CyrusOne Inc.
Q1 2016 Earnings Call Transcript

Published: 6 May 2016

[Operator:]

Good day, and welcome to the CyrusOne First Quarter 2016 Results Conference 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.

[Michael Schafer:]

Thank you, Chad. Good morning, everyone, and welcome to CyrusOne's first quarter 2016 earnings call. Today, I'm joined by Gary Wojtaszek, President and CEO; and Greg Andrews, CFO. Before we begin, I would like to remind you that our first quarter earnings release along with the first quarter financial tables are available on the Investor Relations section of our website at cyrusone.com. I would also like to remind you that comments made on today's call and some of the responses to your questions deal with forward-looking statements related to CyrusOne, and are subject to risks and uncertainties. Factors that may cause our actual results to differ from expectations are detailed in the company's filings with the SEC, which you may access on the SEC's website or on cyrusone.com. We undertake no obligation to revise these statements following the date of this conference call, except as required by law. In addition, some of the company's remarks this 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. Good morning, everyone, and welcome to CyrusOne's first quarter 2016 earnings call. The first quarter was another great quarter for us with exceptionally strong financial and operating results across practically every metric we track. Additionally, the record signings over the past two quarters have enabled us to start the year in our strongest financial position ever. As you can see on slide four, there were a lot of Ws that we posted for the quarter. Our adjusted EBITDA was up 39% over the first quarter of 2015, normalized FFO per share of $0.63 was up 29% and revenue was up 37%. We also closed on the data center acquisition from CME Group and signed a 15-year lease with CME in a transaction that strengthens our position in the financial services vertical in the Chicago market. Inclusive of the CME deal, we signed $43 million of annualized GAAP revenue in the quarter for a total contract value of $475 million, which is consistent with what we did last quarter, but double the average signings over the past four quarters. We leased 181,000 square feet and 25 megawatts of power with non-CME signings representing approximately 60% of the totals and our backlog has grown to a record $74 million as of the end of the quarter with a total contract value of approximately $775 million, setting us up well for continued growth into 2017. Moving to slide five, we now have nearly 950 customers, up almost 40% from last year and we added three additional Fortune 1000 customers keeping pace with our historical average of adding one additional Fortune 1000 company per month over the last several years. As we mentioned at our Investor Day in March, the most important leading indicator for our future success is our ability to attract and retain Fortune 1000 customers, which represent nearly 70% of our revenue and 85% of that is with investment-grade companies. The enterprise sector is also the largest untapped market in the industry today and the increasing growth in data is causing more of them to outsource their requirements to CyrusOne, which positions us well for future growth. This quarter, we added new customer contracts across a variety of industries, including gaming, financial services, IT services, energy and not surprisingly with several cloud companies. What's also really interesting to note this quarter is that more than 50% of our bookings came from new customers. This is the first time in a long time that we were able to generate the majority of our bookings from new customers, which is a very important leading indicator for future success as we know that new customers continue to grow with us over time. Also this quarter, 85% of the new deals we did included lease escalators and all of the new customers who took metered power contracts had the 7% power administration fee included. As I previously mentioned, we expect that over time, the proportion of our metered power contracts that have the power administration fee, will increase, consistent with the way we increase the leased escalator fees across the portfolio, which is now approaching 50%, which is up from 10% at the time of the IPO. Slide six provides an update on interconnection. As we highlighted at our Investor Day, we have partnerships with many of the leading cloud vendors. We have recently announced partnerships providing connectivity to Microsoft Azure, Office 365 and Amazon Web Services. Offering direct connections to our enterprise customers allows for greater reliability, faster speeds, lower latency and enhanced security. The interconnection growth trends remained strong as revenue was up 56% in the first quarter and currently represents 6% of total revenue, up from 2% three years ago. 83% of lease signed in the first quarter included an interconnection product. We now average more than 11 cross-connects per customer, up from three per customer five years ago and have more than 11,000 cross-connects in total across the portfolio. We expect this product line to continue to grow faster than our base business as enterprise has become more familiar with an outsourced network model and take advantage of the lower costs. Turning to slide seven, our development pipeline is the strongest it's ever been with 60% of the capital being deployed towards pre-leased facilities, which is allowing us to maintain high level of utilization. We are also seeing a significant change in customer buying behavior as more and more Internet scale companies are approaching us to do build-to-suit projects for them. They are recognizing that our massively modular design approach allows them to overcome the demand forecasting challenges they face in their business, which creates a tremendous amount of volatility in the accuracy of their capacity planning. As an example, 18 months ago, CyrusOne completed its first ground-up build-to-suit data center project in Phoenix for a very large SaaS provider, which needed a 100,000-square foot data center with 9 megawatts of power. We delivered this in a record 107 days, which has turned out to be a watershed event for us as every single major cloud company in the country took notice of our speed-to-market capabilities, something no one in the market has ever come close to achieving. With our latest Northern Virginia project, we will deliver 30-megawatt facility. So, while this project is three times larger than what we delivered in Phoenix, we will complete it in twice the amount of time that we delivered Phoenix, highlighting the efficiency in our supply chain. And as big country, our man on the ground who's delivering this facility, tells me, boss, vision without execution is hallucination and given what we are doing there, I'd say Dorris is not hallucinating. Importantly, we continue to generate very high yield in the mid-teens on the capital we are deploying and I'm confident that we will be able to continue to do so go forward, as we have enough capacity available to increase the size of the company by nearly 65% and enough land capacity to grow 3.5 times larger than we are today, all of which can be brought online at a cost of less than $6.5 million per megawatt. Moving to slide eight, the most strategically important transaction that we closed this quarter was the acquisition of the Chicago Mercantile Exchange's data center in Chicago. With this deal, we'd entered into a 15-year lease agreement with the CME and we'll partner with them to create the preeminent financial services co-location hub in the industry. We will have 36,000 square feet of space available in this facility to sell and 15 acres of land upon which we intend to develop an additional 500,000-square foot facility. So, one transaction, we acquired one of the premier interconnected facilities in the country, one of the most prestigious financial companies as a customer, diversified our geographic presence with an ability to double in size, increase our presence in the financial services vertical and most recently were awarded our first verbal order for a new 1 megawatt customer there. In closing, we have never started any year in a stronger position. From a financial perspective, we delivered the strongest revenue EBITDA and FFO performance in our history. We have a record $74 million of annualized GAAP revenue, which translates into three quarters of $1 billion in total contract value, positioning us well for growth into 2017 and beyond. And our sales funnel remains just as strong as it was last quarter despite the large bookings we delivered. From a balance sheet perspective, we have never been stronger. Our leverage is less than four times debt to EBITDA, our share price has increased over 20% since the beginning of the year, and we recorded the longest average lease term in our history at 144 months, which is five times longer than the average remaining lease term of the portfolio at the time of the IPO. Also, 60% of our capital investment is earmarked towards pre-leased projects, which is also the highest amount of pre-leasing we have ever done. Lastly, we have also increased guidance. I'm excited about the position we are in and the opportunities in front of us. Then, as the CEO of the company, I couldn't be prouder of the team we have assembled at CyrusOne. The success we generated this quarter was across the board in every area of the company. Our corporate team has raised a significant amount of additional equity and debt financing. Our sales team has booked another record quarter of contracts and the construction and ops teams continue to build and operate at breakneck speeds. I'm grateful that I get to work with such a talented team of professionals, who continue to execute at the highest levels. Now, I'll turn the call over to Greg, who will provide more color on our financial performance.

[Gregory R. Andrews:]

Thank you, Gary. Good morning, everyone, and thank you for joining us today. I'm going to start with our results for the quarter then cover our current financial position and finish with our updated outlook for 2016. Beginning with slide 10, revenue, normalized FFO and AFFO, all showed strong growth again this quarter. Normalized FFO per share increased by 29% to $0.63 with the increase reflecting the high revenue, NOI, and adjusted EBITDA growth rates for the quarter. Churn for the quarter was 1.3%, slightly higher than in recent quarters, but in line with our historical average. Moving to slide 11, our revenue growth of $32.1 million or 37% was driven by last year's acquisition of Cervalis and the leasing of additional capacity delivered in Phoenix, Dallas, Austin and Northern Virginia over the past year. Our NOI margin was up 300 basis points, propelled by higher revenue and lower power and payroll costs. SG&A, however, was higher than typical due to mostly one-time compensation, consulting and legal costs. We expect both our NOI margin and our SG&A expense to revert to normalized levels in future periods. Adjusted EBITDA for the quarter was $62.7 million, which equates to an annualized run rate of $251 million. The 44% increase in normalized FFO was driven primarily by higher adjusted EBITDA, leveraged modestly with our long-term debt financing. Turning to the balance sheet on slide 12, during the quarter, we increased book assets by approximately $300 million to nearly $2.5 billion total. When accumulated appreciation is added back, our gross book assets are nearly $3 billion. Of course, market value is a more meaningful measure. Using that, our enterprise value is roughly $4.6 billion. That puts us above the median for all REITs, which is just $4.4 billion. Based on our current equity market capitalization, we would rank at number 67 on the list of the largest 100 REITs. And another data point, today, the average daily volume in our shares is approximately $40 million, up from just $12 million in the middle of last year. So what does this all mean? It means that as we grow in size and scale, we garner more interest from investors, from lenders and from stock traders. That helps to reduce our cost of capital and drive better returns on our deployment of that capital. Additions to assets during the quarter included the acquisition of the CME data center in Chicago for $130 million. In addition, we expended roughly $120 million towards construction, primarily in Northern Virginia, San Antonio, and Dallas. Finally, we had excess proceeds from our March equity offering and ended the quarter with $88 million in cash. Measured year-over-year, our portfolio expanded by nearly 350,000 square feet of colocation space, including the 72,000-square feet added in Chicago that is leased to CME. Despite this 27% increase in capacity, our portfolio utilization rate was 89%, or the same as a year-ago. What this shows is that we are acquiring a building to meet market demand, which remains robust across our markets. We expect utilization to be at the same level or higher by the end of 2016. Moving to slide 13, as Gary noted earlier, we are signing longer-term leases and as a result, increasing the average lease term of the portfolio. The weighted average term for leases signed in the last 12 months is approximately nine years. The remaining average lease term of the portfolio pro forma for our revenue backlog is 47 months. This compares to just 28 months at the end of 2012. The lease term of our backlog averages more than 10 years and the overwhelming majority of the revenue is generated by investment-grade customers. In short, the long duration of our leases, the high credit quality of our customers and the embedded growth from rent escalators results in a high-quality stream of cash flow. Slide 14 shows the current development pipeline for 2016. The major construction projects that we have underway have an estimated cost to complete in the range of $165 million to $200 million. The vast majority of that will be spent this year. Approximately 60% of the colocation space under construction is contractually committed to customers, or pre-leased in real estate parlance. Projects in Northern Virginia, San Antonio, Phoenix and Dallas are all seeing healthy demand. We're also seeing deal flow in Houston from non-energy and energy customers alike, albeit, at more modest levels. Interest in Chicago has been strong since we announced the acquisition of the CME data center there. We expect to achieve development yields in the mid-teens on our development pipeline in line with our historical returns. Moving to slide 15, at quarter-end, our balance sheet remained strong. Net debt to adjusted EBITDA was 3.8 times even without any rental income recognized during the quarter from our lease with CME Group. Our fixed charge coverage was 4.1 times. At quarter-end, we had over $730 million of readily available liquidity. During the quarter, we raised over $500 million in capital, including $255 million of proceeds from the issuance of common equity and $250 million in proceeds from a new 5.5-year bank term loan. We used the proceeds to fund the CME data center acquisition, to pay down our revolver to a zero balance and for working capital. We continue to focus on improving our credit ratings, which we feel at the current levels fail to reflect the substantial increase in our size and scale, the diversification of our portfolio by market, industry vertical and customer, the high credit quality of our customer base, the lengthening of our remaining average lease term, the consistency of our cash flows and the growth prospects for our business as a whole. Now, we'll review our outlook for 2016 and beyond. Turning to slide 16, our revenue backlog at the end of the quarter was $74 million, nearly twice as big as the $42 million backlog at the end of 2015 and four times as big as a backlog that we had previously in any quarter. As shown on the bottom chart, we expect approximately 40% of that revenue to commence in the second quarter and 60% in the third quarter. The delivery of projects underlying our revenue backlog should help fuel growth well into 2017. Slide 17 includes our updated guidance for 2016. Let me comment on some of the give and take behind our revised guidance. We now expect revenue churn to be somewhat elevated in the second quarter and third quarter of the year with full-year churn more likely to be at the higher end of our 6% to 8% guidance range. Nonetheless, we are increasing our revenue guidance by $15 million to $20 million, driven by our rapid pace of construction, our strong year-to-date leasing and an anticipated increase in equipment sales and installations in the second half of the year. Margins on equipment are not as high as co-location margins and this explains why the flow-through of the additional revenue to adjusted EBITDA yields an increase in guidance in that line of $4 million. We are increasing our guidance for normalized FFO per share by $0.03 to $2.48 to $2.58 per diluted share, reflecting our higher adjusted EBITDA, partly offset by higher interest expense related to the projected timing of our capital spend. Note that we are increasing our per share normalized FFO guidance, despite the reissuance of nearly 7 million shares in March. These shares were only outstanding for a small fraction of the first quarter, but will be fully reflected in our weighted average share count in the remaining quarters of the year. To sum up, we have momentum as we move through 2016, as a result of the developments to be delivered this year and corresponding lease commencements. Data center demand is fundamentally strong and should provide us with an opportunity to build on this momentum throughout the rest of the year and into 2017. Thank you for your time today. This concludes our prepared remarks. Chad, please open the line up for questions.

[Operator:]

Thank you very much. We will now begin the question-and-answer session. The first question comes today from Jordan Sadler with KeyBanc Capital Markets. Please go ahead.

[Jordan Sadler:]

Thanks. Good morning. Trying to assess the opportunity for you guys, obviously, the leasing pace has accelerated pretty dramatically. If we look back at sort of the first three quarters of last year, even all of 2014, you were averaging 9 megawatts a quarter or thereabout. And in the last couple of quarters, obviously, there's been this dramatic acceleration. So can you help us think about the funnel as you described it, just as full, basically today as it was last quarter and really what this pace is going to look like in the future or at least for the rest of 2016?

[Gary J. Wojtaszek:]

Yes. Hey, Jordan, good morning. Look, we feel very confident in what we're looking at in front of us. I mean despite of having record bookings in the last two quarters, our funnel is just as high as it was last quarter. So, we are seeing deals come to us at a really quick pace and the size of the deals are increasing and that's good news. We don't know how long that will continue to last for us, but we continue to be really bullish on the opportunity in front of us. As we sit here now, we're really focused more on what the business is going to look in 2017 and we have never been in a more solid position to the start of any year ever. And what we've been saying over the last couple of years is that there's two trends that are going on. One is, the demand for data is insatiable, but the other thing that we're seeing is that with the enterprise companies in particular, they've jumped the shark, right? They're no longer reticent about outsourcing to a data center provider like ourselves, like they were previously. And so, not only is their willingness to outsource much greater than it was years ago, but the deals that they're doing with us out of the gate, the size of those has also increased. So, we're seeing a couple of broad trends going on. And I think similar to what everyone else is talking about across the industry has been the growth in all the cloud players has been tremendous. We're definitely a beneficiary of that. The thing I'd point out though there is that our ability to deliver capacity at the pace we do is really attractive to those cloud companies, because if your business is growing at 150% a quarter, your ability to forecast two quarters, three quarters, four quarters out is really, really difficult. And given how quickly we could deliver product to them, we become their fallback position where we kind of minimize their forecasting challenges because we can compensate for that by delivering product really fast. So, we're the beneficiaries of that as well.

[Jordan Sadler:]

That's helpful. So, maybe could you help maybe characterize your nuance, the funnel a little bit, did you sign up the big cloud guys last couple of quarters and now you've got the big finance tenants left in the funnel, who backfilled or does it all look the same? And then, in the same context or vein, with the enterprise companies having crossed the threshold if you will or jumped the shark as you said and they've got more comfort putting stuff in your facilities and co-locating et cetera, they've also obviously got more comfort moving to the cloud. And I know, I think this is probably way too early to start thinking about the cannibalization, but can you maybe give some color on as to whether or not you are seeing any of your customers migrate – those enterprise customers migrate some of those requirements toward the cloud?

[Gary J. Wojtaszek:]

Sure. Yes. So, this quarter, we closed another three additional Fortune 1000 companies. Those were not those big cloud providers that everyone is thinking of, these are your traditional Fortune 1000 companies. And we continue to go after that market that has been the primary reason for our success and we will continue to pursue those customers. We only have 20% or so market share, so there is a lot of apples to pick in that orchard. With regard to customers migrating – enterprise companies migrating to the cloud, there is a tremendous amount of buzz and discussion about cloud in the industry overall. We have not seen any large major wholesale moves from any enterprise company to move everything over into a cloud platform. There's lots of talk and discussion on it, but we've not seen that. We've seen bits and pieces of various applications that they've managing moving over into that, but nothing on a wholesale basis. That said, what I would point out, it was either like a box or a Dropbox, I'm not sure. One of the new cloud storage companies that's had a tremendous amount of success over the last couple of years, they were on an Amazon platform and they just built their separate data center to deliver those services for their customers, because they can do so in a cheaper way by managing it themselves. So that's a good example of, there's a lots of different paths that the cloud is taking and that's why I'm very confident about our strategy in terms of we are focused on providing the critical infrastructure to enable any clouds to exist. And we just want to be the owner of all those clouds in our facilities and the way we do that is to deliver that capacity at the lowest cost and at the best as trying to market and that positions us well. So, whether it's an enterprise company continuing to grow big cloud companies or some of these newer startup companies that may migrate off some of the bigger public clouds into privates, we just want to be positioned to have all that business.

[Jordan Sadler:]

Last one, and I'll yield the floor. As the pipeline remains very full and you continue to soak up a lot of your near-term availability or your utilization is growing, how do you think about pricing?

[Gary J. Wojtaszek:]

Our pricing is remaining unchanged. I mean, like for instance, like we've always talked about historically our renewals, pricing up 2%, down 2%, this quarter it was down 2% and we also talk about like for newer deals, pricing is one of those really kind of nebulous terms, right? So, if you looked at a high level in terms of our aggregate pricing for the deals we closed this quarter and you do your back-of-the-envelope calculations, you'll see that the pricing in that has decreased, I mean, we have a really big customer included in there, which signed up for a 15-year agreement with us. So you've got the commensurate pricing differentials associated with term, resiliency that we talk about. But what I would say is like if you pulled out, you know, within all the noise of the pricing, if you looked at some of the other forward price contracts, the ones that didn't have the powered meter in there, the pricing for those were up over 20% relative to the average pricing over the last four quarters for those contracts. So, it's all over, but at the end of the day, our yields are really kind of like the best indication of how we think about the capital that we're deploying relative to the money we're making and we're kind of like a heart attack patient there, right? I mean, our yields have been in the mid-teens not really moving around much for the last eight quarters or so.

[Jordan Sadler:]

Thanks, guys.

[Operator:]

Next question comes from Richard Choe with JPMorgan. Please go ahead.

[Richard Y. Choe:]

Great. Thank you. I wondered on a high level, how much can base revenue continue to go up for this year without CapEx going up and then a few quick development questions after that?

[Gary J. Wojtaszek:]

Well, Richard, I think in some of the comments that Greg talked about and myself, I mean, so 60% of the capital that we are deploying this year is for that $74 million of backlog, which all comes online this year, right? So this is a really good position for us. We have never had customers that have signed up in advance for us to deliver stuff for them previously, so we feel really good. So 60% of that capital we need to deploy to get that revenue. Then there's some additional growth that we would have in there. We're still running at like 86% or 89% utilization. So just within the existing portfolio you got some additional upside there without additional capital, but we've got some additional capital in the forecast for the additional business that we expect to win over the next two quarters.

[Richard Y. Choe:]

And I guess San Antonio got pushed out or got upsized and then the Dallas Carrollton facility got pushed out to 2Q and finally I guess in the development slide, there is nothing slated for 4Q, is it just too early for anything to be starting for 4Q?

[Gary J. Wojtaszek:]

These are all fluid, right? I mean what we mentioned on last quarter's call like subsequent to the quarter end we got some additional deals for San Antonio, so we upsized that, so we're pulling around some of our resources that would have been allocated to other facilities to their where we have a more immediate demand. So I think what that points to overall is the philosophy that we've had in the company in terms of standardizing our building blocks, so the goal here has always been if we can standardize our building blocks that gives us a tremendous amount of capital flexibility where we can allocate capital to any site around the country very easily because it's the same design. And what that does from a financial perspective is it allows us to run at higher utilization still meet customer delivery schedules without putting in a lot of capital at risk.

[Richard Y. Choe:]

Great. Thank you.

[Operator:]

The next question is from Jonathan Atkin with RBC Capital Markets. Please go ahead.

[Jonathan Atkin:]

Yes. So, just can you give us a flavor for the new logos? You mentioned you are particularly active. You mentioned the three Fortune 1000 companies and maybe for those three, were those large initial deployments or can you help us sort of size that in terms of these new logos that are coming in and how big they are? And then on the strategic fronts, I just wondered about your thoughts with regards to new markets, Santa Clara, I think has probably had the heaviest absorption of any market so far this year and just U.S. West Coast generally with Portland and other places, what are your thought processes about expanding westward? And then internationally, you have a small presence, not owned, but to what extent would it make sense to look at other leasehold interest overseas or expanding your platform there? Thank you.

[Gary J. Wojtaszek:]

Sure. Yes, Robert (sic) [Jon] (32

[Jonathan Atkin:]

So, hundreds of kilowatts, or what do you mean by sizable?

[Gary J. Wojtaszek:]

Yes, yes, yes. It's actually in megawatts in there.

[Jonathan Atkin:]

Thank you.

[Gary J. Wojtaszek:]

Yes. And with regard to overseas, our view has always been that this industry is global by nature. Data goes everywhere around the world all the time and our customers are large multinationals, (33

[Jonathan Atkin:]

And then the build-to-suit interest, so does that result in a single tenant or a multitenant situation and how do you sort of leverage that interest to grow new campuses or whatnot? Can you speak to that?

[Gary J. Wojtaszek:]

Yeah. So everything we do is on a multitenant basis, but we believe that in the Pacific Northwest, there will be single tenant opportunities there where those customers are taking down really large section of a building. So the whole facility or campus is going to be multitenant, but we would go there with a dedicated customer in tow before we would put any capital in the ground in that particular location.

[Jonathan Atkin:]

And then finally on the 7% surcharge, I mean you raised the topic of the take rate that you're getting, so I'm just sort of interested in, are you experiencing push-backs in other ways, whether it's on the PUE side or base rents or I'm just sort of interested in – I'm surprised how high the take rate is. I'm just wondering how truly accretive that is versus maybe other areas where you're giving some concessions?

[Gary J. Wojtaszek:]

Yeah. So just to put that in perspective, just so I don't like over blow, the take rate, so these are all the new customers that we signed up this quarter, that wanted metered power deals, we pushed through that admin fee. But that's not saying – we have a lot of legacy customers that have taken increased power with those and under their historical contracts we're not allowed to push that additional surcharge through to them. So just to give you a little more color on that. But that is something that, it's no different than when we started putting in lease escalators. We never had that in our contracts. Originally when we started out the company, we were doing these as typical short-term deals with no escalators, and then when we decided to convert to a real estate trust, we started putting those into all of our contracts. And now, we're close to 50% of our portfolio has those lease escalators in there. Customers, no one likes price increases, but people understand that there is cost of doing business over time and cost do inflate. And I expect that the power admin fee is going to be exactly the same. We've had a lot of success in that since we've rolled it out over the last three quarters or four quarters. Clearly, no one is happy about it, but eventually, you get that and that's going to be second nature. But I would point out, I mean this is fairly common in the industry, I mean some of the guys have been new in this for a while and I thought it was a pretty creative way to kind of continue to just drive additional growth from the assets over time.

[Jonathan Atkin:]

Thank you very much.

[Gary J. Wojtaszek:]

Yes.

[Operator:]

The next question comes from Manny Korchman with Citi. Please go ahead.

[Emmanuel Korchman:]

Good morning, everyone. Gary, you made a comment in your press release here, and I'll try to quote as best I can, but you have a goal of creating largest financial supercenter in Chicago, becoming the nexus for financial, energy, social media, and cloud companies. And I guess my question there is, how much of that comes from Chicago sort of being a strong market at the moment? How much of it comes from the specific asset or is there something else that you can offer these companies that they would sort of sign with you or come to you rather than one of the other competitive assets or developments that are coming into the market?

[Gary J. Wojtaszek:]

Sure. Thanks. Thanks, Manny. And before I get into that, Greg is really jouncing for a balance sheet question, so (38

[Emmanuel Korchman:]

You usually get those before the equity raise, not after.

[Gregory R. Andrews:]

(38

[Gary J. Wojtaszek:]

But to give you some color, so this is a really, really interesting transaction because as Julie, who came down to our Investor Day was kind of explaining the rationale that CME went through with choosing a partner, they're clearly focused on someone who is going to ensure that they always have all the uptime in the world, resiliency is the number one most critically important issue for them, so they spend lots and lots of time doing their diligence around that, but really what I think in their mind and what the thing that we were most excited about this transaction is for what's going on in this space and in this space meaning the financial services industry, right? So when CME saw us, I mean if you put aside, what we could do operationally, what they saw in us as a partner is someone who is going to bring together the customers that we have in that location. So if you look at CyrusOne, we have a really large presence in financial services now particularly after we expand it into the New York metro market with our acquisition last year of Cervalis. Included in that, are some of the most of the largest hedge funds in the world are now customers of us, including all of these large commercial banks and investment banks. The other thing that we had a really big presence in historically has been energy, right? And so if you think about all the different businesses that are around on the energy side and then you think about what CME does in terms of managing futures risk, those are all commodities, oil and gas and all that. We have all those customers and the other thing that we have is our IT customers. So what's going on in the industry in terms of from a financial perspective is all of these things are being aggregated together and looked at differently than they have in the past. And by that what I mean is if you think about social media fees, so what goes on Twitter and Facebook fees, all those things, those are being monetized now, right? People are trying to look at those, divine the entrails about there and coming up with trading algorithms around how to make money on those. What we're trying to do here is, just aggregate all of those different players together in one location, where they can interact with each other and one another and ultimately what that means is that would translate into accelerated trading volume for our customer there. And so that's what we're looking at doing in terms about creating that opportunity there and that's why the additional 15 acres of space that we have on there, we're going to develop something that's massive and that ensures that everyone can locate at that facility at price points that are attractive to them. And collectively, what we're going to do is drive more trading volume through there. What will also kind of be spawned out of that is a lots of new FinTech startup companies. The financial services industry is one of the largest in the country and it is ripe for disruption. And so, we're bringing folks in now that are going to be talking about credit decisioning in their financial information like the amount of inbound flow that we've had from that transaction has never happened to us in any deal prior to that. After we did that, all these companies started reaching out to us kind of on their initiative asking us about this on what we can do. So, we're taking to lots of different providers here and as I mentioned in some of my taking points, I mean we actually got our first verbal commitment from a customer that is going to go there. So, we're really bullish on the opportunity and it wasn't just for what we were doing with CME. It was really about the bigger vision of what we're going to create there in the financial services perspective. That's really cool.

[Emmanuel Korchman:]

Thanks for that level of detail. Maybe with that as a – putting that in context, how are you structuring the sales or support staff there compared to other assets that you own? Is it going to be more of the Cervalis staff who have been more familiar with financial services sort of being the points there, is it people that you've acquired with the acquisition from CME? Is it some of your legacy people as you try to bring those commodity heavy power users or how are you just thinking about that?

[Gary J. Wojtaszek:]

Yes. We've got the best ops team in the world, that's running that facility that has been doing it for years, which was the guys that are running it for CME. So, they joined our team and all we're looking at doing is accelerating some of the work that they were doing as we develop that campus.

[Emmanuel Korchman:]

Great. And I do have one for Greg, but it's not a balance sheet question. You mentioned one-time items in G&A that inflated that versus sort of run rate. Were those deal-related or were they related to something else and can you just give us some detail on what they were?

[Gregory R. Andrews:]

They were just I think I mentioned some legal costs, some consulting costs and things of that nature, temporary staffing, that ran through G&A, and so we do think that that number was elevated this quarter and should moderate down to a more typical level for the balance of the year.

[Emmanuel Korchman:]

Great. Thanks, guys.

[Gregory R. Andrews:]

Thanks, Manny.

[Operator:]

The next question is from Amir Rozwadowski with Barclays. Please go ahead.

[Amir Rozwadowski:]

Thank you very much, and good morning, folks.

[Gary J. Wojtaszek:]

Morning.

[Amir Rozwadowski:]

I wanted to touch upon the comment that you have made on your ability to deploy capacity quickly and how that's serving you particularly with the cloud service providers and specifically do you believe that this can help you disproportionately grow versus the market right now and sort of gain share because when we speak with most folks in the industry, there does seem to be a bit of a rising tide here for the whole industry in terms of the demand environment, and I'm just trying to parse out if you folks are able to incrementally capture more share because of that ability and believe that that's a differentiator?

[Gary J. Wojtaszek:]

Hey, yes, we believe it's a huge differentiator. So I think just to kind of give a little more color on that, it's important to understand the challenges that our customers face, the big web scale companies. So, if you're sitting in there and you're responsible for delivering data center capacity to your customers, which are in the various lines of business within these big cloud providers, what they have to do is they are aggregating up all of the different demand forecast from all the different customers in the cloud companies in order to put together a forecast for bringing data centers online. And just given what's going on in there in this industry in general, it is just a really chaotic situation because of all the growth that's going on. So if you think about it, right, if you're sitting there and you got these big contracts that you're dealing with customers and your growth is 50%, 100%, 150% a quarter and you can think of that just on a consecutive basis, the probability of outcomes in terms of how much capacity you will need is enormous and it gets even – the distribution curve is much, much wider over time and if you think about that in the context of data centers. So, data centers are the things in that IT stack that are the least flexible, right? These are typically really large facilities that take multiple years to build. And so, your ability to deliver that type of capacity over long-terms is really challenging. I mean there is a huge duration mismatch between what these guys are doing on the asset side and the liability side if you kind of look at it from a financial perspective, right? And so, what we're able to do is, we can bring on capacity so quickly for them, that the inherent challenges that they have in their forecasting which create this volatility around the accuracy of it, we kind of complement that and we minimize the downsides of their forecasting inaccuracy. And so, we can deliver a product within a couple of months. We took out a big amount of risk from their ability to make sure that they can hit their top line performance as they deliver capacity for their customers. To give you a perspective, I mean what we did in Phoenix there is we built an entire data center in just about the same amount of time that the computer manufacturers would be able to deliver all of the computing here that would fit into the data center. So, we're building garages just as fast as GM is manufacturing cars, right? And that's what we're able to do. That becomes really, really attractive to folks when they're looking at this curve that is just so up into the right and it's really challenging for our customers to deal with that. So I think our capabilities in that space is just going to continue to bode well for us. What we're doing in Northern Virginia right now, for perspective, it's three times larger than what we did in Phoenix. We're going to deliver 30 megawatts there in six months. In fact, we're talking to allowing the customers to move into the space now, like in May, to help them get up to speed and so that is like three times larger than what we did in Phoenix and just about twice the amount of time, but that is a huge opportunity that we have to sell that capabilities to lots and lots of customers because all of the cloud guys are all struggling with the same challenges.

[Amir Rozwadowski:]

So you'd mentioned that a majority of your bookings are now coming from new customers, based on this opportunity that you see, is it fair to say that these are the types of new customers that you're getting a majority of those new bookings from?

[Gary J. Wojtaszek:]

No, no, actually those – what – it was a Jordan's question earlier or Robert's (sic) [Jon's] (50

[Amir Rozwadowski:]

That's very helpful. Thanks very much for the incremental color.

[Gary J. Wojtaszek:]

Sure.

[Operator:]

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

[Jonathan Schildkraut:]

Great. Thanks for taking the questions. I guess just carrying down the sort of path that last few questions have been on, really about differentiation in the marketplace, it's clear that you guys are taking quite a bit of share particularly on the large footprint side. And you've mentioned ability to deliver space in a timely fashion, but there are other sort of differentiations in your business model versus some of your peers. And I'm just wondering if you could sort of rank order them in terms of understanding what's drawing customers into your facility beyond, say, the ability to have capacity for them in the short time. So, is it shared infrastructure versus the dedicated? Is it lower or different levels of resiliency versus some of the peers that don't have the ability to do that? Is it the interconnection platform, is it Tesh, what are the factors that roll in here as you sort of rank order the different things that draw folks into your centers? And then, I do have one follow-up question. Thanks.

[Gary J. Wojtaszek:]

Yes. Well, clearly, the Tesh factor plays a big key in all of this, right? No, it's a combination of everything there. We develop competencies across all different areas of the portfolio. I mean, we can provide these multiple level resiliency solutions, we can meet timelines that others just can't do, and we'll stand behind that. I mean we'll put in financial penalties that are very significant if we don't do what we say we're going to do. And it's just an ability and willingness to partner with the customer that puts them at ease and gives them the confidence that we really know what we're doing. So they trust us to do more with them. And whether it's the multiple level solutions, the fact that we provide shared infrastructure which gives us a tremendous amount of flexibility, the custom tower solutions for customers, because we just manage that, that inherent kind of risk in the back plane and we sell it to other customers in creative ways. Or what we're doing on the interconnection side, in terms of linking up the facilities together, these are all things that we have thought through, but are all the genesis, hours and hours of conversions that we have with customers understanding, what their current challenges are and where we think their challenges are going to lie in the future and coming up with a solution that works for them. And look, our sales organization is just phenomenal. We have always viewed ourselves as a sales machine. And I believe we've got the best sales group in the industry. That said, I mean, I think all of our – all the guys in the industry do really, really well. I mean average – we were one of the last guys to report. I think we are the last company to report. And I think what you saw in the industry is everyone continues to do well. And I think as we become a bigger portion of the REIT Index overall, I think people are going to see this asset class as something that is unbelievably attractive, right? The data centers overall are the fastest-growing assets in the REIT Index. We have the least amount of leverage. We make the highest returns on the capital that we're deploying. Then I think over time, more and more of the REIT investors are going to allocate a higher proportion of their capital towards this index.

[Jonathan Schildkraut:]

I think that makes a lot of sense. Just one point of clarification, you know you talked about 50% of your MRR coming from new customers, and I'm wondering if CME counted as a new customer for that calculation and given that they were about 40% of the bookings for the quarter, does that mean that 5/6 of the remaining stuff that you booked was with existing customers?

[Gary J. Wojtaszek:]

If CME is included in there, I haven't looked up numbers on those splits, but yes, CME is definitely one of the three included in there.

[Jonathan Schildkraut:]

Okay. All right, thanks. And then just one last one, one of your peers earlier in the week or maybe it was last week, starting to lose track of days there, but had some not extraordinarily positive comments about the Phoenix market and I was just wondering if you could add some color on what you guys are seeing there?

[Gary J. Wojtaszek:]

Yes. I don't know. I mean, we're sold out and we're building more, we have more demand coming there, so...

[Jonathan Schildkraut:]

All right. Thanks, Gary. I appreciate it.

[Gary J. Wojtaszek:]

Yes.

[Operator:]

The next question is from Simon Flannery with Morgan Stanley. Please go ahead.

[Simon Flannery:]

Great. Thank you. You had a great chart in the deck just about the extended term of your customer base. Is this something where you are seeing the customers really looking for much longer terms or is it as you brought on sum of these sort of hyperscale guys that they just have a different, it's more of a wholesale type or much larger longer-term deployment? So, is it more of a mix thing or I guess the question is how should we think about that evolving? Are you going to see a lot more of these 10-year, 12-year deals or are we going to start to level out here? And I think just another thing on the churn, any sort of sense of what's driving that, is that energy in Houston or is that just mergers or what are the kind of factors behind the elevated trend? Thanks.

[Gary J. Wojtaszek:]

Yes, I think over the last several years, you've just seen the average length of all the deals that we've been doing increase, I think the average length of the deal last year, was it nine years?

[Gregory R. Andrews:]

Seven years last year, nine years in the fourth quarter, so...

[Gary J. Wojtaszek:]

Yes. I just think as people become more comfortable with that outsourced model, they're going to do more of it. Actually our energy bookings this quarter were consistent with the same amount of bookings that we've done per quarter over the last year. The churn that we had in the quarter was related to a couple of weird things. One is we have some customers move out of and this is like what we saw last year, we had customers move out of one facility, so get out of contract there, enter into new contract into our facilities, and the facilities that they were getting out of was lease contracts that where we're a sub-tenant of. So we'll be getting out of those, we'll get some bottom line savings that go away, once we get out of those leases as well. And another customer actually gave us space back that's going to allow us to repurpose that this is a customer that's been in facility actually in Cincinnati. They've been in space that's about 30 years old. And so we're going to basically be able to take back space from them and with a fairly incremental amount of additional capital be able to repurpose that and earn three times as much as we were charging previously. So that also gets counted as a churn metric, but even in case of that particular customer, they ended up moving into a smaller space with us at the bigger power densities and entered into a 10-year lease agreement with us.

[Simon Flannery:]

Okay. Thank you.

[Operator:]

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

[Vincent Chao:]

Hey, everyone. How are you guys doing? A quick question. We've talked about the strength of demand in the market that's been building across the industry for quite some time now, yields are very strong, and I'm just curious, I know PE firms and whatnot have been selling out of the space, but how long do you think, the feeding frenzy here can last before you start to see some more players start to poke around and maybe try to build in and capture some of the pie?

[Gary J. Wojtaszek:]

Yeah. So here is a – there is about 7 billion devices connected to the Internet, Vin, and that number is going to get to 25 billion devices in just the next couple of years. So each time, each device gets connected to the Internet, the more data gets created. And all of that data is stored in the garages that we build. And so we expect that the pace of growth in that is going to continue to increase and go up into the right and there is going to be more stuff going on in the future than we can never even imagine the opportunities in front of us relative to where the digital age has gone over the last two decades, it's going to be dwarfed by all the new technologies that we don't even know are going to get created. Our play in that is all ultimately just kind of creating these digital garages that store all the stuff. The business is becoming more and more scaled. So from a competitive perspective, it's becoming the haves and have-nots, and I think what you saw last year in all the M&A that went on in the industry, which was the highest amount of M&A ever, all those deals traded through strategics. And you just become larger and larger black holes, and that type of nexus just becomes much more difficult to compete against. And I don't see that going in an opposite direction at all. I continue to see just like every other industry, as industry matures, there is less competitors and you'll call last around the couple of key players over time. I think just given the underlying growth in this industry, there is still many years left before that happens but, you kind of saw that with the wireless industry about a decade and a half ago, right, where consolidation really started happening and now we're left with the couple of big players. This space will – eventually more to follow that similar type of a consolidation.

[Vincent Chao:]

Okay, thanks for that perspective. And just a quick one here, just maybe in relation to the churn commentary, but there's two of your top tenants have about a quarter left on their term. I'm just curious how those discussions are going and if they're part of that elevated churn comment?

[Gary J. Wojtaszek:]

Yeah, one we know is going to renew with us that will be renewed. The other one we are expecting that they are going to churn and that is the reason why we have assumed elevated churn levels in our forecast.

[Vincent Chao:]

Okay. Thanks, guys.

[Gary J. Wojtaszek:]

Yes.

[Operator:]

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

[Colby Synesael:]

Great. I thought I'd try and get some questions in for Greg. So first off, you guys don't guide to AFFO, but with the CME deal coming online, is there anything notable that we should be thinking about, I guess particularly as it relates to straight line that could start to create a bigger divide between FFO and AFFO or if there is any other color, just in terms of how we should be thinking about FFO going forward? And then also yesterday, you guys filed a shelf registration, I think it was just a standardized renewal. But is there anything you need to call out with that, and I guess what would be the need for capital at this point? Would it simply be M&A or could see yourself potentially coming back into the market simply based on an acceleration in organic demand? Thanks.

[Gregory R. Andrews:]

Yeah, thanks, Colby. So with respect to AFFO, I don't think we see anything particularly different going on there. All of our leases including the CME need to be treated with the straight lining of rent, but I don't think that that's going to drive anything unusual in future quarters. Yeah, with regard to filing the S-3, we were just coming up on the limits of our prior registration and so was trying to kind of refresh with the new shelf, and that's just a universal shelf that will last for three years. But what we think in terms of capital is I think really consistent with what we said at our Investor Day, right, which is that we can do $300 million of development using our retained FFO and debt and remain relatively leverage neutral, because of the high returns that we earn on that capital. To the extent, we start exceeding that $300 million then there is probably additional capital needed around that excess. And then, if we are involved in any kind of acquisitions, we would also look to finance those with some kind of combination of debt and equity in order to maintain a strong balance sheet. For us, that's really a critical feature of our game plan. Gary just talked about kind of this. As far as I can see growth in the business and the demand for data and driving the need for data centers, and so having a strong balance sheet is the way to compete for the long-term for that business. So within those parameters that I just described, we would raise additional capital once we start to exceed the growth that we have currently baked in.

[Colby Synesael:]

And just to touch back on AFFO for one brief second. I guess the point I was trying to make was with you guys now signing much longer deals, one could argue and assuming there is some form of escalator in them, one can assume or make the argument, I would guess that the delta between GAAP recognized revenue and cash revenue could actually start to expand in terms of their differences and I guess and with CME in particular, in the 15-year lease and the size of that company, I just thought that you might start to see a greater gap in AFFO versus FFO which sounds like that's mistaken?

[Gregory R. Andrews:]

Yeah. So your point makes a lot of sense that longer-term leases, if you have large rent escalators built in, could result in a larger gap there for some kind of unique reasons around the structure of that lease side, I don't think we're going to see a large gap developing there. But as we lengthen the term of leases, that might turn out to be the case that there's a little bit more of a gap between cash and GAAP rents going forward.

[Colby Synesael:]

Okay. Thank you so much.

[Operator:]

The next question is from Matthew Heinz with Stifel. Please go ahead.

[Matthew Heinz:]

Hi. Thanks. Greg, I've got another nice fat pitch on the balance sheet for you here.

[Gregory R. Andrews:]

Thanks, Matt.

[Matthew Heinz:]

So, just following up on your comments around credit ratings, I'm curious about the nature of your discussions with the rating agencies and I guess whether there is kind of a line of sight to some upgrades here and if so, what sort of reduction do you anticipate in regards to capital?

[Gregory R. Andrews:]

Yes. It's a good question. So, we remain in kind of almost continuous communication with the rating agencies, that's kind of just how the process works and in my background I've worked with a company that was investment-grade rated and so have familiarity with some of the folks at those shops and kind of know how they like to work. So we're kind of always in front of them telling them how strong our balance sheet is today, but also how we kind of intend to manage that as we move forward. They kind of then will go through their own process on that front in terms of determining what they thing appropriate ratings are in light of the credit metrics of the company as well as their view of the industry, but my main issue I would say there is that, I think they are going through a kind of learning process around the industry, it's kind of hybrid for them between tech and real estate and they don't necessarily know how best to kind of analyze it relative to those other comps, so, as they think about the tech component of it, they look at leverage one way and if they think about the real estate component they look at it in another way and even within the firms they kind of have discussions, but I'm not sure if it's fully like fully have been able to come up the curve yet just because it's relatively new thing for them, but I think over time, they'll come to appreciate what the points we're trying to make here on this call and that we really believe which is that there's consistency in the cash flow that the escalators provide growth in that and that the overall industry continues to grow and as we've positioned our portfolio we diversify in every which way and I think you can diversify and that all of that is deserving better ratings than we currently have.

[Matthew Heinz:]

Okay, that's helpful. Thanks. And then it looks like there was a push out on couple of projects, I think maybe Dallas, Phoenix and Houston. Was just wondering if that's kind of a reallocation of resources towards maybe the CME or other projects with greater urgency or if there is something else driving that?

[Gregory R. Andrews:]

No, we're actually very close to complete on a couple of those, but they were not commissioned during the quarter. So, those got pushed out just for that, but it wasn't certainly resource thing at all. And the other thing I would mention here is that, as we complete some of those facilities, we will – it may take a period of time than to sell into those spaces, so the stabilized portion of that will kind of get delivered as the leases materialize and then the construction and progress fees will kind of remain there until those portions are leased up.

[Matthew Heinz:]

Okay. And just one last one if I may, noticed that the interconnect revenue was flat sequentially. Was there a notable churn event there and should we expect that line item to sort of resume a steady upward trajectory from here?

[Gary J. Wojtaszek:]

No, no. Actually we had our strongest bookings I think in that business this quarter, so that should continue to go. The challenge though is that you're doing these bigger deals, but proportionately IX relative to the bigger deals are smaller, so even though the growth and that continues to go up, we're doing a lot of other deals that are bringing as much proportionally as much IX revenue too. So, Josh has got to work harder.

[Matthew Heinz:]

All right. Thank you.

[Gregory R. Andrews:]

Thank you, Matthew.

[Operator:]

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

[Frank Garreth Louthan:]

Great. Thank you. As you are deploying more assets from companies like Amazon and Microsoft Azure and their 365 product and so forth, what exactly are they putting in your data centers? Are they physically locating there and what percentage do you have physical location of their hubs and what percentage is it more of various types of connections that customers have access to those products?

[Gary J. Wojtaszek:]

Yes, we're going to be putting out more pieces on that, our customers have been very resistant to explaining exactly what types of products and services we can announce there until they're ready to do that, we've just got an agreement with them that we can announce that we have them as partners as part of this and as we roll those out, we will have press releases that explain exactly what each company is going to and is planning to offer there.

[Frank Garreth Louthan:]

Okay. Great. Thank you.

[Operator:]

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

[Gary J. Wojtaszek:]

Thanks, everyone. I appreciate you talking the time to talk with us this morning. We really enjoyed you learning more about our business and just to kind of reiterate what I said earlier, everyone in the industry is doing phenomenally well and I think over time, we're going to continue to see this asset class continue to provide superior rest of performance relative to some of the other asset classes that real estate investors have to choose from. So thanks a lot. See you next quarter.

[Operator:]

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