CyrusOne Inc.
Q4 2018 Earnings Call Transcript

Published: 21 Feb 2019

[Operator:]

Good morning and welcome to the CyrusOne Fourth Quarter 2018 Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] Please also note today's event is being recorded. At this time, I'd like to turn the conference call over to Mr. Michael Schafer. Sir, please go ahead.

[Michael Schafer:]

Thank you, Jamie. Good morning, everyone, and welcome to CyrusOne's fourth quarter 2018 earnings call. Today I'm joined by Gary Wojtaszek, President and CEO; and Diane Morefield, CFO. Before we begin, I would like to remind you that our fourth quarter earnings release along with the fourth 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 Wojtaszek:]

Thanks, Schafer. Howdy, everyone, and welcome to CyrusOne's fourth quarter earnings call. 2018 was a tremendous year for the company with continued strong financial and operational performance. We have taken a number of steps to position the business to serve our enterprise customers globally, creating a significant growth opportunity over the coming years. Slide 4 provides a summary of the highlights for the fourth quarter and full year. We had a record leasing year, signing 103 megawatts, representing $153 million in annualized GAAP revenue, up nearly 50% from last year. And our backlog as of the end of 2018 totaled $54 million. To put this in perspective, this amount of leasing is equivalent to the size of CyrusOne when we IPOed the company a few years ago. We continue to acquire land in key markets in both the U.S. and Europe and we completed instruction on 150 megawatts in 2018 to support the strong leasing as well as deals we are tracking in our late-stage sales funnel. Including the acquisition of Zenium, we increased the size of the portfolio by 30% in 2018. Our balance sheet remains very strong with $1.6 billion in liquidity to fund our growth. Moving to slide 5. The $20 million in annualized revenue signed during the fourth quarter was nearly 15% higher than our bookings in the fourth quarter of 2017. The average price of almost $250 per kW was more than double the prior fourth quarter average and the fourth quarter was our second highest pricing quarter since going public. This was driven by the significant contribution from higher-priced enterprise deals, which totaled the company record $16 million in annualized revenue signed for the quarter, representing approximately 80% of our bookings. The leasing mix in the fourth quarter was impacted by timing related to some larger cloud deals. While the contribution from the cloud vertical was lower than in prior quarters, it continues to be the biggest driver of our growth, accounting for nearly 70% of bookings in 2018. We added 23 new logo store in the quarter including three Fortune 1000 logos and consistent with prior quarters, the leasing was broad-based with deals signed across 9 verticals and 11 markets. Turning to slide 6. Our interconnection business continues to do very well. We had another very strong bookings quarter, signing $2.7 million in annualized interconnection revenue. And for the full year, our bookings totaled more than $10 million, up 14% from 2017. Interconnection revenue was up 17% in the fourth quarter and 6% sequentially, which I believe remains the fastest-growing interconnection business in the United States. We added nearly 1,000 cross connects in the quarter and more than 4,000 for the year and we are up to more than 19,000 across the portfolio. The average number of cross connects per customer is nearly twice the average from three years ago and 6 times the average at the time of our IPO. I also wanted to provide a quick update on the communication tower at our facility in Aurora, just outside of Chicago. As you will recall, we built a 350-foot telecommunications tower, providing the first on-campus wireless access for our financial ecosystem customers. We have completed the first phase and have very strong demand from customers leasing more than 20 antenna positions. While the tower represents a relatively small revenue contribution to our overall business, we expect to generate very high returns in this investment and are looking for other opportunities to replicate across our portfolio. The lower right corner of the slide provides an update for several of the important key operating metrics that we track. 72% of revenues generated from customers with investment-grade ratings. And with more than 210 Fortune 1000 companies, as customers, the credit profile of our customer base is very strong. Nearly three-quarters of the rent is from customers in multiple data centers. Moving to slide 7. We wanted again to highlight the yields we are able to generate and explain why the investments we are making are so compelling. The chart at the top of the slide shows the yield progression on our Carrollton data center, which is in Dallas area. As a reminder, this is nearly 700,000-square foot data center, with seven data halls, generally ranging from 60,000 to 70,000 square feet of raised floor. When the first data hall was brought on line in late 2012, the development yield was negative, as you might expect given the expenses incurred with little revenue during the initial lease-up phase. Two years later, as we have leased up that data hall and built and leased up additional data halls to meet the strong demand in the Dallas market, the yield had increased to 13%. As of the end of 2018, we have invested nearly $350 million in that facility and are generating a development yield of 18%. There is still capacity available, which upon lease-up will further increase that yield. The bottom half of the slide provides more color on why these investments are so attractive. The facility is currently generating approximately $63 million in annualized NOI. Based on leverage in the 5 times range, the investment is supported by nearly 100% debt financing. We have also created significant value at this location. Based on a cape rate assumption of 5% to 6%, the value of this asset would range between $1 billion to $1.3 billion, which is 3.5 times greater than the investment that we made. Additionally, equity returns for our data center investments based on modest 5 times debt-to-EBITDA leverage and assuming low to mid-teens yield, which is consistent with what we are earning on hyperscale facilities, we generate roughly 30% equity returns at 5 times leverage. This is very attractive relative to other investment opportunities and better than you can find across almost every other real estate asset class. Given this investment profile, we will continue to make these investments as we build a global business to support our customers' growth. As an aside, these returns also explain why there is such strong interest from many types of private investors including infrastructure funds, pension and sovereign wealth funds, private equity, and insurance companies. Turning to Slide 8, we continue to acquire sites to support our growth both domestically and internationally. We recently purchased another site in Santa Clara adjacent to our existing location and combined with our third quarter acquisition, this gives us up to nearly 150 megawatts in a supply constrained market which we will start bringing online in 2020. We also acquired more than 20 acres in San Antonio which will allow us to develop 120 megawatts. We also expanded our presence in Amsterdam purchasing a site on the Plant and Park Campus just west of the city giving us more than 70 megawatts of power capacity one of the top European data center markets. As we announced late last year, Tesh has assumed the role of President of Europe and I'm excited to have his experience and leadership in overseeing our expansion efforts to capitalize on a significant growth opportunity as demand accelerates across the continent. He will be focusing his efforts on recreating a sales machine in Europe just like he has done in the U.S and I'm sure he is going to be unbelievably successful. 2018 was a very busy development year for us to keep pace with the strong demand. As I mentioned earlier, we completed construction on 115 megawatts and combined with the impact of the Zenium acquisition, increased the size of our footprint by 30%. The amount of capacity that we added in 2018 was more than the entire size of our business five years ago. This was a tremendous effort by our construction team to keep pace with the record leasing. We also have substantial capacity for future growth with 2.5 million square feet of powered shell and nearly 500 acres of land that can provide over one gigawatt of power capacity which would triple the size of our current footprint. Slide 9 provides an update on our investments in GDS and ODATA. GDS continues to put up staggering numbers in their business as China is exploding. Their third quarter revenue growth was 80%, while EBITDA was up 125% compared to the prior year. Their backlog represents another 60% EBITDA growth under existing run rate. The value of our $100 million investment made in GDS in October 2017 has since increased to approximately $230 million. This is worth more than $2 per share which means that the FFO multiple on our business excluding this investment is more than half a turn lower than what many of you are probably calculating. William and his team have built a great business and the relationship we have developed with them has been outstanding even surpassing my expectations. The nearly 20 megawatts of leasing we did with the Chinese hyperscale customers last year wouldn't have been possible without their partnership. We're also really pleased with the success that ODATA has had recently as they continue to grow their business in Latin America. They have begun construction on their second data center in Brazil which is the largest data center market in the region and will have up to 40 megawatts of power capacity creating the largest data center campus in the market. They also have very strong leasing momentum with fourth quarter bookings totaling $12 million in annualized revenue with the long average lease term. The total contract value of the fourth quarter leasing is significant compared to the value of the investment in the business that we made which was $12 million. Lastly, they have begun construction on the largest carrier-neutral data center in Colombia, a market with demand from both hyperscale companies as well as enterprises. Ricardo and his team are doing an outstanding job growing their business and we are excited to participate in their success and be able to offer solutions to our hyperscale customers as they expand into Latin America. As I've explained, there are a number of specific factors that I mentioned which are impacting our funding needs in 2019 which make this a critical investment year for our business. First, the scale of our leasing is significantly larger than our peers in terms of relative performance to our base of revenues. Said another way, for 2018, we signed new leases representing 21% of our trailing 12-month base revenues. Our public company peers are growing at a significantly slower pace, generally reporting high single to low double-digit leasing as a percentage of their revenue basis. Second, we are in the midst of a significant footprint expansion adding capacity in four new markets in Europe and one new market in the U.S. all while still continuing to add investment in our existing markets. This compares to prior years where we were largely focused only on incremental capacity within our footprint. As we have shown in the Carrollton example, we expect all of these investments will be highly accretive. Finally, we continue to make strategic investments to ensure that we are attracting revenue opportunities from buyers in every major market on the planet with investments like the one we made in GDS and that -- so we can serve our customers wherever those businesses drive them, something we achieve with our LATAM JV with ODATA. In closing, we are in a great position as we begin 2019 have set the company up for continued strong profitable growth in 2020 and beyond. We have a strong track record of operational execution and in expanding international footprint and we are also maintaining a strong balance sheet with substantial liquidity. The secular demand drivers we are seeing have not changed from the long-term trends and we remain focused on maximizing the opportunity for value creation in the coming years. Diane will provide more color on our 2018 performance and 2019 guidance, but note that we are focused on building a global data center platform and in order to get the scale we desire to take full advantage of the secular trends benefiting our industry, we are investing a significant amount of capital that will negatively impact our 2019 FFO per share results. I recognize that the 2019 guidance in this area is less than expected. However, I believe these investments will payoff meaningfully over the coming years. I would point out that 75% of my long-term incentive plan as well as the rest of the senior management team of the company is directly tied to exceeding the performance of the RMZ. So my incentives are very much aligned with those of our investors in terms of benefiting from strong stock price performance for the company. I remain very bullish on our long-term prospects by positioning the company appropriately. I will now turn the call over to Di who will provide more color on our financial performance for the quarter and discuss our guidance for 2019. Thank you.

[Diane Morefield:]

Thanks Gary. Good morning everyone. As Gary mentioned, we had another great year and accomplished a number of key strategic objectives in 2018. Turning to slide 11. Growth in the fourth quarter was strong across all our financial metrics with revenue up 23% and adjusted EBITDA and normalized FFO of 16%. Churn in the quarter was unusually low at 0.8% and full year churn came in at 5% and was also below the lower end of our full year 2018 guidance of 6% to 8%. We now anticipate that full year 2019 churn will be in the 5% to 7% range, which is below the range we have guided in previous years. The weighted average remaining lease term of our portfolio has increased significantly over the last two years as our customers are signing longer-term leases. And at the end of 2018, the average tenure is approximately five years. As a result, the percentage of rents for month-to-month contracts and leases up for renewal in the next 12 months has steadily decreased as shown on the chart at the bottom of that slide. We expect this percentage will continue to decrease over time, as our average new lease terms are longer than the remaining duration of our portfolio. Moving to slide 12. NOI grew 19% in the fourth quarter driven primarily by the growth in revenue. The year-over-year decrease in the adjusted EBITDA margin was driven by the meaningful increase and pass-through meter power reimbursement as a percentage of revenue, which result in zero margin contribution. Normalized FFO growth was in line with adjusted EBITDA growth, while normalized FFO per share growth was up 2% as a result of the 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 is positive in the quarter resulting in higher AFFO, primarily driven by cash received from large installations associated with two customer deployments. For the full-year, AFFO was slightly higher than normalized FFO and in each of the last two years AFFO growth has exceeded normalized FFO growth. Turning to slide 13. Our portfolio is well balanced across markets. And as we continue to expand in Europe, it will become even more diversified. As a result of the strong leasing in 2018, the percentage of total colocation square feet lease was increased -- has increased five percentage points compared to the end of 2017 even with a 17% increase in CSF capacity and is up two percentage points sequentially. We feel this highlights our ability to lease up during the development period with resulting strong occupancy as assets are placed into service. Slide 14 shows our development pipeline as of the end of the year and you can see we are active across a number of domestic and international markets. We have 126 megawatts of power capacity under development, which will represent an 18% increase in portfolio power capacity upon completion of these developments. The pipeline is 33% preleased on per square footage basis. And once this capacity is brought online, we expect that a significant percentage of this inventory will have been leased of. Moving to slide 15, we continue to maintain a strong balance sheet to ensure the company has significant financial flexibility and capacity to fund our growth in the coming years. We have no near-term debt maturities and are fully unsecured with the growth asset value of $6.6 billion and $1.6 billion of liquidity. At the end of December, we settled the forward equity agreement to manage our year-end leverage issuing 2.5 million shares for nearly $150 million in cash. As of December 31, equity represented nearly 70% of our capital structure on a total enterprise value basis. Turning to slide 16. We had a revenue backlog of more than $54 million as of the end of the year with over 80% scheduled to commence by the end of the first quarter. Combined with the full year effective leases that commenced in the latter part of 2018, this significantly de-risked our growth in 2019. Slide 17 shows our initial outlook for 2019. As I mentioned on last quarter's call, we are required to adopt the new lease accounting standard known as ASC 842 effective January 1 of this year. In order to present a more meaningful comparison of the 2019 guidance ranges to 2018 results, we have shown adjusted pro forma 2018 results, which represent our estimate as the standard has been adopted as of January 1, 2018. The guidance midpoint for total revenue reflects a 19% year-over-year increase. The organic revenue growth rate which excludes the year-over-year impact from the in-place Zenium leases is anticipated to be 14%. The guidance midpoint for adjusted EBITDA reflects an 18% year-over-year increase compared to our 21 -- I'm sorry 2018 results adjusted for the new leasing standard and the organic growth rate is 14%. The implied adjusted EBITDA margin for 2019 assuming the midpoints of revenue and adjusted EBITDA guidance is a little over 52%, a slight decrease compared to that as adjusted 2018 margin. This is driven primarily by the full year impact of additional SG&A expense associated with our European expansion as we build out the international platform. We expect capital expenditures to be in the $950 million to $1.1 billion range, up from the 2018 spend of roughly $870 million. This increase reflects additional investments in our international expansion as we plan to invest roughly $400 million in Europe this year. The remaining CapEx spend is in the U.S. with Northern Virginia receiving the largest portion of our domestic investment. We will also be investing to develop the recently acquired site in Santa Clara for anticipated 2020 delivery. We are excited about 2019 in terms of the underlying demand drivers and expansion plan, which again are reflected in the revenue and adjusted EBITDA growth of 19% and 18% respectively. At the same time, we recognize that our NFFO per share outlook seems disappointing. It is important to understand that the marginal decline in NFFO per share comes from a number of contributing factors that are more near-term in nature. As Gary has outlined, we are capitalizing on current market opportunities and positioning ourselves for sustainable long-term cash flow growth. We are expanding in five major new markets simultaneously, which again include the four new European markets in Santa Clara. We also continue to develop in our existing high-demand markets such as Northern Virginia. These expansions represent ground-up development that have negative yields initially similar to the Carrollton example but will begin to produce our low- to mid-teens development yields within 12 to 18 months. At the same time, we are maintaining a fortress balance sheet and on the path to investment-grade. This incredibly attractive top line growth while maintaining our leverage discipline are two competing forces that play out in our guidance for 2019. We have no doubt that we have and are creating one of the premier data center platforms in the world and we need to make these investments to create shareholder value. So while this significant multimarket expansion is dilutive to NFFO per share near term, we anticipate more meaningful per share growth in 2020 and beyond. With regard to the first quarter normalized FFO per share outlook please note that as a result of settling the forward at the very end of 2018, we will have an additional 2.5 million shares outstanding in the first quarter that we did not have in the fourth quarter. Additionally, keep in mind that our reported fourth quarter normalized FFO per share of $0.86 would have been lower, if we adjusted for the impact of the adoption of the new lease accounting standard. We estimate this impact would have been roughly $0.03. Finally as we continue to draw on our line somewhat higher interest rate from the Fed increase, we anticipate our interest expense will increase in the first quarter compared to the fourth quarter. In addition our expected churn has weighted more in the first half of the year. As a result of these items, we expect that first quarter normalized FFO per share will be meaningfully lower than our reported fourth quarter 2018 figure and this is reflected in our overall NOI guidance. In closing, it really was another great year of growth in 2018 and we are very excited about how we have positioned CyrusOne to become a true global platform. Aside from GDS, we believe we have the strongest revenue and EBITDA growth in the public data center industry and we'll continue to execute on this trend this year and into 2020 and beyond. We appreciate you participating on the call and we are now happy to open it up for questions. Operator please open the lines.

[Operator:]

[Operator Instructions] Our first question today comes from Jonathan Atkin from RBC. Please go ahead with your question.

[Jonathan Atkin:]

Thank you. So I was interested in the demand pipeline and another question about kind of global platform. But on demand, in the pipeline that you are seeing, what are the largest contributors as you think about industry vertical or country of origin? And then which parts of your footprint are in greatest demand at present? Any changes that you've seen in that kind of profile in the last six months or so? And then on the strategy side, thinking about global platform and M&A and so forth I'm just sort of interested in how you think about Asia/PAC which is currently missing from your footprint? And as you think about growing there or elsewhere, are you seeing more activity from financial sponsors as competitors on certain processes? Or would you potentially look to partner with some of these financial sponsors? Thank you.

[Gary Wojtaszek:]

Great

[Jonathan Atkin:]

Thank you very much.

[Operator:]

Your next question comes from Nick Del Deo from MoffetNathanson. Please go ahead with your question.

[Nic Del Deo:]

Thanks for taking my question. Gary you just noted that the cloud guys seem to be a bit hesitant to pull the trigger on deals. What do you think is behind that? It seems like an interesting shift from what we observed over the past couple of years?

[Gary Wojtaszek:]

Yes. Well I mean there's always been this kind of slowdown in general with the pace at which they close deals. I don't know what causes it, right? You see this from time-to-time over the years because in aggregate their businesses are still growing really quickly. They are all talking publicly about expanding their data center presence around the world. So to me, I think this is more of a timing issue than anything else. And that's why, if we were concerned about the longer-term trends of the business and that we were concerned about that we weren't in the conversations we are with our customers, we never will continue and invest at the pace that we are. We feel really bullish about the longer-term trends and I think this is just going to be a temporary phenomenon. But that said, I think we judged down what the leasing velocity is going to be this year and we think that we've got a really solid forecast.

[Nick Del Deo:]

Okay. Got it. If I remember correctly, I think you've talked about capital recycling as an option in the past. Can you talk about your current interest in potentially monetizing some of your developed properties? You discuss something else and it seems like there might be some opportunities along those lines.

[Gary Wojtaszek:]

Yes. I mean the Carrollton is a great example. So here is an asset that we developed five years or so ago. It generates $63 million of NOI, $350 million of investments. So we basically have triple bagger on this in terms of what we think would be a good cap rate to apply to this. We are absolutely interested in recycling capital and so we are spending a lot of conversations talking with different interested parties. However, I believe CyrusOne is the premium platform in the industry. And I think we have proven over the last couple of years that there's no one that has the leasing velocity and consistency of execution that we have. And I believe a premium platform like that commands a premium price. So while we're really interested in recycling capital, we are not interested in selling at a discount. And when I see some of these private multiples being paid 25 times, 30 times on an EBITDA basis and in countries that are not really as risky or way more riskier than U.S. basis, I think, we should command a higher price. So once we find a right partner there to recognize the value creation that we can bring to them, we would absolutely be looking to partner and JV those assets with them. But we're not interested at selling what I believe is roast speed for the price of slice of baloney.

[Nick Del Deo:]

All right. Makes sense. Thanks Gary.

[Gary Wojtaszek:]

Sure.

[Operator:]

Our next question comes from Robert Gutman from Guggenheim Securities. Please go ahead with your question.

[Robert Gutman:]

Hi. Thanks for taking my question. So can you clarify just what occurred or didn't occurred during the fourth quarter? The pace trend was a little bit lower than estimated, but the deliveries are actually much higher. I think 52 megawatts versus like 25 that was in the expansion table. So could you just delve deeper in the puts and takes in the quarter?

[Gary Wojtaszek:]

Yes.

[Diane Morefield:]

Yes.

[Gary Wojtaszek:]

Okay. Go ahead.

[Diane Morefield:]

That was in chorus. Gary can add on right after this. But basically base rent and EBITDA for the fourth quarter was the lower original guidance range had been mainly because they were couple of hyperscale commencements that did take occupancy slower than we had originally anticipated in our guidance. So that was really the driver. And obviously because it was base rent, it's always right to EBITDA. Anything to add there, Gary?

[Gary Wojtaszek:]

No. I'm good lady. Go ahead.

[Robert Gutman:]

And then about the tower utilization, meter towers used to be picking taking up as an increasing proportion of total revenue quarter-after-quarter. Is that driven by utilization or is it increasing just increasing pass-through costs?

[Diane Morefield:]

No. I mean, it's customers ramping up. So that's a great sign and that if they're ramping up and taking their capacity, they're likely to lease more capacity. But it was positive to revenue it has no impact on EBITDA completely zero margin business other than the administration fee that we charge on contracts, which is more to cover our costs of administering metered power. We passed it through at its actual cost, but we still view it as a positive sign.

[Robert Gutman:]

And one last thing. On the enterprise side, it was $16 million was very strong. What -- has anything changed in enterprise adoption over the past year that's driving it to that level?

[Gary Wojtaszek:]

No. That was strong. That was actually the -- that was a record quarter for us in terms of enterprise sales. Also, a record quarter for us in terms of the average pricing on those. So that business still continues to do really well. I mean that is really kind of where we cut our teeth on it originally when we started this company. So our ability to identify attack and sell to the enterprise is really still really in place. As we had mentioned over the years, I mean, it's really difficult customer to sell to because the sale cycles are long upwards of three years. I think if anything the commentary to take away from this is just how well diversified our company is in that while a lot of people see us as like the primary providers of the hyperscale providers. The reality is that we started as a co-location company targeting enterprise companies a long time ago and that is at the core of what we do as a company and the hyperscale is really just an add on to what we have been doing really well for a long time.

[Robert Gutman:]

Great. Thank you.

[Operator:]

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

[Erik Rasmussen:]

Yeah. Hi. Thanks for taking the questions. So in looking at your guidance for 2019 and considering your goal of achieving investment-grade, how should be thinking about your leverage in the context of maintaining -- managing the balance sheet to support the development efforts that you've outlined?

[Diane Morefield:]

Sure. We've been transparent particularly with the rating agencies, who we are in front of and communicate with regularly as well the investment community that we manage generally to the mid five times last quarter annualized EBITDA net debt to last quarter annualized. The rating agencies seem comfortable with that. We also said there will be quarters that it may go above that, but over the longer-term that's what we are targeting. So we are at investment-grade on our securities ratings with the S&P. Moody's will likely rate us again at some point this year and we just want to stay on track to ultimately achieve it.

[Erik Rasmussen:]

Okay. And then back to leasing. Obviously, the results for 2018 were very solid, but the industry is also -- the impact of cloud and hyperscale, but things started to tail off at the end of the year and you've seen that also. But what are your thoughts in the current environment in terms of like timing of a recovery from this sort of consumption phase? And can you give any color on how you see the year progressing?

[Gary Wojtaszek:]

Yes. Yes. It's a really good question and this was embedded from the commentary I gave earlier. So we believe that we were involved in every major hyperscale deal in the country. So we have I believe the strongest distribution channel and network going on in the industry, so we have visibility in conversations with everything that's going on. And that's been the case for a couple of years now. And what I mentioned to Aryeh Klein earlier was that our funnel is as big as it's ever been, but we've seen a reluctance from customers to pull the trigger on closing deals. So the guidance that we have included in our forecast is from a leasing velocity perspective, it was lower than what we have assumed or that what we actually generated in 2018. And we think it's consistent with -- what the conversations that we're having with customers. Like a lot of the things that we've seen in the past, customers are challenged with being able to forecast demand, so that can turn around really quickly. And the way we work through that is that, we have a bunch of initiatives underway to give us shelf capacity in all the key markets so that we could be particularly responsive to customers when they need it quickly. So we've got ourselves covered from there. But if you looked at our guidance for the year and kind of backed it into our revenue, you would see that our leasing velocity has been taken down from where it was in 2018 and we think that's appropriate, given the conversations that we're having with our customers now.

[Erik Rasmussen:]

Okay. Thank you.

[Operator:]

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

[Aryeh Klein:]

Thanks. Can you maybe address the spending increase that you're seeing in 2019? What specifically is driving it? And how should we think about the opportunity for margin expansion beyond 2019? And then, what kind of confidence do you have in returning to NFFO growth in 2020?

[Diane Morefield:]

Are you referring primarily to SG&A?

[Aryeh Klein:]

Yes, yes.

[Diane Morefield:]

Yes. So, again, when you open for business pretty much from scratch in four new European markets, it's expensive and you have the overheads going through SG&A without the resulting revenue. Over time, the percent of SG&A as a percent of European revenue, obviously, will decline, but it's at a high percent, probably 20% in 2019. So it is that the -- on the margin the drag to the overall EBITDA on a consolidated basis.

[Aryeh Klein:]

Okay. And then, maybe, Gary, you mentioned a number of times the slow you're seeing on the cloud side. But at the same time you have a step up in CapEx. So to what extent are you building a little bit more speculatively than maybe you have historically? And then, if you just give an update on the timing of Santa Clara?

[Gary Wojtaszek:]

Sure, sure. Yes. I mean, high level, right, you're looking at $500 million to $600 million of capital being invested in the U.S., which is substantially lower than where it was last year. And about a-third of that capital right now is already pre-sold. So on a relative basis we're spending significantly less in the U.S. We are spending significantly more in Europe, roughly $400 million. And so the way to think about it, of the two, they are not opposing, they're very much in line, is that when we are deploying capital, we are doing so on the basis of the underlying secular trends that we're seeing in the market and more in particular with the conversations that we're having with our customers. The demand that we're seeing from them is really large in multiple markets. And one of our customers was just talking about doubling the amount of capacity they're going to be bringing online over the next five years compared to the last five years. So the broader trends are really strong and that's why we're continuing to invest for them. We think that there definitely has been some pull back in terms of when they seem to be pulling the trigger on closing these contracts, which is why we've judged down what our leasing velocity is in 2019. But we think that's more of a short-term phenomenon and not a commentary on the broader trends that we're seeing in the industry. What we're seeing in Europe is really big. I think that that is a market that has really starved for our products. There's no one that has been doing really massive builds out there. Europe has been predominantly an interconnection base market. And I don't think a lot of the providers there want to go into this lower yielding asset class when you're making considerably higher margins doing the interconnection business. So we think that that's a market that's not really served. Tesh is doing a phenomenal job in driving business there and I think you're going to see the results of that when we report our first quarter results in terms of how successful he's been doing on the bookings so far this quarter.

[Aryeh Klein:]

Okay, great. And then just Santa Clara?

[Gary Wojtaszek:]

Yes. Santa Clara, so this is a market that we have spent a number of years trying to find properties to develop there. And there is -- we've had a bunch of different properties under contract over the years and that’s a market that is -- you've got to know what you're doing, right? It's a really expensive market to get into, so you're back solving for yields that you are trying to engineer to and you have to be really spot on. Because the pricings that you're paying for those properties are multiples of what you can get elsewhere around the country. And so, we spent a number of years trying to find properties and we were fortunate now in the last couple of months to get two. So we've been able to assemble two properties that are adjacent to one another and we will have the largest data center campus in Santa Clara. We are working on the permitting and planning for that first property that we acquired last month. We're starting to demolish the buildings and scrape all of the land over there. We look to have capacity online in 2020 in that market. And then, that will give us in that facility upwards of 80 or 90 megs and in the facility just adjacent to it probably going to get another 50 or 60 megs in that facility as well. So that's a really nice market. I mean of all the markets in the U.S. that are really constrained, it's Santa Clara. And given the supply constraints, that's why you see so many companies there getting phenomenal yields on the investments that they made in that particular market.

[Aryeh Klein:]

Thanks.

[Operator:]

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

[Unidentified Analyst:]

This is Michael on for Colby. Two questions if I may. First, can you provide color on your 2019 AFFO per share expectations? And second, how much equity dilution you have assumed in your 2019 FFO per share guidance? Thanks.

[Diane Morefield:]

Yes. We do not gave AFFO guidance. We show the numbers each quarter for the line item that would be actual adjustments to AFFO, but we don't provide guidance on that line just NFFO. And again, on equity contribution over the year, we provide the guidance that we're managing to the 5.5 times leverage. So I think you need to just run your models and determine what that range would be.

[Gary Wojtaszek:]

Just to provide a little more commentary on that. AFFO for us is a difficult metric to forecast, because it's so volatile. But if you looked over the last two years, our AFFO has been higher than our FFO. But it's a really difficult number for us to forecast. That's why we always provide the guidance on FFO which is more of a reliable indicator for us. With regard to equity, I mean, look, we are -- our business right now is of such scale that we can invest roughly $600 million of capital a year and just fund that capital investment through internal cash flow generation and taking on some additional debt. So to the extent that our capital expenditures were about $600 million a year, we do not need to issue any equity. As the business scales and as we're -- as we've explained earlier, we have a significant capital investment program going on. We’re expanding in four European markets, we've got a new market in Santa Clara and we’re investing in our existing facilities. So we think those are appropriate things to invest in, which will yield considerable accretion go forward. And as I pointed out in my script, we fully recognize that the FFO per share forecast for this year is disappointing. And that's tough and we recognize that our share price has come under pressure. And myself and the entire executive leadership team feel this, because 75% of our long-term incentive plan is tied to our share price performance relative to the RMZ. So to the extent our share price is down, that means we’re not getting paid and that's not something that we’re particularly keen on. But we believe that the long-term aspects associated with these investments that we’re making are going to yield considerable returns for us and that's why we’re making those.

[Unidentified Analyst:]

Thank you for the color.

[Gary Wojtaszek:]

Sure.

[Operator:]

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

[Megan Yang:]

It's Megan on for Frank. Hi. So did you walk away from any deals for the sake of development yield in Q4? And then the next question is what's your outlook for bookings next year? So backlog seems to have come down sequentially. So when do you expect the backlog to show up in numbers?

[Gary Wojtaszek:]

Yeah, I'll take the first question. Look there are a number of deals every quarter that we walk away from that are just not realistic. I mean, as I mentioned earlier, we saw roast beef not baloney and we price it accordingly. So, we think we offer a premium product and we’re looking for a premium price and we’re not willing to chase any deal. So every quarter we walk away from a number of deals.

[Diane Morefield:]

And backlog, we outlined. I think we said that the backlog at the end of the year is due to take occupancy like 80% of it in the first quarter.

[Operator:]

Our next question comes from Sami Badri from Credit Suisse. Please go ahead with your question.

[Sami Badri:]

Hi, thank you. So I just want to get some clarifications here on maybe a disconnect that's occurring across the entire tech sector. On one side, we're hearing that hyperscalers are actually going to be scaling up construction of facilities and you have multiple private equity and wholesale players entering the market with new greenfield developments. Then on the flip side, we had a little bit of a pause occur on leasing and occupancy happening in your model and specifically in 4Q, 2018. Could you maybe pinpoint us to a more specific reason why this is occurring? Why exactly has there been -- like what exactly has been the rationale or the reason that's been explained by some of your core customers for the delay in occupancy take up?

[Gary Wojtaszek:]

Yeah, it -- so it's not occupancy take up. So what's been sold and moving into and migrating into those facilities, I mean there’s a practical limitation in terms of how quickly they can deploy in existing facilities that they're doing. I mean, what we've seen about two or three years ago, what we've seen operationally is some of the hyperscales could deploy roughly like pretty efficiently about one megawatt, maybe megawatt and half a month. They've increased their capacity on that that they can do two to three megawatts a month, so they've scaled their operational backend to be able to move into those facilities faster. So that's my commentary on the take up. On the comment about competitors, as I mentioned earlier I mean there is probably a decade's worth of capacity that has been acquired by a bunch of private equity companies and different -- or private equity backed companies in the Northern Virginia market, Dallas market and Phoenix market. That’s predominantly just land speculation. And as I mentioned earlier, the land component in your build cost is relatively insignificant. So it's an easy free option to go spec on land when your aggregate cost the land is only between 3% and 5%. Even in Santa Clara, we're looking at our land value there is not going to be more than 6%. So you can easily spec on land. Where it takes a little more fortitude is, if you're going to go stand up capacity -- data center capacity and shell out the other 95% of the value. The only way you're going to be comfortable making that investment is if you have a line of sight and a bead on a contract to the customer. So anyone can basically do that. You go shop a deal and wait for a customer contract to come in hand and then go arrange the debt financing against that. But when you have a competitive situation and you have proven competitors in the market like us and all of my public company peers that's a much easier way for most of the hyperscalers to go to. It's less risky. These are all public companies. They all do a great job, proven capabilities over and over again and they are not overly leveraged. I think if someone is moving into a facility that is 100% debt leveraged that is something that not typically most Fortune 500 companies do. So I think there's just like a lot of talk and fear and confusion in the market more than anything else with regard to some of the players. I think as I mentioned my general commentary is that I think you see these ups and downs in the hyperscale market over the years and have been for many, many years. But the broader trends are always up and to the right. And I wouldn't think that the read-through and a quarter or two of slowing sales is any broader commentary on what's going on in the industry overall. So we’re still pretty bullish. I mean I think Stan [ph] over the years, he was always under a lot of pressure because he had this feast and famine business and he built up a phenomenal business, did really well just targeting these customers. And I think what this space has proven over time is that their businesses are doing really well, and I think that's reflected in their aggregate performance with all of these guys putting up really large big year-over-year growth numbers whether it's Google or Microsoft or Amazon. Those businesses are just still in the early stages.

[Sami Badri:]

Got it. Thank you. And then -- so I know that Europe is front and center for you guys going into 2019 and even 2020. And I just want to draw one connection. On slide seven where you showed the Dallas Carrollton data center development, are you expecting the European development to follow the same path from a development yield perspective over the same time frame? Or would you say, we would have to be discounting that by about 100, 200 basis points, which was probably I think maybe a bit of guidance that you gave historically? Is that still the case? Or maybe you could just give us more color on expectations for developments?

[Gary Wojtaszek:]

Yeah, yeah, no, that's a great question. So the yield progression as we've shown there's always negative whether in any development unless you have a hyperscaler that's brought everything day one, right. And so that's a big difference between our risk adjusted basis. So we expect that all the European developments as we are bringing those online are all going to suffer from a negative NOI during that phase. And as they lease up, the yields will turn positive and increase over time. The aggregate yields though that we are underwriting in Europe are less, right. We're looking at anywhere between around like 11% or so give or -- plus or minus like 1% or 2% to the extent that we can bring more enterprise customers. And there we can drive those up, but we are not expecting that they are going to come near to the yields that we are getting in our Carrollton facility. And that's a market that historically has been underserved. And those yields that we've been talking about there those lower yields are basically for hyperscalers. So we have not underwritten our business there yet that we're going to be putting in a lot of enterprise sales. But that's Tesh's mandate. The guy has proven repeatedly for a decade that he is the master at developing an enterprise-focused sales force. And so he is hiring a number of individuals throughout that region and we expect what we are going to be really successful in convincing those guys to go to us. But those are pretty low yields, I mean particularly against the backdrop of an interconnection business in Europe. I mean most of the interconnection companies are generating 30% type development yields. And so I think they would be really reluctant to want to go into this space which is more like a real estate play because then it would subject the rest of their business to much lower yields.

[Ahmed Sami Badri:]

Got it. Thank you for the color.

[Operator:]

Our next question comes from James Breen from William Blair. Please go ahead with your question.

[James Breen:]

Thanks for taking the question. As you're looking at the business and seeing some of the decision makers taking a little bit longer from the customers. Have you seen any changes in size of deployments? Are they taking longer because they're thinking about larger deployments over time? Thanks.

[Gary Wojtaszek:]

Yes. Yes. Large deployments in multiple geographies like so -- these are way bigger deals and so more complex, right. So complexity is the enemy of speed. And that's what we're seeing. But the conversation that we're having are really good. They are -- like all of the hyperscalers are struggling from the same thing as their growth is just incredible and they just can't forecast it accurately. And as a result you've seen this kind of general slowdown. But you'll get a manic customer call some on a Friday afternoon saying hey I need this amount of capacity we've got to go on this because we just closed this other deal and we need to get this locked up to move our customer in there. So it's a really exciting business from that perspective. And that's why speed to development and speed to deliver product is such a key differentiator for us. And so if you don't have that capacity available for those customers you're just not going to get the brass ring.

[Diane Morefield:]

And the other thing is these hyperscale deals are -- they're signing 10 to 15-year leases. So those are really long commitments and very big decisions plus all the -- they have to commit to fit out their space. So we have seen definitely a trend that from being in the sales funnel to a signed lease for these large deals, the time period has lengthened.

[James Breen:]

So just going forward now should we expect a little bit more in lumpiness when it comes to those deals? But over time if you look out over a trailing 12-month period, the trend will remain somewhat what it's been in the past? And then how confident are you in your ability to fill in around that with enterprise to sort of smooth the growth curve a little?

[Gary Wojtaszek:]

Yes. So, there is definitely this lumpiness. But my solution to the lumpiness is to drive the sales team to get a bigger problem. So, that's the easiest way to kind of attack that. And so everyone is focused on driving more and I think this last quarter, you just saw a really good healthy execution from our enterprise team. Like we booked a record number of enterprise deals this quarter biggest in our history and that is purely the result of continued focus on that line of business. Yes, the reality though is that it's -- the enterprises just don't buy at the same volume as the cloud guys do. So, when you get a shortfall in the cloud sales it's really difficult to make it up from the enterprise sales even with the fact that their pricing is double or more than double than what you're typically seeing on the hyperscale side. But we continue to try to drive more business. We want to make more inroads in all of these customers both here and in China as well so that we expand our relationships with them. And that's really why the relationships and the investments that we've made in ODATA and GDS are so beneficial for us because it's a way for us to continue to help our customers grow in other markets. And that is more valuable to us longer term than just selling them capacity in one of our own wholly-owned facilities. It's more important to preserve the customer relationship and make that a deeper relationship that we can help them globally.

[James Breen:]

Okay. Thank you.

[Operator:]

Our next question comes from Erik Luebchow from Wells Fargo. Please go ahead with your question.

[Eric Luebchow:]

Hi thanks for taking the question. You talked last year about some additional build cost pressure related to commodity and labor costs. I'm just curious if you could comment on what you are seeing from a cost per megawatt perspective for 2019, perhaps both in North America and Europe? And then what ability you have to kind of drive those build costs even lower with additional design efficiencies or supply chain efficiencies? Thanks.

[Gary Wojtaszek:]

Yes, I'll talk a little bit about what we have seen in the U.S. and maybe Di can give some commentary on Europe because they just went through our efforts there. So, in the U.S. what we talked about last year at this time was that we definitely were seeing inflation in labor in certain markets in particular Northern Virginia as well as increases in commodity prices, copper, concrete, some of these other things, and we've seen that played out. And last year it was about a 10% increase versus where we originally were where we have pulled out 10%. So, we're kind of flat to where we were last year. We are not seeing any increase in our build cost. And -- but conversely we're also not seeing any decrease as well in our build cost for this year. Di if you can give?

[Diane Morefield:]

Yes, in Europe, we -- as we just stated, we -- the yields there will probably be in the 100 to 150 basis points below the yields we achieved in the U.S. just because of land cost and labor cost there and just some marginal cost that we don't have here. On the other hand, we are really pleased -- I think what Gary is referring to as we ran a full blown RFP process for procurement of all of our equipment types in Europe last fall similar to the process we run in the U.S every couple of years. And we originally thought those costs on average would come out more like 8% to 10% higher than what we pay here in the States. And they wound up coming out only a couple of percent higher and we've locked in those prices for all of the equipment for the European build now for the next couple of years. So that was really a positive end result. So the yield will be a little lower, but picks up something by having the equipment procurement process results.

[Erik Luebchow:]

Great. Thank you.

[Operator:]

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

[Jordan Sadler:]

Thank you. Good morning. I wanted to just follow-up a little bit on the funding source if I could. I'm looking at your guidance for the $500 million, $525 million of EBITDA -- adjusted EBITDA for the year and I am just sort of running that against that throughout the upper end of the threshold the 5.5 you are targeting versus your current debt and I'm coming up with a number of about $2.9 billion. And I'm just curious, you're outlining about $1 billion of capital spend here, but it seems like you've got a few hundred million dollars of availability relative to the metrics you're highlighting. So I guess, I'm trying to understand what is sort of baked into the guidance into the FFO per share in terms of a funding source for you all that we could sort of point the market to realize that you guys raised some equity in the second half of last year. And I'm just curious -- I know the stock is down a wee bit, but is there a sensitivity around that that you might be able to offer up? Or any additional color would be helpful.

[Diane Morefield:]

I'm not sure exactly where you are going with the question, but every year we fund our capital. Part of it is from just internal cash flow, but it's a combination of funding it with debt and equity. So -- and that's solving for the mid-five times generally.

[Jordan Sadler:]

Well I guess -- let me clarify I think I used your 5.5 times the $525 million I get to $2.9 billion of debt. You're $2.6 billion outstanding today which leaves you $300 million throughout the year just based on the 2019 EBITDA that you've guided toward the high-end. And so -- but you have $1 billion of capital spend teed up. So there's -- you've got to go get $600 million and I am just wondering how I'm supposed to -- where is that coming from because obviously not borrowings or additional retained cash flow because there is no more that's factored in. So is it asset sales? Or is it...

[Diane Morefield:]

Yes, every year there's new net debt borrowings and there's equity issuance. And potentially some capital recycling. So I mean...

[Jordan Sadler:]

And it's just a mix of that that's embedded?

[Diane Morefield:]

Yes.

[Gary Wojtaszek:]

Yes, your math is basically directionally spot on Jordan you're in that ballpark there. But the mix, so if you are tapped out -- like if you're coming out of the year at roughly where your targeted leverage ratio is given all the capital investment for the year, your math is spot on. And that plug the equity plug is either going to be satisfied through additional equity and/or capital recycling.

[Jordan Sadler:]

Yes and I don't think you're alone in this. I mean I think this is somewhat systemic across the subsector. It's -- there is a long-term secular trend happening and you guys are trying to support it with investments that have good returns. But it's -- how do you fund it on a sustainable basis seems to be the issue. The other question I have for you Diane is just, you talked about the sequential 4Q to 1Q FFO or normalized FFO trajectory. And I guess where I was scratching my head a little bit was I think you guys commenced more than $50 million of revenue in 4Q. And I think you're about to commence another $45.2 million in 1Q which seems like a lot relative to even your existing revenue base. So is there like a large -- smaller flow through or lower margin on that than we should expect? Or is there something else driving that FFO lower?

[Diane Morefield:]

Yes. Yes obviously, the bridge to go from fourth quarter NFFO actual to first quarter. Yes the positive is clearly as the backlog ramps up now that doesn't start on January 1 though. It's over the course of the quarter. And then -- but there again new leasing accounting standard is probably $0.03 to $0.04 negative, higher interest expense and the full impact of the equity issued right at the end of the year. So yes there is obviously positive, but there's a series of negatives that is going to affect actual NFFO for the first quarter. And then there will be a better run rate after that quarter.

[Jordan Sadler:]

Okay. The 4Q commencement, that $55 million, was that back-end weighted? Or was that front-end loaded?

[Gary Wojtaszek:]

Yes.

[Diane Morefield:]

Yes and hence why the revenue and EBITDA was below the calculated guidance based on our full year guidance, so.

[Jordan Sadler:]

It was back-end weighted?

[Gary Wojtaszek:]

Yes.

[Diane Morefield:]

Yes.

[Jordan Sadler:]

Back-end weighted, okay. Okay, thank you guys.

[Diane Morefield:]

You’re welcome.

[Operator:]

[Operator Instructions]

[Gary Wojtaszek:]

Thanks everyone. We appreciate you taking time to join the call today. We are excited about the opportunities for growth. And as I mentioned while the FFO per share is a little lighter than I think many had hoped for I think the investments that we're making are going to materially change the company and the company's look and feel in 2020 is going to be really impressive. So thanks all for joining and we'll talk to you over the course of the next couple of weeks.

[Operator:]

Ladies and gentlemen, that does conclude today's conference call. We do thank you for attending. You may now disconnect your lines.