CyrusOne Inc.
Q3 2014 Earnings Call Transcript

Published: 5 Nov 2014

[Operator:]

Good afternoon, and welcome to the CyrusOne Third Quarter 2014 Results Conference Call. [Operator Instructions] Please note, that this event is being recorded. I'd now like to turn the conference over to Mr. Anubhav Raj. Please go ahead.

[Anubhav Raj:]

Thank you, operator. Good afternoon, everyone, and welcome to CyrusOne's Third Quarter 2014 Earnings Call. Today, I'm joined by Gary Wojtaszek, President and CEO; and Kim Sheehy, CFO. Before we begin, I would like to remind you that our third quarter earnings release, along with the third quarter financial tables, are available on the Investor Relations section of our website at cyrusone.com. I would also like to remind you that comments made on today's call and some of the responses to your questions deal with forward-looking statements related to CyrusOne and are subject to risks and uncertainties. Factors that may cause our actual results to differ from expectations are detailed in the company's filings with the SEC, which you may access on the SEC's website or on cyrusone.com. We undertake no obligation to revise these statements following the date of this conference call, except as required by law. In addition, some of the company's remarks this afternoon contain non-GAAP financial measures. You can find reconciliations to 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, Raj. Good afternoon, everyone, and welcome to CyrusOne's Third Quarter 2014 Earnings Call. We continue to produce strong results, with high growth rates across all key financial metrics, while maintaining a 17% development yield. I'm also particularly excited to announce the deal on Northern Virginia, which gets us off to a fast start in that market, as we establish our presence on the East Coast. As always, I want to thank all the team members at CyrusOne for the hard work and for their commitment to meeting the needs of our customers. After I review some of the highlights for the quarter, Kim will then discuss our quarterly financial results in more detail and provide updated guidance. Beginning with Slide 3. The strong growth trends, as we have seen since becoming a public company, continued in the third quarter. Normalized FFO and AFFO were up 32% and 51%, respectively, over the third quarter of 2014. Revenue was up 26% compared to the prior year quarter, and adjusted EBITDA was up 16%. We leased 33,000 colocation square feet in the third quarter and subsequent to the quarter side, the lease of Northern Virginia for more than 12,000 colocation square feet. We recently completed the Phoenix 2 build in 107 days from start to finish, which we believe is a record time for a ground-up data center construction project. Turning to Slide 4. I just want to remind everyone of the 4 key organic growth drivers for CyrusOne, which includes expansion by our existing customers, acquisitions of new customers, development of new channels and products and portfolio expansion. Once we get customers in our facilities, we know that they will stay a long time and grow with us. So we are keenly focused on bringing in new customers to accelerate the pace of our growth. We are able to generate high-blended rates due to the mix of customers and our offering of ancillary products and services such the National IX. We are able to scale our platform efficiently, as our massively modular design techniques allow us to build quickly at a low cost, thereby, minimizing the amount of capital being deployed. The success we have in growing the business organically through capital-efficient means, translates into shareholder value for our investors. Our primary focus at CyrusOne is to attract and retain profitable customers. We fundamentally believe that data center customers exhibit very different purchasing behaviors than traditional real estate customers that lease office space or apartments. Specifically, we note today, based on our history, that there's a tremendous opportunity of long-term value associated with each customer that chooses to do business with CyrusOne. We estimate that 40% of the net present value of a customer is derived from the business that we do not have today, which is an incredibly powerful financial incentive to make sure we do a good job. Because if you do, you can almost double the value that customer relationship. I contrast this with some of the other types of classic real estate investments such as office, industrial or apartments, where that level of customer growth does not necessarily exist and customers may not show the same level of brand loyalty. This results in business decisions that are primarily focused on optimizing the existing short-term customer relationship. As a result, traditional real estate operators and those industries are primarily focused on increasing growth and profits through price escalations, which we can -- which can create an adversarial relationship between real estate owners and their customers. However, at CyrusOne, our customers are very loyal to our customer, our company, and we can count on steady organic growth with them over the years because the explosion of data and increased comfort with outsourcing causes them to purchase much more data from us. It's this unique phenomena that underlies the vast majority of the business decisions we take at CyrusOne, including pricing, capital investment, marketing, customer service, et cetera, which are all undertaken with the goal of maximizing long-term organic growth. On Slide 5, you can see that the first key organic growth driver is our existing customer base. Our ability to attract Fortune 1000 customers has resulted in a very high-quality customer base, with the Fortune 1000 representing approximately 74% of our annualized rent and investment-grade customers representing 56%. The energy and IT verticals each account for approximately 30% of our rent. Historically, our business had a much higher concentration of oil and gas customers. However, as we've expanded our geographic footprint and launch incremental products such as our National IX, our ability to target and sell across multiple verticals, including new verticals, such as cloud customers, has reduced our industry concentration. Also, as you can see at the bottom of the slide, the percentage of our revenue derived from customers in 2 or more sites has also increased and is now at 61%, up significantly from where we were 2 years ago. Slide 6 shows the new MRR signed over the last 7 quarters for existing and new customers. As I mentioned a minute ago, one of the unique aspects of our customer base, as well as for the industry in general, is that data center customers generally grow with you over time. We estimate that this future growth is worth approximately 40% of the NPV associated with each new customer. We have shown the new MRR signed over the past 7 quarters and separated it between existing customers and new customers. Over this period, the growth from existing customers has varied, but has averaged almost 60% of the new revenue growth during this period. This is an incredibly powerful statistics, especially when placing it in the context of the 26% year-over-year growth the company has experienced, as it clearly highlights the financial benefit of just getting customers in the door. As I've talked about before, oftentimes when enterprises make the decision to outsource for the first time, they may give us just a small portion of their IT staff. While the economic justification for outsourcing is a no-brainer, the CIO can be reluctant to give up full control and the initial deployment may only consist of a selected application. However, over time, as they gain comfort with us and experience the outsourced outstanding customer service that we deliver, they move additional components of their application stack into our facilities. And given the explosion of the growth of data, the growth trajectory of their data center requirements may be much steeper than that of their underlying business. They will often expand into multiple locations, facilitated by our National IX platform, which enables them to replicate their own data center architecture at a fraction of the cost. In summary, our existing customer base is a tremendous asset and the opportunities for growth they generate for us can be much different than those in other real estate assets. Turning to Slide 7. I want to spend a few minutes talking about leasing rates on new contracts and renewals. This is one of the most frequent questions we have received from investors since going public. I've intentionally stayed away from giving these details in the past, as it is a statistic that can be easily misconstrued and is not relevant unless you adjust for the capital deployed behind the various products we sell. The first chart on the slide shows average price per kilowatt on new contracts over the past 6 quarters. As we have discussed on prior calls, given the flexibility of our offering, which accommodates various space requirements, densities, levels of resiliencies and average leasing durations can fluctuate significant from -- significantly from quarter-to-quarter, depending on the product mix. There can be many nuances that go into lease rates such as the density resiliency and contract duration, early termination provisions, customer security requirements and the list goes on and on. Merely looking at it, unadjusted lease rate or the headline rate may not give the most meaningful picture of the lease and its value, as we just don't sell 1 standard commodity product and the mix of products sold in a quarter can dramatically impact this statistic. However, we have attempted to account for a number of these factors by adjusting for the relative capital investment required for our different products and removing the price of power in our full-service leases to convert the leasing rate for these leases to our base five nines reliability power product. In our opinion, this provides a more meaningful statistics since we don't underwrite all of our deals based on price. We underwrite them according to the capital that we deployed to support that particular product line. Over the last 3 quarters using this methodology, the average lease rate on new contracts has ranged from $190 per kilowatt to $220 per kilowatt. Even after adjusting, there are still factors can affect the average from quarter-to-quarter, such as the impact of large deal, as well as variations in the volume of ancillary products and services sold. As a reminder, we evaluate lease rates for individual contracts in the context of the capital investment required to deliver the product, which is an important factor in allowing us to achieve our target returns. In fact, some of the lowest-priced deals have among the highest return profiles. On the bottom of the slide, we show renewal rates. Leases representing $2.1 million of monthly recurring rent were up for renewal in the quarter. Of these leases, leases representing approximately 94% on a weighted average basis were renewed at rates that were equivalent to or higher than previous levels. Leases that were renewed at lower rates were generally associated with conversions from full-service to metered power lease rates. In total, weighted average lease rates on renewals was down 2% on a cash basis. However, what is important to realize is the organic growth phenomena that we have with our customers and the interaction that has on pricing, particularly when it comes to renewals. As I mentioned, enterprise is generally about sourcing only a small portion of their overall data center needs. With this in mind, we will not look to increase the customer's lease rate if we believe it will jeopardize our long-term growth opportunity with them, because we realize that there is much more value in the longer-term relationship and will always forego picking up pennies if we know there are future dollars at stake. Turning to Slide 8. Getting new logos in our facilities is critical to fueling our growth. When enterprises make the decision to outsource, they generally choose a single data center provider. And as I mentioned earlier, once you have them, these same customers continue to grow with you. We have been very successful in attracting new customers with our unique value proposition. So far this year, we have added 44 new logos, including 12 Fortune 1000 customers. Our current customer count at the end of the third quarter stood at 646, including 141 Fortune 1000 customers. We believe that the most important leading indicator for our company's success is based on the number of new customers we are able to attract, because it is a gift that keeps on giving. This is why we spent significantly more investing in sales and marketing than many other traditional real estate companies. The return we get in our investment in sales and marketing is fantastic and is one of the primary reasons for the growth that we have managed to deliver over the past several years. On Slide 9, you can see that the majority of our growth has come from our direct sales force, but the investments we made building out our indirect sales channels has helped supplement the sales we generate directly. We now have more than 120 partners, including value-added resellers, system integrators, hosting partners in our network. The chart shows the percentage of MRR from new customers signed over the last 4 quarters in the direct sales channel and in the indirect channel. As you can see, the mix can vary from quarter-to-quarter at 77% of an MRR signed in the third quarter came from indirect channel compared to almost nothing the prior 2 quarters. As we continue to develop this channel and build new partner relationships, the opportunity set broadens, providing a nice fit with our sales network. On the marketing front, I am pleased with the job the team has done of building our brand and developing awareness since the IPO. Our market research shows that CyrusOne has reached the same level of brand awareness in the marketplace as the largest interconnection competitor in the world, who is, several times larger than us and has a global footprint. Our coverage in the media has grown significantly, as we are featured -- being more featured in more top news publications and asked to speak at more industry events and technology trade shows than ever before. We recently launched the new more user-friendly website optimized for mobile devices, which I encourage you to take a look at, at cyrusone.com. Contacts and phone calls from people visiting the site are up 50% year-to-date, compared to the same period last year. The team is also being recognized for the outstanding work they are doing, as they were recently honored for the campaign of the year with a prestigious gold Stevie award, which my marketing team tells me is the equivalent of an Oscar in marketing circles. In all seriousness, all of our efforts on this front are paying off in terms of lead generation, as we have developed a very robust sales funnel and is the critical differentiator for our company. Turning to Slide 10. The final key growth drivers, portfolio expansion. In order to meet the strong demand across our existing markets and to build out the platform, we have added a lot of capacity. Since the first quarter of 2013, we have invested almost $350 million into the business to support growth, representing an increase of 40% in investment. Despite the substantial increase, we have consistently maintained development yield of around 17%. As I have talked about, the customer phenomena, which causes customers to purchase more data centers based from us, is also what allows us to deploy capital in a very low-risk manner. As we sit here today, we can count on continued organic growth from our existing customers, which greatly derisk the capital we are investing to support that organic growth. What's also important to understand is that by the end of the year, we will have enough shell capacity to nearly double the size of the company today and enough land to nearly quadruple the size of the company, all of which comes at higher incremental capital returns, given all the investment previously made in these locations. For example, within our existing shells, we could build out over 100 megawatts of power at an average cost of approximately $5 million per megawatt. Slide 11 provides an update on Northern Virginia and Phoenix. As I mentioned earlier, we just recently announced the pre-lease of more than 12,000 colocation square feet to an existing Fortune 500 customer at our new facility in Northern Virginia, representing 40% of the raised floor we are bringing online. This deal is representative of the success we have in attracting Fortune 1000 customers and having them expand to multiple locations. We also have commitments from 8 telecom carriers and fiber providers to provide services. Having them along with our National IX ecosystem that will operate in the facility will afford customers a broad range of choices to meet their connectivity needs. We expect the completion of the shell and commission 30,000 square feet of raised floor in the coming weeks. Also, as recently announced, we completed construction on Phoenix 2 facility, including the first 30,000 square feet of raised floor in just 107 days. The data hall is fully leased to a Fortune 100 cloud provider. A typical enterprise could take almost 3 years longer and spend significantly more capital to build the same facility. Our team's expertise in design and construction along with efficiencies we have built through many years of experience, allows us to deliver facilities faster and cheaper. This limits the risk we take when investing in new projects, and helps us to achieve the mid- to upper-teens development yields that we are targeting. Enterprise has also recognized that we can quickly scale to meet their growing needs and constantly changing IT requirements. And it is yet another differentiating factor for us. To close, I am pleased with what we have accomplished so far this year, and we are set up well for 2015, with substantial runway to take advantage of opportunities for growth. I will now turn the call over to Kim, who will discuss our financial results in more detail. Thank you.

[Kimberly H. Sheehy:]

Thank you, Gary. Good afternoon, and thank you for joining the call today. As Gary mentioned, we had another very strong quarter and the results reflect a lot of hard work and good execution by the team. Continuing with Slide 13, revenue for the third quarter was $84.8 million, an increase of $17.3 million or 26% from the third quarter of 2013. The year-over-year increase was driven by a 25% increase in leased colocation square feet and additional IX services, with both new and existing customers contributing significantly to our growth. For the quarter, our IX products represented 4.5% of total revenue, in line with prior quarters and IX revenue was up 26% compared to the third quarter of 2013. As Gary noted, we leased 33,000 colocation square feet in the quarter. And subsequent to the quarter, signed a lease for more than 12,000 colocation square feet in Northern Virginia. The leases signed were for 3.4 megawatts of power, primarily at facilities in our Dallas and Midwest markets. Based on square footage, approximately 70% of the colocation square feet leased was to metered power customers, with executed leases having a weighted average term of 69 months. 66% of the new leases on a monthly reoccurring revenue weighted basis have escalators at an average annual rate for approximately 2.7%. Our rent churn in the third quarter was 2.9%, up from the churn rate in recent quarters. The increase is primarily driven by the impact of 2 customers. The first is the same customer that we talked about on last quarter's call for whom we took a partial receivable write-down in the second quarter and has since moved out of our facility. This space was subsequently re-leased during the third quarter. The second is related to a large Fortune 20 company that we have had a long-standing relationship with. They are currently working to consolidate their global data center deployment. As a result, they expanded into our Dallas and Phoenix locations over the last year, while moving out of one of our Midwest locations this quarter. Overall, this customer has increased their spending with us in the last year. Since we include all reductions and reoccurring rent and do not net against additions, we include the impact of this reduction in the Midwest as churn. Excluding the impact of these 2 customers, churn for the quarter was in line with prior quarters at 1.4%. Moving to Slide 14. The leases signed this quarter represent approximately $700,000 in monthly reoccurring rent on a steady-state basis or approximately $8.3 million on annualized GAAP revenue, excluding estimates for pass-through power. Including estimates for pass-through power charges, the leases signed this quarter represent approximately $10 million of annualized GAAP revenue, once the customer is fully ramped in. By the end of the third quarter, we have commenced approximately 37% of contracted revenue for leases that were executed during the quarter. As of the end of the third quarter, our total backlog of annualized GAAP revenue stood to $12.6 million. We estimate that by the end of the fourth quarter, we will have commenced leases representing 98% or $12.4 million of the total backlog. The remainder is expected to commence in early 2015. I also want to highlight that there is very little -- limited future capital expenditures required to support our current backlog. The commencement of leases signed this quarter is accelerated compared to prior quarters and is representative of specific customer requirements. We do not anticipate that future periods will necessarily have similar accelerated phasing. Moving to Slide 15. Net operating income of $51.8 million for the third quarter, an increase of $8.5 million or 20% from the third quarter of 2013. The NOI margin of 61% was down 3 percentage points versus the third quarter of last year, primarily driven by the impact of higher electricity usage. Adjusted EBITDA increased by $5.7 million to $42.2 million, up 16% from last year, driven primarily by the increase in NOI. This was partially offset by increases in sales, general and administrative expenses due to higher payroll and advertising activities. Normalized FFO for the third quarter was $28.9 million, an increase of 32% from the third quarter of 2013, driven primarily by growth in adjusted EBITDA, as well as a decrease in interest expense as a result of higher capitalized interest. The increase in capitalized interest was primarily driven by an increase in construction in progress and related cash outflow, which allow us to capitalize more interest in the quarter. AFFO for the quarter was $29.1 million, an increase of 51% over the third quarter of 2013, driven primarily by the increase in normalized FFO. Slide 16 compares our performance on a sequential basis. Revenue increased $3.1 million or 4% from the previous quarter, driven primarily by strong recent leasing. NOI increased by $1.9 million, as property operating expenses were $1.2 million higher compared to the prior quarter and the NOI margin was flat. The adjusted EBITDA margin of 50% was also flat compared to the prior quarter, as a slight decrease in sales and marketing expenses was offset by an increase in general and administrative expenses related to incremental headcount, as well as the additional SOX and COSO compliance requirements we referred to on last quarter's call. The increase in normalized FFO was driven by the increase in adjusted EBITDA, as well as a decrease in interest expense related to higher capitalized interest. The increase in the AFFO was driven by the increase in normalized FFO, as well as lower deferred revenue and straight-line rent adjustments, partially offset by higher reoccurring capital expenditures. Moving to Slide 17. We want to quickly highlight the strong growth in normalized FFO and AFFO since the IPO. In the third quarter, both were up more than $11.5 million or more than 65% compared to the first quarter of 2013. This is primarily due to the increase in adjusted EBITDA over the same time period, which was driven by the strong growth in leasing. Furthermore, in early 2013, we had over $330 million in cash from the IPO, while we were paying interest of 6 3/8% on the $525 million unsecured notes, the proceeds of which went to Cincinnati Bell as part of our formation transaction. The pressure placed on our FFO by starting with such a large cash balance will be reduced over time, as the approximately $350 million of assets that have been placed in service since the end of the first quarter of 2013 start generating the mid- to upper-teen returns we see across our broader portfolio. Slide 18 shows a market level snapshot of our portfolio at the end of the third quarter of 2014 and 2013. Utilization is up 3 percentage points compared to last year, even with a 21% capacity increase, reflecting particularly strong demand in our Texas and Phoenix markets. Subsequent to the quarter, we commissioned 30,000 colocation square feet in our new Phoenix facility which, as we indicated on last quarter's call, are already been taken down by a customer. Capital expenditures in the third quarter were $78.1 million compared to $64.3 million last year. During the quarter, we added 11 megawatts of power capacity at our Phoenix 1 facility to support the CyrusOne solutions build at that location. Additional spending relates primarily to continued construction of our new facilities in Houston, San Antonio, Northern Virginia and Phoenix. Slide 19 shows current and planned development activity by market, as we've had several major projects currently in process. As noted earlier, we completed the addition of 11 megawatts of power capacity in our Phoenix 1 location. And in October, we completed the construction of a 107,000 square-foot shell for our second Phoenix facility, with 30,000 square feet of raised floor and 6 megawatts of power capacity initially coming online. We are continuing construction on 3 new facilities in Houston, San Antonio and Northern Virginia. We expect each of the shells, as well as the first data hall through the facilities, to be completed by the end of 2014 or in early 2015. The Houston facility will consist of approximately 329,000 square feet of powered shell. The San Antonio facility will consist of 124,000 square feet shell and 30,000 square feet of raised floor and 3 megawatts of power capacity coming online day 1. The Northern Virginia facility will consist of 129,000 square feet shell, with 30,000 square feet of raised floor and 6 megawatts of power capacity coming online day 1. In addition to the new facility builds, we are adding 21,000 square feet of office space at our Carrollton facility, including the 12,000 square foot custom-build for the 911 dispatch center that we talked about on last quarter's call. You may have noticed, in our underdevelopment table, that there is a slight tick up in the total forecasted development cost for these projects. There are several different factors contributing to this. However, the primary driver is that we have finalized construction plans for these projects. We have increased the scope of work for the first phases of these projects to reduce the cost of future phases. It is more efficient to do some of this prep work currently, as opposed to a later date. None of these changes impact our targeted cost to deliver a megawatt of power, which is around $7 million. We are still very comfortable with these projects, that these projects deliver the same returns as our broader portfolio. With the projects currently underway, we expect to have approximately 1.3 million square feet of raised floor and 1 million square feet of additional power shell available for future development by early 2015. The investments we have made this year to increase the amount of shell we have available for future development position us well for 2015 and beyond. As we have mentioned in the past, having the shell available allows us to accommodate future demand on a just-in-time basis, as we can bring incremental data halls online in approximately 14 weeks. As Gary discussed, these projects also have the highest incremental returns on invested capital. We view it is our responsibility to be efficient stewards of capital, and we'll continue to prioritize investment in markets and assets, which we believe we can achieve the highest return. Slide 20 shows our net debt and market capitalization as of September 30. Our net debt of $538.8 million increased by $48 million over the prior quarter, driven by investments of capital in the expanding facilities. Our net leverage, as of the end of the quarter, remained relatively low at 3.2x annualized third quarter 2014 adjusted EBITDA. As of the end of the third quarter, we have $225.4 million of available liquidity. As we announced last month, subsequent to the end of the quarter, we closed a new $450 million unsecured revolving credit facility and $150 million unsecured term loan. The facilities mature in October 2018 and October 2019, with the revolver including a 1-year extension option. The revolver replaces the $225 million secured credit facility and initially bears at an -- bears interest at a rate of LIBOR, plus 170 basis points. The term loan includes a 6-month delay draw future and at closing, we drew $75 million. It bears interest at a rate of LIBOR, plus 175 basis points. This facility contains an accordion feature that allows us to increase the aggregate commitment up to $300 million. We were pleased with the outcome of the transaction, as moving to an unsecured structure gives us additional financing flexibility and the size of the commitment allows us to fund our capital requirements for the next 24 to 30 months. Additionally, the recent financing helped serve as a catalyst for ratings upgrades. S&P announced a 1 notch upgrade to our corporate credit rating and Moody's announced a 1 notch upgrade to the rating of our unsecured notes, as well as an upgrade to positive outlook on our corporate credit rating. In summary, we believe that our relatively low leverage, significant liquidity, no near-term maturities and overall capital structure provides us ample flexibility to support our future growth. Moving to Slide 21. We are reaffirming the prior 2014 guidance for revenue, adjusted EBITDA and capital expenditures, while moving the range of normalized -- for normalized FFO per share. We are increasing the range for normalized FFO per diluted share and share equivalent to between $1.64 and $1.68. The increase in the normalized FFO range is primarily driven by lower interest expense as a result of the recent bank financing, as well as the impact of higher capitalized interest in the third quarter. As I mentioned on last quarter's call, we had originally conservatively assumed a $200 million to [ph] $250 million high-yield issuance at the then current rates in the fourth quarter. So we will benefit from both the lower rate and lower outstanding debt due to the delay draw future on the new financing for the quarter, compared to our prior forecast. Also, as noted earlier, we have higher capitalized interest in the third quarter, driven by an increase in construction in progress and the related cash outflows. We anticipate that in the fourth quarter, capitalized interest will be approximately half of what it was in the third quarter as large projects, notably in Northern Virginia in Phoenix, come online early in the fourth quarter. In closing, we have been able to sustain the momentum we had coming into the year and continue to deliver strong financial results. Since the beginning of the year, we have increased our revenue, adjusted EBITDA and most recently, our normalized FFO guidance. As we head into 2015, we believe that we are well positioned to capitalize on the opportunities in front of us. Thank you for your time today. This concludes our prepared remarks. Operator, please open the line to questions.

[Operator:]

[Operator Instructions] The first question comes from Jordan Sadler with KeyBanc Capital Markets.

[Jordan Sadler:]

So my question pertains to some of the commentary and some of the new disclosure regarding sort of internal customer growth. I appreciate kind of you parsing it out for us. Can you speak to the pricing experience with these customers? With 59% of leasing coming from existing customers over the last 7 quarters, there was some commentary around how aggressive you need to be on pricing, how it seems to be little bit more important to get the customer in the door. I guess, what happens, from a pricing perspective, once they do get into the door? Is it -- well, how does that sort of play out in your experience?

[Gary J. Wojtaszek:]

Yes. I think -- thanks, Jordan. I think that phenomenon, that you're referring to there, has always been the case, right? And if you look over the last several quarters, what you see is that our business -- as our business has expanded and the increase in the number of customers that are going towards meter powered, which are basically coming in at a lower price relatively speaking than some of the smaller customers that are on a colocation side. You see that trend has been firmly in place for the last 2 years. Over the course of that trend now, we managed to continue the same yields that we have in our assets that we're deploying, near roughly at that 17% rate. So while some of those prices are coming down, others are going up, and we're adding in other types of services and things that are offsetting any of the price declines. Generally, and this is one of the key things we're trying to get across in some of my talking points is that, what we've always historically have shied away from is putting in the 2% to 3% pricing escalators and trying to increase price on a customer, upon renewal. Because ultimately, what we're playing for us is the 90% of the business that we currently don't have with the customer. So we don't want to jeopardize the relationship that we have with the customer by trying to increase price, if it means that it's going to jeopardize our ability to get more business. And so in certain situations, we'll give a pricing reduction to the customer in exchange for a higher amount of business from them because, all in, yields that we're getting on the assets that we're deploying are really attractive to us.

[Jordan Sadler:]

So in general, you would say that pricing tends to go down a little bit from the initial lease over the course of the life of the...

[Gary J. Wojtaszek:]

It varies. I mean, if you look at the stat we just had given out there, like 94% of the customers this quarter that renew were at the same or up. 6% of those customers were down, so it depends. The other thing to factor in as well is, as customers' density increases, right, the relative amount of capital that you're deploying as a function of that price goes down. And so to the extent that your pricing comes down, you can actually make a higher return on the assets that you're deploying as they dense up. And we've been seeing increase in the customer densities continually, I mean, since inception of the business. And I think that's one of the other broader trends that you see behind the scenes in terms of what's going on with the steady yields that we've been able to deliver.

[Jordan Sadler:]

Okay. And then just as a follow-up on the sales front. Obviously, big indirect channel leasing quarter, with 77% of sales coming from that source. Anything in particular going on? Or is this just a culmination of the deepening of the relationship over the last couple of years?

[Gary J. Wojtaszek:]

Yes. I mean, it's -- that channel, right, is something that we started just a little over 2 years ago, that indirect channel. Fred has done a phenomenal job of building it out. We have over 120 partners now in there. And the rate at which those customers bring deals to us is varied, right? I mean, what you see in some of the numbers this quarter, it was almost 80%. The last 2 quarters, it was nothing. So it varies. But what we're expecting that over time, which is the reason why we started developing this channel, is that it should create a bigger proportion of our sales go forward because those companies are able to touch more customers than all the people in our sales organization possibly can.

[Jordan Sadler:]

Okay. Last one was just, I guess, on the build-out costs of sort of incremental building, I know there were sort of 2 different comments. Kim, you still talked about the $7 million per meg, and Gary, you talked about sort of incremental building -- build-out cost of $5 million. Now I guess, as you think about pricing to new and/or existing customers in those yields, what are you using as the benchmark, when you're trying to attain your yields? Are you using the $7 million or the $5 million?

[Gary J. Wojtaszek:]

Yes. We're underwriting our deals on a $7 million all-in number. The $5 million though -- and this is the way we've thought about the business over the years, is that you basically need to have massive scale in order to get great leverage on your operating expense side and also some capital efficiencies in there. And what we've done this last year, as we've built out a tremendous amount of shell capacity, and we can power that up, bringing on 100 megs of additional power at roughly that $5 million mark. So the incremental dollar flow-through for all of the shell capacity that we've built out is going to come out -- kind of drag along a really high return relative to the investments that we've made, but everything is underwritten according to a $7 million build cost. So as we sit now heading into next year, we're not going to be building nearly as much as we had this year. And that was a function of we've been selling out a lot of capacity this year, and we tried to get out ahead of customer demand. And the way that, as you know, kind of building out the shell capacity, you want to build as much as you possibly think you can use over a short amount of time because it's very efficient. And I think coming out of this year, we're going to be sitting on ample inventory that we feel comfortable. We're not going to be missing any opportunities with deals for any particular location. The only location where we're a little tight in inventory, right now, is a little bit in Austin. We've got a couple of thousand square feet there. And Phoenix, where the new facility we just brought online, we basically sold that out. So those are the 2 locations where we still need a little more shell capacity. They're actually more data center capacity. But everything else, we've got adequate inventory.

[Operator:]

The next question comes from Jonathan Schildkraut with Evercore.

[Jonathan A. Schildkraut:]

Just 1 sort of housekeeping question and then 1 a little bit more strategic. It was interesting to take a look at the backlog this quarter, Kim. And I was comparing the deck to last quarter's deck, and you had a very similar slide, where you showed $4.6 million. I'm not sure if this is sort of an apples-to-apples comparison or if that $4.6 million represented something different. So I just wanted to get a little bit more color on that.

[Kimberly H. Sheehy:]

Thanks, Jonathan. This quarter, what we're showing you in that second -- I think you're talking about the second -- the bottom part of the slide. That is the actual backlog from an annual revenue number. That last quarter, I believe, we were showing the rollout of the leases in the quarter or something slightly different. I don't have last year in front of me, but -- or last quarter in front of me, but that -- if you still have questions, we can talk about that offline. But the -- what we tried to show on that slide, the top part, is what was signed, the leases signed during the quarter, how we expect those to start rolling, being commencing and rolling in to revenue. And then on the bottom, a picture of the total backlog, which would be more than just what we signed during this quarter.

[Jonathan A. Schildkraut:]

Great. No, this is actually very helpful. Okay, so I guess my other question has to do with sort of the evolution of the customer. Gary, you made a big point, during your prepared remarks, to talk about the growth opportunity from the existing base and sort of layering that in with some of the commentary about some of the third-party channels. So I was wondering if there had been sort of any change in either process or initial deployments from the customers. So as you get a higher percent of -- in lease in this quarter of your leads through some of the indirect channels, is this mostly sort of RFP responsiveness? Or is it something different? And then as those customers come in, because we've seen a real uptick in sort the multisite location, is there any difference sort of in terms of that initial footprint versus what you were seeing historically? Are people coming in, taking a smaller footprint in across more facilities versus a more concentrated footprint historically? I'm just trying to understand how the customer is evolving relative to that high number of multisite deployment.

[Gary J. Wojtaszek:]

No. Thanks, Mr. Schildkraut. So we've seen a couple of different things with customers. One is just our name recognition has increased dramatically and as a result of that or maybe just different people's experience working with us, that the average size of deployments now are increasing. Customers are coming to us with a bigger request than, historically, they have. And as part of that, it's also in multiple sites, which we hadn't seen historically before. Just this last quarter, I mean, we just talked about this lease in Northern Virginia. That's a customer that's in a couple of other locations with us. Kim talked about one of the customers that had churned out this quarter was someone that left one of the Cincinnati locations, but expanded in 2 other locations across the portfolio. So we're seeing much more acceptance from customers and expansion into different sites, and we expect that, that's going to continue. I mean, we're talking with some customers that are looking at buying from us in terms of just like a capacity, where they're not quite sure where they're going to basically need to do deployments. So they like to negotiate, kind of like a megawatt of capacity that they could take anywhere in the portfolio. And that's something that we would love to do. I mean, it's -- economically, it's the same. Our build costs are really tight around the country. And we think that, that type of deployment is going to occur more and more. I think that the backdrop behind all of this is a couple of things. One is more customers are putting more of the applications to the edges of the network. So they're going to need to do smaller deployments in multiple sites in order to manage their IT stack, and that's even further exacerbated by the fact that these companies are doing cloud deployments. That's forcing more of them to do distributed IT across their networks. The corollary with that or parallel with that is the fact that our IX business, that product line is basically put in place to capture that future growth. What we're hearing for customers now are customers that have only had like 1 or 2 primary data centers where they've done -- they've gone down to the path of doing a distributed data center, where they may be have 7 or 8 clouds [ph] around the country. They're recognizing that the increase in connectivity costs have gone up dramatically. And so one of the things that they didn't really anticipate, going into that, was the increase in connectivity cost. They all thought they were going to get all the benefits associated with the cloud and distributor platform. But the thing that is kind of sneaking up on them is the cost for the telecom. So we think that's just going to play really well to what we're doing on the IX side.

[Jonathan A. Schildkraut:]

All right. Great. If I could sneak one more question in here. Just in terms of the shell capacity that you're building out. So the investments that you've made to support sort of that $5 million per megawatt build in the future, are you -- is that sitting sort of in your PP&E? Or is that in your construction in process -- or progress, rather? So are you dividing sort of -- we're putting x amount of money into the ground and then sort of taking the stuff that's relative to the future phase developments and putting that in construction in progress? Or are you sort of counting your returns against all of that initial investment?

[Kimberly H. Sheehy:]

Jon, it's kind of both. Because what we do is if the shell has a data hall that's constructed and is being leased, the entire shell goes into PP&E. So the only time it sits in CIP is until that first data hall is commissioned.

[Operator:]

The next question comes from Simon Flannery with Morgan Stanley.

[Simon Flannery:]

Gary, I think you just touched on interconnect there a second ago. I wonder if you could just expand a little bit more on how that business is going, Open-IX and so forth. And Kim, thanks for the color on the churn. Is it reasonable to expect we get back to that sort of low to mid ones on an ongoing basis? Or do you think we might see a couple of more lumpy things over the next couple of quarters?

[Kimberly H. Sheehy:]

On the churn, Simon, we would expect it to come back down to our normal rates. I don't have any specific transactions that I expect to see.

[Gary J. Wojtaszek:]

Yes. With regard to the IX, Simon, that's been going really, really well. The rate of growth there has been at the same level of -- as our data center business has. So we would expect that, over time though, that the rate of that product line should grow faster. I mean, it's just been challenging that we've been growing our top line so quickly that it doesn't feel as robust as we would have expected relative to the other product lines. But at 26% year-over-year growth, that's really good. Actually, last quarter, it actually had grown faster than the rate of growth in our top line for the last quarter. So we would expect percentage-wise that, that is going to increase as customers take more of those products. And also, as we penetrate more into the cloud verticals, which we've done a nice job on over the last 15 months or so penetrating, we expect that they are going to be drawing more customers into our facilities that are going to require a higher density of interconnection.

[Simon Flannery:]

And anything on Open-IX?

[Gary J. Wojtaszek:]

Yes. I mean, the weight is on Open-IX. I mean, Josh Snowhorn, the guy that runs that group in our company, he was just appointed to their board. We've been involved since inception of that company. We're pretty excited to see Josh get on the board. With regard to what they're doing, I mean, there's nothing changed in terms of what they've been -- what they set out to do over 1 year or so ago. They just continue to execute according to their plan, which is basically trying to create an alternative nexus for highly interconnected facilities.

[Operator:]

The next question comes from Barry McCarver with Stephens, Inc.

[Barry McCarver:]

So I guess, first question is directed toward sales productivity. If you look at the leases signed during the quarter of 33,000, that feels like it's kind of back to normal after 3 or 4 really strong quarters. Can you just comment on your thoughts about that level going forward and what you see -- expect to see from sales productivity?

[Gary J. Wojtaszek:]

Well, I expected the tests to do a lot more than that, Barry. No. Just joking. We feel really good. We've done -- we sold more in the first 3 quarters of this year than we did all of last year. So we feel really good about where we sit, relatively speaking. I think the momentum that we have coming into the year has been good. I talked about the marketing efforts that we have. I mean, our funnel is just a strong as it was last quarter. I mean, it hasn't really changed much from a funnel coverage perspective, but it's up 50% from where we were 2 years ago. So it's up dramatically. We are expecting that we're going to continue to do the same level of sales next year as we did this year. And that's what we're kind of planning for in terms of what we're going to be able to knock down in '15.

[Barry McCarver:]

That's great. And for the record, that question wasn't directed towards Tesh's ability. I know he's awesome.

[Gary J. Wojtaszek:]

We love to push him.

[Barry McCarver:]

So you commented in your opening remarks and it was in the press release as well about getting that data center from dirt to building in 107 days. Can you point to maybe 2 or 3 factors that allowed CyrusOne to build that so quickly? Is there an advantage there? And then just, I guess, secondly, to that question, can you discuss the advantages of being able to put up space so quickly?

[Gary J. Wojtaszek:]

Yes. It's just a function of doing reps, right? I mean, if you're running the same place over and over again, you just get more efficient at hitting the hole, making sure everyone hits their blocks and doing everything like we normally do, right? We build so many different facilities up over the last 2 years. Actually, one of our vendors, Mitsubishi, gave us their Favorite Supplier or Favorite Customer of the Year award that we bought more UPSs than anyone last year. And I think that's just the function of the growth that we've been on. So we've been doing these things repetitively and that helps improve your speed. Also, the design has really kind of coalesced around a very standardized build. We know exactly what we're doing. We've got a lot of the same teams that are doing this repeatedly. So you've got a good teamwork in place, with all the different trades that are on the job and there's just a lot of strong cohesiveness. Aside from that, I mean, the other thing that we did benefit from was we actually had some material on hand that we diverted from one of our other facilities. So that gave us a little bit of an edge, that we just pushed some of the equipment to Phoenix. But we feel really good about what we were able to do there. With regard to what does that mean? It's a lot, right? We're getting a lot of marketing press out of it. Our customers are really excited because in this particular customer's case, they didn't think that we'd be able to do with this quickly. And we actually delivered the facility in a faster amount of time than they were able to order all the gear that is actually going into the facility. So to the extent that we can bring other customers through there, that derisks their concern about our ability to deliver a product to them, if they've got some really tight time frame. So 2 years ago, I talked about when we were initially launching Phoenix, we had a really large customer there that was very interested in taking down just about half of the space. We lost that deal, because that customer didn't believe that we're going to be able to meet the time frames for construction. We ultimately did, and they are really surprised about that. And this one is really just going to further highlight to them just how well we've improved that process from 2 years ago, that we got it down to 3 months or so. So we're expecting we're going to get a more play out of it. It's going tie up in or play out really well in our custom solutions group, where people look to what we've done historically and they feel much more confident knowing that they can trust us to deliver on time for them.

[Barry McCarver:]

That's great. It's helpful. And then just lastly, usually every quarter, you discussed thoughts on new markets. I know nothing planned for this year, but your thoughts on entering a new market in the next year or 2. Any revision there?

[Gary J. Wojtaszek:]

No. I think the only thing is if we continue to see a strong demand from customers in our existing markets, it'll be like this year, where we will reallocate the capital that we were originally targeting to other markets and put it in into our existing markets. As I was mentioning to one of the other callers, I mean, we have a significant amount of capacity available to -- within our existing facilities today to generate a really high return. So I would think, on average, we're going to be spending less capital in '15 than we did in '14 and the relative return we'll get is probably going to be higher since a lot of this is sunk cost already.

[Operator:]

The next question comes from Colby Synesael with Cowen.

[Colby Synesael:]

Two questions, related to one another. So first off, if I look at your CSF that you built out this year, it's about 208,000 square feet, if we include the extra 60,000 coming online in the fourth quarter from Phoenix. And if I look at what you're already expecting for 2015, is to get another 60,000 between San Antonio and Northern Virginia, although obviously, you're building out the shell in Houston. Is the 208,000 that we're seeing in 2014 a good proxy for what, ultimately, you think could be or will be built out, as it relates to CSF in 2015? And then in terms of timing around that, I think you guys had mentioned it takes about 14 weeks to build that out. So that mean that we, at least on the outside looking in, should expect a fairly limited heads up, if you will, between when you actually tell us you're going to do it and when it actually comes online? And then my second question just has to do with revenue growth. I mean, revenue growth is obviously been very strong, but it has been decelerating the last few quarters. And when I look at the number, the level of space that you're accepting, or we think where you'll bring be on the line in 2015, it does seem like that deceleration in growth is going to continue. Do you think that you're going to be bringing off -- on enough space in 2015 that we could at least get with growth rate to stabilize roughly around where it is, does not actually accelerate?

[Gary J. Wojtaszek:]

Sure. Sort of bunch of different questions in there. So regarding the space, yes. So yes, yes, no, okay. Next question, no. But -- so yes, the 208,000 is a good estimate for next year. We're going to roughly sell about the same. So you should expect that will bring -- will be bringing that online. Also, yes, we -- you should not expect any big surprises on this. So I mean, since we have a lot of shell capacity already build out, there -- everything's going to be kind of tempered and just in line with existing demand. So it's basically all success base. The only caveat to that, as I mentioned, is we're kind of dependent on how well Phoenix goes, right? I mean, we only have about another 30,000 square feet of CSF there. So that could be the next shell that we would build. But in general, they should all be very measured, tempered developments. So with regard to top-line performance, it has notched down, still relatively strong. I think if you assume high-teen percentage year-over-year growth, you're going to be in the ballpark. I think what you're also going to see this year is that our FFO growth should come in faster than revenue growth, as we really start benefiting from all the investments that we've been making over the last 1.5 years. The AFFO growth there is going to perform very nicely, and that's all because of the gearing that we're going to get in the facility.

[Operator:]

The next question comes from Frank Louthan with Raymond James.

[Frank G. Louthan:]

Gary, earlier in the call, you ran through a list of various factors that really impact the pricing and so forth. Could you kind of run through that list again? It's kind of interesting. And then looking at this, your adjusted price per kilowatt, can you give us -- what sort of your expectation of how that's going to trend over the next 12 months? And what are some of the biggest factors that might impact that rate, up or down?

[Gary J. Wojtaszek:]

Yes. Yes, so there's a bunch of different things that go into the price, right? So there is power density is a huge one. There is resiliency, right? So whether we're going to sell our product that has 5, 6, 9 of uptime versus 1 that has 3, 2 or less, right? So those 2 are really big drivers on the capital requirements associated on a per kW basis. Outside of that, you got factors associated with, are they taking other services along with this? Or what's the length of the contract? Are there escalators in there? What are some of the termination rights, if any, in there? I mean, there's a bunch of different things that you think through when you're engaging with that customer. And also, I mean, you can't go without thinking about what the opportunity set for future growth of that particular customer and their ability to attract. It'd be kind of a honeypot to attract other types of customers into those facilities as well. So those are all the things that we think about, but the predominant difference, in terms of the capital, is associated with power density and resiliency.

[Frank G. Louthan:]

Okay, great. And looking out on adjusted price per kW, some of the -- what you're sort of forecast there and factors that may affect that one way or the other?

[Gary J. Wojtaszek:]

Yes. I mean, it's all over. I mean, this was always like historically you know why I never want to share the numbers. Because they vary around a lot. And depending on the mix of deals that you did in that quarter, they can really move dramatically. If you looked at the prices within each of the product sets within there, they're relatively stable. And so I would expect that the future's going to be pretty similar to what the last couple of quarters were.

[Frank G. Louthan:]

Okay. So nothing showing a steady downward or upward trend? Just kind of more of ebb and flow?

[Gary J. Wojtaszek:]

Yes, kind of ebb and flow. I mean, that's like -- and so the reason why we've always been putting out that development yield data was just as a way to kind of level set everyone, in terms of "Hey, this all the capital that we're deploying in the business, and this is the return that we're able to get." So we were trying to give people less focused on price and more focused on the yield that you're able to get from the assets you're deploying, because we think that's the better measure and that's actually the way we think about how we underwrite all the deals for the company.

[Operator:]

The next question comes from Amir Rozwadowski with Barclays.

[Amir Rozwadowski:]

Just wanted to ask 1 question around sort of the trajectory of how we should think about EBITDA here. I mean, clearly, we're looking at your quarterly results, a very strong pickup on an absolute dollar basis from a year ago period. Also, you've mentioned that there is some increased advertising activities and it does seem that those activities are you're able to harvest some of those activities with the improved brand that you're seeing, particularly in some of your new markets. I just wanted a sense, is the sort of the level of spending that we should expect around advertising going forward? Any color you can provide of that perspective would be helpful.

[Kimberly H. Sheehy:]

Yes. I think on the sales and marketing side, what you see in the run rate we've had this year would be what we would expect to see. I mean, it is kind of lumpy a bit, some quarters, based on certain events. But generally, for the year, we think that's the right level.

[Amir Rozwadowski:]

Great, that's helpful. And then if we're thinking about some of the newer properties, clearly, it seems as though you're gaining traction sort of here on the East Coast in terms of brand awareness and being able to book additional customers to fill out some those facilities. Could you talk about sort of what's been sort of the differentiation in terms of being able to draw in additional customers? Is it the expanded footprint? Or anything along those lines would be helpful.

[Gary J. Wojtaszek:]

Yes. I think, historically, what all customers have liked about us is our flexibility, right? We will serve them up exactly what they need and that is whether it's a -- their power densities, whether its resiliency, whether the square footage that they need, and so it's flexibility. And then I think once they're here, what they really recognize and this kind of like what keeps them wanting to do more business with us, is that the customer service we provide, is something that we take a lot of pride in and I think it comes down and I think the customers really like services that we give them. And I think that's resonated very well with them, and it's just more on name recognition has enabled us to expand in these markets. And I would expect that the success that you've seen in the first sale that we had in Northern Virginia is going to repeat. The company has, I mean, just for those who are new to the store, you're right. I mean, the company was founded in 1 location in Houston and has expanded organically over the last decade. So we've been doing this for a number of years and growing the same way, and we expect that this will continue go forward.

[Operator:]

The next question comes from Emmanuel Korchman with Citigroup.

[Archena Alagappan:]

So this is Archena for Manny. Just a quick question here. Looking at the expiry schedule, we can see that lease expirations for the remainder of '14 and 2015 are rather high, with 13% coming due this year and then an additional 18% for the next. So I was wondering if you could give us some commentary or color about like releasing timing, any prospects, things in the pipeline or terms?

[Kimberly H. Sheehy:]

Yes, thanks. This is -- the lease schedule, if you look back, has been very consistent. We do have a lot of historical legacy shorter life leases that come up. But if you look at what we've been able to renew, I mean we haven't -- this has not changed over time. So we're comfortable that as these come up, they'll renew, just like they have been for the past several quarters. So I mean, there's nothing really concerning there to us.

[Operator:]

The next question comes from Tayo Okusanya with Jefferies.

[Omotayo T. Okusanya:]

Congrats on a great quarter. A couple of questions from our end. The first one at Phoenix 2. The increase in the powered shell development to 51,000 square feet from 19,000 on the reduction on the other side on the colo space from 60,000 square feet to 30,000. Can you just talk a little bit about that kind of product mix and why that shift occurred?

[Gary J. Wojtaszek:]

Yes. Tayo, thanks for your compliment as well. Yes, I think in general, all the numbers that you'll see, in terms of the capital that we're deploying, we've -- what we've done is we've estimated what the increased capital spend is that we're intending to do for those facilities. But what we've not done is increase the amount of additional space that we're going to be bringing online. So the upcrease -- the increase that you see in the capital deployed there is associated with about 120,000 increase in raised floor capacity that we expect that we're going to be bringing online, associated with that additional capital. So the amount that we're spending on a per megawatt basis is right in line with what we've estimated to spend historically, which is about the $7 million a meg.

[Omotayo T. Okusanya:]

Okay, that definitely is helpful. And then the other question we had was around Virginia and the pre, I mean, just trying to understand. Well, I get that, you expected yields on a longer-term basis when that products have stabilized, are still kind of in line with your target. Just trying to understand, again, what is that kind of pricing does this customer kind of get initially, before you ultimately ramp up to the higher yield for the incremental space you would be leasing in that space?

[Gary J. Wojtaszek:]

Yes. I mean, this customer is probably getting a pricing that's about 10% less than what we would normally do, but it's not a drastic difference from what we normally do. I mean, what you generally get in these facilities is your -- as you start ramping up and they become stabilized, you're generating much nicer yields. As we were talking about, the $7 million a meg that we're going to deliver that facility for is right in line with what we've done historically. The type of customers that were going to be putting in there are going to be very consistent with the same types of customers that we put across the entire portfolio.

[Operator:]

This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Gary Wojtaszek for any closing remarks. Please go ahead.

[Gary J. Wojtaszek:]

Great. Well, thank you, everyone. It was great talking to you today. Hopefully, we'll see a lot of you at the -- at Nari [ph]. Kim and I are looking forward to visiting there and will be there later this evening and hopefully, we'll meet a lot of you tomorrow and Thursday. Take care.

[Operator:]

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