excited about the new strategic partnership we recently announced with ODATA, a leading data center company in Brazil that, like us, is focused on serving hyperscale customers. Brazil is the largest and fastest growing data center market in Latin America. However, it's currently served by a limited number of quality providers resulting in few options and higher prices for our customers. This partnership presents customers with a compelling alternative, further strengthening our relationship as we continue to offer solutions to meet their need throughout the world. We invested $12 million in exchange for a 10% equity interest and we have the ability to increase our investment over time. We have also entered into a commercial agreement that will compensate us for leases signed to referrals. ODATA will be able to leverage our supply chain and design and construction expertise as they scale the business to drive efficiencies. The company is currently expanding its portfolio to develop over 100 megawatts in Brazil and is breaking ground on a new facility in Colombia. They are majority owned by a fund of Patria Investments, a leading Brazilian private equity which is in turn 40% owned by Blackstone. Customers will have access to dark fiber and lit services through Vogel Telecom, another portfolio company of Patria. Moving to slide 10, we are excited to close Zenium to begin our European expansion. For our customers, knowing that CyrusOne now has existing data centers with available capacity in London and Frankfurt is important, and we expect to have a lot of success in the region that continues to experience an acceleration in demand. In the first half of year, take-up was 50% higher compared to the same period in 2017, and the size and deployments continues to increase, driven by demand from hyperscale cloud companies. Last week, we entered into an interesting new land development that is being planned to deliver six 45-megawatt cloud centers, which will be the largest data center development in Europe. Inclusive of our other sites, we will have a prospective footprint across Europe that will enable us to deliver nearly 500 megawatts of critical load power capacity. On slide 11, we highlight the track record of executing on our commitments. Words are meaningless without intent and follow-through, and we have a history of doing what we are saying going to do. We wanted to have a robust domestic offering with a presence in all key U.S. data center markets. We have worked hard to accomplish that objective over the last few years, and our recently acquired property in Santa Clara represents the last location we needed to meet our goal. Since our IPO, I've also discussed the importance of building a global platform, given the increasingly global needs of the many Fortune 500 companies that we count as customers. About a year and a half ago, I started talking specifically about our desire to enter Europe, and we have now done that. And with the announcement we made yesterday, I believe we will have the largest wholesale data center portfolio in Europe with close to 500 megawatts of developable capacity. Additionally, we are now able to offer our customer solutions in China and Brazil as a result of our partnerships with GDS and ODATA. That's three new continents in less than a year, which is pretty amazing and a significant accomplishment for our company. Additionally, we were early to recognize the tremendous opportunity with the cloud companies given our costs and time to market advantage. And we've positioned ourselves to attack this segment. It has obviously worked out well as demand from these companies has accelerated our growth trajectory as we are one of the fastest organically-growing REITs in the country. Lastly, as you know, one of our longstanding strategic objectives has been to get to investment grade. The reason I have always been focused on achieving an investment grade rating is the strategic importance that it conveys in terms of always ensuring access to the capital markets. The secular demand for our product over the last few years is very strong, and I never want to jeopardize our ability to continue to grow with our customers by creating a weak balance sheet. As we have seen over the past few weeks, the capital markets can become very volatile. I think as interest rates begin to trend upward and willingness from lenders decreases, many of the private data center alternatives which have been fueled by massive amounts of leverage, will become more challenged. The recent upgrade from S&P is reflective of strong underlying industry fundamentals, the growth and diversification of our business, and prudent balance sheet management. All of these objectives were identified specifically due to the key strategic value that they had to the business, and we are now set up very well for continued strong growth over the years to come. In closing, we are one of the largest data center companies to report – we're one of the last data center companies to report results this quarter and, generally speaking, I believe CyrusOne and the overall industry continue to do well. The recent decline in our share price is very disheartening and does not reflect our strong underlying performance. We ended the quarter with the largest backlog in our history, which is matched by a record sales funnel. We have $2 billion of liquidity which will fund all of our needs through 2020. We recently upgraded to investment grade further assuring access to capital and now have an international portfolio to sell into. I believe the company is well positioned for long-term continued growth, and that our continued expansion execution will be rewarded. I will now turn the call over to Diane, who will provide more color on our financial performance for the quarter and an update on our guidance for the year. Thank you.

[Diane M. Morefield:]

Thanks, Gary. Good morning, everyone. As Gary mentioned, it was a very productive quarter for us with many notable achievements. Slide 13 highlights our strong year-over-year growth in revenue at 18%, EBITDA growing 16%, and normalized FFO up 10%. The Zenium acquisition closed at the end of August, so the third quarter reflects one month of results from these data centers. Also highlighted on slide 13, and as I guided to on our last quarterly call, churn was elevated in the third quarter at 2.6% primarily related to non-renewing leases which we had anticipated. In addition, we exited our Midway location in Dallas, a facility that we had leased and chose not to renew, which also accounted for a portion of the churn in the quarter. We anticipate full-year churn to be within our original guidance range of 6 to 8% but likely closer to the lower end of the range. Moving to slide 14, NOI grew 15% in the third quarter driven primarily by the increase in revenue. The adjusted EBITDA margin was down approximately 1 percentage point compared to the same period in 2017 due to the year-over-year increase in metered power reimbursement, which is a zero margin pass through for actual power charges to our customers under metered power contracts. Normalized FFO grew at a slightly lower rate than adjusted EBITDA driven primarily by an increase in interest expense to fund our development pipeline and acquisition activity, while normalized FFO per share was flat year-over-year as a result of equity issued to fund our growth and manage our leverage. As the chart of the bottom of the slide shows, the net impact of the adjustments to normalized FFO were positive in the third quarter resulting in higher AFFO driven by cash received from large installations associated with a few deployments. Slide 15 provides an update on our portfolio by geography. And as you can see, it is very balanced across all our markets. The Zenium asset, an additional planned European expansion, will further enhance our diversification across several international markets. The percentage leads for the total portfolio was up 4 percentage points year-over-year even with a 17% increase in CSF capacity, reflecting the continued strong leasing demand. Slide 16 provides an overview of our development pipeline, highlighting the projects we have underway across a number of domestic and international markets. We will deliver nearly 400,000 colocation square feet and more than 100 megawatts of power capacity across Northern Virginia, Dallas, Raleigh-Durham, New York Metro area, as well as our European markets. Similarly to the second quarter, the percentage of our pipeline that is pre-leased remains very high with 74% of colocation square feet under development committed to customers under signed leases. As a result, a substantial portion of the capital investment to fund the development pipeline is fully derisked. This continues to be an industry-wide trend as customers have become increasingly comfortable signing leases before the capital has been deployed. Once all of the projects in our pipeline have delivered, we will have a footprint of more than $4 million colocation square feet. Slide 17 highlights some of the key credit metrics of the company. As of the end of the quarter and as Gary mentioned, we had total liquidity of nearly $2 billion. We have no debt maturing until 2023, a weighted average remaining debt term of nearly six years, and an almost fully unencumbered asset base with a growth asset value of $6.5 billion. The available liquidity allows us to fund our ongoing capital plan into 2019. As Gary also mentioned, we were very pleased with the S&P upgrade on our issue level credit rating to investment grade following our equity offering at the end of September. While we still need an investment grade credit rating from another rating agency to issue in that market, this is a very important first step. The $400 million in equity that we raised in the quarter helped to manage our leverage, and more than 70% of our capital structures at the end of the quarter represented equity. The forward which will result in nearly $150 million in additional proceeds upon settlement further derisked our future equity requirements while providing significant flexibility as it can be settled at any time at our election through September 15, 2019. We think it's particularly important to have a strong balance sheet in periods of market volatility. This year, the 10-year treasury yield has increased more than 60 basis points, creating turbulence in the capital market. Recently, a lot of technology companies have come under pressure, and there is increasing debt and equity volatility. We are focused on maintaining a strong capital structure so that we can continue to build out our global platform. We remain very confident in the broad secular demands over the next few years so maintaining excess liquidity and a rock-solid balance sheet is core to our ongoing success. Turning to slide 18, our revenue backlog as of the end of the quarter was $89 million. As Gary mentioned, this is the highest quarter-end backlog in the history of the company and the second straight quarter at a record level. Given our estimated timing of commencement, the backlog will not have a material impact on this year's results, but it sets us up nicely for continued strong growth into 2019. As shown in the bottom chart, we anticipated nearly all of this revenue will commence anticipate nearly all of this revenue will commence over the next two quarters. Moving to slide19, we are reaffirming our guidance for 2018. When we last gave guidance, we assumed Zenium would close on October 1, and it closed effectively September 1. Given the funding impact associated with the transaction for an additional month as well the impact of our equity offering at the end of the quarter, we are tracking toward the lower end of our normalized FFO per share guidance range. An important topic going into 2019 is the new lease accounting standard, which is impacting virtually all REITs. We have assessed the impact that adopting the new standard would have had on a pro forma basis on our financial metrics in 2018. Based on our preliminary analysis, we estimate that if we had adopted at the beginning of this year, it would have had a negative impact of approximately $15 million to $16 million in adjusted EBITDA and approximately $8 million to $9 million on normalized FFO. This impact is primarily a result of the 97-10 leases in our portfolio that will revert to being classified as operating leases beginning January 1, 2019. We anticipate a similar impact for 2019 from these lease reclassifications, and there could be other residual financial impact once we fully implement the new standards. As we have done in prior years, we are planning to issue guidance for 2019 when we report earnings for the fourth quarter of 2018 in February next year. In closing, it really was another strong quarter, and we are very excited to have launched our international expansion and build on the success we have had in the U.S. as we help our customers expand globally. We appreciate you participating on this call and are now happy to take questions. Operator, please, open the line.

[Operator:]

And our first question will come from Frank Louthan with Raymond James. Please go ahead.

[Frank Garreth Louthan:]

Great. Thank you. So can you walk us through the Santa Clara property? What development yield are you underwriting that to? And how should we think about that going forward given the increased cost in that market?

[Gary J. Wojtaszek:]

Sure. Hey, Frank, Yes. So Santa Clara was the last remaining location in the U.S. that we were looking for capacity that we didn't have. It's one of the largest data center markets in the country. And we've been looking for the last several years. And we've had other properties under contract that we couldn't get the yields to work out given the price that the sellers had wanted on this. So the pricing in that market is probably 50% to 60% higher than what we see in the rest of the portfolio. And so the yields that we expect that we're going to be generating on that facility are going to be consistent. And potentially by the time this thing has actually developed even higher, that's the one market in the U.S. where there is tremendous pricing capabilities in there just because the market is so land locked. What's unique about that property is that we have a cogeneration plant on it which I believe is the only one in that market, maybe potentially the only one in the U.S. that has a cogeneration facility on site.

[Frank Garreth Louthan:]

Okay. Thank you. And I apologize if I missed this but I think you've discussed some future contracts with some Chinese hyperscalers. Could you talk to us about the current status of that and if any trade war issues or anything like that? Do you think that would derail that or limit the opportunities you have with your relationship – your development with GDS? Thanks.

[Gary J. Wojtaszek:]

Sure. Yes. So, this was another deal that we closed this quarter in addition to the two or three that we closed last quarter. So, we're doing really well with that relationship, and in particular with the Chinese hyperscalers. I mean, today that hasn't really impacted their growth. I mean, they are aggressively expanding outside of China. They've been doing a lot of work in the U.S. and we're talking to them about expanding in Europe as well. So, it hasn't really impacted that part of the business and given that they're basically dealing in services, most of the tariffs that people are talking about are really related to products.

[Frank Garreth Louthan:]

All right. Great. Thank you very much.

[Operator:]

Your next question will come from Robert Gutman with Guggenheim Securities. Please go ahead.

[Robert Gutman:]

Hi. Thanks for taking my question. So, can you update us on what the revenue split today is between hyperscale and enterprise? And on the enterprise side, are you seeing a benefit to MRR and potentially yields from the incremental connectivity solutions and any other incremental services?

[Gary J. Wojtaszek:]

Sure. Yeah. I mean – so if you look percentage-wise, proportion of our revenue as of right now of 38% is in the cloud and that's up pretty substantially from a couple of years ago. And we continue to do most of our bookings in that space quarter-to-quarter, it ranges between 60% and 90% of our bookings. So, the business is continuing to skew more and more towards cloud. The other thing that you point out that I don't think is as well noticed is our IX business continues to benefit by the work that we're doing there. I mean, this quarter our IX business grew 14% year-over-year. I think that's one of the fastest growing cross connect businesses in the country. And we're not typically thought of as a cross-connect type or interconnection-focused company. But I think that gives you a really good insight in terms of the broad trends that are going on in the cloud. So, what we're seeing is as more and more companies are wanting to connect to the cloud, we're seeing tremendous take rates up with a lot of the SDN providers, particularly the Megaports of the world. I mean, our Megaport business is up 300% year-over-year. And that just gives you a really good sense of what's happening in that space as companies are going directly to kind of like a Megaport in our facilities connecting to various cloud companies that we work with, kind of bypassing some of the other more traditional ways to access the cloud on ramps.

[Robert Gutman:]

Great. Thank you.

[Operator:]

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

[Simon Flannery:]

Great. Thanks very much. I think you referenced a record sales funnel. I wonder if you can give us a little bit more color on what you're seeing in the pipeline, particularly around the hyperscale. I know it's lumpy, but anything there will be helpful. And then, on Europe, how do you look at the return characteristics in the European market relative to the U.S. market overall? Are these similar return development projects, better returns?

[Gary J. Wojtaszek:]

Sure. Yes. So, on the record sales funnel, so last quarter, if you recall, was the first quarter in about two years that our sales funnel actually decreased. I think it decreased 3% or 4% sequentially. This quarter is back up to the highest levels again and it's substantially higher than it was before. And I don't want to give like a lot of color on that, just to say we're feeling really good about the funnel. These things take time to work through, but we're building a business for the long run here. And the demand that we're seeing from customers both domestically and now internationally has increased pretty substantially and we feel really good about where that's going to take us over the next couple of years. With regard to the development yields or returns that we're looking in Europe, I think we've talked about this before. We're looking at those as down about 100 to 200 bps lower than what we'd get in the U.S. at least initially, right. And so, we're going in with underwriting expectations that we're not going to be able to get the same costs out or deliver the same type of product with the same cost levels that we do in the U.S. But we expect that over time, as our processes become more refined just like we've done in the U.S., we'll be able to ride that efficiency curve down just like a traditional manufacturing company does through increased repetition. So, we expect, over time, we'll probably get better yields there as we do more work. And then just from a commercial perspective, I'd just point out is that, with what we've just announced yesterday with the Agriport deal, we will now have capacity for close to 500 megawatts of power in Europe. That'll make us one of the largest players in that market. And I think to-date, the European market has been predominantly dominated by an interconnection play there. We expect that the wholesale data center market is going to arrive on those shores. We've seen a number of deals, 5 megawatt to 10 megawatt plus range and we expect that that's going to continue. We think that having that really large portfolio is going to put us in a really strong position to gain outsize share of market there.

[Simon Flannery:]

Great. Thank you.

[Operator:]

Our next question comes from Sami Badri with Credit Suisse. Please go ahead. Sami Badri - Credit Suisse Securities (USA) LLC Hi. Thank you. The first question I had was mainly on metered power reimbursements and you reported about 16.3% of base rent in the quarter versus 14.2% in 2Q 2018. Is it just safe to assume that going forward we should be modeling out this line item in the same levels of intensity in future years or should it go back down to more 2017 levels?

[Diane M. Morefield:]

Hi, Sami. Metered power is really difficult to forecast and it also can have some seasonality to it. So as you point out, our metered power third quarter over second quarter was almost $5 million higher. Again, that put some pressure on the EBITDA margins this quarter and it was certainly higher than last year. I don't know that you can draw any particular trend going into next year, but the one thing we would say is metered power going up is really a positive for future demand because it means our customers are really ramping up and utilizing their capacity more quickly. So we see this as a sign that they may need more capacity and space over time. Sami Badri - Credit Suisse Securities (USA) LLC Got it. Thank you. And then, the other question I had had a little bit to do with some of your major customers and potential – this is more forward looking and I'm just trying to understand, did any of your major customers decide to push out some of their leases or when they were going to be commenced? Did you see a little bit of behavior associated with that in 3Q 2018 results? And I just have one more follow up after that.

[Gary J. Wojtaszek:]

No, not really. I mean, we provide the bookings for the quarter and how that relates to our backlog in terms of when that revenue is going to be flowing through online. And what you see is just about all of our bookings would commence by the end of the first quarter next year. And if you compare that to what we put on our second quarter results, you'll see like a similar trend. I mean everything that we're expecting to happen is playing out as we had modeled out. Sami Badri - Credit Suisse Securities (USA) LLC Got it. And then my last question has a lot to do with investment grade mechanics. So now that you're investment grade rated and considering your cost of debt, should we be expecting you to be swapping out old notes with newer notes at lower interest rates? Or is this going to be more of a new debt funding type of dynamic where the interest rates will essentially be coming down given the benefit of your rating? I just want to understand the mechanics of how this is going to work over the next two years.

[Diane M. Morefield:]

It's really more the new long-term fixed rate debt notes in the future. Once we get to investment grade, we'll be more competitively priced than we can certainly issue today. I think our long-term fixed rate debt is in the 5% area. So, it's still really a compelling rate. As you know, (34

[Gary J. Wojtaszek:]

Hey, Sami. Just to add to that. So, our own focus in terms of pursuing investment grade was never related to the interest rate cost differential that it provides. To me, that's clearly a great benefit that we're going to have because of it but the purpose of this was really to ensure that we always had access to capital. Our opportunity in front of us is really large. It's been growing. I had pointed out earlier to Simon that we're on a record sales funnel. We never want to jeopardize not being able to meet our customers' demands. And that's what the investment grade rating really kind of ensures that we continue to access those capital markets. We always wanted to maintain a strong balance sheet. And I think the other thing that this does is what we've seen here is tremendous volatility and interest rates creeping up quite substantially, as well as those capital markets really kind of closing down a lot. And I think what that's going to do is really kind of put a lot of pressure on some of these private operators that had been fueled by massive amounts of debt. Some lenders were willing to provide 100% debt financing to these opportunities. And as interest rates are going up and some of these lenders are becoming more squeamish, I think that type of access to capital is going to go away, and I think that broadly is going to help a lot of the stronger public companies in the industry over the next year or two. Sami Badri - Credit Suisse Securities (USA) LLC Got it. Thank you so much for the questions.

[Operator:]

Our next question comes from Richard Choe with JPMorgan. Please go ahead.

[Richard Y. Choe:]

Hi. I just wanted to ask given Santa Clara, the U.S. development, Zenium, and now expansion into Latin America, how should we think about the CapEx level from the $850 million, $900 million this year and maybe going forward and the thoughts on how it will be funded? I know you have the equity forward for next year until 2019. But what should we think about in terms of a CapEx level and how you plan on funding that maybe for the next few years? Thank you.

[Diane M. Morefield:]

Yeah. Obviously, we haven't given any guidance for 2019. And when we give CapEx guidance, it's directly tied to our sales funnel and where we see the demand coming and in various markets. So, I think unless demand were to dry up, we don't see CapEx being materially different one way or the other going into the future. It will be more spread out maybe less in some U.S. markets and more in the international markets as we ramp up the leasing in those markets. Again, we're going into next year with $2 billion of liquidity. We manage leverage, but we're fine with it going up or down depending on what the capital markets look like at any given time, but we have no issues in being able to fund our CapEx going into next year.

[Richard Y. Choe:]

And then, in terms of – the margin dipped a little bit this quarter, I assume that could be Zenium, it could be some of the ramping of other developments. How should we think about margin going forward?

[Diane M. Morefield:]

Well, again, this quarter, we pointed out it really was from the increase in metered power pass-through that provides zero margin. But I think our margins have remained pretty stable and we see those increasing over time.

[Gary J. Wojtaszek:]

Yeah. And just on that, Rich...

[Richard Y. Choe:]

Great. Thank you.

[Gary J. Wojtaszek:]

So, the third quarter is the worst quarter, there are seasonality and the power numbers in the third quarter just because of the summer months and you see a combination of two things. One is, there's more power needed because the ambient temperature is hotter, so you need to basically cool these facilities more plus the rate on the power that you're also paying goes up pretty substantially. So, we're looking at a couple of million dollars of a hit that quarter and that is both on an absolute fall-through to EBITDA as well as in the margin impact to it as well.

[Richard Y. Choe:]

Great. Thank you.

[Operator:]

Our next question comes from Aryeh Klein with BMO Capital Markets. Please go ahead.

[Aryeh Klein:]

Thank you. Diane, can you maybe provide a little bit of color on the contribution from Zenium in the quarter whether it's on bookings backlog, the pipeline, et cetera? And then, Gary, just following up on an earlier question about the business ex the cloud providers and I think the non-cloud revenue growth is now in the high single digits. You did a little bit more on the leasing side there, but is there an opportunity to do more?

[Diane M. Morefield:]

On the Zenium, again, just really one month of contribution and so it's pretty immaterial to the total quarterly results, I think the revenue was around $3 million from Zenium in the third quarter. And their backlog now would be layered over our backlog that's highlighted in the slide deck and supplemental, etcetera. So, clearly, their numbers now will all be layered into the full fourth quarter into our backlog, and obviously, we'll get a full year contribution in 2019 from the Zenium asset.

[Gary J. Wojtaszek:]

Yeah. With regard to your other point about the enterprise, yeah, so I think this quarter highlights again just how well diversified our business is. So, a lot of people think of us just because of the success we've had over the last couple of years as purely kind of this big hyperscaler. But I think what this quarter highlights is how well we do in tackling the enterprise, right? We had 7 new Fortune 1000 customers this quarter bringing our total up to 208. And what you saw was that our price per KW this quarter was up substantially, about $150 KW, close to 25% increase from where we had been tracking. With regard to continued growth in that, absolutely, as I pointed out in my prepared remarks, last week, I met with two Fortune 1000 – Fortune 100 companies actually that were just starting to outsource more to the cloud. They were just in the beginning stages of this. And then later that week, I met with a really large cloud provider which was sharing the challenges they had in terms of trying to attack that market because the enterprises have a lot of legacy IT equipment and applications that worked really well. And they're struggling with how to go from some of the legacy applications to a cloud application and do that in a really kind of easy, less impactful way. So, the reason why all of the cloud companies are continuing to do more and more business with us is because of the opportunity in enterprise is enormous. Only about 12% of the enterprise business today or so is outsourced to the cloud. So, it's a tremendous opportunity for the cloud companies to go after. And that's why they're working with us to partner with us to attack those accounts.

[Aryeh Klein:]

Thanks.

[Operator:]

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

[Colby Synesael:]

Great. Two questions if I may. First off, on the 2018 guidance, it assumes a notable step up in revenue in the fourth quarter. I was just hoping, can you give us a little bit more color on what's expected or what's assumed in that as it relates both to Zenium and then the amount of demand or new deals you need to sign actually in the fourth quarter and get installed versus what's already in the backlog? And then secondly on development, you mentioned that you have, I don't know, call about 400,000 square feet under development. But in your more explicit disclosures, you mentioned specific properties that are coming online both in the fourth quarter and the first quarter and nothing really beyond that. I was wondering if you can give us a little more color on the trajectory of development through 2019. Is there any risk or concern that we could hit some air pockets in some of your more important markets where you're seeing demand today that could result in some delays in being able to sell capacity? Thank you.

[Diane M. Morefield:]

Well, first on revenue, Colby, obviously, it's really backlog in the full quarter of Zenium. Really anything we signed in the fourth quarter is going to impact 2019 revenue and not 2018. So, I think those two factors are just what you're seeing in the implied increase...

[Colby Synesael:]

What's the assumption for Zenium in the quarter?

[Diane M. Morefield:]

I don't have the exact number.

[Michael Schafer:]

I mean, I think, Colby, I think we talked about this at the last call, it's similar assumptions to what we laid out at the beginning of the year in terms of run rate, revenue and EBITDA. I think we talked about EBITDA for full year for Zenium of $17 million to $19 million range, so whatever the fourth quarter implies for that.

[Gary J. Wojtaszek:]

Yeah. And if you look at the supplemental or in the presentation, Colby, you'll see what the – and in terms of the backlog how that's going to roll through in revenue. You see pretty substantial amount of that is going to hit in the fourth quarter this year. I mean, probably more weighted towards the end of that quarter, but there's a fair amount of backlog coming on line that will hit revenue. With regard to air pockets, no, I think we're pretty good. I mean, the one market that we do have where we are running flat is San Antonio. We are just about ready to close on something there. We're still in the diligence space there. That's the one market where we sold out earlier this year. All the other markets we have adequate amount of inventory available to meet that demand that we're tracking there.

[Colby Synesael:]

And I guess basically maintain the broad trajectory of growth that you're seeing in the business in 2018.

[Gary J. Wojtaszek:]

Yes. Yeah.

[Colby Synesael:]

Thank you.

[Operator:]

The next question comes from Eric Luebchow with Wells Fargo. Please go ahead.

[Eric Luebchow:]

Hi. Thanks for taking the question. Diane, as you look to get a second investment grade rating, do you have kind of any sense around the timing? Are there any plans to seek a rating from a different rating agency such as Fitch or Morningstar? And I'm looking at your capital plan. Would you be comfortable pushing leverage at higher 5, 6 times range if you got that second rating?

[Diane M. Morefield:]

No. Look, again, we've been pretty transparent where we manage leverage to, in the 5 to mid-5 range and don't see ourselves really wavering from that. As you point out, well, Moody's already covers us and will review us on a regular basis and there are other rating agencies that we will likely have conversations with in the future. So, we talk to other rating agencies and we have also been pretty transparent. And I think in our first quarter earlier this year, we showed the benchmark of ourselves against other already investment grade REITs and we have actually better metrics than those REITs in terms of our leverage and our growth metric and things like that. So, we feel pretty strongly that we already operate at an investment grade level. So, those are the conversations we continue to have across all the rating agencies. And, again, most other are already rated – investment grade rated REITs carry much higher leverage than us. So, we should get there, we hope, sooner rather than later.

[Gary J. Wojtaszek:]

Eric, I mean, there's a lot of focus on people really wanting to take up leverage and put that up. And I really don't think that is the right call to do. We are doing really well fundamentally with all of our customers. We are looking at a really big opportunity with them. And what we've seen over the last two months has been just incredible volatility and on both the equity markets and the debt markets. And in the face of that, in particular, you want to go into that type of headwind with that stronger balance sheet as possible. And so while there's always some focus or a desire from particularly the equity folks wanting to take on more leverage, I don't think that's appropriate thing to do given the conversations that we're having with our customers. I mean, what I expect that is going to happen with more of our customers is once one of these assets that they've got into that have been really levered up have a problem, again, to a really distressed situation, I think that market is going to die in a hurry and I think all of those really large public companies are going to go to the companies with strong balance sheets because that's what big Fortune 500 companies do. They don't generally deal with small operators that are just kind of setting up shop in an individual asset. So, I think longer term, if you have a stronger balance sheet, it's going to accrue bigger benefits to you over time. And that's what we're playing for.

[Eric Luebchow:]

Okay. Great. Thanks.

[Operator:]

And the next question comes from Nick Del Deo with MoffettNathanson. Please go ahead.

[Nicholas Ralph Del Deo:]

Hi. My first question is a decidedly dull one. Can you talk a bit about the corporate infrastructure, like accounting, legal, treasury, and so on, the command and control systems you've put in place to ensure that you can run the business you're building in Europe, without any operational hiccups that might get in the way of capitalizing on demand?

[Diane M. Morefield:]

Yes. We have a really strong and broad finance organization including obviously accounting, finance (49

[Gary J. Wojtaszek:]

And just to comment on that, we're basically almost done with that integration, right? And by that what I mean is, Zenium is – we've done a number of these integrations in the past and acquisitions and integrations in the past. And we've gotten better and better over time and so, now it's a well-run process where we know exactly what the playbook is to get everyone on the same system, so our same ticketing system, same security protocols, the same security SLAs that we provide in here, the same accounting system, everything else, like it's a really well-run process and that's become mechanized, and everyone is on the same customer service platform. All those things, we've done really well over the years, and I expect that as we continue to scale the company and expand to other markets that we're bringing on capacity there we're going to do the same. So, it's actually one of the strengths that we've developed as a company having done so many of these now.

[Nicholas Ralph Del Deo:]

Okay. That's great color. And then maybe one on land. If we set aside Santa Clara which is obviously kind of a unique market, are you running into any challenges on any land parcels that are suitable for development at reasonable prices? And do you feel the need to add your land holdings in the coming years at a pace like what you've done this past year or do you think you can coast for a while given your land bank?

[Gary J. Wojtaszek:]

Yes. Yeah. This was kind of like in Colby's question. So, the one market in the U.S. where we are sure is San Antonio. So, we are doing diligence on a piece of land there now. We expect that that's going to close sooner and then that would give us a presence in a market that's been – we've been really successful and then just have recently sold out earlier this year. So, that's the one market where I think we are pinched for land. Everywhere else across the portfolio, I believe we have adequate amount of land. I think if there's any future land acquisitions that you're going to see us take, it's going to be more probably geared towards the European acquisitions than the U.S. as we kind of built out that platform over there.

[Nicholas Ralph Del Deo:]

Okay. Thanks, Gary.

[Gary J. Wojtaszek:]

Sure.

[Operator:]

Our next question comes from Jonathan Atkin with RBC Capital. Please go ahead.

[Jonathan Atkin:]

Thanks. So, I was interested, just given the very rapid pace of change in terms of your footprint and where you've got assets now for development or capacity to sell, I just wondered, are there additional geographies in Europe or perhaps in a different region that it would make sense to look at or do you go through a period of kind of digestion and just sort of expand where you currently have access? And then, secondly, you were kind enough to kind of give some indication of pricing trends in Santa Clara and how that differs from the rest of your portfolio, and I wondered if you could sort of level set us on perhaps the two Zenium markets and how does pricing there sort of compare to elsewhere? Thank you.

[Gary J. Wojtaszek:]

Sure. So, look, I mean, we've done a lot in Europe over the last year but we're going to continue to look for additional capacity. So, right now, we're predominantly located in some of the markets in the north of Europe and we're going to be looking at expanding into the south. All right? So we have nothing in France. We have nothing in Spain. Nothing in Italy. Those are markets that we will continue to look in to build out that platform. So if you're looking for other markets, that's probably more likely where they will pop up rather than buying additional capacity in the markets that we're currently involved in. With regard to pricing in Europe, I mean, it is – it's kind of like in line. I mean, we look at the price relative to yield. So, the yields that we're getting there are a little lower than we're modeling in the U.S. However, the deals are going to be different and we expect that over time our productivity is going to increase. So, we're hoping that over time that they do increase to more similar type yields that we're able to get in the U.S., which are like the mid-teens in Europe, it's lower double digits. What was the question on Santa Clara?

[Jonathan Atkin:]

Thank you. And then – no, you answered the question about pricing. So, I had a follow-up then about The Netherlands and Agriports and I'm just interested in how you see the potential for that market to develop for multitenant requirements or is that primarily a location for large scale computes?

[Gary J. Wojtaszek:]

Yeah. We are looking at building large scale compute there. There are currently really large cloud companies building out big facilities around there now and we expect that we're going to accelerate that market. So, we talked about in my remarks, we're looking at that particular location delivering seven 45-megawatt facilities on that location. And we expect that that's going to develop in Europe very similar to the way the U.S. hyperscale market has developed.

[Jonathan Atkin:]

Thank you.

[Gary J. Wojtaszek:]

Hey nice work, Atkin, on finding out our Santa Clara purchase.

[Operator:]

Our next question comes from Erik Rasmussen with Stifel. Please go ahead.

[Erik Peter Rasmussen:]

Yeah. Thanks. I think there's a little bit of misconception out there in terms of the demand trends that you're all seeing. There seems to be some data that suggests there's a slowdown in the growth rate of CapEx from the major hyperscalers. And I think – but they all cited pretty healthy underlying trends this quarter. They all reported in the last week or so. But with the quarterly pause in leasing this quarter, which obviously I think after a record first half was somewhat expected, probably put some pressure on the group. But what are you seeing now with conversations with your largest customers that would kind of suggest that demand does remain healthy. I know you had one in your slides that you talked about it. But I'm just trying to help reconcile that versus kind of this rate of CapEx spend decline.

[Gary J. Wojtaszek:]

Yeah. Look, I mean, what's happened in the last couple of weeks is really amazing to me, right. I mean, Amazon put up, I think, their quarterly growth rate this quarter was 46% down from 49%, and it's a $30 billion business, right? The amount of capital that they are spending is just incredible. And I think that people are inferring some of the equity trading positions and what's happening on the equity side through the underlying business. And that's not the case at all. As I've pointed out in terms of the aggregate amount of CapEx for those big companies, Microsoft, Amazon, Google, Facebook, they are spending more capital than some of the oil and gas companies and the industrial companies, the auto companies of the world, which is really incredible. And I think if you just infer from their CapEx, which is typically a leading indicator of their forward expectations, you see that they're all really bullish about what's ahead of them. And I've talked about since the beginning of the year and the conversations I've had with our cloud companies, the large ones are all talking about needing a gigawatt of capacity over the next five years, and that's a global number. These are enormous amounts of capital required to support that growth. So, I think a lot of people just overreact to what's happened in the equity markets, and they basically are trying and extrapolate that to fundamental demand changes. And we're not seeing that at all. As I've pointed out, in our business, like, we're sitting on a record funnel again, which was larger than where we were in the first quarter, which was a record funnel for us then. And so the conversations that we're having are really big. The deals are really large. There are global type conversations now. And we don't see that trending down. That's why when you see our relative amount of CapEx, it's basically because of the deals that we're tracking with our customers that we feel comfortable that we're going to be able to deploy that capital and make a really great return over the next couple of years.

[Erik Peter Rasmussen:]

Thanks for that. And then, maybe just a lot of questions asked, but just the Agriport deal that you just announced, timing, maybe just trying to get a sense of just like timing for development of that and then maybe just how competitive was this? Were there others that were interested when you were looking at it?

[Gary J. Wojtaszek:]

I don't know if there were others that were interested in this, but we're going into this on a real partnership. So Anton has been a great partner with us. We've been working with him for close to a year now on this transaction, trying to structure this that it works well for them and us. And so, now that we close, we are now launching into the design and development phase, permitting, and so that we can basically pitch these solutions to our hyperscale customers that need that type of scale in The Netherlands.

[Erik Peter Rasmussen:]

Great. Thank you.

[Operator:]

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

[Jordan Sadler:]

Thanks. So just following up on the last conversation regarding what the cloud titans are doing, we're seeing this aggressive sell off in the data center space. I think I agree with you that's coming from, to some extent, last week's announcements from these companies, but we're also hearing from investors' concerns about supply in markets like Northern Virginia, returns in pricing, decel in terms of leasing volumes sequentially. I totally hear you on the pipeline and I think your peers are saying similar things and that this is a long-term trend. But I guess how do we bridge the gap between the narrative that's building over the last week or two or three and the future?

[Gary J. Wojtaszek:]

Sure.

[Jordan Sadler:]

In other words, there's big capital requirements needed to fund this growth for you guys. So, what do you do in the interim?

[Gary J. Wojtaszek:]

Yeah. I just look at it as only 11%, 12% of the enterprise high-teen market today is outsourced to the cloud. So, you have – to come up with a credible short thesis why longer term our business isn't going to continue to do well, you have to assume that not all the enterprises are going to outsource with the cloud. And I think the thinking from all of our customers is you know they believe 60% of that spending is ultimately going to get outsourced to the cloud and that's what they're positioning themselves for. So, there's huge demand there. Maybe you see some kind of quarter-to-quarter changes on the CapEx. But the broader demand driver here is enormous and that's just on the enterprise. Later into that, what's happening on the consumer side and just the whole digitization of everything out there, that's creating more and more opportunities on that side of the house. And then, the one that's a little longer term, kind of still not yet taken hold is really AI. All right? I mean, AI demand is starting off at a very small base right now but it's growing dramatically and I think the best leading indicator of that is if you look at like NVIDIA and what their GPU chips are going in, that trend has been taking hold in that company for almost two years now and they have a dominant position in those chips and those are predominantly going into some of those applications today, and that's just starting. You're seeing a lot of the other semiconductor companies now positioned their companies to attack that GPU market more because they see the opportunities there. And all of those opportunities are almost all going into different AI opportunities. And that yet still hasn't really kind of manifested itself in in broad data center demand, which we think is absolutely going to occur. So, I don't know. I mean, it's really disheartening. I mean, I see our share price. I mean, it's – yeah, maybe it went up too much earlier in the summer but the trade off over the last couple of weeks has been horrible and not reflective at all of the underlying demand trends that we've seen.

[Jordan Sadler:]

Is it fair to assume that – I mean, given sort of Diane's discussion around leverage that in order to just continue to plow forward and fund the growth for the next – for the foreseeable future that you just continue to raise equity but not at an attractive price and hopefully the growth will translate into a better stock price over time?

[Diane M. Morefield:]

I think a couple things on equity. Again, I think we've been pretty prudent how we raised the equity over time. We have no near-term need. We have the forward. We have $2 billion of liquidity. And on our share price, if you look at now our trading model is ridiculous, but even where we (01

[Gary J. Wojtaszek:]

Yeah. I would further add to that. I mean, high level, there is roughly about $70 billion of private equity capital being raised currently to go into infrastructure funds which are predominantly digital infrastructure funds, so data centers, fiber, and towers. And so, if you have some of the – conceivably some of the smartest money in the world raising $70 billion of funds that are going after the similar types of investments that we are and when the public equity companies are concerned with that, there's like a huge disconnect between the opportunity sets that some of these big funds are seeing over the next several years versus how the public equity markets are seeing it. And in all of our remarks and everything that we talk about, we're trying to convey the opportunities that we see out in front of us relative to what were the conversations we're having with our customers. And the backdrop behind all of this, there's $70 billion of equity being raised to get into this space. So, we feel really good about the position we're in. And while we didn't have a blowout quarter in bookings, two of my peers had like killer bookings quarter this quarter. And I think that just kind of bodes well for the industry broadly, and I think we're all going to do well over the next several years as we've done over the last few years.

[Jordan Sadler:]

Yeah. That's fair. Maybe it's just tactical. Last one for you, Diane. Just on the commencements, the $50 million in 4Q, is that mid-quarter timing or is it back-end weighted? How do we think about that, the full year...

[Diane M. Morefield:]

Yeah. It's hard. I think most just use a mid-quarter assumption, just because it's hard to say. But sometimes it is more back end, but again, I think we've – given our guidance range, it would fall within where we're comfortable on the overall guidance metrics.

[Jordan Sadler:]

Okay. That's helpful. On the accounting impact you mentioned, the 97-10 leases...

[Diane M. Morefield:]

Yes.

[Jordan Sadler:]

Were you also factoring in something there on the capitalized leasing cost? Do you guys (01

[Diane M. Morefield:]

No. And that's why in my formal comments I said there will also be some other residual impacts because we haven't really quantified that yet. We just wanted to quantify on the pro forma for 2018. Certainly, the bigger impact is these 97-10 leases that have to be classified as operating leases starting January 1. There will be some other financial impacts to your point on – you can no longer, for example, capitalize legal costs for leases. You can still capitalize commissions, which is the bigger cost, for executed leases, but there will be some other residual adjustments for 2019, and we will include that in our guidance when we give guidance, as well as we will call out what part of the guidance is the adjustment from the new lease standard. And we plan and hope to on a quarterly basis next year and our supplemental show actual 2019 which these numbers will run through actual to pro forma 2018 so you can see more of an apples-to-apples comparison because otherwise, it's going to be a pretty big difference between the years.

[Jordan Sadler:]

Thanks for clarifying.

[Diane M. Morefield:]

You're welcome.

[Operator:]

And at this time, I am showing no further questions so I would like to turn the call back to Gary Wojtaszek for any closing remarks.

[Gary J. Wojtaszek:]

Okay. Thanks, everyone. We appreciate you joining us today and have a great Thanksgiving and we look forward to talking to you in several months. Thank you.

[Diane M. Morefield:]

Yeah. Maybe next week.

[Gary J. Wojtaszek:]

Yeah.

[Diane M. Morefield:]

Thank you, everyone.

[Gary J. Wojtaszek:]

Ciao.

[Diane M. Morefield:]

Bye.

[Operator:]

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