CyrusOne Inc.
Q4 2015 Earnings Call Transcript

Published: 25 Feb 2016

[Operator:]

Good day, ladies and gentlemen. Thank you for standing by and welcome to the CyrusOne fourth quarter 2015 results conference call. My name is Jamie, and I will be your conference operator today. At this time, all participants are in a listen-only mode. After the prepared remarks, management from CyrusOne will conduct a question-and-answer, and conference participants will be given instructions at that time. As a reminder, today's conference call is being recorded. I would now like to turn the conference call over to Mr. Michael Schafer, Senior Director of Investor Relations. Sir, please go ahead.

[Michael Schafer:]

Thank you, Jamie. Good morning, everyone, and welcome to CyrusOne's fourth quarter 2015 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 fourth quarter earnings release along with the fourth quarter financial tables are available on the Investor Relations section of our website at cyrusone.com. I would also like to remind you that comments made on today's call and some of the responses to your questions deal with forward-looking statements related to CyrusOne, and are subject to risks and uncertainties. Factors that may cause our actual results to differ from expectations are detailed in the company's filings with the SEC, which you may access on the SEC's website or on cyrusone.com. We undertake no obligation to revise these statements following the date of this conference call, except as required by law. In addition, some of the company's remarks this morning contain non-GAAP financial measures. You can find reconciliations of those measures to the most comparable GAAP measures in the earnings release, which is posted on the Investors section of the company's website. I would now like to turn the call over to our President and CEO, Gary Wojtaszek.

[Gary J. Wojtaszek:]

Thanks, Schafer. Good morning, everyone, and welcome to CyrusOne's fourth quarter 2015 earnings call. 2015 was a record year for CyrusOne by just about any measure. We leased a record 342,000 square feet and 49 megawatts and signed more than 1,400 leases. Taking into account the lease term, the deals we signed in 2015 represent nearly $600 million in total contract value, and our backlog stood at $42 million in annualized revenue as of the end of the year. This demonstrates that we have a very broad product offering, and the sales and operational capabilities to deliver single-rack highly connected solutions up to 10-megawatt wholesale solutions is very compelling to customers. I believe we are well positioned to have another great year. As shown on slide four, normalized FFO per share of $0.61 was up 27% over the fourth quarter of 2014. Adjusted EBITDA was up 36% for the quarter compared to the same period last year, and revenue was up 30%. We leased a record 205,000 colocation square feet and 30 megawatts in the quarter, with signings of 326 new leases, generating $44 million in annualized new revenue. Based on the anticipated phasing for leases signed in the quarter, we estimate approximately half of this revenue will be recognized in 2016 with the full $44 million recognized in 2017, which will position us really well for continued growth into 2017. We are also pleased to announce a 21% increase in the quarterly dividend to $0.38 a share beginning in the first quarter of 2016, up from $0.315 in 2015. Our quarterly dividend is nearly 140% higher compared to 2013, which highlights the underlying growth of our business and our focus on driving returns for our shareholders. We are continuing to add multiple new Fortune 1000 logos each quarter, and are now at 173. Lastly, subsequent to the end of the quarter, we pre-leased the next two phases, or 9 megawatts, at our new San Antonio facility. The next few slides highlight the success we have had in growing and diversifying the business since going public. As shown on slide five, we now have more than 940 customers, nearly doubling the size of the customer base since the end of 2012. The growth in customer base has significantly reduced our top 10 in concentration, and our top 10 largest customers represent less than 30% of our revenue. This is down from approximately one-third from the end of 2012, when the top 10 customers accounted for 45% of our revenue. Also, as I said before, new logo acquisition is the most important leading indicator for the business, given the future contribution to growth from customers after the initial signing. In that regard, what I would point out is that, in addition to this quarter being our largest bookings quarter ever, this quarter was also the largest bookings quarter from new customers in almost two years. We closed approximately $8 million of annual revenue with all new customers we added this quarter, including four Fortune 1000 companies. Moving to slide six, we have significantly grown and diversified our data center footprint since the end of 2012. At the time of our IPO, we had data centers in Texas and the Midwest. Since then, we've expanded both West and East with very good results. 2013, we established the Western region presence with the addition of the Phoenix market and it has been one of our strongest markets with over 150,000 square feet of raised floor leased. And then a little over a year ago, we stood up our first data center in Northern Virginia, establishing a presence on the East Coast. We already leased 215,000 colocation square feet, including the pre-leasing of nearly 160,000 square feet of raised floor at a second Northern Virginia facility that is currently under development. With every expansion we have announced, investors have expressed concerns about our ability to be successful in a new market. Northern Virginia was no exception but, as we've consistently shown, we can successfully expand into new markets even when there are many incumbent competitors. Our Northern Virginia launch has been our most successful ever and it highlights the importance of having a very well diversified product offering, so that you can sell a mix of retail, wholesale and interconnection products. As a result of these new market expansions, we have significantly enhanced the geographical diversity of the portfolio with no single market representing more than 22% of our revenue. We have nearly doubled the raised floor to approximately 1.6 million square feet as of the end of 2015. Slide seven shows the changes in the composition of industry verticals in our portfolio over the last three years. At the time of the IPO, the Energy vertical represented 37% of revenue with Cloud and IT at 17%, and Financial Services at 9%. Since we began targeting cloud companies two years ago, we have seen very strong demand from them for our flexible product offering. Taking into account the impact of our year-end backlog, that vertical now represents 33% of our revenue. While we don't talk about specific customers, what I can say is that the decision we made 24 months ago to focus on selling to large cloud companies has been very successful. These companies have recognized that CyrusOne's model of being been able to deliver customized solutions at the fastest times to market is extremely valuable to them. Our enablement platform for the cloud, which we refer to as The Sky for the Cloud, provides a home for the cloud in our facilities. As a reminder, it's designed to optimize power usage effectiveness and enable fast interconnection to business partners, content providers, networks, Internet service providers as well as a marketplace of buyers and sellers. We have added more than 30 cloud customers in the last two years and we now account eight of the largest cloud companies in the world as our customers. We are also in discussions with several other large cloud providers as well. As we continue to add cloud vendors along with network and content providers in our core base of Fortune 1000 enterprises, we can create an ecosystem in which everyone is working together in mutually beneficial relationships. Each new cloud vendor enhances the value of our product offering as we are now able to offer more choices for our enterprise customers in selecting a cloud provider. The Financial Services vertical has more than doubled in size. And as a result of our expansion into new markets as well as strong demand across other verticals, Energy customers now only account for approximately 18% of revenue, down from 37% at the time of the IPO. While I understand there has been concern about the impact of the decline in oil prices, bookings in the Energy vertical have been relatively stable for us, with approximately $500,000 in new MRR signed in 2015, which is in line with the $500,000 in new MRR signed in 2014. Additionally, I'd point out that the overall quality of customers in the portfolio is very good, with over 85% of our revenue in the vertical generated by customers with more than $5 billion in annual revenue. Slide eight shows some of our key leasing metrics over the last three years. We have seen very strong trends in leasing velocity with CSF and megawatts signed growing at compound annual rates of 39% and 35%, respectively. The number of leases signed has grown at a compound annual rate of 24% and averaged more than 350 per quarter in 2015, with the high leasing volume reflecting the diversity of our retail, wholesale and customized product offerings and the benefit of having a best-in-class sales force. As I mentioned on last quarter's call, we have implemented a 7% power administration fee on metered power leases as a way to recoup some of the costs associated with providing this service. These leases are more administratively burdensome than our traditional retail full-service product that has a fixed price per month, and we expect over time that this will help protect profitability, especially as usage increases. I am pleased with the success we have had so far with implementation, with 70% of new metered power leases signed in the fourth quarter, including the fee, which is being rolled out in a very similar way when we began rolling out our annual 3% lease escalators, which are now included nearly 40% of our portfolio. And lastly, as I mentioned earlier, we had a record year of leasing. We signed deals representing nearly $600 million of total contract value, with an average term of approximately seven years. This is a significant amount of business to book in one year and is a validation that our platform has broad appeal. Moving to slide nine, the trends remain strong in our interconnection business. As we have said in the past, our National IX platform enables Fortune 1000 enterprises to easily replicate the multi-node data center architecture they require at a fraction of the cost. Connectivity is becoming an increasingly important product offering, as enterprises continue to shift to more distributed architecture that demands robust connectivity solutions such as the National IX. Our IX product was designed to be complementary to our data center offering. But most importantly, we wanted it to be standardized and replicable so that it can scale with our growth without adding new head count. Interconnection revenue was up 68% in the fourth quarter compared to the fourth quarter of 2014. Interconnection revenue now represents 6% of the total revenue, up from 4% two years ago. And the attachment rate is high, with 82% of leases signed in 2015 including an interconnection product. We expect that interconnection will continue to grow at a faster rate than our base business, as this is an area that is relatively immature and underpenetrated in our customer base. We also recently announced an alliance agreement with Megaport to deliver elastic cloud interconnection services in CyrusOne data centers. Customers can access multiple cloud providers over the Megaport fabric and scale bandwidth up or down with flexible terms. The ability to leverage our National IX as an enabler and on-ramp to Megaport's cloud products enhances the overall connectivity solution that we can provide to our customers. Lastly, on our interconnection product line, I wanted to point out that we now have more than 11,000 cross-connects installed in our data centers, highlighting the success that we have had in growing this part of our business. In closing, 2015 was a tremendous year for CyrusOne, with continued strong financial performance, record leasing, and the successful acquisition of Cervalis. And while 2015 was a great year, we are beginning 2016 in the strongest position that we've ever started any year. This is our biggest revenue backlog ever. Subsequent to the quarter end, we just sold out the next two phases, or 9 megawatts, in our San Antonio facility, and our sales funnel is actually larger now than it was a year ago. Given the strong execution and solid underlying fundamentals, we are well positioned to capitalize on a number of attractive opportunities, and I am looking forward to another great year in 2016, which should carry into 2017. I will now turn the call over to Greg, who will provide more color on our financial performance and speak to our guidance.

[Gregory R. Andrews:]

Thank you, Gary. Good morning, everyone. Because this is my first call, I'd like to take a moment to tell you why I joined CyrusOne. Then I'll cover our results for the quarter, our financial position at year end, and our outlook for 2016. As a longstanding real estate guy, what impressed me the most about CyrusOne before I arrived was the tremendous underlying demand for the company's data center developments. There's nothing like a business with wind at your back; that is, a business that consistently generates mid-teen returns on investment, that is growing at over 20%, and that has a strong balance sheet. That is a recipe for tremendous value creation. Having now been here for four months, what I've come to appreciate that is harder to see from the outside is the incredible talent throughout the CyrusOne organization. Compared to the industry as a whole, I believe this talented team can build faster and at lower cost, lease across a wider array of deployments, configurations, and resiliencies, and operate with the customer at the center of everything we do. The investments made in our organizational infrastructure are paying off with more pre-leasing of developments, longer lease lengths, and more services and interconnections per customer. I am thrilled to join the CyrusOne team at such an exciting time. Now turning to our results for the fourth quarter, beginning with slide 11, revenue, normalized FFO, and AFFO all showed strong growth again this quarter. Churn for the quarter was 0.4%, which is our lowest level since becoming a public company. Per share normalized FFO increased 27% to $0.61 per diluted share. This increase reflects revenue, NOI, and adjusted EBITDA growth all at 30% or higher for the quarter. Moving to slide 12, our revenue growth of $26.4 million or 30% was driven by our midyear acquisition of Cervalis as well as by organic growth from strong leasing across our portfolio and our developments over the last year. Cervalis is on track with our underwritten expectations. We are actively cross-selling our portfolio to Cervalis customers looking for replication or disaster recovery locations away from the New York metro. We're also rolling out select scalable managed services offered by Cervalis to new locations starting later this quarter. Property operating expenses came in better than expectations due to lower power expense and lower property taxes. SG&A expense, excluding severance, management transition, and legal claim costs, increased only 8% compared to Q4 2014, as we realized the benefits of scale and the payoff of investments in organizational efficiency. As a result, adjusted EBITDA for the quarter was $60.5 million, or an annualized run rate of $242 million. A number of items also contributed to normalized FFO per share exceeding our prior expectations. These include lower than anticipated interest expense and stock-based compensation, as well as accrual adjustments related to property taxes and income taxes. In aggregate, these add-ins amounted to approximately $0.02 to $0.03 to normalized FFO for the quarter. Turning to the balance sheet on slide 13, we invested approximately $95 million into construction this quarter. Our major projects are all in existing markets where we have strong customer relationships, including Dallas, San Antonio, Houston, Phoenix, and Northern Virginia. We funded our construction with approximately $30 million of cash, $30 million of borrowings under our revolving line of credit, and the remainder with cash flow from operations and working capital. During the quarter we commissioned the first data hall at our Austin 3 facility. We are migrating customers from our leased Austin 1 facility and expect to decommission that property later this year and exit our lease there. The opening of the first data hall at Austin 3, which at year end had approximately 58,000 colocation square feet available, has caused our overall utilization rate to decrease to 86% as of year end. We expect utilization will increase by the end of 2016, as we deliver pre-leased developments and fill available space across our portfolio. One other notable balance sheet item was the year-end conversion by Cincinnati Bell of all of its remaining operating partnership units into shares of common stock. As a result, we now own 100% of our operating partnership, which streamlines our reporting requirements and creates greater clarity for investors. Moving to slide 14, as Gary described in detail, our portfolio is substantially diversified by geography, industry vertical, and customer. Our new leases increasingly have two important characteristics. First, new leases are being signed for longer terms. In fact, the weighted average term of leases signed in the fourth quarter was approximately nine years. And for leases signed in 2015, the average term was seven years. Pro forma for leases signed in the fourth quarter, our remaining average lease term is now 40 months compared to just 28 months at the end of 2012. Second, the overwhelming majority of new leases include rent escalators. As a result of these two features in new leases, our cash flow characteristics are increasingly comparable to other sectors of real estate. We believe that a more secure, predictable, and growing stream of cash flow warrants a higher multiple or lower cap rate, as is typically applied in real estate valuations. Slide 15 shows 2015 development and the current pipeline for 2016. The major construction projects that we have underway have an estimated cost to complete of $180 million to $220 million. The projects are generally focused on markets where we have either substantially pre-leased the capacity we are building, such as Northern Virginia and San Antonio, or where we have evidence of healthy demand fundamentals, such as Dallas and Phoenix. We are continuing to engineer costs out of our design in order to drive our build costs well below $7 million per megawatt. We believe our development projects will achieve development yields in the mid-teens range, in line with our actual historical returns. Moving to slide 16, at year end, our balance sheet remained strong. Net debt to adjusted EBITDA was 4.2 times. Fixed charge coverage was 4.3 times. And we had over $400 million of liquidity available under our line of credit. During the quarter, we met with all three rating agencies to reinforce our commitment to maintaining a strong balance sheet at all times. We also showcased our progress in growing the business, diversifying our revenue and extending our lease life. Subsequent to year end, we launched a new $150 million term loan with our existing bank group. The loan will have a term of 5.5 years and pricing and covenants that are consistent with our existing bank facility. We have already received commitments for the $150 million, subject to customary closing conditions, nearly two weeks ahead of our deadline, opening up the possibility of upsizing this new facility. This additional capital source will ensure ample liquidity even as we deploy more capital in 2016 than we have in each of the last two years. We will report on our progress with this term loan next quarter. Moving to slide 17, as Gary mentioned, we are increasing the dividend for the first quarter of 2016 to $0.38 per share, up 21% from the 2015 quarterly dividend. This represents an annualized yield of 4.0% based on the February 22 closing share price of $37.92. The 2015 AFFO payout ratio was 54%, slightly below the peer group average. Historically, the tax allocation of our dividend payout has been 40% to 100% return of capital, providing a highly attractive after-tax yield for investors. Now, let me turn to our outlook for 2016 and beyond. Turning to slide 18, our backlog at year-end was $42 million. That is more than twice as big as any backlog we have previously had at the end of any quarter. We expect the majority of that revenue to phase in during the second half of the year. This backlog, together with additional pre-leasing that has taken place subsequent to quarter-end, notably the 9 megawatts at San Antonio that Gary referenced, provides unusually good visibility on revenue and income for the year. With the timing of lease commencements weighted towards the latter part of the year, revenue and EBITDA growth will carry over nicely into 2017, again providing far more visibility into the sustainability of growth than is usual. Slide 19 includes our guidance for 2016. Our guidance at the midpoint for revenue, adjusted EBITDA and normalized FFO per share reflect increases of 23%, 24% and 15%, respectively. In providing our guidance, we have taken into account the following considerations

[Operator:]

Our first question today comes from Jonathan Atkin from RBC Capital Markets. Please go ahead with your question.

[Jonathan Atkin:]

Good morning. I was interested in any kind of updates on Cervalis and more detail on how you might extend that managed services or hosting product out of region, and does that require any kind of infrastructure investment. And then on San Antonio, I was curious about kind of just the overall contours around types of customer demands and supply and how that differs from some of the Tier 1 markets, and if there are any other markets beside San Antonio that saw substantial pre-leasing year to date. Thank you.

[Gary J. Wojtaszek:]

Hey, Jonathan, Gary here, hope you're well. On the Cervalis integration, I think what we mentioned on the last quarter's call was that that was going really well. We were effectively done with that in November. Our actual cost synergies were higher than what we were projecting, think we got about a $3 million run rate out of that operation. With regard to the sales, revenue synergies, those are coming along nicely. Some of the bookings that we had this quarter were the result of that. We're seeing a lot of interest, as I mentioned on the last call, with those customers looking at additional workforce recovery locations in some of our other facilities and the sales that we're having there are growing nicely. We just hired a number of additional sales folks for the New York metro area. So we're looking forward to coming out of a party there to really kind of accelerate the revenue growth that we expect that we're going to get out of those facilities. With regard to San Antonio, we think that that is a really nice market. Whether it's Tier 1 or Tier 2 is kind of debatable. All I can say is that we've continued to sell really well in that market across a number of different verticals. San Antonio is actually one of the largest cities in the country and it's also one of the fastest growing cities in the country. So we expect that we're going to be doing a lot more there. We've got capacity on that campus for an additional 250,000 square feet of space, and my sales team is really excited about filling the rest of that up.

[Jonathan Atkin:]

And then any non-San Antonio geographies where you saw substantial pre-leasing that you would want to call out?

[Gary J. Wojtaszek:]

No. I mean, the San Antonio one was unique because we sold a lot of it. I mean we're just in the process of building it out. So that was a really great way to start the quarter.

[Jonathan Atkin:]

And then any kind of update on just legacy Midwest markets and any plans to modify or expand there?

[Gary J. Wojtaszek:]

I think the trends that you've seen over the last several years in the Midwest are going to continue. I mean, we've seen single-digit type growth there and we expect that that's going to continue. Actually our market share in the Midwest is pretty enviable. I wish the rest of our business had that level of market share. We probably have about 90% market share of every large Fortune 1000 company in the locations that we operate in there.

[Jonathan Atkin:]

Thank you.

[Operator:]

Our next question comes from Amir Rozwadowski from Barclays. Please go ahead with your question.

[Amir Rozwadowski:]

Thanks very much. And good morning, folks.

[Gary J. Wojtaszek:]

Hey, Roz.

[Gregory R. Andrews:]

Good morning.

[Amir Rozwadowski:]

I was wondering if we could chat a bit about the churn expectations for next year. It sounds like when we think about the complexity of the business (00

[Gary J. Wojtaszek:]

Look, I think what you saw in our last three quarters is record low churn for us. That was not what we were expecting. We were expecting our churn – and this is what we model long-term is always in that roughly six-ish percentage range of churn. If you look at the two years combined, we're basically going to be at that number, so I don't think it's a change. I mean, I think in general what you see in our forecast for the year is a good dose of conservatism.

[Amir Rozwadowski:]

Okay, that's helpful. And then going back to Cervalis, I know we had talked during the original acquisition there was a potential for a halo effect with respect to getting additional customers signed. Obviously, some of your new business activity has been at pretty high levels. Has that been sort of generated from that halo effect with respect to the acquisition? Any color along those lines will be very helpful.

[Gary J. Wojtaszek:]

Absolutely. I mean to the extent that you just kind of grow your customer base, you just continue to attract additional business from those existing customers. But I think the other important thing to point out this quarter, that was maybe somewhat lost over just given how big a monster booking it was this quarter, was that our new logo acquisitions was actually our highest in almost two years. We had just about $8 million of annualized revenue from new logos that we just added. And what we've said historically is once you get a new customer in the door, what we've seen is that there's a roughly a 21% CAGR growth in their footprint expansion over the next several years after they first come in with you. So that's actually the thing that's probably the most important leading indicator for us.

[Amir Rozwadowski:]

Excellent. Thank you so much for the incremental color.

[Operator:]

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

[Richard Y. Choe:]

Great, thank you. Just to follow up, a lot of your development is in Texas and Northern Virginia. What's giving you the confidence to build out there and can you give us a sense of what verticals are going to be the most – biggest drivers in those markets?

[Gary J. Wojtaszek:]

Anytime that you see us build, our build decisions are basically a derivative of the sales funnel that we're tracking. So we don't really go out and deploy the capital unless there is some good visibility to a customer or customers that we think are going to take it. We have a pretty disciplined sales process. There's a four-stage funnel. And we try to bring on inventory to match the customer demand that we're tracking and try to bring that on on a just-in-time basis so that we're not putting out capital that's not making money for us. I think if you looked at our funnel broadly speaking, it's going to be the same as it was in this last quarter with a vast majority of the deals coming in cloud and IT service companies. That portion of our business has doubled relative to – proportionately from where we were a couple of years ago, and we expect that that's going to accelerate further. It's kind of interesting. It wasn't that long ago where people were so concerned that the cloud was going to basically subsume all of the colocation companies out there. And I think what you saw this quarter was that there were record results from everyone, I mean Tom and Chris and Steve and Chad and myself have all put up good numbers this quarter and I expect that Bill is going to do the same tomorrow. And so I think broadly speaking, what we're seeing is that we're all the beneficiaries of cloud and data growth, and I expect that this is going to continue over the next several years.

[Richard Y. Choe:]

Great. And then with the churn, how much of that churn guidance of the 68% is coming from moving out of the Austin 1 facility?

[Gary J. Wojtaszek:]

Not much. I mean that's actually a very small portion of our business. What we're just assuming is that we're going to get back to more normal levels for us. We had just record low churn numbers for us last year.

[Richard Y. Choe:]

Okay. Great. Thank you.

[Operator:]

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

[Jordan Sadler:]

Thank you, good morning. Just wanted to follow up on the development spend. So obviously you guys had quite a bit of success on the leasing front in the quarter and afterwards. So I'm just trying to gauge how much of the 40% increase in development spend versus 2015 is a function of just building to accommodate the leases you've signed versus incremental speculative build?

[Gary J. Wojtaszek:]

No, it's almost all for that. So if you assume our base run rate, it is what it is, or you add to it the capital required to build out for these things and that's how you get roughly to that number.

[Jordan Sadler:]

Okay, so you said it's all basically spoken for?

[Gary J. Wojtaszek:]

No, no. Jordan. Just to be clear of what I'm saying is that the incremental amount versus what we have spent this year would have been spoken for with regard to these builds. We're still looking at deploying additional capital kind of on a same run-rate basis to meet the demand that we're tracking in our sales funnel currently.

[Jordan Sadler:]

I'm with you. So like the incremental $80 million or so is for the stuff that's spoken for basically?

[Gary J. Wojtaszek:]

No, no, it's higher than that.

[Jordan Sadler:]

Okay. I can follow up on that down the road. So then maybe talk a little bit about the sources and uses. Obviously you mentioned leverage 4.2 times net, but what is the sources-and-uses plan for 2016 and target or expected leverage at year end?

[Gregory R. Andrews:]

Hey, Jordan, it's Greg.

[Jordan Sadler:]

Hey, Greg.

[Gregory R. Andrews:]

One of the reasons we have gone back to the bank market to tie up this term loan is to ensure ample liquidity, knowing that we're spending a little more this year than we did last year. And so the proceeds from that will pay down our line and give us tremendous capacity on assets to fund all of the capital needed this year with cushion at the end of the year. What you probably will see from a debt-to-EBITDA perspective is a little bit of a tick-up in the first couple of quarters just because we're spending the capital before the EBITDA hits. And then in the back half of the year, that will come back down somewhere in the mid-four times range, which is certainly a level which we're comfortable with.

[Jordan Sadler:]

Okay. And then just lastly on the dividend on page 17 or so on the slides, you've got the historical tax allocation and return of capital of 40% to 100%. You mentioned 2015 100%. Can you walk us through the thought process or what the dividend policy is? And I see the increase obviously here with this release, so the growth is great, and I get that the payout relative to AFFO is low, but you guys are obviously a capital consumer. Can you just bridge that for me?

[Gary J. Wojtaszek:]

Is your question like why are we continuing to pay out a healthy dividend?

[Jordan Sadler:]

100%, so the return of capital component of your dividend is what I'm asking about specifically...

[Gary J. Wojtaszek:]

Got you.

[Jordan Sadler:]

...which has the effect of reducing an investor's basis. And it's something that you as a REIT, which is not required to pay tax, you don't have to pay that out. So you're overpaying your dividend. You're returning capital to investors. What I'm saying is why wouldn't you just retain the capital?

[Gary J. Wojtaszek:]

Sure, sure. I think if we announced that we weren't going to pay any dividend, I think that would be not well received from our investors. What we're trying to strike a balance here is returning an appropriate amount of cash flow to those investors that are searching for an immediate cash yield and trying to balance that with just corporate finance needs associated with reinvesting that back into the business. I think if we were to not pay a dividend out, we could probably accelerate our FFO growth by probably like a percentage point or two on an annual basis, so we'd get a really nice lift in that. But I think the flip side is that if we cut the dividend, as we've seen in some of the telco companies, some of those investors that invest in that space, they get really penalized if we're not paying the dividend. I think the most important takeaway on those points that Greg mentioned in terms of how big a proportion of our dividend that's going out as return of capital is really a unique benefit that we have in the way we were structured in terms of the carve-out from Cincinnati Bell, in that we have a such a high basis in our assets that we're able to provide a cash dividend to investors and particularly retail investors, which aren't going to incur the immediate tax cost on that. So for those folks, it's really an attractive benefit for them.

[Jordan Sadler:]

Okay, that helps. There's nothing in the taxable net income calculation, and I know you don't forecast taxable net income. But is there anything that sunsets in the next couple of years that would cause it to – in terms of depreciation or some other expense, that would cause taxable net income to grow?

[Gary J. Wojtaszek:]

No. Believe me, I was trying to work with our tax folks here and say hey, can we give a little more color to it. There are a lot of things that go in that calculation, but there's nothing immediate that's going to suggest anything falls off. But what we just provided was just historical, so people can get a sense for what the last three years looked like.

[Jordan Sadler:]

All right, thanks for all the color.

[Gregory R. Andrews:]

Jordan, if I could just chime in, our FFO per share grew 27%, our dividend we increased 21%. I don't want to speak to the policy which is ultimately defined by our board. But I think conceptually the idea would be to increase the dividend at a rate something below what the underlying cash flow is growing. It's just that we do retain a little bit more capital each and every year.

[Jordan Sadler:]

Okay, that's helpful. Thank you.

[Operator:]

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

[Simon Flannery:]

Great, okay. Thanks very much. Coming back to your bookings number, really impressive number. I wonder if you could just give us a little bit more color. Was this one or two very large contracts which make it pretty lumpy, or are you really starting to see an inflection here, so we might see a few more quarters like this in the years to come? And I think you've talked very well about the success of Phoenix, the success of Northern Virginia. So given that, how are you thinking about further geographic expansion, maybe the West, Northwest, or whatever either in 2016 or 2017? Thanks.

[Gary J. Wojtaszek:]

Sure. Hey, Simon.

[Simon Flannery:]

Good morning.

[Gary J. Wojtaszek:]

Look, it was a really good quarter. And as I mentioned, there were a number of new logos signed, including four new Fortune 1000 companies, and those are some big cloud operators in there as well. So we've signed a number of new customers. We've had some bigger deals in there this quarter than what we've seen in the past. We don't really comment on customers. But what I can say is that if you look at Northern Virginia, we have about 23 customers that we have sold to in that facility, some large customers and some small customers. But I think the most important point to take away from that is that it's the ability from our sales and operating capabilities to be able to sell to a single-rack customer up to a 10-meg type customer. That type of diversification is the thing that's most important because it allows you to smooth out your continued revenue growth. With regard to expansions in other markets, what we've said before is that we are looking at expanding into new locations. We think somewhere out west, Pacific Northwest is an area that we're spending some time focusing on, and in the Southeast where we have holes in our portfolio. So we are looking at expanding into those locations as well.

[Simon Flannery:]

And would that be build versus buy? How do you think about that given that there are a few properties on the marketplace?

[Gary J. Wojtaszek:]

It's both. If we can find assets that are strategically important for us that make sense, and that is getting us in new locations with additional types of customers that we're going after, and we could make them accretive, those are things that would definitely work for us, similar to what we did with Cervalis. But if those deals can't be worked out, we're very comfortable being able to go out on our own and organically build it. This company has been – other than the Cervalis acquisition, this company has grown organically from one facility in Houston. And we've expanded across the country, all organically, all maintaining really high yields on the capital that we're deploying, and we think we can replicate that going forward.

[Simon Flannery:]

Great, thank you.

[Operator:]

Our next question comes from Matthew Heinz from Stifel. Please go ahead with your question.

[Matthew Heinz:]

Hi, thanks for taking the questions. I'd appreciate if we could just get a sense of what kind of incremental leasing activity or leasing assumptions are embedded in the high end versus the low end of your revenue guidance and if the range assumes sort of any variability in the timing of lease commencements you highlighted in the backlog.

[Gregory R. Andrews:]

Yeah. This is Greg, Matt. Yeah, absolutely, the timing of lease commencements weighs in. Given the size of that backlog, just moving it even a couple of months can have some impact on the overall revenue for the year. In terms of kind of the normal course of leasing beyond what the backlog offers us, I think our assumptions are that we have activity kind of a little bit ahead of where we tracked last year, and so kind of same-city demand driving a similar level of leasing and then a little bit more in 2016.

[Matthew Heinz:]

Okay. So I guess the leasing assumptions are a little bit up year-over-year. And then can you just kind of drill down a little bit more on your comment on the timing of commencements? Is that a driver of the high end versus the low end of the guidance or are you basically saying that the midpoint of guidance is sort of what you expect if things commence as you've currently articulated?

[Gregory R. Andrews:]

Yeah. I mean there are a lot of drivers to the guidance. So there's so many moving pieces, I wouldn't want to pin it down to any one item, but certainly that is one of the items – I think the way we think about providing guidance is that the midpoint coincides with kind of our base case assumptions and there's some variability around this.

[Matthew Heinz:]

Okay, thanks. And then just as a follow-up on the development pipeline, it looks like the estimated delivery date of certain projects moved around a bit from last quarter. I guess, San Antonio, Houston and Dallas were pushed back a quarter or two and then Phoenix was moved up. Can you just comment on the drivers there on those projects?

[Gregory R. Andrews:]

It's construction, so there's always some differences in your expectations when you start and where you end up. But specifically with San Antonio, the reason for that is we've enhanced our build there now from we were doing just a couple megawatts and now we're going to do nine megawatts. So that additional capacity that we're adding has pushed out the delivery date for that.

[Matthew Heinz:]

Okay. All right. Thanks very much, guys. Good quarter.

[Gregory R. Andrews:]

Thanks.

[Gary J. Wojtaszek:]

Thank you.

[Operator:]

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

[Colby Synesael:]

I have two questions, somewhat similar, but I was hoping to get both Gary and Greg's perspective from slightly different angles. So I guess, first for Gary, as a strategy, are you seeing more opportunities as you go forward to do more wholesale like deals than I guess typically retail type deals? It seems like at least within this fourth quarter there certainly was more wholesale like deals, and should we expect to see more of those as we go forward in terms of the mix of new leases being done or square feet? And then for Greg, when we look at the implied price per kW on the new leases that were signed in the fourth quarter, it was down notably versus recent quarters, while CapEx is obviously expected to be up notably in 2016 both year-over-year and also versus what expectations were. But when we look at the improvement in EBITDA and FFO versus expectations, it's only slightly higher than what the Street had been anticipating, I guess what I'm getting there is I know you mentioned that you're still anticipating mid-teens type returns on the investments that you're doing, but what could we look at in terms of metrics that you provide that should be able to give us some confidence in that business? Again, when I look at some of those metrics, it is somewhat hard to get there. Thanks.

[Gary J. Wojtaszek:]

Sure. Hey, Colby, hope you're well. Yeah, with regard to wholesale/retail, I mean as we have said historically, we don't view the world through that lens. I mean the way we've engineered our business and the way we go to market is that we want to basically be able to provide a solution to any customer that comes to our doors. So whether they want a rack or 10 megawatts or 20 megawatts, we're indifferent. We'll be able to service them both equally the same. We can sell to them the same. We can operate and provide service capabilities to handle them. And...

[Colby Synesael:]

But do you see actually – but do you see more opportunity for these bigger deals which are coming at lower kW pricing than you have historically I guess is really what I'm getting at.

[Gary J. Wojtaszek:]

I think – and I don't know if we – I don't recall exactly if it's in our supplemental here or not, but what we have tried to show historically was the mix between a full-service and metered power deals and low resiliency, we've also showed the cuts of data showing those customers that are less than 1 megawatt or greater than 1 megawatt as different flavors for how customers are buying. So if the definition of a wholesale deal is a metered power deal, what we have been seeing is that customers are buying more of those products over time and they're going down in size. So you'll get metered power deals at 200 kW type deals if that's the definition of wholesale. We don't really ascribe to that. What I can say though is that the growth in this business is expanding. So when customers were originally coming to us years ago, they were only doing small deals with us for short-term periods of time. I think as the level of comfort and the adoption of the outsource model has taken root and we've really kind of made the case to all of our customers that we can deliver them a product that's superior to what they can do on their own at a price point that they can never touch, they are now willing to do much more of their data center deployments with us. And the result of that is that they're going for longer periods of time, I think what we just saw in this quarter where our average lease term was like close to nine years or so. And the result is that you're going for longer term at a lower price, which is a good trade. When we underwrite these deals, we're still underwriting with the same mid-teen terms in mind. Our cost-out initiatives are they don't stop. I mean we're not sitting here and when we were first going out on the IPO, we were talking about $7 million per megawatt type deliveries. At that point in time, people didn't really believe us, didn't think that we can deliver that type of capability. And while we explained to some of the skeptics about how we do it, proved it out historically and we showed returns on our assets to really justify that, we've not sat there. I mean our guys are constantly being pushed to do more. I mean some of these new builds that we're delivering here, we've pulled out another 10% and got some more shekels out of that build cost, and that's all going to help to deliver yields that are going to be consistent with what we've been able to do in the past. I'll turn it over to Greg for the other questions.

[Gregory R. Andrews:]

Hey, Colby. So just to follow on with Gary's point is from – how we model this out, we think these developments are going to deliver mid-teens returns consistent with what we've done in the past. The wringing out of cost is a key part of that. The challenge that you probably have seen that is just that the timing of the deployment of capital and the timing of the return are hard things to kind of capture, whereas we have the benefit of kind of looking at each deal in its own kind of static model. But what I would say is that the returns that we're getting here are back-end weighted this year. And so while we don't see as much impact on that capital this year, the beauty of it is how much carry-over there is into 2017 and the visibility that we have that 2017 is going to be another really strong growth year even from where we sit today before we sic our sales force on continuing to grow and lease more beyond that. So I think that's a really important point that we have really good visibility for at least a couple of years out now.

[Gary J. Wojtaszek:]

The other thing that I'd mention, Colby, is that in the executive management team's long-term incentive program, one of those metrics are return on asset metric that we have in there. So we are held accountable to deliver – we just don't kind of give up the balance sheet and not get returns. So we're being held accountable to deliver a really nice return on the capital that we're deploying.

[Colby Synesael:]

Okay, thank you.

[Operator:]

Our next question comes from Emmanuel Korchman from Citi. Please go ahead with your question.

[Emmanuel Korchman:]

Morning, everyone.

[Gregory R. Andrews:]

Hey, Manny.

[Emmanuel Korchman:]

Maybe Gary or Greg, just a follow-up on Colby's sort of last question here. So if we think about Northern Virginia in isolation and say right now you've filled up a bunch of that capacity or at least the next phase of capacity with wholesale lower rate tenants, could you fill the rest of the capacity with tenants at those rates and still hit the target returns?

[Gary J. Wojtaszek:]

Yes.

[Emmanuel Korchman:]

Or to hit the target returns, you need to go into the higher rent, smaller tenant?

[Gary J. Wojtaszek:]

Yes. We are engineering our facilities to – and we're nicely below $7 million a megawatt in Virginia. So we're going to hit returns there that are consistent with what we've done before. And to the extent that the mix shift towards more of the smaller customers that are high paying, we're going to get a nicer return there than what we've assumed we would.

[Emmanuel Korchman:]

Great. And then on San Antonio, I think you mentioned that it was 9 megawatts of leasing. What's the corresponding revenue number to that?

[Gary J. Wojtaszek:]

I don't think we've disclosed that. We'll put it out next quarter.

[Emmanuel Korchman:]

So is that excluded from the backlog slide, I guess the slide 18 in the deck as well?

[Gary J. Wojtaszek:]

Yes, that just came in. It was a disappointment with Tesh. We were really pushing to trying to get him to close it in the fourth quarter, but he just couldn't deliver. He's sitting next to me here.

[Emmanuel Korchman:]

Tell him to move faster next time. All right. Thanks, guys.

[Gregory R. Andrews:]

Yeah. The follow-on for that Manny is that, yeah, that you can expect the backlog to increase in the first quarter, by the end of the first quarter. And so that's pretty cool.

[Emmanuel Korchman:]

Great. To that point, will that then be 2017 income or is there some of that that's going to be in 2016 as well?

[Gregory R. Andrews:]

Back half of 2016 and then carry-over into 2017.

[Emmanuel Korchman:]

Okay. Thanks.

[Operator:]

Our next question comes from Vincent Chao from Deutsche Bank. Please go ahead with your question.

[Vincent Chao:]

Hey. Good morning, everyone. Just one follow-up on the geographic expansion. I think last quarter you guys were talking about exploring a development within the Cervalis portfolio, I guess around New York. Just curious what the thinking is there, that's my first question.

[Gary J. Wojtaszek:]

We have a little bit of capacity left, so we are looking at expanding in that facility and basically in God's country across the river in Jersey there. So we are going to be looking at expanding there.

[Vincent Chao:]

Okay. And then just maybe going back to the Northern Virginia, the 30 megawatts, you talked about I think 23 tenants in total in Northern Virginia. Was the pre-leasing of the four phases, was that all just one tenant or was there a couple wholesale deals there?

[Gary J. Wojtaszek:]

There is a couple different customers we sold last quarter in there.

[Vincent Chao:]

Wholesale deals, okay. I think most of my other questions have been answered. Thanks a lot.

[Gary J. Wojtaszek:]

Yes. Thanks, Vin.

[Gregory R. Andrews:]

Thanks, Vin.

[Operator:]

Our next question comes from Frank Niles (sic) [Frank Louthan] from Raymond James. Please go ahead with your question.

[Frank G. Louthan:]

Great, lovely. So just to clarify on the backlog there in H2, just given the nature of the contracts you have, if they didn't really materialize in H2, would that be a result of maybe the contracts falling through, the customers not going through with the projects, or just possibly getting pushed out further? And then just a clarification from a question I've gotten from investors around the space. When you're describing your customers in your cloud and IT bucket, do you mean customers that are specifically cloud and IT type shops as distinct from enterprise type cloud deployments, or are those commingled? Thank you.

[Gary J. Wojtaszek:]

I'll take the second. Yes, so the growth in that vertical has been over the last two years or so. That has been like your pure traditional cloud companies, big companies that are also large enterprises, but the real big cloud operators. We have like eight of the largest cloud operators in the world now as customers. Previously though, at the time of our IPO, included in that bucket were really big Fortune 500 type enterprise IT companies like the ones you can think about there that you wouldn't necessarily originally have associated with cloud, like the IBM types, the HPs, the Dells, those bigger type companies. So that's the distinctions. Now they're rolling in together. And where do some of these companies draw the line? It gets bigger, but I can tell you that all the growth that we've seen in that has been all the result of large cloud deployments with some of those largest companies.

[Frank G. Louthan:]

Okay, so it's not an energy company deploying a cloud application that's getting put in that bucket in...

[Gregory R. Andrews:]

No, no, that would be in the energy bucket.

[Frank G. Louthan:]

Got it, okay. Thank you for clarifying that. And then on that the potential backlog shift?

[Gregory R. Andrews:]

Yes, Frank, on that part, there's a very high degree of certainty that all that revenue that we project out for the second half will be realized in that timeframe. So it's more a question of exactly in which quarter, but it's not really a question of it pushing out beyond 2016.

[Frank G. Louthan:]

Great, all right. Thank you, that's very helpful.

[Operator:]

Our next question is a follow-up from Jordan Sadler from KeyBanc Capital Markets. Please go ahead with your question.

[Jordan Sadler:]

Thanks, guys. Apologies, I figured out a better way to ask my question on development. So just maybe quantify or some way you can qualify your appetite for spec development today, given the outlook that you have described in terms of the customers and the business being in as good of a place as it's ever been essentially.

[Gary J. Wojtaszek:]

Look, I don't think our appetite has changed, although if you look at me, you'll somewhat question that.

[Jordan Sadler:]

That's funny.

[Gary J. Wojtaszek:]

But the way we've always thought about it, Jordan, is anytime we go into – for any of our existing markets, we feel really comfortable that we can continue to deploy capital there. We've got good bead on line of sight for customers. And we just want to maintain just an inventory that's slightly running ahead of our customers, so we don't lose any deals and we always do right by our customers and always give them space as they grow. When we look at new markets, we go into those markets with the same set of underwriting criteria that we've always done. We look at the market in terms of do we see enough demand from our existing customers to get into that market. And we think that if we go there, do we have enough of a differentiated offering that we can sell other customers into that market. We look at historically those markets that customers have asked us to go into, either existing or other customers that we don't have that we declined that we weren't there. And we look at all of those things in retrospect before we make the decision to enter in that market. Once we enter that market, then it's game on. And then it's like how do you bring all the marketing and sales resources to bear to make sure that that is going to be a successful launch. And I think what you see in Northern Virginia was that. We had a lot of people concerned about our ability to go compete there with it being such a big data center market and there being a lot of incumbent players. And I think what we've proven is that our model absolutely resonates. We have real capabilities to be able to sell to customers in there and attract more customers to that market. That thing is just – it's repeatable. We've done the same thing in Phoenix and Austin and San Antonio. And every market we've done, we do the same thing. The only thing that gets better is we get smarter on it. We know what works, what doesn't work. We know how to lay the groundwork to get more people excited about it early on. So we expect that as we continue to expand, we're going to be able to replicate that success in other markets. But if it still doesn't meet the criteria that we see a lot of demand in the market, we're not going to go.

[Jordan Sadler:]

So how are you going to and how do you measure how much spec you want to have available in a particular market at one time? So is it one room, one pod, and is that changing because the base is getting larger?

[Gary J. Wojtaszek:]

Generally speaking, what we have tried to keep outstanding is roughly 10,000 to 20,000 square feet of additional capacity in markets. But it's predominantly driven by the deals that we're seeing in there. So we've got a four-stage sales funnel, and the deals that we're tracking in stage three and stage four, those are the deals that are much more likely to close. And so we think about the deals that we're tracking by site. And what you see then is that the capital that we're deploying in any market is relative to the demand that we're tracking. So if you looked at us broadly, what you're not going to see is you're not going to see us spending a boatload of capital in the Midwest because we don't really see the demand in our funnel to support that. You'll see us deploying additional amount of capital to grow at a nice single-digit rate, right in line with the demand we're tracking. In Dallas, we're just seeing really strong demand and we continue to deploy more and more capital there, all relative to the demand that we're tracking in the funnel. So for all the existing markets that we're at, the capital that we're deploying is a derivative of the demand that we're tracking. In the new markets, which is a little further out on the risk profile, that one you've got to – you're making a little – you're going a longer bet there to establish that presence. But once you're there, then you've derisked yourself. So we feel that like the next expansion that we're going to do in Northern Virginia is going to be pretty similar to what we've done elsewhere. And this is why like when a lot of people are talking about what you're seeing in the markets from other competitors, we are less focused on what other competitors are doing and more focused on making sure we understand our funnel. If we understand our funnel, then we feel that we're making good capital allocation decisions. If we're not seeing demand in our funnel, which could be the result of success some of our other competitors are having in the market, then that sends a signal to us to not deploy capital as quickly there.

[Jordan Sadler:]

That's really helpful. New Jersey, to follow up on Vin's question, you want to create more capacity there. Would you be interested in buying any additional assets there, or are you build-only?

[Gary J. Wojtaszek:]

No, no, if we can get an asset that's available in Jersey for the right price, we'd be interested in doing that. We feel that we've got a really broad sales capability and funnel to support filling that up.

[Jordan Sadler:]

Okay. Last question, apologies, is just on energy, hate to be the one to ask it, but you gave a description of your customer base and I know you're growing MRR consistently. The greater than 80% of the customers with $5 billion of annual revenue, that is reminiscent of I think the first time you laid it out for us, but I'm sort of recognizing that oil is down quite a bit from the peak. So I guess is there any way to – are there energy customers that you are having any signs of distress with besides the 80%? Is there anybody who is looking to contract or cancel a lease or is that just entire segment rock solid?

[Gary J. Wojtaszek:]

I wouldn't say rock solid by any means, I mean they are – that is an industry that is going through a really tumultuous period. What I can say is, as we pointed out, like our bookings this year, we booked roughly $0.5 million, roughly $6 million annualized in revenue in the oil industry this past year. That was the same $6 million that we booked in 2014. So it hasn't really changed much from a bookings perspective. What we talked about last year, and I don't think a lot of people realize, was that our oil and gas business was only growing at like a 7% CAGR over the last three years back into at the end of 2014. So it hadn't really been growing too dramatically. The other verticals have been growing much faster than oil and gas. And what we were trying to highlight in some of my prepared remarks were we're really highlighting the fact that our exposure to oil and gas has halved. We were about 38%, 37% at the time of IPO. It's down to 18% now, and not because it hasn't grown, it's because the other industry verticals that we've been focusing on have grown at a much faster pace. So we're always in discussions with the customers trying to help them out, trying to do the right thing by them, but there's nothing that we're particularly concerned about at this moment.

[Jordan Sadler:]

No watch list additions in the quarter or anything like that?

[Gary J. Wojtaszek:]

No, what?

[Jordan Sadler:]

Watch list, customer watch list?

[Gary J. Wojtaszek:]

Watch list, oh, watch list, no.

[Gregory R. Andrews:]

Yeah, yeah.

[Gary J. Wojtaszek:]

I mean even if you look at our – the top 20 customers, there's one customer that we're talking was, but it's like a 1% customer, that's up for renewal this year and we're talking to them.

[Jordan Sadler:]

All right. Thanks. guys.

[Gary J. Wojtaszek:]

Yeah.

[Gregory R. Andrews:]

Thanks, Jordan.

[Operator:]

And ladies and gentlemen, at this time we've reached the end of today's question-and-answer session. I'd like to turn the conference call back over to Mr. Gary Wojtaszek for any closing remarks.

[Gary J. Wojtaszek:]

Yeah. Thanks, everyone, for making time and spending time hearing what we had to say. We are really excited about the way the fourth quarter and 2015 progressed. As I mentioned, this is the strongest period we've ever started any year in and it gives us really good line of sight into the second half of 2016 and, more importantly, into 2017. I think everyone at this point in time has received invitations from us for our first investor day that we're holding in New York on March 22. So we're really looking forward to share a lot more information about the company at that point in time. Our intent then is to have some of the senior leadership team there to give an overview of their particular areas and provide a lot more insight into why we think we have a really interesting company, why we offer a really compelling investment opportunity. Also at that, you'll have an opportunity to talk with some customers that are planning to attend as well. So we're hoping that we can spend several hours with you educating on why we are a good investment. I think the other thing I'd point out, again, just more broadly is that the data center asset class within the real estate industry is, in my mind, one of the most compelling opportunities out there. I think what everyone has shown this quarter is that there's really great growth, there's great return on assets. And I think just broadly speaking, as a group we're significantly under-levered versus your typical real estate investment. So I think we offer really compelling opportunity. I obviously would like more of that mindshare out there, but I think everyone has shown this quarter that as an asset class we're all performing really well. Look forward to seeing you on March 22. Have a great week. Take care, bye.

[Operator:]

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