ITEM 1. BUSINESS
The Company
We are a premier data center real estate investment trust (REIT). We own, operate and develop enterprise-class, carrier-neutral, multi-tenant data center properties. Our data centers are generally purpose-built facilities with redundant power and cooling. They are not network-specific and enable customer interconnectivity to a range of telecommunication carriers. We provide mission-critical data center facilities that protect and ensure the continued operation of information technology (IT) infrastructure for 932 customers (not including customers that have signed leases but have not begun occupying space) in 35 data centers and 2 recovery centers in 11 distinct markets (9 cities in the U.S., London and Singapore). We provide twenty-four-hours-a-day, seven-days-a-week security guard monitoring with customizable security features.
Recent Developments
On March 17, 2016, CyrusOne LP entered into a first amended and restated credit agreement (the First Amended and Restated Credit Agreement) which amended and restated in its entirety the credit agreement governing its senior unsecured revolving credit facility (the Revolving Credit Facility) and senior unsecured term loan facility (the Initial Term Loan), originally dated as of October 9, 2014. The First Amended and Restated Credit Agreement provided for an additional $250.0 million senior unsecured term loan facility (the Additional Term Loan, together with the Initial Term Loan, the Term Loans) in addition to the existing $650.0 million Revolving Credit Facility and the $300.0 million Initial Term Loan. CyrusOne LP borrowed $250.0 million under the Additional Term Loan facility and used the proceeds to repay a portion of the amount outstanding under the Revolving Credit Facility. On November 21, 2016, CyrusOne LP entered into a second amended and restated credit agreement (the Second Amended and Restated Credit Agreement) which amended and restated in its entirety the First Amended and Restated Credit Agreement. The Second Amended and Restated Credit Agreement, among other things, increases the available commitments under the Revolving Credit Facility to $1.0 billion.
On March 21, 2016, CyrusOne Inc. completed a public offering of 6.9 million shares of its common stock for $255.0 million, net of underwriting discounts of approximately $10.6 million. CyrusOne LP used the proceeds to acquire the Chicago-Aurora I data center from CME Group for $131.1 million and to fund its development pipeline. During the first quarter of 2016, the Company received $0.9 million from the exercise of stock options and $0.1 million relating to common shares purchased under the employee stock purchase plan. In total, offerings of common stock during the first quarter of 2016 resulted in $256.0 million of cash flow from financing activities on the consolidated statements of cash flows.
On May 2, 2016, CyrusOne Inc. and CyrusOne GP amended and restated the Agreement of Limited Partnership of CyrusOne LP (Amended LP Agreement) to reflect that CBI and its subsidiaries have ceased to be partners or hold any partnership interests in CyrusOne LP and therefore have no rights under the Amended LP Agreement. The Amended LP Agreement also effects certain changes to clarify language, comply with or conform to Maryland and partnership tax law and make various technical corrections and ministerial changes.
On May 4, 2016, CyrusOne Inc. filed a Form S-3 with the SEC as a "well-known seasoned issuer" ("WKSI") using an automatic shelf registration process. Under this process, CyrusOne Inc. or any selling security holders may sell any combination of the securities described in the registration statement from time to time in one or more offerings in amounts to be determined at the time of any offering.
On July 1, 2016, the Company filed a prospectus supplement and entered into sales agreements (the Sales Agreements) with each of Raymond James & Associates, Inc., Jefferies LLC, KeyBanc Capital Markets Inc., Merrill Lynch, Pierce, Fenner & Smith Incorporated and SunTrust Robinson Humphrey, Inc., as sales agents, pursuant to which CyrusOne Inc. may issue and sell from time to time shares of its common stock having an aggregate gross sales price of up to $320.0 million, pursuant to an “at the market” program. Sales of shares of CyrusOne Inc. common stock under the Sales Agreements are made by means of ordinary brokers’ transactions on the NASDAQ Global Select Market or otherwise at market prices prevailing at the time of sale, at prices related to prevailing market prices or, subject to specific instructions of CyrusOne Inc., at negotiated prices. During the year ended December 31, 2016, the Company sold 0.5 million shares of its common stock under this program, generating net proceeds of approximately $26.3 million after giving effect to sales agent commissions of $0.3 million.
On August 15, 2016, CyrusOne Inc. completed a public offering of 3.4 million shares of its common stock for $164.8 million, net of underwriting discounts of approximately $6.9 million. CyrusOne Inc. contributed the net proceeds from the sale of its shares to its operating partnership in exchange for an equivalent number of newly issued operating partnership units (the August OP Contribution and Issuance). CyrusOne LP has used and intends to use the proceeds from the August OP Contribution and Issuance to fund growth capital expenditures related to recently signed leases, to repay borrowings under its Revolving Credit Facility, and for general corporate purposes, which may include funding future acquisitions, investments or capital expenditures. In connection with this offering, on August 10, 2016, CyrusOne Inc. entered into (a) a forward sale agreement with Goldman, Sachs & Co. (the Forward Sale Agreement) with respect to 3.4 million shares
of its common stock, and (b) an additional forward sale agreement with Goldman, Sachs & Co. (the Additional Forward Sale Agreement, and together with the Forward Sale Agreement, the Forward Sale Agreements) with respect to approximately 1.0 million shares of its common stock in connection with the underwriters' exercise of their option to purchase these shares.
Pursuant to the terms of the Forward Sale Agreements, and subject to CyrusOne Inc.’s right to elect cash or net share settlement under the Forward Sale Agreements, CyrusOne Inc. intends to issue and sell, upon physical settlement of such Forward Sale Agreements, approximately 4.4 million shares of its common stock to Goldman, Sachs & Co. in exchange for cash proceeds per share equal to the applicable forward sale price, which was initially $48.48 per share and is subject to certain adjustments as provided in the applicable forward sale agreement. CyrusOne Inc. expects to physically settle the Forward Sale Agreements in full, which settlement or settlements will occur on or before August 1, 2017.
On February 6, 2017, CyrusOne Inc. announced the execution of a definitive agreement to purchase two data centers located in Raleigh-Durham, North Carolina and Somerset, New Jersey for a total purchase price of $490 million, excluding transaction-related costs, in an all cash transaction. The transaction is expected to close in the next 30 to 45 days, subject to the fulfillment of customary closing conditions. These facilities add more than 160,000 colocation square feet and approximately 21 megawatts of power capacity to our portfolio. This transaction is expected to provide enhanced geographic diversification, establishing a presence in Raleigh-Durham and expanding our footprint in the Northeast.
The following diagram depicts our ownership structure as of December 31, 2016:
Our Business
We provide mission-critical data center facilities that protect and ensure the continued operation of IT infrastructure for our customers. Our goal is to be the preferred global data center provider to Fortune 1000, including the largest enterprises and providers of cloud services. As of December 31, 2016, our customers included 181 of the Fortune 1000 or private or foreign enterprises of equivalent size. These 181 customers provided 69% of our annualized rent as of December 31, 2016.
Data centers are highly specialized and secure real estate assets that serve as centralized repositories of server, storage and network equipment. They are designed to provide the space, power, cooling and network connectivity necessary to efficiently operate mission-critical IT equipment. Telecommunications carriers typically provide network access into a data center through optical fiber. The demand for data center infrastructure is being driven by many factors, but most importantly by significant growth in data as well as an increased demand for outsourcing. The market for third-party data center facilities includes, among other companies, established “traditional” enterprises that are web-enabling their applications and business processes as well as cloud-centric companies with sophisticated technology requirements.
We cultivate long-term strategic relationships with our customers and provide them with solutions for their data center facilities and IT infrastructure challenges. Our offerings provide flexibility, reliability and security delivered through a tailored, customer service focused platform that is designed to foster long-term relationships. We focus on attracting customers that have not historically outsourced their data center needs and providing them with solutions that address their current and future needs. Our facilities and construction design allow us to offer flexibility in density and power resiliency, and the opportunity for expansion as our customers' needs grow. We provide twenty-four-hours-a-day, seven-days-a-week security guard monitoring with customizable security features. The CyrusOne National IX Platform (the National IX Platform) delivers interconnection across states and between metro-enabled sites within the CyrusOne footprint and beyond. The platform enables high-performance, low-cost data transfer and accessibility for customers by uniting our data centers.
Our Competitive Strengths
Our ability to attract and retain the world’s largest customers is attributed to the following competitive strengths, which distinguish us from other data center operators and will enable us to continue to grow our operations.
High Quality Customer Base. The high quality of our assets combined with our reputation for serving the needs of large enterprises has enabled us to focus on the Fortune 1000 to build a quality customer base. We currently have 932 customers (not including customers that have signed leases but have not begun occupying space) from a broad spectrum of industries. Our revenue is generated by a stable enterprise customer base, as evidenced by the fact that as of December 31, 2016, 69% of our annualized rent comes from the Fortune 1000 or private or foreign enterprises of equivalent size. We serve a diversity of industries, including information technology, financial services, energy, oil and gas, mining, medical and consumer goods and services.
As of December 31, 2016, one customer represented more than 10% of revenue, with that customer representing 13% of our annualized rent. Our top 10 customers represented 38% of our annualized rent.
Strategically Located Portfolio. Our portfolio is located in several domestic and international markets possessing attractive characteristics for enterprise-focused data center operations. We have domestic properties in six of the top 10 largest U.S. cities by population (Chicago, Dallas, Houston, New York, Phoenix and San Antonio), according to the U.S. Census Bureau, and six of the top 10 cities for Fortune 500 headquarters (Chicago, Cincinnati, Dallas, Houston, San Antonio and New York). We believe cities with large populations or a large number of corporate headquarters are likely to produce incremental demand for IT infrastructure. In addition, being located close to our current and potential customers provides chief information officers (CIOs) with additional confidence when outsourcing their data center infrastructure to us.
Modern, High Quality, Flexible Facilities. Our portfolio includes highly efficient, reliable facilities with flexibility to customize customer solutions and accessibility to hundreds of connectivity providers. To optimize the delivery of power, our properties include modern engineering technologies designed to minimize unnecessary power usage and, in our newest facilities, we are able to provide power utilization efficiency ratios that we believe to be among the best in the multi-tenant data center industry. Fortune 1000 CIOs are dividing their application stacks into various groups as some applications require 100% availability, while others may require significant power to support complex computing, or robust connectivity. Our construction design enables us to deliver different power densities and resiliencies to the same customer footprint, allowing customers to tailor solutions to meet their application needs. In addition, the National IX Platform provides access to hundreds of telecommunication and Internet carriers.
Massively Modular® Construction Methods. Our Massively Modular® design principles allow us to efficiently stage construction on a large scale and deliver critical power and colocation square feet (CSF) in a timeframe that we believe is one of the best in the industry. We acquire or build a large powered shell capable of scaling with our customers’ power and colocation space needs. The powered shell
can be acquired or constructed for a relatively inexpensive capital cost. Once the building shell is ready, we can build individual data center halls in portions of the building space to meet the needs of customers on a modular basis. This modular data center hall construction can be completed in 12 to 16 weeks to meet our customers’ immediate needs. This short construction timeframe ensures a very high utilization of the assets and minimizes the time between our capital investment and the receipt of customer revenue, favorably impacting our return on investment while also translating into lower costs for our customers. Our design principles also allow us to add incremental equipment to increase power densities as our customers’ power needs increase, which provides our customers with a significant amount of flexibility to manage their IT demands. We believe this Massively Modular® approach allows us to respond to rapidly evolving customer needs, to commit capital toward the highest return projects and to develop state-of-the-art data center facilities.
Significant Leasing Capability. Our focus on the customer, our ability to scale with their needs, and our operational excellence provides us with embedded future growth from our customer base. During 2016, we signed new leases representing $147.8 million in annualized revenue, with previously existing customers accounting for approximately 76% of this amount. Since December 31, 2015, we have increased our CSF by approximately 506,000 square feet or 32%, while maintaining a high percentage of CSF utilized of 85% and 86% as of December 31, 2016 and 2015, respectively.
Significant, Attractive Expansion Opportunities. As of December 31, 2016, we had 825,000 net rentable square feet (NRSF) of powered shell available for future development and approximately 239 acres of land that are available for future data center facility development. The powered shell available for future development in locations that are part of our domestic portfolio, and consists of approximately 500,000 NRSF in the Southwest (Texas and Phoenix) and 325,000 NRSF in the Northeast and Midwest. Our current development properties and available acreage were selected based on extensive site selection criteria and the collective industry knowledge and experience of our management team with a focus on markets with a strong presence of and high demand by Fortune 1000 companies. As a result, we believe that our development portfolio contains properties that are located in markets with attractive supply and demand conditions and that possess suitable physical characteristics to support data center infrastructure.
Differentiated Reputation for Service. We believe that the decision CIOs make to outsource their data center infrastructure has material implications for their businesses, and, as such, CIOs look to third-party data center providers that have a reputation for serving similar organizations and that are able to deliver a customized solution. We take a consultative approach to understanding the unique requirements of our customers, and our design principles allow us to deliver a customized data center solution to match their needs. We believe that this approach has helped fuel our growth. Our current customers are also often the source of new contracts, with referrals being an important source of new customers.
Experienced Management Team. Our management team is comprised of individuals drawing on diverse knowledge and skill sets acquired through extensive experiences in the real estate, telecommunications, technology and mission-critical infrastructure industries.
Balance Sheet Positioned to Fund Continued Growth. As of December 31, 2016, we had $772.5 million in available liquidity, including $757.9 million in borrowing capacity under our Revolving Credit Facility. The Second Amended and Restated Credit Agreement also includes an accordion feature that allows us to increase the aggregate commitment by up to $300 million. We believe that we are appropriately capitalized with sufficient financial flexibility and capacity to fund our anticipated growth.
Experienced Sales Force with Robust Partner Channel. We have an experienced sales force with a particular expertise in selling to large enterprises, which can require extensive consultation and drive long sales cycles as these enterprises make the initial outsourcing decision. As of December 31, 2016, we had 39 sales-related employees. We believe the depth, knowledge, and experience of our sales team differentiates us from other data center companies, and we are not as dependent on brokers to identify and acquire customers as some other companies in the industry. To complement our direct sales efforts, we have developed a robust network of more than 175 partners, including value added resellers, systems integrators and hosting providers.
Business and Growth Strategies
Our objective is to grow our revenue and earnings and maximize stockholder returns and cash flow by continuing to expand our data center infrastructure outsourcing business.
Increasing Revenue from Existing Customers and Properties. We have historically generated a significant portion of our revenue growth from our existing customers. We will continue to target our existing customers because we believe that many have significant data center infrastructure needs that have not yet been outsourced, and many will require additional data center space and power to support their growth and their increasing reliance on technology infrastructure in their operations. To address new demand, as of December 31, 2016, we have approximately 615,000 NRSF currently available for lease. We also have approximately 1,657,000 NRSF under development, as well as 825,000 NRSF of additional powered shell space under roof available for development.
Attracting and Retaining New Customers. Increasingly, enterprises are beginning to recognize the complexities of managing data center infrastructure in the midst of rapid technological development and innovation. We believe that these complexities, brought about by the rapidly increasing levels of Internet traffic and data, obsolete existing corporate data center infrastructure, increased power and cooling
requirements and increased regulatory requirements, are driving the need for companies to outsource their data center facility requirements. Consequently, this will significantly increase the percentage of companies that use third-party data center colocation services over the next several years. We believe that our high quality assets and reputation for serving large enterprises have been, and will be, key differentiators for us in attracting customers that are outsourcing their data center infrastructure needs.
We acquire customers through a variety of channels. We have historically managed our sales process through a direct-to-the-customer model but are now utilizing third-party leasing agents and indirect leasing channels to expand our universe of potential new customers. Over the past few years, we have developed a robust network of partners in our indirect leasing channels, including value added resellers, systems integrators and hosting providers. These channels, in combination with our award-winning internal marketing team, have enabled us to build both a strong brand and outreach program to new customers. Throughout the life cycle of a customer’s lease with us, we maintain a disciplined approach to monitoring their experience, with the goal of providing the highest level of customer service. This personal attention fosters a strong relationship and trust with our customers, which leads to future growth and leasing renewals.
Expanding into New Markets. Our expansion strategy focuses on developing new data centers in markets where our customers are located and in markets with a strong presence of and high demand by Fortune 1000 customers. We conduct extensive analysis to ensure an identified market displays strong data center fundamentals, independent of the demand presented by any particular customer. In addition, we consider markets where our existing customers want us to be located. We regularly meet with our customers to understand their business strategies and potential data center needs. We believe that this approach combined with our Massively Modular® construction design reduces the risk associated with expansion into new markets because it provides strong visibility into our leasing opportunities and helps to ensure targeted returns on new developments. When considering a new market, we take a disciplined approach in evaluating potential business, property and site acquisitions, including a site’s geographic attributes, availability of telecommunications and connectivity providers, access to power, and expected costs for development.
Growing Interconnection Business. In April 2013, we launched the National IX Platform, delivering interconnection across states and between metro-enabled sites within the CyrusOne facility footprint and beyond. The platform enables high-performance, low-cost data transfer and accessibility for customers seeking to connect between CyrusOne facilities, from CyrusOne to their own private data center facility, or with one another via private peering, cross connects and/or public switching environments. Interconnection within a facility or on the National IX Platform allows our customers to share information and conduct commerce in a highly efficient manner not requiring a third-party intermediary, and at a fraction of the cost normally required to establish such a connection between two enterprises. The demand for interconnection creates additional rental and revenue growth opportunities for us, and we believe that customer interconnections increase our likelihood of customer retention by providing an environment not easily replicated by competitors. We act as a trusted neutral party that enterprises, carriers and content companies utilize to connect to each other. We believe that the reputation and industry relationships of our executive management team place us in an ongoing trusted provider role. In 2014, we became the first colocation provider in North America to receive multi-site certification from the Open-IX Association, a non-profit industry group formed to promote better standards for data center interconnection and Internet Exchanges in North America.
Our principal executive offices are located at 2101 Cedar Springs Road, Suite 900, Dallas, TX 75201. Our telephone number is (972) 350-0060. We maintain a website, www.cyrusone.com. The information contained on, or accessible through, our website is not incorporated by reference into this Annual Report on Form 10-K.
Our Portfolio
As of December 31, 2016, our property portfolio included 35 data centers and 2 recovery centers in 11 distinct markets (9 cities in the U.S., London and Singapore) collectively providing approximately 3,904,000 NRSF and powered by approximately 369 MW of available critical load capacity. We own 23 of the buildings in which our data center facilities are located. We lease the remaining 14 buildings, which account for approximately 650,000 NRSF, or approximately 17% of our total operating NRSF. These leased buildings accounted for 24% of our total annualized rent as of December 31, 2016. We also currently have 1,657,000 NRSF under development, as well as 825,000 NRSF of additional powered shell space under roof available for development. In addition, we have approximately 239 acres of land that are available for future data center shell development. Along with our primary product offering, leasing of colocation space, our customers are also interested in ancillary office and other space. We believe our existing operating portfolio and development pipeline will allow us to meet the evolving needs of our existing customers and continue to attract new customers. For the year ended December 31, 2016, our capital expenditures were $731.1 million, including the purchase of Aurora Properties. We continuously evaluate our existing portfolio for recoverability, and we recorded an impairment of $5.3 million related to two properties for the year ended December 31, 2016. The properties were South Bend-Crescent, a leased facility, and Cincinnati-Goldcoast, an owned facility. The following tables provide an overview of our operating and development properties as of December 31, 2016.
CyrusOne Inc.
Data Center Portfolio
As of December 31, 2016
(unaudited)
*
Indicates properties in which we hold a leasehold interest in the building shell and land. All data center infrastructure has been constructed by us and is owned by us.
**
Indicates properties in which we hold a leasehold interest in the building shell, land, and all data center infrastructure.
***
The information provided for the West Seventh Street (7th St.) property includes data for two facilities, one of which we lease and one of which we own.
(a)
Represents the total square feet of a building under lease or available for lease based on engineers' drawings and estimates but does not include space held for development or space used by CyrusOne.
(b)
Stabilized properties include data halls that have been in service for at least 24 months or are at least 85% utilized. Pre-stabilized properties include data halls that have been in service for less than 24 months and are less than 85% utilized.
(c)
Represents monthly contractual rent (defined as cash rent including customer reimbursements for metered power) under existing customer leases as of December 31, 2016, multiplied by 12. For the month of December 2016, customer reimbursements were $56.4 million annualized and consisted of reimbursements by customers across all facilities with separately metered power. Customer reimbursements under leases with separately metered power vary from month-to-month based on factors such as our customers' utilization of power and the suppliers' pricing of power. From January 1, 2015 through December 31, 2016, customer reimbursements under leases with separately metered power constituted between 10.6% and 12.6% of annualized rent. After giving effect to abatements, free rent and other straight-line adjustments, our annualized effective rent as of December 31, 2016 was $519.9 million. Our annualized effective rent was greater than our annualized rent as of December 31, 2016 because our positive straight-line and other adjustments and amortization of deferred revenue exceeded our negative straight-line adjustments due to factors such as the timing of contractual rent escalations and customer prepayments for services.
(d)
CSF represents the NRSF at an operating facility that is currently leased or readily available for lease as colocation space, where customers locate their servers and other IT equipment.
(e)
Percent leased is determined based on CSF being billed to customers under signed leases as of December 31, 2016 divided by total CSF. Leases signed but not commenced as of December 31, 2016 are not included.
(f)
Utilization is calculated by dividing CSF under signed leases for colocation space (whether or not the lease has commenced billing) by total CSF.
(g)
Represents the NRSF at an operating facility that is currently leased or readily available for lease as space other than CSF, which is typically office and other space.
(h)
Percent leased is determined based on Office & Other space being billed to customers under signed leases as of December 31, 2016 divided by total Office & Other space. Leases signed but not commenced as of December 31, 2016 are not included.
(i)
Represents infrastructure support space, including mechanical, telecommunications and utility rooms, as well as building common areas.
(j)
Represents the NRSF at an operating facility that is currently leased or readily available for lease. This excludes existing vacant space held for development.
(k)
Represents space that is under roof that could be developed in the future for operating NRSF, rounded to the nearest 1,000.
(l)
Critical load capacity represents the aggregate power available for lease and exclusive use by customers expressed in terms of megawatts. The capacity reported is for non-redundant megawatts, as we can develop flexible solutions to our customers at multiple resiliency levels. Does not sum to total due to rounding.
CyrusOne Inc.
NRSF Under Development
As of December 31, 2016
(Dollars in millions)
(unaudited)
(a)
Represents NRSF at a facility for which activities have commenced or are expected to commence in the next two quarters to prepare the space for its intended use. Estimates and timing are subject to change.
(b)
Represents NRSF under construction that, upon completion, will be powered shell available for future development into operating NRSF.
(c)
Critical load capacity represents the aggregate power available for lease and exclusive use by customers expressed in terms of megawatts. The capacity reported is for non-redundant megawatts, as we can develop flexible solutions to our customers at multiple resiliency levels. Does not sum to total due to rounding.
(d)
Actual to date is the cash investment as of December 31, 2016. There may be accruals above this amount for work completed, for which cash has not yet been paid.
(e)
Represents management’s estimate of the total costs required to complete the current NRSF under development. There may be an increase in costs if customers require greater power density.
Customer Diversification
Our portfolio is currently leased to 932 customers, many of which are leading global companies. The following table sets forth information regarding the 20 largest customers, including their affiliates, in our portfolio based on annualized rent as of December 31, 2016:
CyrusOne Inc.
Customer Diversification(a)
As of December 31, 2016
(unaudited)
(a)
Customers and their affiliates are consolidated.
(b)
Represents monthly contractual rent (defined as cash rent including customer reimbursements for metered power) under existing customer leases as of December 31, 2016, multiplied by 12. For the month of December 2016, customer reimbursements were $56.4 million annualized and consisted of reimbursements by customers across all facilities with separately metered power. Customer reimbursements under leases with separately metered power vary from month-to-month based on factors such as our customers' utilization of power and the suppliers' pricing of power. From January 1, 2015 through December 31, 2016, customer reimbursements under leases with separately metered power constituted between 10.6% and 12.6% of annualized rent. After giving effect to abatements, free rent and other straight-line adjustments, our annualized effective rent as of December 31, 2016 was $519.9 million. Our annualized effective rent was greater than our annualized rent as of December 31, 2016 because our positive straight-line and other adjustments and amortization of deferred revenue exceeded our negative straight-line adjustments due to factors such as the timing of contractual rent escalations and customer prepayments for services.
(c)
Represents the customer’s total annualized rent divided by the total annualized rent in the portfolio as of December 31, 2016, which was approximately $509.7 million.
(d)
Weighted average based on customer’s percentage of total annualized rent expiring and is as of December 31, 2016, assuming that customers exercise no renewal options and exercise all early termination rights that require payment of less than 50% of the remaining rents. Early termination rights that require payment of 50% or more of the remaining lease payments are not assumed to be exercised because such payments approximate the profitability margin of leasing that space to the customer, such that we do not consider early termination to be economically detrimental to us.
Lease Distribution
The following table sets forth information relating to the distribution of customer leases in the properties in our portfolio, based on NRSF under lease as of December 31, 2016:
CyrusOne Inc.
Lease Distribution
As of December 31, 2016
(unaudited)
(a)
Represents all leases in our portfolio, including colocation, office and other leases.
(b)
Represents the number of customers occupying data center, office and other space as of December 31, 2016. This may vary from total customer count as some customers may be under contract, but have yet to occupy space.
(c)
Represents the total square feet at a facility under lease and that has commenced billing, excluding space held for development or space used by CyrusOne. A customer’s leased NRSF is estimated based on such customer’s direct CSF or office and light-industrial space plus management’s estimate of infrastructure support space, including mechanical, telecommunications and utility rooms, as well as building common areas.
(d)
Represents monthly contractual rent (defined as cash rent including customer reimbursements for metered power) under existing customer leases as of December 31, 2016, multiplied by 12. For the month of December 2016, customer reimbursements were $56.4 million annualized and consisted of reimbursements by customers across all facilities with separately metered power. Customer reimbursements under leases with separately metered power vary from month-to-month based on factors such as our customers' utilization of power and the suppliers' pricing of power. From January 1, 2015 through December 31, 2016, customer reimbursements under leases with separately metered power constituted between 10.6% and 12.6% of annualized rent. After giving effect to abatements, free rent and other straight-line adjustments, our annualized effective rent as of December 31, 2016 was $519.9 million. Our annualized effective rent was greater than our annualized rent as of December 31, 2016 because our positive straight-line and other adjustments and amortization of deferred revenue exceeded our negative straight-line adjustments due to factors such as the timing of contractual rent escalations and customer prepayments for services.
Lease Expiration
The following table sets forth a summary schedule of the customer lease expirations for leases in place as of December 31, 2016, plus available space, for each of the 10 full calendar years beginning January 1, 2017, at the properties in our portfolio.
CyrusOne Inc.
Lease Expirations
As of December 31, 2016
(unaudited)
(a)
Leases that were auto-renewed prior to December 31, 2016 are shown in the calendar year in which their current auto-renewed term expires. Unless otherwise stated in the footnotes, the information set forth in the table assumes that customers exercise no renewal options and exercise all early termination rights that require payment of less than 50% of the remaining rents. Early termination rights that require payment of 50% or more of the remaining lease payments are not assumed to be exercised.
(b)
Number of leases represents each agreement with a customer. A lease agreement could include multiple spaces and a customer could have multiple leases.
(c)
Represents monthly contractual rent (defined as cash rent including customer reimbursements for metered power) under existing customer leases as of December 31, 2016, multiplied by 12. For the month of December 2016, customer reimbursements were $56.4 million annualized and consisted of reimbursements by customers across all facilities with separately metered power. Customer reimbursements under leases with separately metered power vary from month-to-month based on factors such as our customers' utilization of power and the suppliers' pricing of power. From January 1, 2015 through December 31, 2016, customer reimbursements under leases with separately metered power constituted between 10.6% and 12.6% of annualized rent. After giving effect to abatements, free rent and other straight-line adjustments, our annualized effective rent as of December 31, 2016 was $519.9 million. Our annualized effective rent was greater than our annualized rent as of December 31, 2016 because our positive straight-line and other adjustments and amortization of deferred revenue exceeded our negative straight-line adjustments due to factors such as the timing of contractual rent escalations and customer prepayments for services.
(d)
Represents the final monthly contractual rent under existing customer leases that had commenced as of December 31, 2016, multiplied by 12.
Regulation
General
Properties in our markets are subject to various laws, ordinances and regulations, including regulations relating to common areas. We believe that each of our properties has the necessary permits and approvals for us to operate our business.
Americans With Disabilities Act
Our properties must comply with Title III of the Americans with Disabilities Act of 1990, or the ADA, to the extent that such properties are “public accommodations” as defined by the ADA. The ADA may require removal of structural barriers to access by persons with disabilities in certain public areas of our properties where such removal is readily achievable. We believe that our properties are in substantial compliance with the ADA and that we will not be required to make substantial capital expenditures to address the requirements of the ADA. However, noncompliance with the ADA could result in imposition of fines or an award of damages to private litigants. The obligation to make readily achievable accommodations is an ongoing one, and we will continue to assess our properties and to make alterations as appropriate in this respect.
Environmental Matters
We are subject to laws and regulations relating to the protection of the environment, the storage, management and disposal of hazardous materials, emissions to air and discharges to water, the cleanup of contaminated sites and health and safety matters. These include various regulations promulgated by the Environmental Protection Agency and other federal, state, and local regulatory agencies and legislative bodies relating to our operations, including those involving power generators, batteries, and fuel storage to support co-location infrastructure. While we believe that our operations are in substantial compliance with environmental, health, and human safety laws and regulations, as an owner or operator of property and in connection with the current and historical use of hazardous materials and other operations at its sites, we could incur significant costs, including fines, penalties and other sanctions, cleanup costs and third-party claims for property damages or personal injuries, as a result of violations of or liabilities under environmental laws and regulations. Fuel storage tanks are present at many of our properties, and if releases were to occur, we may be liable for the costs of cleaning up resulting contamination. Some of our sites also have a history of previous commercial operations, including past underground storage tanks.
Some of the properties may contain asbestos-containing building materials. Environmental laws require that asbestos-containing building materials be properly managed and maintained, and may impose fines and penalties on building owners or operators for failure to comply with these requirements.
Environmental consultants have conducted, as appropriate, Phase I or similar non-intrusive environmental site assessments on recently acquired properties and if appropriate, additional environmental inquiries and assessments on recently acquired properties. Nonetheless, we may acquire or develop sites in the future with unknown environmental conditions from historical operations. Although we are not aware of any sites at which we currently have material remedial obligations, the imposition of remedial obligations as a result of spill or the discovery of contaminants in the future could result in significant additional costs to us.
Our operations also require us to obtain permits and/or other governmental approvals and to develop response plans in connection with the use of our generators or other operations. These requirements could restrict our operations or delay the development of data centers in the future. In addition, from time to time, federal, state or local government regulators enact new or revise existing legislation or regulations that could affect us, either beneficially or adversely. As a result, we could incur significant costs in complying with environmental laws or regulations that are promulgated in the future.
Insurance
We carry comprehensive liability, fire, extended coverage, business interruption and rental loss insurance covering all of the properties in our portfolio under a blanket policy. In the opinion of our management, our policy specifications, limits and insurance carriers are appropriate given the relative risk of loss, the cost of coverage and industry practice. We cannot provide any assurance that the business interruption or property insurance we have will cover all losses that we may experience, that the insurance carrier will be solvent, that rates will remain commercially reasonable, that insurance carriers will not cancel our policies, or that the insurance carriers will pay all claims made by us. Certain circumstances, such as acts of war, are generally uninsurable under our policies. See also “Risk Factors-Risks Related to Our Business and Operations." Any losses to our properties that are not covered by insurance, or that exceed our policy coverage limits, could adversely affect our business, financial condition and results of operations.
Competition
We compete with numerous developers, owners and operators of technology-related real estate, many of which own properties similar to ours in the same markets in which our properties are located. If our competitors offer space at rental rates below current market rates or below the rental rates we currently charge our customers, or if our competitors offer space that tenants perceive to be superior to ours
(based on factors such as available power, security considerations, location or connectivity), we may lose potential customers and we may be pressured to reduce our rental rates below those we currently charge in order to retain customers when our customers’ leases expire or incur costs to improve our properties. In addition, our customers have the option of building their own data center space which can also place pressure on our rental rates.
As a developer of data center space and provider of interconnection services, we also compete for the services of key third-party providers of services, including engineers and contractors with expertise in the development of data centers. There is competition for the services of specialized contractors and other third-party providers required for the development of data centers, increasing the cost of engaging such providers and the risk of delays in completing our development projects.
In addition, we face competition from real estate developers in our sector and in other industries for the acquisition of additional properties suitable for the development of data centers. Such competition may reduce the number of properties available for acquisition, increase the price of these properties and reduce the demand for data center space in the markets we seek to serve.
Employees
We employ approximately 380 persons. None of these employees are represented by a labor union.
Financial Information
For financial information related to our operations, please refer to the financial statements including the notes thereto, included in this Annual Report on Form 10-K.
How to Obtain Our SEC Filings
We file annual, quarterly and current reports, proxy statements and other information with the Securities and Exchange Commission (SEC). All reports we file with the SEC will be available free of charge via EDGAR through the SEC website at http://www.sec.gov. In addition, the public may read and copy materials we file with the SEC at the SEC’s public reference room located at 100 F Street, N.E., Washington, D.C. 20549. Information about the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330. We make available our reports on Forms 10-K, 10-Q, and 8-K (as well as all amendments to these reports), and other information, free of charge, at the "Investors" section of our website at http://www.cyrusone.com. The information found on, or otherwise accessible through, our website is not incorporated by reference into, nor does it form a part of, this report or any other document that we file with the SEC.
ITEM 1A.
ITEM 1A. RISK FACTORS
You should carefully consider all the risks described below, as well as the other information contained in this document when evaluating your investment in our securities. Any of the following risks could materially and adversely affect our business, results of operations or financial condition. The risks and uncertainties described below are those that we currently believe may materially affect our Company. Additional risks and uncertainties of which we are unaware or that we currently deem immaterial also may become important factors that affect our Company. The occurrence of any of the following risks might cause you to lose all or a part of your investment. Some statements in this Form 10-K, including statements in the following risk factors, constitute forward-looking statements. Please refer to the section entitled “Special Note Regarding Forward-Looking Statements.”
Risks Related to Our Business and Operations
A small number of customers account for a significant portion of our revenue. The loss or significant reduction in business from one or more of our large customers could significantly harm our business, financial condition and results of operations, and impact the amount of cash available for distribution to our stockholders.
We currently depend, and expect to continue to depend, upon a relatively small number of customers for a significant percentage of our revenue. Our top 10 customers collectively accounted for approximately 38% of our total annualized rent as of December 31, 2016. We have one customer which accounted for approximately 13% of our total annualized rent as of December 31, 2016. As a result of this customer concentration, our business, financial condition and results of operations, including the amount of cash available for distribution to our stockholders, could be adversely affected if we lose one or more of our larger customers, if such customers significantly reduce their business with us or if we choose not to enforce, or to enforce less vigorously, any rights that we may have now or in the future against these significant customers because of our desire to maintain our relationship with them.
A significant percentage of our customer base is also concentrated in industry sectors that may from time to time experience volatility, including the information technology, financial services and energy sectors. Enterprises in the information technology, financial services and energy industries comprised approximately 37%, 22% and 14%, respectively, of our annualized rent as of December 31, 2016. A downturn in one of these industries could negatively impact the financial condition of one or more of our information technology, financial services or energy customers, including several of our larger customers. In addition, instability in financial markets and economies generally may adversely affect our customers’ ability to replace or renew maturing liabilities on a timely basis, access the capital markets to meet liquidity and capital expenditure requirements and may result in adverse effects on our customers’ financial condition and results of operations. As a result of these factors, customers could default on their obligations to us, delay the purchase of new services from us or decline to renew expiring leases, any of which could have an adverse effect on our business, financial condition and results of operations. A diverse customer base may minimize exposure to economic fluctuations in any one industry, business sector or customer type, or any particular customer. Our relative mix of customers may change over time, as may the industries represented by our customers, the concentration of customers within specified industries and the economic value and risks associated with each customer, and there is no assurance that we will be able to maintain a diverse customer base, which could have a material adverse effect on our business, financial condition and results of operations.
Additionally, if any customer becomes a debtor in a case under the U.S. Bankruptcy Code, applicable bankruptcy laws may limit our ability to terminate our contract with such customer solely because of the bankruptcy or recover any amounts owed to us under our agreements with such customer. In addition, applicable bankruptcy laws could allow the customer to reject and terminate its agreement with us, with limited ability for us to collect the full amount of our damages. Our business, including our revenue and cash available for distribution to our stockholders, could be adversely affected if any of our significant customers were to become bankrupt or insolvent.
A significant percentage of our customer leases expire each year or are on a month-to-month basis, and many of our leases contain early termination provisions. If leases with our customers are not renewed on the same or more favorable terms or are terminated early by our customers, our business, financial condition and results of operations could be substantially harmed.
Our customers may not renew their leases upon expiration. This risk is increased by the significant percentage of our customer leases that expire every year. As of December 31, 2016, leases representing 21%, 20% and 12% of the annualized rent for our portfolio will expire during 2017, 2018 and 2019, respectively, and an additional 2% of the 2016 annualized rent for our portfolio was from month-to-month leases. While historically we have retained a significant number of our customers, including those leasing from us on a month-to-month basis, upon expiration our customers may elect not to renew their leases or renew their leases at lower rates, for less space, for fewer services or for shorter terms. If we are unable to successfully renew or continue our customer leases on the same or more favorable terms or subsequently re-lease available data center space when such leases expire, our business, financial condition and results of operations could be adversely affected.
In addition, many of our leases contain early termination provisions that allow our customers to reduce the term of their leases subject to payment of an early termination charge that is often a specified portion of the remaining rent payable on such leases. The exercise by customers of early termination options could have an adverse effect on our business, financial condition and results of operations.
We generate a substantial portion of our revenue from a small number of metropolitan markets, which makes us more susceptible to regional economic downturns.
Our portfolio of properties consists primarily of data centers geographically concentrated in the metropolitan areas of Dallas, Cincinnati, Houston and New York. These markets comprised 20%, 18%, 17%, and 13%, respectively, of our annualized rent as of December 31, 2016. As such, we are susceptible to local economic conditions and the supply of, and demand for, data center space in these markets. If there is a downturn in the economy, a natural disaster or an oversupply of, or decrease in demand for, data centers in these markets, our business could be adversely affected to a greater extent than if we owned a real estate portfolio that was more diversified in terms of both geography and industry focus.
Even if we have additional space available for lease at any one of our data centers, our ability to meet existing customer requirements or lease this space to existing or new customers could be constrained by our ability to provide sufficient electrical power and cooling capacity.
Customers are increasing their deployment of high-density IT equipment in our data centers, which has increased the demand for power and cooling capacity. As current and future customers increase their power footprint in our facilities over time, we may be required to upgrade or add to our existing infrastructure or add additional infrastructure to meet customer requirements. Power and cooling systems are difficult and expensive to upgrade, and such changes may be required at a time or on a timeline during which we lack the financial or operational ability to make such changes. Our failure to timely upgrade or add additional infrastructure could result in a failure to meet the requirements of our existing customers, or limit our ability to increase occupancy rates or density within our existing facilities, whether for new or existing customers. Similarly, even when successful in implementing such changes, we may not be able to pass on any additional costs to our customers.
We do not own all of the buildings in which our data centers are located. Instead, we lease or sublease certain of our data center spaces and the ability to retain these leases or subleases could be a significant risk to our ongoing operations.
We do not own 14 buildings that account for approximately 650,000 NRSF, or approximately 17% of our total operating NRSF. These leased buildings accounted for 24% of our total annualized rent as of December 31, 2016. Our business could be harmed if we are unable to renew the leases for these data centers on favorable terms or at all. Additionally, in several of our smaller facilities we sublease our space, and our rights under these subleases are dependent on our sublandlord retaining its rights under the prime lease. When the primary terms of our existing leases expire, we generally have the right to extend the terms of our leases for one or more renewal periods, subject to, in the case of several of our subleases, our sublandlord renewing its term under the prime lease. For four of these leases and subleases, the renewal rent will be determined based on the fair market value of rental rates for the property, and the then prevailing rental rates may be higher than the current rental rates under the applicable lease. The rent for the remaining leases and subleases will be based on a fixed percentage increase over the base rent during the year immediately prior to expiration. Several of our data centers are leased or subleased from other data center companies, which may increase our risk of non-renewal or renewal on less than favorable terms. If renewal rates are less favorable than those we currently have, we may be required to increase revenues within existing data centers to offset such increase in lease payments. Failure to increase revenues to sufficiently offset these projected higher costs would adversely impact our operating income. Upon the end of our renewal options, we would have to renegotiate our lease terms with the applicable landlords.
Additionally, if we are unable to renew the lease at any of our data centers, we could lose customers due to the disruptions in their operations caused by the relocation. We could also lose those customers that choose our data centers based on their locations. In addition, it is not typical for us to relocate data center infrastructure equipment, such as generators, power distribution units and cooling units, from their initial installation. The costs of relocating such equipment to different data centers could be prohibitive and, as such, we could lose the value of this equipment. For these reasons, any lease that cannot be renewed could adversely affect our business, financial condition and results of operations.
Any losses to our properties that are not covered by insurance, or that exceed our coverage limits, could adversely affect our business, financial condition and results of operations.
The properties in our portfolio are subject to risks, including from causes related to riots, war, terrorism or acts of God. For example, our properties located in Texas are generally subject to risks related to tropical storms, tornadoes, hurricanes, floods and other severe weather or natural events and our properties located in the Midwest are generally subject to risks related to earthquakes, tornadoes and other severe weather. All our properties could have unknown title defects or encumbrances. While we carry
commercial property insurance including business interruption, flood and earth movement covering all of the properties in our portfolio, and title insurance on a substantial number of our properties, the amount of insurance coverage may not be sufficient to fully cover losses we may incur.
If we experience a loss that is uninsured or exceeds our policy coverage limits, we could lose the capital invested in the damaged properties as well as the anticipated future cash flows from those properties. In addition, if the damaged properties were subject to recourse indebtedness, we could continue to be liable for the indebtedness even if these properties were irreparably damaged or subject of a loss.
In addition, even if a title defect or damage to our properties is covered by insurance, a disruption of our business caused by a casualty event may result in the loss of business or customers. The business interruption insurance we carry may not fully compensate us for the loss of business or customers due to an interruption caused by a title defect or casualty event.
A failure of an insurance company to make payments to us upon an event of loss covered by an insurance policy could adversely affect our business, financial condition and results of operations. We monitor our insurance carrier's financial strength rating and financial size category by only placing insurance with carriers who have an A.M. Best Rating of A- XII or better. However, it can be difficult to evaluate the stability and net assets or capitalization of insurance companies, and any insurance company's ability to meet its claim payment obligations.
Any failure of our physical infrastructure or services could lead to significant costs and disruptions that could reduce our revenues and harm our brand and reputation.
Our business depends on providing customers with a highly reliable data center environment. We may fail to provide such service as a result of numerous factors, including:
•human error;
•failure to timely deploy adequate infrastructure to meet customer requirements;
•unexpected equipment failure;
•power loss or telecommunications failures;
•improper building maintenance by our landlords in the buildings that we lease;
•physical or electronic security breaches;
•fire, tropical storm, hurricane, tornado, flood, earthquake and other natural disasters;
•water damage;
•war, terrorism and any related conflicts or similar events worldwide; and
•sabotage and vandalism.
Problems at one or more of our data centers, whether or not within our control, could result in service interruptions or equipment damage. Substantially all of our leases include terms requiring us to meet certain service level commitments primarily in terms of electrical output to, and maintenance of environmental conditions in, the data center raised floor space leased by customers. Any failure to meet these commitments or any equipment damage in our data centers, including as a result of mechanical failure, power outage, human error on our part or other reasons, could subject us to liability under our lease terms, including service level credits against customer rent payments, or, in certain cases of repeated failures, the right by the customer to terminate the lease. For example, although our data center facilities are engineered to reliably power and cool our customers’ computing equipment, it is possible that an outage could adversely affect a facility’s power and cooling capabilities. Depending on the frequency and duration of these outages, the affected customers may have the right to terminate their lease, which could have a negative impact on our business. We may also be required to expend significant financial resources to upgrade or add to existing infrastructure to meet customer requirements for power and cooling, and we may not be financially or operationally able to do so in a timely manner.
We may be vulnerable to security breaches which could lead to significant costs and disrupt our operations.
We may be required to expend significant financial resources to protect against physical or cyber security breaches that could result in the misappropriation of our proprietary information or the information of our customers. We may not be able to implement security measures in a timely manner or, if and when implemented, these measures might be circumvented. Service interruptions, equipment failures or security breaches may also expose us to additional legal liability and damage our brand and reputation, and could cause our customers to terminate or not renew their leases. In addition, we may be unable to attract new customers if we have a reputation for significant or frequent service disruptions, equipment failures or physical or cyber security breaches in our data centers. Any such failures could adversely affect our business, financial condition and results of operations.
Our growth depends on the development of our properties and our ability to successfully lease those properties, and any delays or unexpected costs associated with such projects or the ability to lease such properties may harm our growth prospects, future business, financial condition and results of operations.
Our growth depends in part upon successfully developing properties into operating data center space. Current and future development projects will involve substantial planning, allocation of significant company resources and certain risks, including risks related to financing, zoning, regulatory approvals, construction costs and delays. These projects will also require us to carefully select and rely on the experience of one or more general contractors and associated subcontractors during the construction process. Should a general contractor or significant subcontractor experience financial or other problems during the construction process, we could experience significant delays, increased costs to complete the project and other negative impacts to our expected returns.
Site selection is also a critical factor in our expansion plans, and there may not be suitable properties available in our markets at a location that is attractive to our customers and has the necessary combination of access to multiple network providers, a significant supply of electrical power, high ceilings and the ability to sustain heavy floor loading. Furthermore, while we may prefer to locate new data centers adjacent to our existing data centers, we may be limited by the inventory and location of suitable properties.
In addition, in developing new properties, we will be required to secure an adequate supply of power from local utilities, which may include unanticipated costs. For example, we could incur increased costs to develop utility substations on our properties in order to accommodate our power needs. Any inability to secure an appropriate power supply on a timely basis or on acceptable financial terms could adversely affect our ability to develop the property on an economically feasible basis, or at all.
These and other risks could result in delays or increased costs or prevent the completion of our development projects and growth of our business, which could adversely affect our business, financial condition and results of operations.
In addition, we have in the past undertaken development projects prior to obtaining commitments from customers to lease the related data center space. We will likely choose to undertake future development projects under similar terms. Such development involves the risk that we will be unable to attract customers to the relevant properties on a timely basis or at all. If we are unable to attract customers and our properties remain vacant or underutilized for a significant amount of time, our business, financial condition and results of operations could be adversely affected.
We are dependent upon third-party suppliers for power and certain other services, and we are vulnerable to service failures of our third-party suppliers and to price increases by such suppliers.
We rely on third-party local utilities to provide power to our data centers. We are therefore subject to an inherent risk that such local utilities may fail to deliver such power in adequate quantities or on a consistent basis, and our recourse against the utility and ability to control such failures may be limited. If power delivered from the local utility is insufficient or interrupted, we would be required to provide power through the operation of our on-site generators, generally at a significantly higher operating cost than we would pay for an equivalent amount of power from the local utility. We may not be able to pass on the higher cost to our customers. In addition, if the generator power were to fail, we would generally be subject to paying service level credits to our customers, who may in certain instances also have the right to terminate their leases. Furthermore, any sustained loss of power could reduce the confidence of our customers in our services thereby impairing our ability to attract and retain customers, which would adversely affect both our ability to generate revenues and our results of operations.
In addition, even when power supplies are adequate, we may be subject to pricing risks and unanticipated costs associated with obtaining power from various utility companies. While we actively seek to lock-in utility rates, many factors beyond our control may increase the rate charged by the local utility. For instance, municipal utilities in areas experiencing financial distress may increase rates to compensate for financial shortfalls unrelated to either the cost of production or the demand for electricity. Utilities may be dependent on, and be sensitive to price increases for, a particular type of fuel, such as coal, oil or natural gas. In addition, the price of these fuels and the electricity generated from them could increase as a result of proposed legislative measures related to climate change or efforts to regulate carbon emissions. In any of these cases, increases in the cost of power at any of our data centers could put those locations at a competitive disadvantage relative to data centers served by utilities that can provide less expensive power. These pricing risks are particularly acute with respect to our customer leases that are structured on a full-service gross basis, where the customer pays a fixed amount for both colocation rental and power. Our business, financial condition and results of operations could be adversely affected in the event of an increase in utility rates under these leases, which, as of December 31, 2016, accounted for approximately 30% of our leased NRSF, because we may be limited in our ability to pass on such costs to these customers.
We depend on third parties to provide network connectivity to the customers in our data centers, and any delays or disruptions in connectivity may adversely affect our business, financial condition and results of operations.
Our customers require internet connectivity and connectivity to the fiber networks of multiple third-party telecommunications carriers. In order for us to attract and retain customers, our data centers need to provide sufficient access for customers to connect to those carriers. While we provide space and facilities in our data centers for carriers to locate their equipment and connect customers to their networks, any carrier may elect not to offer its services within our data centers or may elect to discontinue its service. Furthermore, carriers may periodically experience business difficulties which could affect their ability to provide telecommunications services, or the service provided by a carrier may be inadequate or of poor quality. If carriers were to terminate
connectivity within our data centers or if connectivity were to be degraded or interrupted, it could put that data center at a competitive disadvantage versus a competitor’s data center that does provide adequate connectivity. A material loss of adequate third-party connectivity could have an adverse effect on the businesses of our customers and, in turn, our own results of operations and cash flow.
Furthermore, each new data center that we develop requires significant amounts of capital to be expended by third-party telecommunications carriers for the construction and operation of a sophisticated redundant fiber network. The construction required to connect multiple carrier facilities to our data centers is complex and involves factors outside of our control, including regulatory requirements, the availability of construction resources and the sufficiency of such third-party telecommunications carriers’ financial resources to fund the construction. Additionally, hardware or fiber failures could cause significant loss of connectivity. If we are unable to establish highly diverse network connectivity to our data centers, or if such network connectivity is materially delayed, is discontinued or is subject to failure, our ability to attract new customers or retain existing customers may be negatively affected and, as a result our results of operations and cash flows may be adversely affected.
The loss of access to key third-party technical service providers and suppliers could adversely affect our current and any future development projects.
Our success depends, to a significant degree, on having timely access to certain key third-party technical personnel who are in limited supply and great demand, such as engineering firms and construction contractors capable of developing our properties, and to key suppliers of electrical and mechanical equipment that complement the design of our data center facilities. For any future development projects, we will continue to rely on these personnel and suppliers to develop data centers. Competition for such technical expertise is intense, and there are a limited number of electrical and mechanical equipment suppliers that design and produce the equipment that we require. We may not always have or retain access to such key service providers and equipment suppliers, which could adversely affect our current and any future development projects.
The long sales cycle for data center services may adversely affect our business, financial condition and results of operations.
A customer’s decision to lease space in one of our data centers and to purchase additional services typically involves a significant commitment of resources, significant contract negotiations regarding the service level commitments, and significant due diligence on the part of the customer regarding the adequacy of our facilities, including the adequacy of carrier connections. As a result, the sale of data center space has a long sales cycle. Furthermore, we may expend significant time and resources in pursuing a particular sale or customer that may not result in revenue. Our inability to adequately manage the risks associated with the data center sales cycle may adversely affect our business, financial condition and results of operations.
Our international activities are subject to special risks different from those faced by us in the United States, and we may not be able to effectively manage our international business.
Our operations are primarily based in the United States with a more limited presence in the United Kingdom and Southeast Asia. Expanding our international operations involves risks not generally associated with investments in the United States, including:
•our limited knowledge of and relationships with sellers, customers, contractors, suppliers or other parties in these markets;
•complexity and costs associated with staffing and managing international development and operations;
•difficulty in hiring qualified management, sales and construction personnel and service providers in a timely fashion;
•problems securing and maintaining the necessary physical and telecommunications infrastructure;
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multiple, conflicting and changing legal, regulatory, entitlement and permitting, and tax and treaty environments with which we have limited familiarity;
•exposure to increased taxation, confiscation or expropriation;
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fluctuations in foreign currency exchange rates, currency transfer restrictions and limitations on our ability to distribute cash earned in foreign jurisdictions to the United States;
•longer payment cycles and problems collecting accounts receivable;
•laws and regulations on content distributed over the Internet that are more restrictive than those in the United States;
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difficulty in enforcing agreements in non-U.S. jurisdictions, including those entered into in connection with our acquisitions or in the event of a default by one or more of our customers, suppliers or contractors;
•political and economic instability, including sovereign credit risk, in certain geographic regions; and
•exposure to restrictive foreign labor law practices.
Our inability to overcome these risks could adversely affect our foreign operations and growth prospects and could harm our business, financial condition and results of operations.
We may be unable to identify and complete acquisitions and successfully operate acquired properties.
We continually evaluate the market for available properties and may acquire data centers or properties suited for data center development when opportunities exist. For example, on February 6, 2017, we announced our entry into a definitive agreement to acquire two data centers located in Raleigh-Durham, North Carolina and Somerset, New Jersey. Our ability to complete the acquisitions of such properties, or any other acquisitions, on favorable terms and to successfully develop and operate acquired properties involves significant risks, including:
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we may be unable to acquire a desired property because of competition from other data center companies or real estate investors with more capital;
•
even if we are able to acquire a desired property, competition from other potential acquirers may significantly increase the purchase price of such property;
•we may be unable to realize the intended benefits from acquisitions or achieve anticipated operating or financial results;
•we may be unable to finance the acquisition on favorable terms or at all;
•we may underestimate the costs to make necessary improvements to acquired properties;
•
we may be unable to quickly and efficiently integrate new acquisitions into our existing operations resulting in disruptions to our operations or the diversion of our management’s attention;
•acquired properties may be subject to reassessment, which may result in higher than expected tax payments;
•we may not be able to access sufficient power on favorable terms or at all;
•market conditions may result in higher than expected vacancy rates and lower than expected rental rates; and
•we may face challenges in retaining the customers of acquired properties.
Many of these risks will be outside of our control and any one of them could result in increased costs, decreases in the amount of expected revenue, and diversion of our management's time and energy, which could adversely affect our business, financial condition and results of operations. In addition, even if we successfully operate acquired properties, we may not realize the full benefits of the acquisition, including the synergies, operating efficiencies, or sales or growth opportunities that are expected. If we are unable to successfully acquire, develop and operate data center properties, our ability to grow our business and compete will be significantly impaired, which could adversely affect our business, financial condition and results of operations.
Our customers may choose to develop or relocate into new data centers or expand their own existing data centers, which could result in the loss of one or more key customers or reduce demand for our newly developed data centers.
In the future, our customers may choose to develop or relocate to new data centers or expand or consolidate into their existing data centers that we do not own. In the event that any of our key customers were to do so, it could result in a loss of business to us or put pressure on our pricing. If we lose a customer, we cannot provide assurance that we would be able to replace that customer at a competitive rate or at all, which could adversely affect our business, financial condition and results of operations.
A decrease in the demand for data center space could adversely affect our business, financial condition and results of operations.
Our portfolio of properties consists primarily of data center space. The adverse effect on our business, financial condition and results of operations from a decreased demand for data center space would likely be greater than if we owned a portfolio with a more diversified customer base or less specialized use. Adverse developments in the outsourced data center space industry could lead to reduced corporate IT spending or reduced demand for outsourced data center space. Changes in industry practice or in technology, such as server virtualization technology, more efficient or miniaturization of computing or networking devices, or devices that require higher power densities than today’s devices, could also reduce demand for the physical data center space we provide or make the customer improvements in our facilities obsolete or in need of significant upgrades to remain viable.
We may have difficulty managing our growth.
We have significantly and rapidly expanded the size of our Company. For example, we increased our footprint by 32% from approximately 2,954,000 NRSF at the end of 2015 to approximately 3,904,000 NRSF by December 31, 2016. Our growth may significantly strain our management, operational and financial resources and systems. An inability to manage our growth effectively or the increased strain on our management, our resources and systems could materially adversely affect our business, financial condition and results of operations.
To fund our growth strategy and refinance our indebtedness, we depend on external sources of capital, which may not be available to us on commercially reasonable terms or at all.
In order to maintain our qualification as a REIT, we are required under the Code, among other things, to distribute at least 90% of our REIT taxable income annually, determined without regard to the dividends paid deduction and excluding any net capital gains. Even if we maintain our qualification as a REIT, we will be subject to U.S. federal income tax at regular corporate rates to the extent that we distribute less than 100% of our REIT taxable income, determined without regard to the dividends paid deduction
and including any net capital gains, as well as U.S. federal income tax at regular corporate rates for income recognized by our taxable REIT subsidiaries (TRS). Because of these distribution requirements, we will likely not be able to fund future capital needs, including any necessary acquisition financing, from operating cash flow. Consequently, we intend to rely on third-party capital markets sources for debt or equity financing to fund our growth strategy. In addition, we may need third-party capital markets sources to refinance our indebtedness at maturity. Continued or increased turbulence in the U.S., European and other international financial markets and economies and tighter credit conditions may adversely affect our ability to replace or renew maturing liabilities on a timely basis, access the capital markets to meet liquidity and capital expenditure requirements and may result in adverse effects on our business, financial condition and results of operations. As such, we may not be able to obtain the financing on favorable terms or at all. Our access to third-party sources of capital also depends, in part, on:
•the market’s perception of our growth potential;
•our then-current debt levels;
•our historical and expected future earnings, cash flow and cash distributions;
•the market price per share of our common stock; and
•our lenders' ability to meet their financing commitments.
In addition, our ability to access additional capital may be limited by the terms of our then-existing indebtedness which may restrict our incurrence of additional debt. If we cannot obtain capital when needed, we may not be able to acquire or develop properties when strategic opportunities arise or refinance our debt at maturity, and we may need to increase our liquidity by disposing of properties possibly on disadvantageous terms or renewing leases on less favorable terms than we otherwise would, which could adversely affect our business, financial condition and results of operations.
Our level of indebtedness and debt service obligations could have adverse effects on our business.
As of December 31, 2016, we had a total combined indebtedness, including capital lease obligations, of approximately $1,250.9 million and lease financing arrangements of $135.7 million. We also currently have the ability to borrow up to an additional $757.9 million under our Revolving Credit Facility, net of outstanding letters of credit of approximately $7.1 million, subject to satisfying certain financial tests. Our Second Amended and Restated Credit Agreement also contains an accordion feature that, as of December 31, 2016, allows the operating partnership to request an increase in the total commitment by up to $300.0 million. There are no limits on the amount of indebtedness we may incur other than limits contained in the 6.375% senior notes indenture, our Second Amended and Restated Credit Agreement or future agreements that we may enter into. A substantial level of indebtedness could have adverse consequences for our business, financial condition and results of operations because it could, among other things:
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require us to dedicate a substantial portion of our cash flow from operations to make principal and interest payments on our indebtedness, thereby reducing our cash flow available to fund working capital, capital expenditures and other general corporate purposes, including to make distributions on our common stock as currently contemplated or as necessary to maintain our qualification as a REIT;
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require us to maintain certain debt coverage and other financial metrics at specified levels, thereby reducing our financial flexibility;
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make it more difficult for us to satisfy our financial obligations, including borrowings under the Second Amended and Restated Credit Agreement;
•increase our vulnerability to general adverse economic and industry conditions;
•expose us to increases in interest rates for our variable rate debt;
•limit our ability to borrow additional funds on favorable terms or at all to expand our business or ease liquidity constraints;
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limit our ability to refinance all or a portion of our indebtedness on or before maturity on the same or more favorable terms or at all;
•limit our flexibility in planning for, or reacting to, changes in our business and our industry;
•place us at a competitive disadvantage relative to competitors that have less indebtedness;
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increase our risk of property losses as the result of foreclosure actions initiated by lenders in the event we should incur mortgage or other secured debt obligations; and
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require us to dispose of one or more of our properties at disadvantageous prices or raise equity that may dilute the value of our common stock in order to service our indebtedness or to raise funds to pay such indebtedness at maturity.
The agreements governing our indebtedness place restrictions on us and our subsidiaries, reducing operational flexibility and creating default risks.
The agreements governing our indebtedness contain covenants that place restrictions on us and our subsidiaries. These covenants restrict, among other things, our and our subsidiaries’ ability to:
•merge, consolidate or transfer all, or substantially all, of our or our subsidiaries’ assets;
•incur additional debt or issue preferred stock;
•make certain investments or acquisitions;
•create liens on our or our subsidiaries’ assets;
•sell assets;
•make capital expenditures;
•make distributions on or repurchase our stock;
•enter into transactions with affiliates;
•issue or sell stock of our subsidiaries; and
•change the nature of our business.
These covenants could impair our ability to grow our business, take advantage of attractive business opportunities or successfully compete. In addition, our Second Amended and Restated Credit Agreement requires us to maintain specified financial ratios and satisfy financial condition tests. The indenture governing our 6.375% senior notes also requires our operating partnership and its subsidiaries to maintain total unencumbered assets of at least 150% of their unsecured debt on a consolidated basis. Our ability to comply with these ratios or tests may be affected by events beyond our control, including prevailing economic, financial and industry conditions. A breach of any of these covenants or covenants under any other agreements governing our indebtedness could result in an event of default. Cross-default provisions in our debt agreements could cause an event of default under one debt agreement to trigger an event of default under our other debt agreements. Upon the occurrence of an event of default under any of our debt agreements, the lenders or holders thereof could elect to declare all outstanding debt under such agreements to be immediately due and payable. If we were unable to repay or refinance the accelerated debt, the lenders or holders, as applicable, could proceed against any assets pledged to secure that debt, including foreclosing on or requiring the sale of our data centers, and our assets may not be sufficient to repay such debt in full.
We may become subject to litigation or threatened litigation which may divert management time and attention, require us to pay damages and expenses or restrict the operation of our business.
We may become subject to disputes with commercial parties with whom we maintain relationships or other parties with whom we do business, including as a result of any breach in our security systems or downtime in our critical electrical and cooling systems. Any such dispute could result in litigation between us and the other parties. Whether or not any dispute actually proceeds to litigation, we may be required to devote significant management time and attention to its resolution (through litigation, settlement or otherwise), which would detract from our management’s ability to focus on our business. Any such resolution could involve the payment of damages or expenses by us, which may be significant. In addition, any such resolution could involve our agreement with terms that restrict the operation of our business.
We could incur significant costs related to environmental matters.
We are subject to laws and regulations relating to the protection of the environment, including those governing the management and disposal of hazardous materials, the cleanup of contaminated sites and health and safety matters. We could incur significant costs, including fines, penalties and other sanctions, cleanup costs and third-party claims for property damages or personal injuries, as a result of violations of or liabilities under environmental laws and regulations. Some environmental laws impose liability on current owners or operators of property regardless of fault or the lawfulness of past disposal activities. For example, many of our sites contain above ground fuel storage tanks and, in some cases, currently contain or formerly contained underground fuel storage tanks, for back-up generator use. Some of our sites also have a history of previous commercial operations. We also may acquire or develop sites in the future with unknown environmental conditions from historical operations. Although we are not aware of any sites at which we currently have material remedial obligations, the imposition of remedial obligations as a result of spills or the discovery of contaminants in the future could result in significant additional costs. We also could incur significant costs complying with current environmental laws or regulations or those that are promulgated in the future.
We may incur significant costs complying with the Americans with Disabilities Act, or ADA, and similar laws, which
could materially adversely affect our financial condition and operating results.
Under the ADA, all places of public accommodation must meet federal requirements related to access and use by disabled persons. A number of additional federal, state and local laws may also require modifications to our properties. We have not conducted an audit or investigation of all of our properties to determine our compliance with the ADA. If one of our properties is not in compliance with the ADA, we would be required to incur additional costs to bring the property into compliance. Additional federal, state and local laws may require modifications to our properties, or restrict our ability to renovate our properties. We cannot predict the ultimate amount of the cost of compliance with the ADA or other legislation. If we incur substantial costs to comply with the ADA and any other similar legislation, our financial condition and results of operations could be materially adversely affected.
We may be adversely affected by regulations related to climate change.
If we, or other companies with which we do business, become subject to existing or future laws and regulations related to climate change, our business could be impacted adversely. For example, in the normal course of business, we enter into agreements with providers of electric power for our data centers, and the costs of electric power comprise a significant component of our operating expenses. Changes in regulations that affect electric power providers, such as regulations related to the control of greenhouse gas emissions or other climate change related matters, could adversely affect the costs of electric power and increase our operating costs and may adversely affect our business, financial condition and results of operations or those of our customers.
We may be subject to unknown or contingent liabilities related to properties or businesses that we acquire for which we may have limited or no recourse against the sellers.
Assets and entities that we have acquired or may acquire in the future, including the properties contributed to us by CBI, may be subject to unknown or contingent liabilities for which we may have limited or no recourse against the sellers. Unknown or contingent liabilities might include liabilities for clean-up or remediation of environmental conditions, claims of customers, vendors or other persons dealing with the acquired entities, tax liabilities and other liabilities whether incurred in the ordinary course of business or otherwise. In the future, we may enter into transactions with limited representations and warranties or with representations and warranties that do not survive the closing of the transactions, in which event we would have no or limited recourse against the sellers of such properties. While we usually require the sellers to indemnify us with respect to breaches of representations and warranties that survive, such indemnification is often limited and subject to various materiality thresholds, a significant deductible, an aggregate cap on losses or a survival period.
As a result, there is no guarantee that we will recover any amounts with respect to losses due to breaches by the sellers of their representations and warranties. In addition, the total amount of costs and expenses that we may incur with respect to liabilities associated with acquired properties and entities may exceed our expectations, which may adversely affect our business, financial condition and results of operations. Finally, indemnification agreements between us and the sellers typically provide that the sellers will retain certain specified liabilities relating to the assets and entities acquired by us. While the sellers are generally contractually obligated to pay all losses and other expenses relating to such retained liabilities, there can be no guarantee that such arrangements will not require us to incur losses or other expenses as well.
We have limited operating history as a REIT and as an independent public company, and our inexperience may impede our ability to successfully manage our business or implement effective internal controls.
We have limited operating history as a REIT and as a public company. While we formerly operated as a subsidiary of a public company, and key members of our management team have served in leadership roles of other REITS and other public companies, we have limited operating history as a REIT and as an independent public company. We cannot assure you that our past experience will be sufficient to successfully operate our company as a REIT or an independent public company. We are required to maintain substantial control systems and procedures in order to continue to qualify as a REIT, satisfy our periodic and current reporting requirements under applicable SEC regulations and comply with the Sarbanes-Oxley Act of 2002 (Sarbanes-Oxley Act), the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 and NASDAQ Global Select Market listing standards. As a result, our management and other personnel need to devote a substantial amount of time to comply with these rules and regulations and establish and maintain the corporate infrastructure and controls demanded of a publicly traded REIT.
An inability to maintain effective disclosure controls and procedures and internal control over financial reporting or to remediate deficiencies could cause us to fail to meet our reporting obligations under the Securities Exchange Act of 1934, as amended (Exchange Act), or result in material weaknesses, material misstatements or omissions in our Exchange Act reports, any of which could cause investors to lose confidence in our Company and could adversely affect our business, financial condition and results of operations.
The failure to successfully implement changes to our information technology system could adversely affect our business.
From time to time, we make changes to our information technology system to meet our business and financial reporting needs. Transitioning to new or upgraded systems can create difficulties, including potential disruption to our financial reporting data, security vulnerabilities and decreases in productivity until personnel become familiar with new systems. In addition, our management information systems will require modification and refinement as we grow and as our business needs change, which could prolong difficulties we experience with systems transitions, and we may not always employ the most effective systems for our purposes. If we experience difficulties in implementing new or upgraded information systems or experience significant system failures, or if we are unable to successfully modify our management information systems and respond to changes in our business needs, our operating results could be harmed or we may fail to meet our reporting obligations.
We face significant competition and may be unable to lease vacant space, renew existing leases or re-lease space as leases expire, which may adversely affect our business, financial condition and results of operations.
We compete with numerous developers, owners and operators of technology-related real estate and data centers, many of which own properties similar to ours in the same markets, as well as various other public and privately held companies that may provide data center colocation as part of a more expansive managed services offering, and local developers. In addition, we may face competition from new entrants into the data center market. Some of our competitors may have significant advantages over us, including greater name recognition, longer operating histories, lower operating costs, pre-existing relationships with current or potential customers, greater financial, marketing and other resources, and access to less expensive power. These advantages could allow our competitors to respond more quickly to strategic opportunities or changes in our industries or markets. If our competitors offer data center space that our existing or potential customers perceive to be superior to ours based on numerous factors, including power, security considerations, location or network connectivity, or if they offer rental rates below our or current market rates, we may lose existing or potential customers, incur costs to improve our properties or be forced to reduce our rental rates.
The loss of any of our key personnel, including our executive officers or key sales associates, could adversely affect our business, financial condition and results of operations.
Our success will continue to depend to a significant extent on our executive officers and key sales associates. Each of our executive officers has a national or regional industry reputation that attracts business and investment opportunities and assists us in negotiations with lenders, existing and potential customers and industry personnel. The loss of key sales associates could hinder our ability to continue to benefit from existing and potential customers. We cannot provide any assurance that we will be able to retain our current executive officers or key sales associates. The loss of any of these individuals could adversely affect our business, financial condition and results of operations.
We have experienced a change in our senior management team in the past year. We appointed a new Chief Financial Officer in November 2016. Changes in senior management are inherently disruptive and may have a materially adverse impact on our business, financial condition and results of operations. We may experience operational disruptions and inefficiencies during the transition.
Our data center infrastructure may become obsolete, and we may not be able to upgrade our power and cooling systems cost-effectively, or at all.
The markets for the data centers we own and operate, as well as the industries in which our customers operate, are characterized by rapidly changing technology, evolving industry standards, frequent new service introductions, shifting distribution channels and changing customer demands. Our data center infrastructure may become obsolete due to the development of new systems to deliver power to or eliminate heat from the servers that we house. Additionally, our data center infrastructure could become obsolete as a result of the development of new server technology that does not require the levels of critical load and heat removal that our facilities are designed to provide and could be run less expensively on a different platform. In addition, our power and cooling systems are difficult and expensive to upgrade. Accordingly, we may not be able to efficiently upgrade or change these systems to meet new demands without incurring significant costs that we may not be able to pass on to our customers. The obsolescence of our power and cooling systems could have a material negative impact on our business, financial condition and results of operations. Furthermore, potential future regulations that apply to industries we serve may require customers in those industries to seek specific requirements from their data centers that we are unable to provide. These may include physical security requirements applicable to the defense industry and government contractors and privacy and security regulations applicable to the financial services and health care industries. If such regulations were adopted, we could lose some customers or be unable to attract new customers in certain industries, which would have a material adverse effect on our results of operations.
Declining real estate valuations and impairment charges could adversely affect our earnings and financial condition.
We review each of our properties for indicators that its carrying amount may not be recoverable. Examples of such indicators may include a significant decrease in market price, a significant adverse change in the extent to or manner in which the property is being used or in its physical condition, an accumulation of costs significantly in excess of the amount originally expected for the acquisition or development, or a history of operating or cash flow losses. When such impairment indicators exist, we review an estimate of the future undiscounted net cash flows (excluding interest charges) expected to result from the real estate investment’s use and eventual disposition and compare it to the carrying value of the property. We consider factors such as future operating income, trends and prospects, as well as the effects of leasing demand, competition and other factors. If our future undiscounted net cash flow evaluation indicates that we are unable to recover the carrying value of a real estate investment, an impairment loss is recorded to the extent that the carrying value exceeds the estimated fair value of the property. For example, we recorded an impairment of $5.3 million related primarily to two properties for the year ended December 31, 2016. These losses have a direct impact on our net income because recording an impairment loss results in an immediate negative adjustment to net income. The evaluation of anticipated cash flows is highly subjective and is based in part on assumptions regarding future occupancy, rental rates and capital requirements that could differ materially from actual results in future periods. A worsening real estate market
may cause us to re-evaluate the assumptions used in our impairment analysis. Impairment charges could adversely affect our business, financial condition and results of operations.
Any failure of the National IX Platform could lead to significant costs and disruptions that could reduce our revenue and harm our business reputation and financial results.
We have deployed the National IX Platform throughout several of our properties, and expect that we will further deploy it throughout our portfolio to meet customer demand. The National IX Platform allows our customers to connect to third-party carriers and other customers. We may be required to incur substantial additional costs to operate and expand the National IX Platform. The National IX Platform is subject to failure resulting from numerous factors, including but not limited to:
•human error;
•equipment failure;
•physical, electronic, and cyber-security breaches;
•fire, earthquake, hurricane, flood, tornado and other natural disasters in our facilities;
•failure to properly connect to third-party carriers or other customers;
•fiber cuts;
•power loss;
•terrorist acts;
•sabotage and vandalism; and
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failure of business partners who provide components of the National IX Platform or third-party connectivity from the National IX Platform.
Problems with the National IX Platform, whether or not within our control, could result in service interruptions or significant equipment damage. We have service level commitment obligations to certain of our customers, including our significant customers. As a result, service interruptions in the National IX Platform could result in difficulty maintaining service level commitments to these customers and in potential claims related to such failures. In addition, any loss of service, equipment damage or inability to meet our service level commitment obligations could reduce the confidence of our customers and could consequently impair our ability to obtain and retain customers, which would adversely affect both our ability to generate revenues and our operating results.
Risks Related to the Real Estate Industry
Our performance and value are subject to risks associated with real estate assets and with the real estate industry.
Our ability to make expected distributions to our stockholders depends on our ability to generate revenues in excess of expenses, scheduled principal payments on debt and capital expenditure requirements. Events and conditions generally applicable to owners and operators of real property that are beyond our control may decrease cash available for distribution to our stockholders and the value of our properties. These events include:
•local oversupply, increased competition or reduction in demand for technology-related space;
•inability to collect rent from customers;
•vacancies or our inability to rent space on favorable terms;
•inability to finance property development and acquisitions on favorable terms;
•increased operating costs to the extent not paid for by our customers;
•costs of complying with changes in governmental regulations;
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the relative illiquidity of real estate investments, especially the specialized real estate properties that we hold and seek to acquire and develop; and
•changing market demographics.
Illiquidity of real estate investments, particularly our data centers, could significantly impede our ability to respond to adverse changes in the performance of our properties, which could harm our financial condition.
Because real estate investments are relatively illiquid, our ability to promptly sell one or more properties in our portfolio in response to adverse changes in the real estate market or in the performance of such properties may be limited, thus harming our financial condition. The real estate market is affected by many factors that are beyond our control, including:
•adverse changes in national and local economic and market conditions;
•changes in interest rates and in the availability, cost and terms of debt financing;
•changes in governmental laws and regulations, fiscal policies and zoning ordinances and costs of compliance therewith;
•the ongoing cost of capital improvements that are not passed on to our customers, particularly in older structures;
•changes in operating expenses; and
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civil unrest, acts of war, terrorism and natural disasters, including fires, earthquakes, tropical storms, hurricanes, and floods, which may result in uninsured and underinsured losses.
The risks associated with the illiquidity of real estate investments are even greater for our data center properties. Our data centers are highly specialized real estate assets containing extensive electrical and mechanical systems that are uniquely designed to house and maintain our customers’ equipment, and, as such, have little, if any, traditional office space. As a result, most of our data centers are not suited for use by customers as anything other than as data centers and major renovations and expenditures would be required in order for us to re-lease data center space for more traditional commercial or industrial uses, or for us to sell a property to a buyer for use other than as a data center.
Risks Related to Our Organizational Structure
Our rights and the rights of our stockholders to take action against our directors and officers are limited.
Maryland law provides that a director has no liability in the capacity as a director if he or she performs his or her duties in good faith, in a manner he or she reasonably believes to be in the company’s best interests and with the care that an ordinarily prudent person in a like position would use under similar circumstances. As permitted by the Maryland General Corporation Law (MGCL), our charter limits the liability of our directors and officers to the company and our stockholders for money damages, except for liability resulting from:
•actual receipt of an improper benefit or profit in money, property or services; or
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a final judgment based upon a finding of active and deliberate dishonesty by the director or officer that was material to the cause of action adjudicated.
In addition, our charter authorizes us to obligate the company, and our bylaws require us, to indemnify our directors and officers for actions taken by them in those capacities and to pay or reimburse their reasonable expenses in advance of final disposition of a proceeding to the maximum extent permitted by Maryland law, and we have entered into indemnification agreements with our directors and executive officers. As a result, we and our stockholders may have more limited rights against our directors and officers than might otherwise exist under common law. Accordingly, in the event that any of our directors or officers are exculpated from, or indemnified against, liability but whose actions impede our performance, our stockholders’ ability to recover damages from that director or officer will be limited.
Conflicts of interest exist or could arise in the future with our operating partnership or its partners.
Conflicts of interest exist or could arise in the future as a result of the relationships between us and our affiliates, on the one hand, and our operating partnership or any partner thereof, on the other. Our directors and officers have duties to our company under applicable Maryland law in connection with their direction of the management of our company. At the same time, we, as trustee, have duties to CyrusOne GP, which, in turn, as general partner of our operating partnership, has duties to our operating partnership and to the limited partners under Maryland law in connection with the management of our operating partnership. Under Maryland law, the general partner of a Maryland limited partnership has fiduciary duties of care and loyalty, and an obligation of good faith, to the partnership and its partners. While these duties and obligations cannot be eliminated entirely in the limited partnership agreement, Maryland law permits the parties to a limited partnership agreement to specify certain types or categories of activities that do not violate the general partner’s duty of loyalty and to modify the duty of care and obligation of good faith, so long as such modifications are not unreasonable. These duties as general partner of our operating partnership to the partnership and its partners may come into conflict with the interests of our company. Under the partnership agreement of our operating partnership, the limited partners of our operating partnership expressly agree that the general partner of our operating partnership is acting for the benefit of the operating partnership, the limited partners of our operating partnership and our stockholders, collectively. The general partner is under no obligation to give priority to the separate interests of the limited partners in deciding whether to cause our operating partnership to take or decline to take any actions. If there is a conflict between the interests of us or our stockholders, on the one hand, and the interests of the limited partners of our operating partnership, on the other, the partnership agreement of our operating partnership provides that any action or failure to act by the general partner that gives priority to the separate interests of us or our stockholders that does not result in a violation of the contractual rights of the limited partners of our operating partnership under the partnership agreement will not violate the duties that the general partner owes to our operating partnership and its partners.
Additionally, the partnership agreement of our operating partnership expressly limits our liability by providing that we and our directors, officers, agents and employees will not be liable or accountable to our operating partnership or its partners for money damages. In addition, our operating partnership is required to indemnify us, our directors, officers and employees, the general partner and its trustees, officers and employees, employees of our operating partnership and any other persons whom the general partner may designate from and against any and all claims arising from operations of our operating partnership in which any indemnitee may be involved, or is threatened to be involved, as a party or otherwise unless it is established by a final judgment that the act or omission of the indemnitee constituted fraud, intentional harm or gross negligence on the part of the indemnitee,
the claim is brought by the indemnitee (other than to enforce the indemnitee’s rights to indemnification or advance of expenses) or the indemnitee is found to be liable to our operating partnership, and then only with respect to each such claim.
No reported decision of a Maryland appellate court has interpreted provisions that are similar to the provisions of the partnership agreement of our operating partnership that modify the fiduciary duties of the general partner of our operating partnership, and we have not obtained an opinion of counsel regarding the enforceability of the provisions of the partnership agreement that purport to waive or modify the fiduciary duties and obligations of the general partner of our operating partnership.
Our charter and bylaws and the partnership agreement of our operating partnership contain provisions that may delay, defer or prevent an acquisition of our common stock or a change in control.
Our charter and bylaws contain a number of provisions, the exercise or existence of which could delay, defer or prevent a transaction or a change in control that might involve a premium price for our stockholders or otherwise be in their best interests, including the following:
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Our Charter Contains Restrictions on the Ownership and Transfer of Our Stock. In order for us to qualify as a REIT, no more than 50% of the value of outstanding shares of our stock may be owned, beneficially or constructively, by five or fewer individuals at any time during the last half of each taxable year other than the first year for which we elect to be taxed as a REIT. Subject to certain exceptions, our charter prohibits any stockholder from owning beneficially or constructively more than 9.8% in value or in number of shares, whichever is more restrictive, of the outstanding shares of our common stock, or 9.8% in value of the aggregate of the outstanding shares of all classes or series of our stock. We refer to these restrictions collectively as the “ownership limits.” The constructive ownership rules under the Code are complex and may cause the outstanding stock owned by a group of related individuals or entities to be deemed to be constructively owned by one individual or entity. As a result, the acquisition of less than 9.8% of our outstanding common stock or the outstanding shares of all classes or series of our stock by an individual or entity could cause that individual or entity or another individual or entity to own constructively in excess of the relevant ownership limits. Our charter also prohibits any person from owning shares of our stock that would result in our being “closely held” under Section 856(h) of the Code or otherwise cause us to fail to qualify as a REIT. Any attempt to own or transfer shares of our common stock or of any of our other capital stock in violation of these restrictions may result in the shares being automatically transferred to a charitable trust or may be void. These ownership limits may prevent a third-party from acquiring control of us if our board of directors does not grant an exemption from the ownership limits, even if our stockholders believe the change in control is in their best interests. Although it is under no continuing obligation to do so, our board of directors has granted some limited exemptions from the ownership limits applicable to other holders of our common stock, subject to certain initial and ongoing conditions designed to protect our status as a REIT, including the receipt of an Internal Revenue Service (IRS) private letter ruling or an opinion of counsel from a nationally recognized law firm that the exercise of any such exemption should not cause any rent payable by CBI to jeopardize our REIT status.
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Our Board of Directors Has the Power to Cause Us to Issue Additional Shares of Our Stock Without Stockholder Approval. Our charter authorizes us to issue additional authorized but unissued shares of common or preferred stock. In addition, our board of directors may, without stockholder approval, amend our charter to increase the aggregate number of our shares of stock or the number of shares of stock of any class or series that we have authority to issue and classify or reclassify any unissued shares of common or preferred stock and set the preferences, rights and other terms of the classified or reclassified shares. As a result, our board of directors may establish a series of shares of common or preferred stock that could delay or prevent a transaction or a change in control that might involve a premium price for our shares of common stock or otherwise be in the best interests of our stockholders.
Certain provisions of Maryland law may limit the ability of a third-party to acquire control of us.
Certain provisions of the MGCL may have the effect of inhibiting a third-party from acquiring us or of impeding a change of control under circumstances that otherwise could provide our common stockholders with the opportunity to realize a premium over the then-prevailing market price of such shares, including:
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“business combination” provisions that, subject to limitations, prohibit certain business combinations between an “interested stockholder” (defined generally as any person who beneficially owns 10% or more of the voting power of our outstanding shares of voting stock or an affiliate or associate of the corporation who, at any time within the two-year period immediately prior to the date in question, was the beneficial owner of 10% or more of the voting power of the then outstanding stock of the corporation) or an affiliate of any interested stockholder and us for five years after the most recent date on which the stockholder becomes an interested stockholder, and thereafter imposes two super-majority stockholder voting requirements on these combinations; and
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“control share” provisions that provide that holders of “control shares” of our company (defined as voting shares of stock that, if aggregated with all other shares of stock owned or controlled by the acquirer, would entitle the acquirer to exercise one of three increasing ranges of voting power in electing directors) acquired in a “control share acquisition” (defined as the direct or indirect acquisition of issued and outstanding “control shares”) have no voting rights except to the extent approved by our stockholders by the affirmative vote of at least two-thirds of all of the votes entitled to be cast on the matter, excluding all interested shares.
Pursuant to the Maryland Business Combination Act, our board of directors has by resolution exempted from the provisions of the Maryland Business Combination Act business combinations between any other person and us, provided that such business combination is first approved by our board of directors (including a majority of our directors who are not affiliates or associates of such person). Our bylaws contain a provision exempting from the Maryland Control Share Acquisition Act any and all acquisitions by any person of shares of our stock. There can be no assurance that these exemptions or resolutions will not be amended or eliminated at any time in the future.
Additionally, Title 3, Subtitle 8 of the MGCL permits our board of directors, without stockholder approval and regardless of what is currently provided in our charter or bylaws, to implement certain takeover defenses, such as a classified board, some of which we do not have.
Our bylaws designate the Circuit Court for Baltimore City, Maryland, as the sole and exclusive forum for certain types of actions and proceedings that may be initiated by our stockholders, which could limit our stockholders’ ability to bring a claim in a judicial forum that the stockholders believe is a more favorable judicial forum for disputes with us or our directors, officers or other employees.
Our bylaws provide that, subject to limited exceptions, the Circuit Court for Baltimore City, Maryland, is the sole and exclusive
forum for (a) any derivative action or proceeding brought on our behalf, (b) any action asserting a claim of breach of any duty owed by any of our directors, officers or other employees to us or our stockholders, (c) any action asserting a claim against us or any of our directors, officers or other employees arising pursuant to any provision of the MGCL, our charter or our bylaws or (d) any action asserting a claim against us or any of our directors, officers or other employees that is governed by the internal affairs doctrine. This provision may limit a stockholder’s ability to bring a claim in a judicial forum that it believes is more favorable for disputes against us or our directors, officers or employees, which may discourage such lawsuits against us and our directors, officers and other employees.
Risks Related to Status as a REIT
If we fail to remain qualified as a REIT, we will be subject to U.S. federal income tax as a regular corporation and could face a substantial tax liability, which would reduce the amount of cash available for distribution to our stockholders.
CyrusOne, Inc. has elected to be taxed as a REIT under the Code commencing with our initial taxable year ending December 31, 2013. We intend to continue to operate in a manner that will allow us to remain qualified as a REIT. Our qualification as a REIT depends on our satisfaction of certain asset, income, organizational, distribution, stockholder ownership and other requirements on a continuing basis. Our ability to satisfy the asset tests depends upon our analysis of the characterization and fair market values of our assets, some of which are not susceptible to a precise determination, and for which we do not obtain independent appraisals.
We have received a private letter ruling from the IRS with respect to certain issues relevant to our qualification as a REIT. In general, the ruling provides, subject to the terms and conditions contained therein, that certain structural components of our properties (e.g., relating to the provision of electricity, heating, ventilation and air conditioning, regulation of humidity, security and fire protection, and telecommunications services) and intangible assets, and certain services that we or CBI may provide, directly or through subsidiaries, to our tenants, will not adversely affect our qualification as a REIT. Although we may generally rely upon the ruling, no assurance can be given that the IRS will not challenge our qualification as a REIT on the basis of other issues or facts outside the scope of the ruling.
If we were to fail to qualify as a REIT in any taxable year, we would be subject to U.S. federal income tax, including any applicable alternative minimum tax, on our taxable income at regular corporate rates, and dividends paid to our stockholders would not be deductible by us in computing our taxable income. Any resulting corporate tax liability could be substantial and would reduce the amount of cash available for distribution to our stockholders, which in turn could have an adverse impact on the value of our common stock. Unless we were entitled to relief under certain Code provisions, we would also be disqualified from re-electing to be taxed as a REIT for the four taxable years following the year in which we failed to qualify as a REIT.
Qualifying as a REIT involves highly technical and complex provisions of the Code.
Qualification as a REIT involves the application of highly technical and complex Code provisions for which only limited judicial and administrative authorities exist. Even a technical or inadvertent violation could jeopardize our REIT qualification. Our continued qualification as a REIT will depend on our satisfaction of certain asset, income, organizational, distribution, stockholder ownership and other requirements on a continuing basis. In addition, our ability to satisfy the requirements to qualify as a REIT may depend in part on the actions of third parties over which we have no control or only limited influence, including in cases where we own an equity interest in an entity that is classified as a partnership for U.S. federal income tax purposes.
Dividends payable by REITs do not qualify for the reduced tax rates available for some dividends.
Income from “qualified dividends” payable to U.S. stockholders that are individuals, trusts and estates is generally subject to tax at preferential rates. Dividends payable by REITs, however, generally are not eligible for the preferential rates. Although these rules do not adversely affect the taxation of REITs, the more favorable rates applicable to regular corporate qualified dividends could cause investors who are individuals, trusts and estates to perceive investments in REITs to be relatively less attractive than investments in the stocks of non-REIT corporations that pay dividends, which could adversely affect the value of the stock of REITs, including our common stock.
REIT distribution requirements could adversely affect our ability to execute our business plan.
We generally must distribute annually at least 90% of our REIT taxable income, determined without regard to the dividends paid deduction and excluding any net capital gains, in order for us to qualify as a REIT (assuming that certain other requirements are also satisfied) so that U.S. federal corporate income tax does not apply to earnings that we distribute. To the extent that we satisfy this distribution requirement and qualify for taxation as a REIT but distribute less than 100% of our REIT taxable income, determined without regard to the dividends paid deduction and including any net capital gains, we will be subject to U.S. federal corporate income tax on our undistributed net taxable income. In addition, we will be subject to a 4% nondeductible excise tax if the actual amount that we distribute to our stockholders in a calendar year is less than a minimum amount specified under U.S. federal tax laws. We intend to make distributions to our stockholders to comply with the REIT requirements of the Code.
From time to time, we may generate taxable income greater than our cash flow as a result of differences in timing between the recognition of taxable income and the actual receipt of cash or the effect of nondeductible capital expenditures, the creation of reserves or required debt or amortization payments. If we do not have other funds available in these situations, we could be required to borrow funds on unfavorable terms, sell assets at disadvantageous prices or distribute amounts that would otherwise be invested in future acquisitions to make distributions sufficient to enable us to pay out enough of our taxable income to satisfy the REIT distribution requirement and to avoid corporate income tax and the 4% excise tax in a particular year. These alternatives could increase our costs or reduce our equity. Thus, compliance with the REIT requirements may hinder our ability to grow, which could adversely affect the value of our common stock.
Even if we remain qualified as a REIT, we may face other tax liabilities that reduce our cash flow.
Even if we remain qualified for taxation as a REIT, we may be subject to certain U.S. federal, state and local taxes on our income and assets, including taxes on any undistributed income and state or local income, property and transfer taxes. For example, in order to meet the REIT qualification requirements, we may hold some of our assets or conduct certain of our activities through one or more TRS or other subsidiary corporations that will be subject to federal, state, and local corporate-level income taxes as regular C corporations. In addition, we may incur a 100% excise tax on transactions with a TRS if they are not conducted on an arm’s length basis. Any of these taxes would decrease cash available for distribution to our stockholders.
Complying with REIT requirements may cause us to liquidate or forgo otherwise attractive opportunities.
To qualify as a REIT, we must ensure that, at the end of each calendar quarter, at least 75% of the value of our assets consists of cash, cash items, government securities and “real estate assets” (as defined in the Code), including certain mortgage loans and securities. The remainder of our investments (other than government securities, qualified real estate assets and securities issued by a TRS) generally cannot include more than 10% of the outstanding voting securities of any one issuer or more than 10% of the total value of the outstanding securities of any one issuer. In addition, in general, no more than 5% of the value of our total assets (other than government securities, qualified real estate assets and securities issued by a TRS) can consist of the securities of any one issuer, and no more than 25% of the value of our total assets can be represented by securities of one or more TRS. If we fail to comply with these requirements at the end of any calendar quarter, we must correct the failure within 30 days after the end of the calendar quarter or qualify for certain statutory relief provisions to avoid losing our REIT qualification and suffering adverse tax consequences. As a result, we may be required to liquidate or forgo otherwise attractive investments. These actions could have the effect of reducing our income and amounts available for distribution to our stockholders.
In addition to the asset tests set forth above, to continue to qualify as a REIT we must continually satisfy tests concerning, among other things, the sources of our income, the amounts we distribute to our stockholders and the ownership of our stock. We may
be unable to pursue investments that would be otherwise advantageous to us in order to satisfy the source-of-income or asset-diversification requirements for qualifying as a REIT. Thus, compliance with the REIT requirements may hinder our ability to make certain attractive investments.
Complying with REIT requirements may limit our ability to hedge effectively and may cause us to incur tax liabilities.
The REIT provisions of the Code substantially limit our ability to hedge our assets and liabilities. Any income from a hedging transaction that we enter into to manage risk of interest rate changes with respect to borrowings made or to be made to acquire or carry real estate assets does not constitute “gross income” for purposes of the 75% or 95% gross income tests that apply to REITs, provided that certain identification requirements are met. To the extent that we enter into other types of hedging transactions or fail to properly identify such transaction as a hedge, the income is likely to be treated as non-qualifying income for purposes of both of the gross income tests. As a result of these rules, we may be required to limit our use of advantageous hedging techniques or implement those hedges through a TRS. This could increase the cost of our hedging activities because our TRS may be subject to tax on gains or expose us to greater risks associated with changes in interest rates than we would otherwise want to bear. In addition, losses in our TRS will generally not provide any tax benefit, except that such losses could theoretically be carried back or forward against past or future taxable income in the TRS.
Legislative or other actions affecting REITs could have a negative effect on us.
The rules dealing with U.S. federal income taxation are constantly under review by persons involved in the legislative process and by the IRS and the U.S. Department of the Treasury (Treasury). Changes to the tax laws or interpretations thereof, with or without retroactive application, could materially and adversely affect our investors or us. We cannot predict how changes in the tax laws might affect our investors or us. New legislation, Treasury regulations, administrative interpretations or court decisions could significantly and negatively affect our ability to qualify as a REIT or the U.S. federal income tax consequences to our investors and us of such qualification.
Risks Related to our Debt and Equity Securities
Our cash available for distribution to stockholders may not be sufficient to make distributions at expected levels, and we may need to borrow in order to make such distributions; consequently, we may not be able to make such distributions in full.
If cash available for distribution generated by our assets is less than our estimate or if such cash available for distribution decreases in future periods from expected levels, our inability to make the expected distributions could result in a decrease in the market price of our common stock. Distributions made by us will be authorized and determined by our board of directors in its sole discretion out of funds legally available therefor and will be dependent upon a number of factors, including restrictions under applicable law and our capital requirements. We may not be able to make or sustain distributions in the future. To the extent that we decide to make distributions in excess of our current and accumulated earnings and profits, such distributions would generally be considered a return of capital for U.S. federal income tax purposes to the extent of the holder’s adjusted tax basis in its shares. A return of capital is not taxable, but it has the effect of reducing the holder’s adjusted tax basis in its investment. To the extent that distributions exceed the adjusted tax basis of a holder’s shares, they will be treated as gain from the sale or exchange of such stock. If we borrow to fund distributions, our future interest costs would increase, thereby reducing our earnings and cash available for distribution from what they otherwise would have been.
Future offerings of debt, which would be senior to our common stock upon liquidation, and/or preferred equity securities, which may be senior to our common stock for purposes of distributions or upon liquidation, may adversely affect the market price of our common stock.
In the future, we may attempt to increase our capital resources by making additional offerings of debt or preferred equity securities, including medium-term notes, trust preferred securities, senior or subordinated notes and preferred stock. Upon liquidation, holders of our debt securities and shares of preferred stock and lenders with respect to other borrowings will receive distributions of our available assets prior to the holders of our common stock. Additional equity offerings may dilute the holdings of our existing stockholders or reduce the market price of our common stock, or both. Holders of our common stock are not entitled to preemptive rights or other protections against dilution. Our preferred stock, if issued, could have a preference on liquidating distributions or a preference on distribution payments that could limit our ability to make a distribution to the holders of our common stock. Because our decision to issue securities in any future offering will depend on market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing or nature of our future offerings. Thus, our stockholders bear the risk of our future offerings reducing the market price of our common stock and diluting their stock holdings in us.
Increases in market interest rates may cause potential investors to seek higher dividend yields and therefore reduce demand for our common stock and result in a decline in our stock price.
One of the factors that may influence the price of our common stock is the dividend yield on our common stock (the amount of dividends as a percentage of the price of our common stock) relative to market interest rates. An increase in market interest rates, which are currently at low levels relative to historical rates, may lead prospective purchasers of our common stock to expect a higher dividend yield, which we may be unable or choose not to provide. Higher interest rates would likely increase our borrowing costs and potentially decrease the cash available for distribution. Thus, higher market interest rates could cause the market price of our common stock to decline.
The number of shares available for future sale could adversely affect the market price of our common stock.
We cannot predict whether future issuances of shares of our common stock or the availability of shares of our common stock for resale in the open market will decrease the market price per share of our common stock. Sales of a substantial number of shares of our common stock in the public market, or the perception that such sales might occur, could adversely affect the market price of the shares of our common stock. In addition, upon physical settlement of the Forward Sale Agreements, we will issue approximately 4.4 million shares of our common stock. Physical settlement of the Forward Sale Agreements will result in dilution to our earnings per share. We have registered shares of common stock that were reserved for issuance under our Restated 2012 Long Term Incentive Plan and under our 2014 Employee Stock Purchase Plan, and they can generally be freely sold in the public market, assuming any applicable restrictions and vesting requirements are satisfied. If any or all of these holders cause a large number of their shares to be sold in the public market, the sales could reduce the trading price of our common stock and could impede our ability to raise future capital on terms acceptable to us or at all. In addition, upon physical settlement of the Forward Sale Agreements, which is expected to occur on February 27, 2017, we will issue approximately 4.4 million shares of our common stock. Physical settlement of the Forward Sale Agreements will result in dilution to our earnings per share.
The market price and trading volume of our common stock may be volatile.
The market price of our common stock may be volatile. In addition, the trading volume in our common stock may fluctuate and cause significant price variations to occur. If the market price of our common stock declines significantly, a holder may be unable to resell shares at a profit or at all. We cannot provide any assurance that the market price of our common stock will not fluctuate or decline significantly in the future.
Some of the factors that could negatively affect the market price of our common stock or result in fluctuations in the price or trading volume of our common stock include:
•actual or anticipated variations in our quarterly results of operations or distributions;
•changes in our funds from operations or earnings estimates;
•publication of research reports about us or the real estate, technology or data center industries;
•increases in market interest rates that may cause purchasers of our shares to demand a higher yield;
•changes in market valuations of similar companies;
•adverse market reaction to any additional debt we may incur in the future;
•additions or departures of key personnel;
•actions by institutional stockholders;
•speculation in the press or investment community about our company or industry or the economy in general;
•the occurrence of any of the other risk factors presented in this Annual Report on Form 10-K; and
•general market and economic conditions.
Our earnings and cash distributions will affect the market price of shares of our common stock.
To the extent that the market value of a REIT’s equity securities is based primarily upon market perception of the REIT’s growth potential and its current and potential future cash distributions, whether from operations, sales, acquisitions, development or refinancing and is secondarily based upon the value of the underlying assets, shares of our common stock may trade at prices that are higher or lower than the net asset value per share. To the extent we retain operating cash flow for investment purposes, working capital reserves or other purposes rather than distributing the cash flow to stockholders, these retained funds, while increasing the value of our underlying assets, may negatively impact the market price of our common stock. Our failure to meet market expectations with regard to future earnings and cash distributions would likely adversely affect the market price of our common stock.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2.
ITEM 2. PROPERTIES
The information set forth under the caption “Our Portfolio” in Item 1 of this Annual Report on Form 10-K is incorporated by reference herein.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
In the ordinary course of our business, from time to time, we are subject to claims and administrative proceedings. We do not believe any currently outstanding matters would have, individually or in the aggregate, a material effect on our business, financial condition and results of operations or liquidity and cash flows.
ITEM 4.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
Part II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASE OF EQUITY SECURITIES.
A)Market Information
Our common stock is listed on the NASDAQ Global Select Market under the symbol “CONE”. The following table sets forth the high and low sales price of our common stock and the distributions we declared with respect to the periods indicated.
B)Holders
As of February 21, 2017, CyrusOne Inc. had 83,441,227 outstanding shares.
C)Distribution Policy
We have made distributions in the form of dividends each quarter since the completion of our IPO as shown in the chart above. In order to comply with the REIT requirements of the Code, we plan to continue to make quarterly distributions to our shareholders of at least 90% of our taxable income. Distributions made by us will be authorized and determined by our board of directors in its sole discretion out of funds legally available therefore and will be dependent upon a number of factors, including restrictions under applicable law and other factors. If we have underestimated our cash available for distribution, we may need to increase our borrowings in order to fund our intended distributions. Notwithstanding the foregoing, our Second Amended and Restated Credit Agreement and indenture restrict CyrusOne LP from making distributions to holders of its operating partnership units, or redeeming or otherwise repurchasing shares of its operating partnership units, after the occurrence and during the continuance of an event of default, except in limited circumstances including as necessary to enable CyrusOne Inc. to maintain its qualification as a REIT and to minimize the payment of income taxes.
D)Recent Sales of Unregistered Securities
None.
E) Stock Performance
The following graph compares the cumulative total stockholder return on CyrusOne Inc.’s common stock for the year ended December 31, 2016, with the cumulative total return on the S&P 500 Market Index and the MSCI US REIT Index (RMZ). The comparison assumes that $100 was invested on January 17, 2013, the date of the Company's IPO, in CyrusOne Inc.’s common stock and in each of these indices and assumes reinvestment of dividends, if any.
F) Issuer Purchases of Equity Securities
None.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected financial and operating data on a consolidated and combined historical basis.
Our business was originally comprised of the historical data center activities and holdings of CBI. CBI operated a Cincinnati-based data center business for 10 years before acquiring Cyrus Networks LLC, a data center operator in Texas. In anticipation of our IPO, these businesses were combined under our operating partnership, CyrusOne LP, which was created as a Maryland limited partnership on July 31, 2012. CyrusOne Inc., a Maryland corporation, was also formed on July 31, 2012, and is the parent of the wholly owned general partner of the operating partnership. Effective December 31, 2013, CyrusOne Inc. qualified as a real estate investment trust for federal income tax purposes. Certain activities are conducted through our taxable REIT subsidiary, CyrusOne TRS Inc., a Delaware corporation.
The financial information presented below as of December 31, 2016 and 2015, for the years ended December 31, 2016, December 31, 2015 and December 31, 2014 has been derived from our audited consolidated financial statements included elsewhere in the Form 10-K. The financial information for the periods ended January 23, 2013 (January 1, 2013 to January 23, 2013) and December 31, 2013 (January 24, 2013 to December 31, 2013) has been derived from our audited consolidated and combined financial statements not included in this Form 10-K. The historical financial information as of December 31, 2013 and 2012, and for the year ended December 31, 2012, has been derived from CBI's combined financial statements not included in this Form 10-K and are presented as the Predecessor in the financial information.
You should read the following selected financial data in conjunction with our combined historical financial statements and the related notes and with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” which are included elsewhere in this Form 10-K.
(a)
Represents a restructuring charge recognized in 2013 as a result of moving certain administrative functions to the Company's corporate office.
(b)
Represents legal, accounting and consulting fees incurred in connection with the formation transactions, our qualification as a REIT and completed and potential business combinations, integration of acquisitions, failed transactions and costs of secondary offerings.
(c)
Represents management fees charged by CBI for services it provided to the Predecessor including executive management, legal, treasury, human resources, accounting, tax, internal audit and IT services.
(d)
Represents the sale by the Predecessor of most of its trade and other accounts receivable to Cincinnati Bell Funding LLC (CBF), a bankruptcy-remote subsidiary of CBI, at a 2.5% discount to the receivables’ face value. Effective October 1, 2012, we terminated our participation in this program.
(e)
See Item 7
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
You should read the following discussion and analysis of our results of operations, financial condition and liquidity in conjunction with our consolidated financial statements and the related notes included elsewhere in this Annual Report on Form 10-K. Some of the information contained in this discussion and analysis or set forth elsewhere in this report, including information with respect to our plans and strategies for our business, statements regarding the industry outlook, our expectations regarding the future performance of our business and the other non-historical statements contained herein are forward-looking statements. See “Special Note Regarding Forward-Looking Statements.” You should also review the “Risk Factors” section of this report for a discussion of important factors that could cause actual results to differ materially from the results described herein or implied by such forward-looking statements.
The consolidated financial statements included in this Form 10-K reflect the historical financial position, results of operations and cash flows of CyrusOne for all periods presented.
Overview
Our Company. We are a premier data center real estate investment trust (REIT). We own, operate and develop enterprise-class, carrier-neutral multi-tenant data center properties. Our data centers are generally purpose-built facilities with redundant power, cooling and access to a range of telecommunications carriers. We provide mission-critical data center facilities that protect and ensure the continued operation of information technology (IT) infrastructure for 932 customers (not including customers that have signed leases but have not begun occupying space) in 35 data centers and 2 recovery centers in 11 distinct markets (9 cities in the U.S., London and Singapore). We provide twenty-four hours-a-day, seven-days-a-week security guard monitoring with customizable security features.
We provide mission-critical data center real estate assets that protect and ensure the continued operation of IT infrastructure for our customers. Our goal is to be the preferred global data center provider to Fortune 1000, including the largest enterprises and providers of cloud services. As of December 31, 2016, our customers included 181 of the Fortune 1000 or private or foreign enterprises of equivalent size. These 181 Fortune 1000 customers or private or foreign enterprises of equivalent size provided 69% of our annualized rent as of December 31, 2016. Additionally, as of December 31, 2016, our top 10 customers represented 38% of our annualized rent.
We cultivate long-term strategic relationships with our customers and provide them with solutions for their data center facilities
and IT infrastructure challenges. Our offerings provide flexibility, reliability and security delivered through a tailored, customer
service focused platform that is designed to foster long-term relationships. We focus on attracting customers that have not historically
outsourced their data center needs and providing them with solutions that address their current and future needs. Our facilities and
construction design allow us to offer flexibility in density, power resiliency and the opportunity for expansion as our customers'
needs grow. We provide twenty-four-hours-a-day, seven-days-a-week security guard monitoring with customizable security features. The National IX Platform delivers interconnection across states and between metro-enabled sites within the CyrusOne footprint and beyond. The platform enables high-performance, low-cost data transfer and accessibility for customers by uniting all of our data centers.
Our Portfolio. As of December 31, 2016, our property portfolio included 35 data centers and 2 recovery centers in 11 distinct markets (9 cities in the U.S., London and Singapore) collectively providing approximately 3,904,000 net rentable square feet (NRSF) and powered by approximately 369 MW of available critical load capacity. Since December 31, 2015, the NRSF increased
by 950,000 due to increases in Chicago of 342,000, San Antonio of 117,000, Northern Virginia of 305,000, and other properties accounted for the remaining increase. We own 23 of the buildings in which our data center facilities are located. We lease the remaining 14 buildings, which account for approximately 650,000 NRSF, or approximately 17% of our total operating NRSF. These leased buildings accounted for 24% of our total annualized rent as of December 31, 2016. We also had approximately 1,657,000 NRSF under development as well as an aggregate of approximately 825,000 NRSF of additional powered shell space under roof available for development. In addition, we have approximately 239 acres of land that are available for future data center
shell development. Other than the purchase of the Chicago-Aurora I data center and approximately 15 acres of land directly adjacent
to the data center (the Aurora Properties), during the year ended December 31, 2016, the Company purchased four properties
for development for approximately $54.5 million. Along with our primary product offering, leasing of colocation space, our customers are increasingly interested in ancillary office and other space. We believe our existing operating portfolio and development pipeline will allow us to meet the evolving needs of our existing customers and continue to attract new customers.
Business Model
Revenue. As of December 31, 2016, we had approximately 932 customers (not including customers that have signed leases but have not begun occupying space), many of which have signed leases for multiple sites and multiple services, amenities and/or features. We generate recurring revenues from leasing colocation space and nonrecurring revenues from the initial installation and set-up of customer equipment. We provide customers with data center services pursuant to leases with a customary initial term of three to five years. As of December 31, 2016, the weighted average initial term of our leases was approximately 6.0 years and the weighted average remaining term was 4.0 years based upon annualized rent. Lease expirations through 2019, excluding month-to-month leases, represent 35% of our total NRSF, or 53% of our aggregate annualized rent as of December 31, 2016. At the end of the lease term, customers may sign a new lease or automatically renew pursuant to the terms of their lease. The automatic renewal period could be for varying lengths, depending on the terms of the contract, such as, for the original lease term, one year or month-to-month. As of December 31, 2016, 1% of the NRSF in our portfolio was subject to month-to-month leases.
Costs and expenses. Our property operating expenses generally consist of electricity (including the cost to power data center equipment), salaries and benefits of data center operations personnel, real estate taxes, security, rent, insurance and other site operating and maintenance costs. Our property operating expenses are expected to increase as we expand our existing data center facilities and develop new facilities.
Our sales and marketing expenses consist of salaries and benefits of our sales personnel, marketing and advertising costs. Sales and marketing expenses are expected to increase as our business continues to grow.
General and administrative expenses consist of salaries and benefits of senior management and support functions, legal costs and consulting costs. These costs increased during 2016 as we augmented our team and back office infrastructure, including IT systems, to support the growth and expansion of our business. Additionally, costs rose for legal, accounting, board fees and other governance related expenses.
Depreciation and amortization expense consists of depreciation on both owned and leased property, amortization of intangible assets and amortization of deferred sales commissions. Depreciation and amortization expense is expected to increase in future periods as we acquire and develop new properties and expand our existing data center facilities.
Key Operating Metrics
Annualized Rent. We calculate annualized rent as monthly contractual rent (defined as cash rent including customer reimbursements for metered power) under existing customer leases as of December 31, 2016, multiplied by 12. Monthly contractual rent is primarily for data center space, power and connectivity; however, it includes rent for office space and other ancillary services. For the month of December 2016, customer reimbursements were $56.4 million annualized and consisted of reimbursements by customers across all facilities with separately metered power. Other companies may not define annualized rent in the same manner. Accordingly, our annualized rent may not be comparable to others. Management believes annualized rent provides a useful measure of our currently in place lease revenue.
Colocation Square Feet (CSF). We calculate CSF as the NRSF at an operating facility that is currently leased or readily available for lease as colocation space, where customers locate their servers and IT equipment.
Utilization Rate. We calculate utilization rate by dividing CSF under signed leases for available space (whether or not the customer has occupied the space) by total CSF. Utilization rate differs from percent leased presented elsewhere in this report because utilization rate excludes office space and supporting infrastructure NRSF and includes CSF for signed leases under which the customer has occupied the space. Management uses utilization rate as a measure of CSF leased.
Recurring Rent Churn. We calculate recurring rent churn as any reduction in recurring rent due to customer terminations, service reductions or net pricing decreases as a percentage of rent at the beginning of the period, excluding any impact from metered power reimbursements or other usage-based or variable billing.
Capital Expenditures. Expenditures that expand, improve or extend the life of real estate and non-real estate property are deemed capital expenditures. Management views its capital expenditures as comprised of acquisition of real estate, development of real estate, recurring real estate expenditures and all other non-real estate capital expenditures. Purchases of land or buildings from third parties represent acquisitions of real estate. Discretionary capital spending that expands or improves our data centers is deemed development of real estate. Replacements of data center assets are considered recurring real estate expenditures. Purchases of software, computer equipment and furniture and fixtures are included in all other non-real estate capital expenditures.
Factors That May Influence Future Results of Operations
Rental Income. Our revenue growth will depend on our ability to maintain our existing revenue base and to sell new capacity that becomes available as a result of our development activities. As of December 31, 2016, we have customer leases for approximately 84% of our CSF. Our ability to grow revenue will also be affected by our ability to maintain or increase rental rates at our properties.
We believe the current rates charged to our customers generally reflect appropriate market rates. This is consistent with our relatively flat historical re-leasing spreads. As such, we do not anticipate significant rate increases or decreases in the aggregate as contracts renew. However, negative trends in one or more of these factors could adversely affect our revenue in future periods. Future economic downturns, regional downturns affecting our markets or oversupply of, or decrease in demand for, data center colocation services could impair our ability to attract new customers or renew existing customers’ leases on favorable terms, and this could adversely affect our ability to maintain or increase revenues.
Leasing Arrangements. As of December 31, 2016, 30% of our leased NRSF was to customers on a full-service gross basis. Under a full-service gross model, the customer pays a fixed monthly rent amount, and we are responsible for all data center facility electricity, maintenance and repair costs, property taxes, insurance and other utilities associated with that customer’s space. For leases under this model, fluctuations in our customers’ monthly utilization of power and the prices our utility providers charge us impact our profitability. As of December 31, 2016, 70% of our leased NRSF was to customers with separately metered power. Under the metered power model, the customer pays us a fixed monthly rent amount, plus its actual costs of sub-metered electricity used to power its data center equipment, plus an estimate of costs for electricity used to power supporting infrastructure for the data center, expressed as a factor of the customer’s actual electricity usage. We are responsible for all other costs listed in the description of the full-service gross model above. Fluctuations in a customer’s utilization of power and the supplier pricing of power do not impact our profitability under the metered power model. In future periods, we expect more of our contracts to be structured to bill power on a metered power basis.
Growth and Expansion Activities. Our ability to grow our revenue and profitability will depend on our ability to acquire and develop data center space at an appropriate cost and to lease the data center space to customers on favorable terms. During the year ended December 31, 2016, we increased our operational NRSF by 950,000, primarily in Chicago, San Antonio and Northern Virginia, bringing our total operating NRSF to approximately 3,904,000 at December 31, 2016. Our portfolio, as of December 31, 2016, also included approximately 1,657,000 NRSF under development, as well as 825,000 NRSF of additional powered shell space under roof available for development. In addition, we have approximately 239 acres of land that are available for future data center shell development. We expect that the eventual construction of this future development space will enable us to accommodate a portion of the future demand of our existing and future customers and increase our future revenue, profitability and cash flows.
Scheduled Lease Expirations. Our ability to maintain low recurring rent churn and renew expiring customer leases on favorable terms will impact our results of operations. Our data center uncommitted capacity as of December 31, 2016, was approximately 615,000 NRSF. Excluding month-to-month leases, leases representing 16% and 9% of our total NRSF are scheduled to expire in 2017 and 2018, respectively. These leases represented approximately 21% and 20% of our annualized rent as of December 31, 2016. Month-to-month leases represented 2% of our annualized rent as of December 31, 2016. Our recurring rent churn for each quarter in 2016 ranged from 1.3% to 3.8%, in comparison to a range of 0.4% to 3.1% in 2015.
Conditions in Significant Markets. Our operating properties are located primarily in the metropolitan areas of Dallas, Cincinnati, Houston, and New York. These markets comprised 20%, 18%, 17%, and 13%, respectively, of our annualized rent as of December 31, 2016. Positive or negative conditions in these markets could impact our overall profitability.
Related Party Transactions
The following related party transactions are based on agreements and arrangements that were in place during the reporting periods presented. At December 31, 2015, CBI owned 9.5% of the outstanding common stock of CyrusOne Inc. and no operating partnership units, at which point it ceased to be a related party of CyrusOne Inc. As of December 31, 2016, CBI owned less than 5.0% of the outstanding common stock of CyrusOne Inc. See Note 18 to our audited consolidated financial statements included elsewhere in this Annual Report on Form 10-K for additional information on these arrangements.
(a) We lease colocation space in our data centers to Cincinnati Bell Telephone Company LLC (CBT) and Cincinnati Bell Technology Solutions (CBTS) subsidiaries of CBI. In November 2012, we entered into separate data center colocation agreements with CBT and CBTS whereby we will continue to lease colocation space to each of them at certain of our data centers. The data center colocation agreement with CBT provides for CBT’s lease of data center space, power and cooling in our West Seventh Street (7th St.), Kingsview Drive (Lebanon), Knightsbridge Drive (Hamilton) and Industrial Road (Florence) data center facilities for a period of five years. Our data center colocation agreement with CBTS provides for CBTS’s lease of data center space, power and cooling in our West Seventh Street (7th St.), Kingsview Drive (Lebanon) and Industrial Road (Florence) data center facilities for a period of five years. Both agreements are renewable for an additional five year term at market rates.
(b) CBT occupies space in our 229 West Seventh Street facility that is utilized in its network operations. In November 2012, in connection with our purchase of this property, we entered into an agreement to lease this space to CBT for a period of five years, with three renewal options of five years each, plus a proportionate share of building operating costs. Commencing on January 1, 2014, and on January 1 of each year thereafter, such base rent shall increase by 1% of the previous year’s base rent.
(c) In November 2012, we entered into agreements to lease office space to CBT at our Goldcoast Drive (Goldcoast) data center facility and to CBTS at our Parkway (Mason) data center facility. The term of these agreements are five years each. Both agreements contain three five-year renewal options at market rates.
(d) In January 2012, we entered into a transition services agreement to provide CBTS with network interface services. In November 2012, we entered into a new transition services agreement with CBTS where we will continue to provide them with network interface services. The annual fee to be paid by CBTS for these services may decline in future periods as CBTS migrates its network interfaces onto an independent architected and managed CBTS network. These services will be provided on a month-to-month basis, until such time the services in question have been fully transitioned. As of December 31, 2015, we continued to utilize these services provided by CBTS.
(e)As of December 31, 2015, CBTS continues to be the named lessor for two data center leases. In 2012, we entered into an agreement with CBTS whereby we perform all obligations of CBTS under the lease agreements. CBTS confers the benefits received under such lease agreements to us and CBTS is granted sufficient usage rights in each of our data centers so that it remains as lessor under each such lease agreement. In addition, CBTS will continue to perform billing and collections on these accounts.
(f) In January 2012, we entered into a transition services agreement with CBTS where CBTS provided us with network support, services calls, monitoring and management, storage and backup and IT systems support. Under the CBTS services agreement, CBTS has agreed to provide us with certain managed storage and backup services. These services will be provided on a month-to-month basis, and charges will be based on the variable amount of gigabytes managed by CBTS each month. CBTS will charge us a rate of $0.56 per gigabyte. The services under this agreement ended January 31, 2016.
(g) Under the CBT services agreement, CBT provides us with connectivity services for a period of five years related to several of our data center facilities. These services are related to the use of fiber and circuit assets that are currently a part of the CBI network. The annual fee for these services is subject to reduction if we terminate certain services.
(h) In November 2012, we also entered into an agreement to lease space at CBT’s 209 West Seventh Street facility for a period of five years, with three renewal options of five years each, plus our proportionate share of building operating costs. Commencing on January 1, 2014, and on January 1 of each year thereafter, such base rent shall increase by 1% of the previous year’s base rent.
Other Related Party Transactions
Our director, Lynn A. Wentworth, is a member of the board of directors of CBI, and serves as the chair of its audit and finance committee.
The spouse of one of our former directors, who served until May 2015, is a partner with Skadden, Arps, Slate, Meagher & Flom LLP (Skadden). For the years ended December 31, 2015 and 2014, CyrusOne paid Skadden an immaterial amount and $1.1 million, respectively, for services rendered.
In the ordinary course of its business, CyrusOne periodically pays brokerage commissions to real estate brokerage firms in connection with property transactions and tenant leases. The spouse of one of our former directors, who served until 2014, is a principal with Jones Lang LaSalle. In 2014, CyrusOne paid $1.0 million to Jones Lang LaSalle.
Results of Operations
Comparison of Years Ended December 31, 2016 and 2015
*
See “Key Operating Metrics” for a definition of capital expenditures, CSF and utilization rate.
Revenue
Revenue for the year ended December 31, 2016 was $529.1 million, an increase of $129.8 million, or 32.5%, compared to $399.3 million for the year ended December 31, 2015. The acquisition of Cervalis on July 1, 2015 resulted in an increase in revenue of $36.8 million for the six months ended June 30, 2016. The 15-year lease for data center space at the Aurora Properties with the CME Group, entered into on April 1, 2016, increased revenue by $19.0 million for the year ended December 31, 2016. Equipment sales and termination fees for 2016 were $14.7 million and $18.1 million, compared to $3.6 million and $0.1 million for 2015, respectively. The addition of new customers and growth from existing customers, net of churn, equipment sales and termination fee revenue, resulted in increased revenue of $44.9 million for the year ended December 31, 2016. As of December 31, 2016, we had approximately 3,904,000 NRSF, an increase of approximately 950,000 NRSF from December 31, 2015. As of December 31, 2016, we had 181 Fortune 1000 customers or private or foreign enterprises of equivalent size, compared to 173 Fortune 1000 customers or private or foreign enterprises of equivalent size as of December 31, 2015. As of December 31, 2016, we had a total of 932 customers (not including customers that have signed leases but have not begun occupying space) as compared to approximately 930 customers as of December 31, 2015.
Our capacity at December 31, 2016 was approximately 2,080,000 CSF, which is an increase of 32% from December 31, 2015. The utilization rate of our data center facilities was 85% as of December 31, 2016, compared to 86% as of December 31, 2015. As of December 31, 2016, we have added to the portfolio two newly constructed data centers that are in the early stages of lease up. In all, we have three data centers in the lease-up stage, and we refer to these as pre-stabilized properties. Excluding these properties, the utilization rate for our stabilized portfolio was 92% as of December 31, 2016 as compared to 86% as of December 31, 2015.
Recurring rent churn was 10.8%, which includes company initiated churn of approximately 2.6%, for the year ended December 31, 2016, compared to 5.0% for the year ended December 31, 2015.
Costs and Expenses
Property operating expenses-For the year ended December 31, 2016, Property operating expenses were $187.5 million, an increase of $38.8 million, or 26.1%, compared to $148.7 million for the year ended December 31, 2015. The acquisition of Cervalis on July 1, 2015 resulted in an increase in Property operating expenses of $13.2 million. The purchase of the Aurora Properties from CME on March 31, 2016 increased Property operating expenses by $6.1 million. Equipment cost of sales was $12.0 million and $0.6 million for the years ended December 31, 2016 and 2015, respectively. Excluding the impact of Cervalis, Aurora and equipment cost of sales, Property operating expenses increased $8.1 million. Costs to operate our facilities increased by $4.1 million for payroll and employee related costs, $3.1 million for electricity costs, $0.9 million for additional security, property taxes and other costs, primarily to support our additional CSF deployed. During the year ended December 31, 2015, we incurred $1.4 million of lease exit costs.
Sales and marketing expenses-For the year ended December 31, 2016, Sales and marketing expenses were $16.9 million, an increase of $4.8 million, or 39.7%, compared to $12.1 million for the year ended December 31, 2015. The acquisition of Cervalis on July 1, 2015 resulted in an increase in Sales and marketing expenses of $1.0 million. The remaining increase was primarily due to higher payroll-related costs of $1.8 million and advertising and other costs of $2.0 million.
General and administrative expenses-For the year ended December 31, 2016, General and administrative expenses were $60.7 million, an increase of $14.1 million compared to $46.6 million for the year ended December 31, 2015. The acquisition of Cervalis on July 1, 2015 resulted in an increase in General and administrative expenses of $0.7 million. Severance and management transition costs were $1.9 million and $6.0 million for the year ended December 31, 2016 and 2015, respectively. Payroll costs increased $7.2 million due to higher payroll taxes because of a large vesting of equity awards granted at the time of the IPO, higher recruiting, relocation and payroll costs to support the increased growth in business. Professional fees for legal, consulting and temporary staffing increased $5.8 million. Provision for bad debt increased $1.6 million. Increased costs of investor relations, commercial insurance and other costs accounted for the remaining increase of $2.9 million.
Depreciation and amortization expense-For the year ended December 31, 2016, Depreciation and amortization expense was $183.9 million, an increase of $42.4 million, or 30.0%, compared to $141.5 million for the year ended December 31, 2015. The acquisition of Cervalis on July 1, 2015 and the purchase of the Aurora Properties from CME on March 31, 2016 resulted in an increase in Depreciation and amortization expense of $22.8 million for the year ended December 31, 2016. The remainder of the increase was driven by assets that were placed in service after the fourth quarter of 2015. Depreciation and amortization expense is expected to increase in future periods as we acquire and develop new properties and expand our existing data center facilities.
Transaction and acquisition integration costs-For the year ended December 31, 2016, the Company incurred costs of $4.3 million associated with diligence efforts on certain targeted acquisitions including unrealized acquisitions. For the year ended December
31, 2015, the Company incurred $12.9 million in transaction related costs primarily related to the acquisition of Cervalis. During the fourth quarter of 2015, the Company incurred costs of $1.2 million related to secondary equity offerings and costs associated with a transaction that the Company decided not to pursue.
Asset impairments and loss on disposal of assets-For the year ended December 31, 2016, we recognized Asset impairment and loss on disposal of $5.3 million which related primarily to two properties, South Bend-Crescent, a leased facility, and Cincinnati-Goldcoast, an owned facility. For the year ended December 31, 2015, we recognized Asset impairment and loss on disposal of $13.5 million which related primarily to the exit of Austin 1, which is a leased facility, and loss on disposal of certain other assets.
Non-Operating Expenses
Interest expense-For the year ended December 31, 2016, Interest expense was $48.8 million, an increase of $7.6 million, or 18.4%, as compared to $41.2 million for the year ended December 31, 2015. The increase was primarily a result of additional borrowings under our Second Amended and Restated Credit Agreement, the issuance of 6.375% senior notes in July 2015 and increased interest expense related to Lease financing arrangements, partially offset by a reduction in Interest expense due to an increase in capitalized interest. The capitalized interest was $10.6 million and $6.1 million for the years ended December 31, 2016 and 2015, respectively.
Income tax expense-For both years ended December 31, 2016 and 2015, Income tax expense was $1.8 million.
Capital Expenditures
For the year ended December 31, 2016, capital expenditures were $731.1 million, as compared to $234.5 million for the year ended December 31, 2015. This included the purchase of the Aurora Properties for $131.1 million, the purchase of four properties for development in Northern Virginia, Chicago and Phoenix for approximately $54.5 million and $545.5 million for other developments primarily in Northern Virginia, Phoenix, San Antonio, Carrollton and Houston.
Results of Operations
Comparison of Years Ended December 31, 2015 and 2014
*
See “Key Operating Metrics” for a definition of capital expenditures, CSF and utilization rate.
Revenue
Revenue for the year ended December 31, 2015 was $399.3 million, an increase of $68.4 million, or 20.7%, compared to $330.9 million for the year ended December 31, 2014. The acquisition of Cervalis in July 2015 resulted in an increase in revenue of $37.7 million for the year ended December 31, 2015. Revenue also increased due to the addition of new customers, net of churn, which resulted in increased revenue of $30.7 million for the year ended December 31, 2015. As of December 31, 2015, we had approximately 2,954,000 leased NRSF, an increase of approximately 719,000 NRSF from December 31, 2014.
Our capacity at December 31, 2015 was approximately 1,574,000 CSF, which is an increase of 28.5% from December 31, 2014. The utilization rate of our data center facilities was 86% as of December 31, 2015, compared to 88% as of December 31, 2014.
Costs and Expenses
Property operating expenses-Property operating expenses for the year ended December 31, 2015 were $148.7 million, an increase of $24.2 million, or 19.4%, compared to $124.5 million for the year ended December 31, 2014. The acquisition of Cervalis resulted in $14.7 million of the increase and the remaining $9.5 million was due to increase in property operating costs as follows: higher circuit and bandwidth costs of $2.4 million due to expansion of our National IX Platform; lease exit costs of $1.4 million at our Austin 1 facility; property taxes of $1.8 million; payroll and employee related costs of $1.4 million; and repairs and maintenance of $1.1 million; the remaining $1.4 million to other costs associated with operating our facilities.
Sales and marketing expenses-Sales and marketing expenses for the year ended December 31, 2015 were $12.1 million, a decrease of $0.7 million, or 5.5%, compared to $12.8 million for the year ended December 31, 2014. The acquisition of Cervalis resulted in an increase in sales and marketing expenses of $0.9 million for the year ended December 31, 2015. This increase was offset primarily by decreases in advertising and marketing costs of $0.8 million and salaries and wages and other selling costs of $0.8 million.
General and administrative expenses-General and administrative expenses for the year ended December 31, 2015 were $46.6 million, an increase of $12.0 million, or 34.7%, compared to $34.6 million for the year ended December 31, 2014. The acquisition of Cervalis resulted in an increase in general and administrative expenses of $1.4 million for the year ended December 31, 2015. Two senior executives who left the Company in 2015 resulted in severance costs of $6.0 million, of which $2.4 million was due to the acceleration of stock-based equity awards. Costs of stock-based compensation plans increased $1.3 million for 2015 compared to 2014. Due to business growth in 2015 compared to 2014, total payroll and employee related costs increased $0.9 million, and IT license and facility costs increased $1.1 million. Consulting, legal and other costs accounted for the remaining increase.
Depreciation and amortization expense-Depreciation and amortization expense for the year ended December 31, 2015 was $141.5 million, an increase of $23.5 million, or 19.9%, compared to $118.0 million for the year ended December 31, 2014. Our acquisition of Cervalis (the Cervalis Acquisition) resulted in an increase in depreciation and amortization expense of $12.9 million for the year ended December 31, 2015.The remainder of the increase was driven by assets that were placed in service during 2014 and 2015. Depreciation and amortization expense is expected to increase in future periods as we acquire and develop new properties and expand our existing data center facilities.
Transaction and acquisition integration costs-During the second quarter of 2015, the Company entered into an agreement to acquire Cervalis in a cash transaction which was consummated on July 1, 2015. As part of that process, we incurred expenses for outside professional services in the areas of legal, banking, financing, accounting and advisory services related to the consummation of the transaction and its integration. For the year ended December 31, 2015, transaction and integration costs related to the Cervalis Acquisition were $12.9 million. During the fourth quarter of 2015, the Company incurred costs of $1.2 million related to secondary equity offerings and costs associated with a transaction that the Company decided not to pursue. During 2014, the Company incurred $1.0 million in transaction related expenses as it investigated various opportunities that were not completed.
Asset impairments and loss on disposal of assets-For the year ended December 31, 2015, we recognized Asset impairment and loss on disposal of $13.5 million which related primarily to the exit of Austin 1, which is a leased facility, and loss on disposal of certain other assets.
Non-Operating Expenses
Interest expense-Interest expense for the year ended December 31, 2015 was $41.2 million, an increase of $1.7 million, or 4.3%, as compared to $39.5 million for the year ended December 31, 2014. The increase for the year ended December 31, 2015 was primarily a result of additional borrowings under our Second Amended and Restated Credit Agreement and the issuance of 6.375% senior notes in July 2015, partially offset by a reduction in interest expense due to our bond repurchase program in the fourth quarter of 2014 and an increase in capitalized interest.
Loss on extinguishment of debt- Loss on extinguishment of debt was $13.6 million for the year ended December 31, 2014. Loss on extinguishment of debt for 2014 was related to costs associated with the repurchase of $150.2 million in aggregate face value of our 6.375% senior notes for a purchase price of $163 million and the write-off of deferred financing costs.
Income tax expense-Income tax expense for the year ended December 31, 2015 was $1.8 million, an increase of $0.4 million, or 28.6%, as compared to $1.4 million for the year ended December 31, 2014.
Capital Expenditures
Capital expenditures for the year ended December 31, 2015 were $234.5 million, as compared to $284.2 million for the year ended December 31, 2014. The significant expenditures in 2015 included the development of additional square footage and power in our Northern Virginia, Phoenix 2, Houston West 3 and Carrollton data centers, and the purchase of Austin 4 in February of 2015.
Key Performance Indicators
Funds from Operations and Normalized Funds from Operations
We use Funds from Operations (FFO) and Normalized Funds from Operations (Normalized FFO), which are non-GAAP financial measures commonly used in the REIT industry, as supplemental performance measures. We use FFO and Normalized FFO as supplemental performance measures because, when compared period over period, they capture trends in occupancy rates, rental rates and operating costs. We also believe that, as widely recognized measures of the performance of REITs, FFO and Normalized FFO are used by investors as a basis to evaluate REITs.
We calculate FFO as net income (loss) computed in accordance with GAAP before real estate depreciation and amortization and Asset impairments and gain or loss on disposal. While it is consistent with the definition of FFO promulgated by the National Association of Real Estate Investment Trusts (NAREIT), our computation of FFO may differ from the methodology for calculating FFO used by other REITs. Accordingly, our FFO may not be comparable to others.
We calculate Normalized FFO as FFO plus amortization of customer relationship intangibles, transaction and acquisition integration costs, legal claim costs and lease exit costs, and other special items including loss on extinguishment of debt and severance and management transition costs, as appropriate. Other REITs may not calculate Normalized FFO in the same manner. Accordingly, our Normalized FFO may not be comparable to others.
In addition, because FFO and Normalized FFO exclude real estate depreciation and amortization and real estate impairments, and capture neither the changes in the value of our properties that result from use or from market conditions, nor the level of capital expenditures and leasing commissions necessary to maintain the operating performance of our properties, all of which have real economic effect and could materially impact our results from operations, the utility of FFO and Normalized FFO as measures of our performance is limited. Therefore, FFO and Normalized FFO should be considered only as supplements to net income (loss) as measures of our performance. FFO and Normalized FFO should not be used as measures of our liquidity or as indicative of funds available to fund our cash needs, including our ability to make distributions. FFO and Normalized FFO also should not be used as supplements to or substitutes for cash flow from operating activities computed in accordance with GAAP.
The following table reflects the computation of FFO and Normalized FFO for the years ended December 31, 2016, 2015 and 2014:
CyrusOne Inc.
Reconciliation of Net Income (Loss) to FFO and Normalized FFO
(Dollars in millions)
(Unaudited)
Net Operating Income
We use Net Operating Income (NOI), which is a non-GAAP financial measure commonly used in the REIT industry, as a supplemental performance measure. We use NOI as a supplemental performance measure because, when compared period over period, it captures trends in occupancy rates, rental rates and operating costs. We also believe that, as a widely recognized measure of the performance of REITs, NOI is used by investors as a basis to evaluate REITs.
We calculate NOI as revenue less property operating expenses, each of which are presented in the accompanying consolidated statements of operations. However, the utility of NOI as a measure of our performance is limited. Other REITs may not calculate NOI in the same manner. Accordingly, our NOI may not be comparable to others. Therefore, NOI should be considered only as a supplement to revenue and to net income (loss) as a measure of our performance. NOI should not be used as a measure of our liquidity or as indicative of funds available to fund our cash needs, including our ability to make distributions. NOI also should not be used as a supplement to or substitute for cash flow from operating activities computed in accordance with GAAP.
The following table reflects the computation of NOI and Net Income (Loss) for the years ended December 31, 2016, 2015 and 2014:
CyrusOne Inc.
Reconciliation of Revenue to Net Operating Income to Net Income (Loss)
(Dollars in millions)
(Unaudited)
Financial Condition, Liquidity and Capital Resources and Material Terms of Our Indebtedness
Liquidity and Capital Resources
We are required to distribute at least 90% of our REIT taxable income, determined without regard to the dividends paid deduction and excluding any net capital gains, to our stockholders on an annual basis in order to maintain our status as a REIT for federal income tax purposes. Accordingly, we intend to make, but are not contractually bound to make, regular quarterly distributions to common stockholders from cash flow from operating activities. All such distributions are at the discretion of our board of directors.
We have an effective shelf registration statement that allows us to offer for sale unspecified amounts of various classes of equity and debt securities and warrants. As circumstances warrant, we may issue debt, equity and/or warrants from time to time on an opportunistic basis, dependent upon market conditions and available pricing.
On July 1, 2016, we established an “at the market” stock offering program (ATM Program), pursuant to which CyrusOne Inc. may issue and sell from time to time shares of common stock having an aggregate gross sales price of up to $320.0 million to or through sales agents. Sales of shares of CyrusOne Inc. common stock under the ATM Program are made by means of ordinary brokers’ transactions on the NASDAQ Global Select Market or otherwise at market prices prevailing at the time of sale, at prices related to prevailing market prices or, subject to specific instructions of CyrusOne Inc., at negotiated prices. During the year ended December 31, 2016, the Company sold 0.5 million shares of its common stock under this program, generating net proceeds of approximately $26.3 million after giving effect to sales agent commissions of $0.3 million.
On August 15, 2016, CyrusOne Inc. completed a public offering of 3.4 million shares of its common stock for $164.8 million, net of underwriting discounts of approximately $6.9 million. CyrusOne Inc. contributed the net proceeds from the sale of its shares to its operating partnership in exchange for an equivalent number of newly issued operating partnership units (the August OP Contribution and Issuance). CyrusOne LP has used and intends to use the proceeds from the August OP Contribution and Issuance to fund growth capital expenditures related to recently signed leases, to repay borrowings under its Revolving Credit Facility, and for general corporate purposes, which may include funding future acquisitions, investments or capital expenditures. In connection with this offering, on August 10, 2016, CyrusOne Inc. entered into (a) a forward sale agreement with Goldman, Sachs & Co. (the Forward Sale Agreement) with respect to 3.4 million shares of its common stock, and (b) an additional forward sale agreement with Goldman, Sachs & Co. (the Additional Forward Sale Agreement, and together with the Forward Sale Agreement, the Forward
Sale Agreements) with respect to approximately 1.0 million shares of its common stock in connection with the underwriters' exercise of their option to purchase these shares.
Pursuant to the terms of the Forward Sale Agreements, and subject to CyrusOne Inc.’s right to elect cash or net share settlement under the Forward Sale Agreements, CyrusOne Inc. intends to issue and sell, upon physical settlement of such Forward Sale Agreements, approximately 4.4 million shares of its common stock to Goldman, Sachs & Co. in exchange for cash proceeds per share equal to the applicable forward sale price, which was initially $48.48 per share and is subject to certain adjustments as provided in the applicable forward sale agreement. CyrusOne Inc. expects to physically settle the Forward Sale Agreements in full, which settlement or settlements will occur on or before August 1, 2017.
As of December 31, 2016, the total number of outstanding shares of common stock was approximately 83.5 million.
Short-term Liquidity
Our short-term liquidity requirements primarily consist of operating, sales and marketing, and general and administrative expenses, dividend payments and capital expenditures composed primarily of acquisition and development costs for data center properties. For the year ended December 31, 2016, our capital expenditures, including the purchase of the Aurora Properties in March, 2016 were $731.1 million. Our capital expenditures are discretionary, excluding leases under contract, and will be applied to expand our existing data center properties, acquire or construct new facilities, or both. We intend to continue to pursue additional growth opportunities and are prepared to commit additional resources to support this growth. We expect to fund future capital expenditures from the cash available on our balance sheet, borrowings under our Revolving Credit Facility and other financings including potential issuances of debt and equity securities. We expect our total capital expenditures for 2017 to be between $550 million and $600 million.
Long-term Liquidity
Our long-term liquidity requirements primarily consist of operating, sales and marketing, and general and administrative expenses, distributions to stockholders and the acquisition and development of additional data center properties. We expect to meet our long-term liquidity requirements with cash flows from our operations, issuances of debt and equity securities and borrowings under our Revolving Credit Facility.
As of December 31, 2016, our Long-term debt, Capital lease obligations and Lease financing arrangements were $1,386.6 million, consisting of $477.3 million of 6.375% senior notes, including bond premium, $235.0 million outstanding under the Revolving Credit Facility, $550.0 million outstanding, in the aggregate, under the Initial Term Loan and Additional Term Loan, Capital lease obligations of $10.8 million and Lease financing arrangements of $135.7 million, partially offset by deferred financing costs of $22.2 million. Available capacity as of December 31, 2016, was $757.9 million, which includes $1.0 billion under the Revolving Credit Facility less outstanding borrowings of $235.0 million and letters of credit of $7.1 million. Total liquidity as of December 31, 2016 is $772.5 million, which includes availability of $757.9 million and cash equivalents of $14.6 million.
Material Terms of Our Indebtedness
Second Amended and Restated Credit Agreement
On October 9, 2014, CyrusOne LP entered into a credit agreement (the Credit Agreement) which provided for a $450 million senior unsecured revolving credit facility to replace CyrusOne LP's $225 million secured credit facility, and a $150 million senior unsecured term loan.
On June 22, 2015, CyrusOne entered into an amendment to the Credit Agreement and other loan documents governing its revolving credit facility and term loan facility. The amendment increased the size of the Credit Agreement's accordion feature, which gave the operating partnership the ability to request an increase in the total commitment under the Credit Agreement, from $300 million to $600 million. Immediately after entering into the amendment, the operating partnership exercised $350 million of this accordion feature and obtained commitments to increase the total commitment under the Credit Agreement from $600 million to $950 million, comprised of $650 million of commitments under the revolving credit facility (the Revolving Credit Facility) and $300 million under the term loan (the Initial Term Loan).
On July 1, 2015, CyrusOne borrowed an additional $150 million under the term loan facility which was used to partially finance the Cervalis Acquisition.
On March 17, 2016, CyrusOne LP entered into a first amended and restated credit agreement (the First Amended and Restated Credit Agreement) which amended and restated in its entirety the Credit Agreement, as amended previously. The First Amended and Restated Credit Agreement provided for an additional $250.0 million senior unsecured term loan facility (the Additional Term
Loan, and together with the Initial Term Loan, the Term Loans) in addition to the existing $300.0 million Initial Term Loan and the existing $650.0 million Revolving Credit Facility. The First Amended and Restated Credit Agreement had an accordion feature under which CyrusOne LP may request an increase in the total commitments up to an amount not to exceed $250 million. Deferred financing costs of $2.1 million related to the Additional Term Loan were recorded as of December 31, 2016.
On November 21, 2016, CyrusOne LP entered into a second amended and restated credit agreement (the Second Amended and Restated Credit Agreement) which amended and restated in its entirety the First Amended and Restated Credit Agreement. The Second Amended and Restated Credit Agreement, among other things, increases the available commitments under the Revolving Credit Facility to $1.0 billion.
The Revolving Credit Facility is scheduled to mature in November 2020 and includes a one-year extension option, which if exercised by CyrusOne LP would extend the maturity date to November 2021. The Initial Term Loan is scheduled to mature in January 2022. The Additional Term Loan is scheduled to mature in September 2021. The Revolving Credit Facility currently bears interest at a rate per annum equal to LIBOR plus 1.55% and the Initial Term Loan and the Additional Term Loan currently bear interest at a rate per annum equal to LIBOR plus 1.50%.
The Second Amended and Restated Credit Agreement requires us to maintain certain financial covenants including the following, in each case on a consolidated basis:
•
A minimum fixed charge ratio;
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Maximum total and secured leverage ratios;
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A minimum consolidated tangible net worth ratio;
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A maximum secured recourse indebtedness ratio;
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A minimum unencumbered debt yield ratio; and
•
A maximum ratio of unsecured indebtedness to unencumbered asset value.
Notwithstanding these limitations, we will be permitted, subject to the terms and conditions of the Second Amended and Restated Credit Agreement, to distribute to our shareholders cash dividends in an amount not to exceed 95% of our Funds From Operations (as defined in the Second Amended and Restated Credit Agreement) for any period. Similarly, our indenture permits dividends and distributions necessary for us to maintain our status as a REIT.
Our most restrictive covenants are generally included in our Second Amended and Restated Credit Agreement. In order to continue to have access to amounts available to us under the Second Amended and Restated Credit Agreement, we must remain in compliance with all covenants.
As of December 31, 2016, there were outstanding borrowings of $235.0 million on the Revolving Credit Facility and aggregate borrowings of $550.0 million on the Term Loans. In addition, the Second Amended and Restated Credit Agreement contains an accordion feature that allows CyrusOne LP to increase the aggregate commitment by up to $300 million.
6.375% Senior Notes due 2022
On November 20, 2012, CyrusOne LP and CyrusOne Finance Corp. (Issuers) issued $525.0 million of 6.375% senior notes due 2022 (6.375% senior notes). The 6.375% senior notes are senior unsecured obligations of the Issuers, which rank equally in right of payment with all existing and future unsecured senior debt of the Issuers. The 6.375% senior notes are effectively subordinated to all existing and future secured indebtedness of the Issuers to the extent of the value of the assets securing such indebtedness. The 6.375% senior notes are fully and unconditionally and jointly and severally guaranteed by CyrusOne Inc., CyrusOne GP, and each of CyrusOne LP’s existing and future domestic subsidiary that guarantees other indebtedness of CyrusOne LP or any guarantor, subject to certain exceptions. Each such guarantee is a senior unsecured obligation of the applicable guarantor, ranking equally with all existing and future unsecured senior debt of such guarantor and effectively subordinated to all existing and future secured indebtedness of such guarantor to the extent of the value of the assets securing that indebtedness. The 6.375% senior notes are structurally subordinated to all liabilities (including trade payables) of each subsidiary of the Issuers that does not guarantee the 6.375% senior notes. The 6.375% senior notes bear interest at a rate of 6.375% per annum, payable semi-annually on May 15 and November 15 of each year.
The 6.375% senior notes will mature on November 15, 2022. However, prior to November 15, 2017, the Issuers may, at their option, redeem some or all of the 6.375% senior notes at a redemption price equal to 100% of the principal amount of the 6.375% senior notes being redeemed, together with accrued and unpaid interest, if any, to the date of redemption plus a “make-whole” premium. On or after November 15, 2017, the Issuers are permitted, at their option, to redeem some or all of the 6.375% senior notes at any time at declining redemption prices equal to (i) 103.188% beginning on November 15, 2017, (ii) 102.125% beginning on November 15, 2018, (iii) 101.063% beginning on November 15, 2019 and (iv) 100.000% beginning on November 15, 2020
and thereafter, plus, in each case, accrued and unpaid interest, if any, to the applicable redemption date. In addition, before November 15, 2015, and subject to certain conditions, the Issuers may, at their option, redeem up to 35% of the aggregate principal amount of the 6.375% senior notes with the net proceeds of certain equity offerings at a redemption price equal to 106.375% of the principal amount thereof, plus accrued and unpaid interest, if any, to the date of redemption; provided that (i) at least 65% of the aggregate principal amount of the 6.375% senior notes remained outstanding after the redemption and (ii) the redemption occurred within 90 days of the closing of any such equity offering.
In November and December of 2014, we repurchased a portion of our 6.375% senior notes with an aggregate face value of $150.2 million for a purchase price of $163.0 million, including accrued and unpaid interest. This resulted in a loss on extinguishment of debt of $12.8 million.
On July 1, 2015, the Issuers closed a private offering of $100.0 million aggregate principal amount of the 6.375% senior notes (New Notes) plus a premium of $3.8 million. The New Notes were issued as additional notes under the Indenture dated November 20, 2012 as supplemented by the first supplemental indenture dated July 1, 2015, and the New Notes have terms substantially identical to those of the 6.375% senior notes issued in November 2012. On December 29, 2015, all notes issued on July 1, 2015 were exchanged for registered notes that are freely tradable. As of December 31, 2016, the outstanding balance on the 6.375% senior notes was $477.3 million, including bond premium.
Cash Flows
During 2016, our primary source of cash were earnings from our operations, net proceeds from our Second Amended and Restated Credit Agreement, and proceeds from issuances of common stock and 6.375% senior notes. Our primary uses of cash were capital expenditures for the development of real estate, funding our operations, payment of dividends and acquisition of operating partnership units from CBI.
The following table summarizes our cash flows for the years ended December 31, 2016, 2015 and 2014.
Comparison of Years Ended December 31, 2016 and 2015
Cash flow increased by $40.4 million for the year ended December 31, 2016. Cash provided by operations was $180.6 million for the year ended December 31, 2016, compared to $140.2 million for the year ended December 31, 2015. The increase was primarily driven by an increase in net operating income of $91.0 million. This increase was offset by the following: Deferred revenue and straight-line rent recognized increased $18.0 million primarily due to free rent periods on long-term, large contracts; leasing commissions paid in 2016 increased $5.2 million as a result of obtaining these large, long-term contracts; and Interest expense increased $7.6 million. The remaining increase was partially offset by increased sales and marketing and general and administrative expenses.
Cash used in investing activities was $729.6 million for the year ended December 31, 2016, compared to $625.6 million for the year ended December 31, 2015. Our capital expenditures for 2016 included the purchase of the Aurora Properties for $131.1 million, the purchase of four properties for development in Northern Virginia, Chicago and Phoenix for approximately $54.5 million and $545.5 million for other developments primarily in Northern Virginia, Phoenix, San Antonio, Carrollton and Houston. Cash used in investing activities for 2015 related primarily to the acquisition of Cervalis in July 2015 for $398.4 million. Capital expenditures for 2015 included the development of additional square footage and power in our Phoenix 2, Houston West 3, Carrollton and Northern Virginia data centers and the purchase of Austin 4 in February 2015. The change in Restricted cash accounted for the remaining change.
Cash provided by financing activities was $549.3 million for the year ended December 31, 2016, compared to $463.2 million for the year ended December 31, 2015. During the year of 2016, cash provided by financing activities was due to net borrowings from the credit facility of $250.0 million and the net proceeds from issuances of common stock of $447.1 million. Cash used in financing activities during the year of 2016 was due to dividends paid to stockholders of $114.3 million, tax payments upon the exercise of equity awards of $14.2 million and other items of $19.4 million. During the year ended December 31, 2015, cash provided by financing activities was due to the issuance of common stock of $799.5 million and net borrowings from the credit facility and 6.375% senior notes of $353.8 million. Cash used in financing activities during 2015 was due to the cost of the acquisition of partnership units of $596.4 million, dividends paid to stockholders of $80.8 million and other items of $12.9 million.
Comparison of Years Ended December 31, 2015 and 2014
As of December 31, 2015, cash and cash equivalents were $14.3 million, down from $36.5 million as of December 31, 2014, a decrease of $22.2 million.
Cash provided by operations was $140.2 million for the year ended December 31, 2015, compared to $111.1 million for the year ended December 31, 2014, an increase of $29.1 million. The increase in net cash generated from operations was primarily driven by an increase in net operating income of $44.2 million. This increase was offset by increased payments for income taxes of $3.0 million, interest (net of amount capitalized) of $2.4 million, and all other items, primarily transaction and acquisition integration costs accounted for the remaining $9.7 million.
Cash used in investing activities was $625.6 million for the year ended December 31, 2015, compared to $284.2 million for the year ended December 31, 2014. The increase was a result of the $398.4 million used for the Cervalis Acquisition in 2015, offset by a decrease in capital expenditures and changes in restricted cash of $57.0 million.
Cash provided by financing activities was $463.2 million for the year ended December 31, 2015, compared to $60.8 million for the year ended December 31, 2014. During 2015, cash provided by financing activities was due to the issuance of common stock
of $799.5 million and net borrowings from the credit facility and 6.375% senior notes of $353.8 million. Cash used in financing activities during 2015 was due to the cost of the acquisition of partnership units of $596.4 million, dividends paid to stockholders of $80.8 million and other items of $12.9 million. During 2014, cash provided by financing activities was due to the issuance of common stock of $356.0 million and net borrowings from the credit facility of $285.0 million. Cash used in financing activities during 2014 was due to the cost of the acquisition of partnership units of $355.9 million, repurchase of $150.2 million of the Company's 6.375% senior notes, related debt extinguishment costs of $12.8 million, dividends paid to stockholders of $50.9 million, and other items of $10.4 million.
Contractual Obligations
The following contractual obligations table summarizes our contractual obligations as of December 31, 2016:
(1)
Represents the principal portion of the 6.375% senior notes, Revolving Credit Facility and Term Loans.
(2)
Includes contractual interest payments on the 6.375% senior notes, Revolving Credit Facility, Term Loans, capital leases and lease financing arrangements assuming no early payment of debt in future periods and the exercise of the one-year extension option on the Revolving Credit Facility.
(3)
We have issued purchase orders for construction related activities. CyrusOne has non-cancellable purchase commitments related to certain services and contracts related to construction of data center facilities and equipment. These agreements range from one to two years and provide for payments for early termination or require minimum payments for the remaining term.
(4)
Represents lease financing arrangements of $135.7 million for leased data centers where we are deemed the accounting owner, and asset retirement obligations of $0.3 million.
(5)
Employment contracts have been excluded from this table for named executive officers as the Proxy and other SEC filings have those details. All other employees are subject to at-will employment.
The contractual obligations table is presented as of December 31, 2016. The amount of these obligations can be expected to change over time as new contracts are initiated and existing contracts are completed, terminated or modified.
Contingencies
We are periodically involved in litigation, claims and disputes. Liabilities are established for these claims when losses associated with these matters are judged to be probable and the loss can be reasonably estimated. Based on information currently available, consultation with counsel and established reserves, management believes the outcome of all claims will not individually, nor in the aggregate, have a material effect on our financial position, results of operations or cash flows. For the year ended December 31, 2016, we were not involved in any material lawsuits that required us to recognize an expense.
Off-Balance Sheet Arrangements
Indemnification
During the normal course of business, we make certain indemnities, commitments and guarantees under which we may be required to make payments in relation to certain transactions. These include (i) intellectual property indemnities to customers in connection with the use, sale and/or license of products and services, (ii) indemnities to vendors and service providers pertaining to claims based on our negligence or willful misconduct and (iii) indemnities involving the representations and warranties in certain contracts. In addition, we have made contractual commitments to several employees providing for payments upon the occurrence of certain prescribed events. The majority of these indemnities, commitments and guarantees do not provide for any limitation on the maximum potential for future payments that we could be obligated to make.
Critical Accounting Policies and Estimates
Our discussion and analysis of financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with U.S. GAAP. The preparation of these consolidated financial statements in conformity with U.S. GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amount of revenue and expenses in the reporting period. Our management evaluates these estimates on an ongoing basis, based upon information currently available and on various assumptions management believes are reasonable as of the date of the financial statements.
Our actual results may differ from these estimates. We have provided a summary of our significant accounting policies in Note 4 to our audited consolidated financial statements included elsewhere in this Form 10-K. We describe below those accounting policies that require material subjective or complex judgments and that have the most significant impact on our financial condition and results of operations:
•revenue recognition;
•goodwill impairment;
•accounting for real estate and other definite-lived assets; and
•accounting for income taxes.
Revenue Recognition-Colocation rentals are generally billed monthly in advance, and some contracts have escalating payments over the term of the contract. If rents escalate without the lessee gaining access to or control over additional leased space or power, and the lessee takes possession of, or controls the physical use of the property (including all contractually committed power) at the beginning of the lease term, the rental payments by the lessee are recognized as revenue on a straight-line basis over the term of the lease. If rents escalate because the lessee gains access to and control over additional leased space or power, revenue is recognized in proportion to the additional space or power in the periods that the lessee has control over the use of the additional space or power. The excess of revenue recognized over amounts contractually due is recognized in Other assets in the accompanying consolidated balance sheets.
Some of our leases are structured on a full-service gross basis in which the customer pays a fixed amount for both colocation rent and power. Other leases provide that the customer will be billed for power based upon actual usage which is separately metered. In both cases, this revenue is presented as Revenue in the accompanying consolidated statements of operations. Power is generally billed one month in arrears, and an estimate of this revenue is accrued in the month that the associated costs are incurred. We generally are not entitled to reimbursements for real estate taxes, insurance or other operating expenses. Generally, we receive an administrative fee when we manage the meters for our customers.
Revenue is recognized for services or products that are deemed separate units of accounting. When a customer makes an advance payment or they are contractually obligated to pay any amounts in advance, which is not deemed a separate unit of accounting, Deferred revenue is recorded. This revenue is recognized ratably over the expected term of the lease, unless the pattern of service suggests otherwise. As of December 31, 2016 and 2015, Deferred revenue was $76.7 million and $78.7 million, respectively.
Certain customer leases require specified levels of service or performance. If we fail to meet these service levels, our customers may be eligible to receive credits on their contractual billings. These credits are recognized against revenue when an event occurs that gives rise to such credits.
A provision for doubtful accounts is recognized when the collection of contractual rent, straight-line rent or customer reimbursements are deemed to be uncollectible.
Goodwill Impairment-We evaluate goodwill for possible impairment at least annually or upon the occurrence of
a triggering event. A triggering event is an event or circumstance that would more likely than not reduce the fair value of a reporting unit below its carrying amount, including sales of properties for which the relative size of the sold property is significant to the reporting unit, that could impact our goodwill impairment calculations.
For our annual impairment evaluation, we have the option of performing a qualitative or quantitative goodwill impairment analysis. A qualitative analysis, Step zero, analyzes the macro-economic environment in which we operate for any significant changes such as deterioration in the market that the Company operates or overall financial performance such as declining cash flows. Also, entity specific changes are analyzed such as change in management, strategy or composition of reporting unit.
A quantitative analysis, Step one, requires the Company to estimate the fair value of the reporting unit and compare the fair value to the carrying value to identify whether the value of the recorded goodwill is impaired. If the fair value is below the carrying value the Company estimates the fair value of all the assets and liabilities of the reporting unit and compares them to the carrying value to determine the amount of the impairment, Step two.
For the 2016 annual impairment assessment, the Company applied Step zero and determined that it is more likely than not that the fair value of the reporting unit is more than the carrying amount and no impairment has been recognized through December 31, 2016.
The carrying value of our goodwill totaled $455.1 million as of December 31, 2016. As of October 1, 2016, which is the date of our most recent impairment test, the fair value of CyrusOne was in excess of its carrying value. No impairments have been recognized since inception.
The impact of each assumption change within the sensitivity analysis was calculated independently and excludes the impact of the other assumed changes. Based on our calculation, the Company's market value of equity exceeded its carrying value by $2.8 billion as of October 1, 2016, and a 5% decline in the value of the Company's stock will cause a decrease of approximately $200 million to its market value of equity.
Accounting for Real Estate and Other Definite-Lived Assets-Investments in real estate consist of land, buildings, improvements and integral equipment utilized in our data center operations. Real estate acquired from third parties has been recorded at its acquisition cost. Real estate acquired from CBI and its affiliates has been recorded at its historical cost basis. Additions and improvements which extend an asset’s useful life or increase its functionality are capitalized and depreciated over the asset’s remaining life. Maintenance and repairs are expensed as incurred.
When we are involved in the construction of structural improvements to leased property, we are deemed the accounting owner of the leased real estate. In these instances, we bear substantially all the construction period risk, including managing or funding construction. As we have substantially all of the construction risks, we are deemed the “owner” of the asset under construction for accounting purposes during the construction period, and are therefore required to capitalize the construction costs on the accompanying consolidated balance sheets. At inception, the fair value of the building (excluding land) is recorded as an asset and the construction and modification costs to the building, which are not funded by us, would be recorded as a liability. As construction progresses, the value of the asset and obligation increases by the fair value of the structural improvements. At completion of the construction, Sales-Leaseback Accounting under ASC 840-40-25 is also evaluated. Due to our continuing involvement with the lessor, Sales-Leaseback Accounting is precluded and the liability is not derecognized. When the asset is placed in service, depreciation commences, and the leased real estate is depreciated to the lesser of (i) its estimated fair value at the end of the term or (ii) the expected amount of the unamortized obligation at the end of the term. The associated obligation is presented as Lease financing arrangements in the accompanying consolidated balance sheets.
When we are not deemed the accounting owner of leased real estate, we further evaluate the lease to determine whether it should be classified as a capital or operating lease. One of the following four characteristics must be present to classify a lease as a capital lease: (i) the lease transfers ownership of the property to the lessee by the end of the lease term, (ii) the lease contains a bargain purchase option, (iii) the lease term is equal to 75% or more of the estimated economic life of the leased property or (iv) the net present value of the lease payments is at least 90% of the fair value of the leased property.
Construction in progress includes direct and indirect expenditures for the construction and expansion of our data centers and is stated at its acquisition cost. Independent contractors perform substantially all of the construction and expansion efforts of our data centers. Construction in progress includes costs incurred under construction contracts including project management services, engineering and schematic design services, design development, construction services and other construction-related fees and services. Interest, property taxes and certain labor costs are also capitalized during the construction of an asset.
Depreciation is calculated using the straight-line method over the estimated useful life of the asset. Useful lives range from nine to thirty years for buildings, three to thirty years for building improvements, and three to twenty years for equipment. Leasehold improvements are amortized over the shorter of the asset’s useful life or the remaining lease term, including renewal options which are reasonably assured.
Management reviews the carrying value of long-lived assets, including intangible assets with finite lives, when events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. Examples of such indicators may include a significant adverse change in the extent to which or manner in which the property is being used, an accumulation of costs significantly in excess of the amount originally expected for acquisition or development, or a history of operating or cash flow losses. When such indicators exist, we review an estimate of the undiscounted future cash flows expected to result from the use of an asset (or group of assets) and its eventual disposition and compare such amount to its carrying amount. We consider factors such as future operating income, leasing demand, competition and other factors. If our undiscounted net cash flows indicate that we are unable to recover the carrying value of the asset, an impairment loss is recognized. An impairment loss is measured as the amount by which the asset’s carrying value exceeds its estimated fair value.
For the year ended December 31, 2016, we recognized Asset impairment and loss on disposal of $5.3 million which related primarily to two properties, Crescent, a leased facility, and Goldcoast, an owned facility. For the year ended December 31, 2015, we recognized Asset impairment and loss on disposal of $13.5 million which related primarily to the exit of Austin 1, which is a leased facility, and loss on disposal of certain other assets.
The useful lives of real estate and other definite-life long-lived assets are estimated in order to determine the amount of depreciation and amortization expense to be recorded during any reporting period. Depreciation of our real estate, and other tangible assets, except for leasehold improvements, is based on the straight-line method over the estimated economic useful life. Depreciation of leasehold improvements is based on a straight-line method over the lesser of the economic useful life or term of the lease, including optional renewal periods if renewal of the lease is reasonably assured. Amortization of acquired customer relationships is estimated using an accelerated amortization method to match the projected benefit derived from this asset. All other intangible assets are amortized applying a straight-line amortization method.
We review the carrying value of long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. Events and circumstances that we consider when assessing long-lived assets associated with each of our data center facilities include vacancy rates, declines in rental or occupancy rates and other factors. An impairment loss is recognized when the estimated future undiscounted cash flows expected to result from the use of an asset (or group of assets) and its eventual disposition is less than its carrying amount. Impairment exists when the Company's net book value of real estate assets is greater than the estimated fair value.
The estimate of expected future cash flows is inherently uncertain and relies to a considerable extent on estimates and assumptions, including current and future market conditions, projected growth in our CSF, projected recurring rent churn, lease renewal rates and our ability to generate new leases on favorable terms. It may be more difficult to sign new customers to fill some of our smaller data centers because the available space at these locations is relatively small. If there are changes to any of these estimates and assumptions in future periods, an impairment loss could occur.
Accounting for Income Taxes-CyrusOne Inc. was included in CBI's Texas consolidated tax return until June 26, 2014, when CBI's ownership percentage in our operating partnership was reduced below 50%. The accompanying 2014 financial statements reflect income taxes as if we were a separate stand-alone company. The income tax provision consists of an amount for taxes currently payable and an amount for tax consequences deferred to future periods. CBI’s previous Texas tax filings are subject to normal reviews by regulatory agencies until the related statute of limitations expires. With a few exceptions, CBI is no longer subject to State of Texas examinations for years prior to 2012.
The tax provision for periods prior to November 20, 2012, was computed as a C corporation. Net operating loss carryforwards were generated at the federal, foreign, state and local levels. Effective November 20, 2012, CBI contributed its data center properties to CyrusOne LP, the partnership formed to operate the data center business. As a partnership, the taxable income of CyrusOne LP flowed through to its partners. Upon the ownership transfer of all CBI partnership interest to CyrusOne Inc. on December 31, 2015, CyrusOne LP was terminated for tax purposes, with all taxable income flowing to CyrusOne Inc.
In addition, CBI contributed the Predecessor’s historical deferred tax assets and liabilities (excluding any deferred tax assets created by federal net operating losses) to CyrusOne LP at the contribution date of November 20, 2012. Thus, CyrusOne Inc. will have no federal or state net operating losses available to offset its future taxable income. CyrusOne retained the net operating losses related to its foreign operations. Historically, we have recorded a full valuation allowance on our net foreign deferred tax assets related to our foreign generated net operating losses due to the uncertainty of their realization. In 2015 and 2016, management determined it was necessary to record a full valuation allowance on all of our domestic and foreign net deferred tax assets due to the uncertainty of their realization. As of December 31, 2016 and 2015, the valuation allowance was $6.5 million and $6.3 million, respectively.
Recently Issued Accounting Standards
Refer to Note 5 for our audited consolidated financial statements for further information on recently issued accounting standards. We do not expect the adoption of these new accounting standards to have a material impact on our financial condition, results of operations or cash flows on a prospective basis.
Inflation
Our customer leases generally do not provide for annual increases in rent based on inflation. As a result, we bear the risk of increases in the costs of operating and maintaining our data center facilities. Some of our leases have annual escalators, typically ranging from 2-3%; however, these escalators are not based on inflation and as a result we bear the risk of increases in operating costs in excess of the annual escalator. Some of our leases are structured to pass-through the cost of sub-metered utilities. In the future, we expect more of our leases to pass-through utility costs.
ITEM 7A.
ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk
Interest Rate Risk
We have exposure to interest rate risk, arising from variable-rate borrowings under our Second Amended and Restated Credit Agreement and our fixed-rate long-term debt. As of December 31, 2016, the credit facility comprised of commitments of $1.0 billion under the Revolving Credit Facility and $300.0 million under the Initial Term Loan and $250.0 million under the Additional Term Loan and the outstanding borrowings were $235.0 million under the Revolving Credit Facility, $300.0 million under the Initial Term Loan and $250.0 million under the Additional Term Loan.
The Revolving Credit Facility is scheduled to mature in November 2020 and includes a one-year extension option, which if exercised by CyrusOne LP would extend the maturity date to November 2021. The Initial Term Loan is scheduled to mature in January 2022. The Additional Term Loan is scheduled to mature in September 2021. The Revolving Credit Facility currently bears interest at a rate per annum equal to LIBOR plus 1.55% and the Initial Term Loan and the Additional Term Loan currently bear interest at a rate per annum equal to LIBOR plus 1.50%.
On November 20, 2012, CyrusOne LP and CyrusOne Finance Corp. issued $525.0 million of 6.375% senior notes due 2022, which bear interest at a fixed rate of 6.375% per annum. In November and December of 2014, we repurchased 6.375% senior notes with an aggregate face value of $150.2 million for a purchase price of $163.0 million, including accrued interest. On July 1, 2015, CyrusOne LP and CyrusOne Finance Corp. issued an additional $100.0 million aggregate principal amount of 6.375% senior notes. As of December 31, 2016, our 6.375% senior notes had an outstanding balance of $477.3 million, including bond premium.
The following table sets forth the carrying value and fair value face amounts, maturity date and average interest rates at December 31, 2016, for our fixed-rate and variable-rate debt, excluding capital leases and other financing arrangements:
The fair value of our 6.375% senior notes as of December 31, 2016 was based on the quoted market price for these notes, which is considered Level 1 of the fair value hierarchy. The carrying value of the Revolving Credit Facility and Term Loans approximates estimated fair value as of December 31, 2016, due to the variability of interest rates and the stability of our credit ratings. The fair value of other financing arrangements at December 31, 2016 was calculated using a discounted cash flow model that incorporates current borrowing rates for obligations of similar duration.
Foreign Currency Risk
Substantially all of our revenue and expenses are denominated in U.S. dollars. We do not currently employ forward contracts or other financial instruments to mitigate foreign currency risk. As our international operations grow, we may engage in hedging activities to hedge our exposure to foreign currency risk.
Commodity Price Risk
Certain of our operating costs are subject to price fluctuations caused by the volatility of the underlying commodity prices, including electricity used in our data center operations, and building materials, such as steel and copper, used in the construction of our data centers. In addition, the lead time to purchase certain equipment for our data centers is substantial which could result in increased costs for these construction projects. In addition, we have entered into several contracts to purchase electricity. As of December 31, 2016, these contracts represent less than our forecasted usage. We intend to obtain additional fixed price contracts as our electricity usage grows.
We do not currently employ forward contracts or other financial instruments to mitigate the risk of commodity price risk other than the electricity contracts discussed above.
ITEM 8.
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
CyrusOne Inc.
Dallas, TX
We have audited the accompanying consolidated balance sheets of CyrusOne Inc. and subsidiaries (the "Company") as of December 31, 2016 and 2015, and the related consolidated statements of operations, comprehensive income (loss), equity, and cash flows for each of the three years in the period ended December 31, 2016. Our audits also included the financial statement schedules listed in the Index at Item 15(a). These financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statements and financial statement schedules based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of CyrusOne Inc. and subsidiaries as of December 31, 2016 and 2015, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2016, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company's internal control over financial reporting as of December 31, 2016, based on the criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 24, 2017 expressed an unqualified opinion on the Company's internal control over financial reporting.
Dallas, Texas
February 24, 2017
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
CyrusOne Inc.
Dallas, TX
We have audited the internal control over financial reporting of CyrusOne Inc. and subsidiaries (the "Company") as of December 31, 2016, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Annual Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed by, or under the supervision of, the company's principal executive and principal financial officers, or persons performing similar functions, and effected by the company's board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on the criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements and financial statement schedules as of and for the year ended December 31, 2016 of the Company and our report dated February 24, 2017 expressed an unqualified opinion on those financial statements and financial statement schedules.
Dallas, Texas
February 24, 2017
CYRUSONE INC.
Consolidated Balance Sheets
The accompanying notes are an integral part of the consolidated financial statements
CYRUSONE INC.
Consolidated Statements of Operations
The accompanying notes are an integral part of the consolidated financial statements
CYRUSONE INC.
Consolidated Statements of Comprehensive Income (Loss)
The accompanying notes are an integral part of the consolidated financial statements
CYRUSONE INC.
Consolidated Statements of Equity
The accompanying notes are an integral part of the consolidated financial statements
CYRUSONE INC.
Consolidated Statements of Cash Flows
The accompanying notes are an integral part of the consolidated financial statements
CYRUSONE INC.
Notes to Consolidated Financial Statements
1. Description of Business
CyrusOne Inc., together with CyrusOne GP, a wholly owned subsidiary of CyrusOne Inc., through which CyrusOne Inc. wholly owns CyrusOne LP (the operating partnership) and the subsidiaries of the operating partnership (collectively, “CyrusOne”, “we”, “us”, “our”, and the “Company”) is an owner, operator and developer of enterprise-class, carrier-neutral, multi-tenant data center properties. Our customers operate in a number of industries, including information technology, financial services, energy, oil and gas, mining, medical and consumer goods and services. We currently operate 35 data centers and 2 recovery centers located in the United States, United Kingdom and Singapore.
2. Formation and Recent Developments
Formation
On January 24, 2013, CyrusOne Inc. completed its initial public offering (the IPO) of common stock. During 2014, 2015 and 2016, the Company completed public offerings of 16.0 million, 27.3 million, and 10.3 million shares of its common stock and received $355.9 million, $799.3 million and $419.8 million net proceeds, respectively, from these public offerings.
On December 14, 2015, CyrusOne Inc. completed a public secondary offering of 1.4 million shares of common stock on behalf of CBI. The Company received no proceeds from the offering. On December 31, 2015, CyrusOne Inc. completed an issuance of approximately 6.3 million newly issued shares of common stock in exchange for an equal number of operating partnership units of CyrusOne LP, held by a subsidiary of CBI. As of December 31, 2015, CBI owned 9.5% of the common stock of CyrusOne Inc.
As of December 31, 2016, CBI owned less than 5.0% of the common stock of CyrusOne Inc. All of the 83.5 million outstanding operating partnership units of CyrusOne LP are owned, directly or indirectly, by CyrusOne Inc.
Recent Developments
On March 17, 2016, CyrusOne LP entered into a first amended and restated credit agreement (the First Amended and Restated Credit Agreement) which amended and restated in its entirety the credit agreement governing its senior unsecured revolving credit facility (the Revolving Credit Facility) and senior unsecured term loan facility (the Initial Term Loan), originally dated as of October 9, 2014. The First Amended and Restated Credit Agreement provided for an additional $250.0 million senior unsecured term loan facility (the Additional Term Loan, and together with the Initial Term Loan, the Term Loans) in addition to the existing $300.0 million Initial Term Loan and existing $650.0 million Revolving Credit Facility. CyrusOne LP borrowed $250.0 million under the Additional Term Loan and used the proceeds to repay a portion of the amount outstanding under the Revolving Credit Facility. On November 21, 2016, CyrusOne LP entered into a second amended and restated credit agreement (the Second Amended and Restated Credit Agreement) which amended and restated in its entirety the First Amended and Restated Credit Agreement. The Second Amended and Restated Credit Agreement increased the available commitments under the Revolving Credit Facility to $1.0 billion.
On March 21, 2016, CyrusOne Inc. completed a public offering of 6.9 million shares of its common stock for $255.0 million, net of underwriting discounts of approximately $10.6 million. CyrusOne LP used the proceeds to acquire the Chicago-Aurora I data center from CME Group for $131.1 million and to fund its development pipeline. During the first quarter of 2016, the Company received $0.9 million from the exercise of stock options and $0.1 million relating to common shares purchased under the employee stock purchase plan. In total, offerings of common stock during the first quarter of 2016 resulted in $256.0 million of cash flow from financing activities on the consolidated statements of cash flows.
On May 2, 2016, CyrusOne Inc. and CyrusOne GP amended and restated the Agreement of Limited Partnership of CyrusOne LP (Amended LP Agreement) to reflect that CBI and its subsidiaries have ceased to be partners or hold any partnership interests in CyrusOne LP and therefore have no rights under the Amended LP Agreement. The Amended LP Agreement also effects certain changes to clarify language, comply with or conform to Maryland and partnership tax law and make various technical corrections and ministerial changes.
On May 4, 2016, CyrusOne Inc. filed a Form S-3 with the SEC as a "well-known seasoned issuer" ("WKSI") using an automatic shelf registration process. Under this process, CyrusOne Inc. or any selling security holders may sell any combination of the securities described in the registration statement from time to time in one or more offerings in amounts to be determined at the time of any offering.
On July 1, 2016, the Company filed a prospectus supplement and entered into sales agreements (the Sales Agreements) with each of Raymond James & Associates, Inc., Jefferies LLC, KeyBanc Capital Markets Inc., Merrill Lynch, Pierce, Fenner & Smith Incorporated and SunTrust Robinson Humphrey, Inc., as sales agents, pursuant to which CyrusOne Inc. may issue and sell from time to time shares of its common stock having an aggregate gross sales price of up to $320.0 million, pursuant to an “at the
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Notes to Consolidated Financial Statements - (continued)
market” program. Sales of shares of CyrusOne Inc. common stock under the Sales Agreements are made by means of ordinary brokers’ transactions on the NASDAQ Global Select Market or otherwise at market prices prevailing at the time of sale, at prices related to prevailing market prices or, subject to specific instructions of CyrusOne Inc., at negotiated prices. During the year ended December 31, 2016, the Company sold 0.5 million shares of its common stock under this program, generating net proceeds of approximately $26.3 million after giving effect to sales agent commissions of $0.3 million.
On August 15, 2016, CyrusOne Inc. completed a public offering of 3.4 million shares of its common stock for $164.8 million, net of underwriting discounts of approximately $6.9 million. CyrusOne Inc. contributed the net proceeds from the sale of its shares to its operating partnership in exchange for an equivalent number of newly issued operating partnership units (the August OP Contribution and Issuance). CyrusOne LP has used and intends to use the proceeds from the August OP Contribution and Issuance to fund growth capital expenditures related to recently signed leases, to repay borrowings under its Revolving Credit Facility, and for general corporate purposes, which may include funding future acquisitions, investments or capital expenditures. In connection with this offering, on August 10, 2016, CyrusOne Inc. entered into (a) a forward sale agreement with Goldman, Sachs & Co. (the Forward Sale Agreement) with respect to 3.4 million shares of its common stock, and (b) an additional forward sale agreement with Goldman, Sachs & Co. (the Additional Forward Sale Agreement, and together with the Forward Sale Agreement, the Forward Sale Agreements) with respect to approximately 1.0 million shares of its common stock in connection with the underwriters' exercise of their option to purchase these shares.
Pursuant to the terms of the Forward Sale Agreements, and subject to CyrusOne Inc.’s right to elect cash or net share settlement under the Forward Sale Agreements, CyrusOne Inc. intends to issue and sell, upon physical settlement of such Forward Sale Agreements, approximately 4.4 million shares of its common stock to Goldman, Sachs & Co. in exchange for cash proceeds per share equal to the applicable forward sale price, which was initially $48.48 per share and is subject to certain adjustments as provided in the applicable forward sale agreement. CyrusOne Inc. expects to physically settle the Forward Sale Agreements in full, which settlement or settlements will occur on or before August 1, 2017.
3. Basis of Presentation
The accompanying financial statements as of December 31, 2016 and December 31, 2015, and for the years ended December 31, 2016, December 31, 2015 and December 31, 2014, are prepared on a consolidated basis.
In addition, the accompanying financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). All intercompany transactions and balances have been eliminated in consolidation. All prior year amounts have been presented to conform to current year's presentation.
During the third quarter of 2016, the Company identified certain immaterial errors relating to prior periods where Depreciation and amortization and Interest expense were understated. In 2016, we corrected the cumulative amount of these errors which resulted in additional Depreciation and amortization of $2.6 million and related Interest expense of $1.1 million.
4. Significant Accounting Policies
Use of Estimates-Preparation of the consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. These estimates and assumptions are based on management’s knowledge of current events and actions that we may undertake in the future. Estimates are used in determining the fair value of leased real estate, including purchase price allocations for business combinations and asset acquisitions, the useful lives of real estate and other long-lived assets, future cash flows associated with goodwill and other long-lived asset impairment testing, deferred tax assets and liabilities and loss contingencies. Actual results may differ from these estimates and assumptions.
Investment in Real Estate-Investment in real estate consist of land, buildings, improvements and integral equipment utilized in our data center operations. Real estate acquired from third parties has been recorded at its acquisition cost. Additions and improvements which extend an asset’s useful life or increase its functionality are capitalized and depreciated over the asset’s remaining life. Maintenance and repairs are expensed as incurred.
When we are involved in the construction of structural improvements to leased property, we are deemed the accounting owner of the leased real estate. In these instances, we bear substantially all the construction period risk, including managing or funding construction. As we have substantially all of the construction risks, we are deemed the “owner” of the asset under construction for accounting purposes during the construction period, and are therefore required to capitalize the construction costs on the accompanying consolidated balance sheets. At inception, the fair value of the building (excluding land) is recorded as an asset and the construction and modification costs to the building, that are not funded by us would be recorded as a liability. As construction progresses, the value of the asset and obligation increases by the fair value of the structural improvements. At completion of the
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Notes to Consolidated Financial Statements - (continued)
construction, Sales-Leaseback Accounting under ASC 840-40-25 is also evaluated. Due to our continuing involvement with the lessor, Sales-Leaseback Accounting is precluded and the liability is not derecognized. When the asset is placed in service, depreciation commences, and the leased real estate is depreciated to the lesser of (i) its estimated fair value at the end of the term or (ii) the expected amount of the unamortized obligation at the end of the term. The associated obligation is presented as Lease financing arrangements in the accompanying consolidated balance sheets.
When we are not deemed the accounting owner of leased real estate, we further evaluate the lease to determine whether the lease should be classified as a capital or operating lease. One of the following four characteristics must be present to classify a lease as a capital lease: (i) the lease transfers ownership of the property to the lessee by the end of the lease term, (ii) the lease contains a bargain purchase option, (iii) the lease term is equal to 75% or more of the estimated economic life of the leased property or (iv) the net present value of the lease payments is at least 90% of the fair value of the leased property.
Construction in progress includes direct and indirect expenditures for the construction and expansion of our data centers and is stated at its acquisition cost. Independent contractors perform substantially all of the construction and expansion efforts of our data centers. Construction in progress includes costs incurred under construction contracts including project management services, engineering and schematic design services, design development, construction services and other construction-related fees and services. Interest, property taxes and certain labor costs are also capitalized during the construction of an asset. Capitalized interest in 2016, 2015, and 2014 was $10.6 million, $6.1 million, and $4.6 million, respectively. These costs are depreciated over the estimated useful life of the related assets.
Depreciation is calculated using the straight-line method over the estimated useful life of the asset. Useful lives range from nine to thirty years for buildings, three to thirty years for building improvements, and two to twenty years for equipment. Leasehold improvements are amortized over the shorter of the asset’s useful life or the remaining lease term, including renewal options which are reasonably assured.
Management reviews the carrying value of long-lived assets, including intangible assets with finite lives, when events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. Examples of such indicators may include a significant adverse change in the extent to which or manner in which the property is being used, an accumulation of costs significantly in excess of the amount originally expected for acquisition or development, or a history of operating or cash flow losses. When such indicators exist, we review an estimate of the undiscounted future cash flows expected to result from the use of an asset (or group of assets) and its eventual disposition and compare such amount to its carrying amount. We consider factors such as future operating income, leasing demand, competition and other factors. If our undiscounted net cash flows indicate that we are unable to recover the carrying value of the asset, an impairment loss is recognized. An impairment loss is measured as the amount by which the asset’s carrying value exceeds its estimated fair value.
For the years ended December 31, 2016 and 2015, we recognized impairments and loss on disposal of $5.3 million and $13.5 million, respectively. There were no impairments recognized for the year ended December 31, 2014.
Business Combinations-The Company applies the purchase method for business combinations, where all tangible and identifiable intangible assets acquired and all liabilities assumed are recorded at fair value. Any excess purchase price is recorded as goodwill. Transaction costs associated with business combinations are expensed as incurred. Revenues and the results of operations of the acquired business are included in the accompanying consolidated financial statements commencing on the date of acquisition.
Cash and Cash Equivalents-Cash and cash equivalents include all non-restricted cash held in financial institutions and other non-restricted highly liquid short-term investments with original maturities at acquisition of three months or less.
Restricted Cash-Restricted cash includes cash equivalents held to collateralize standby letters of credit and/or deposited in escrow to fund construction or pending potential acquisition transactions. In addition, we may have other cash that is not immediately available for use in current operations.
Goodwill-We evaluate goodwill for possible impairment at least annually or upon the occurrence of a triggering event. A triggering event is an event or circumstance that would more likely than not reduce the fair value of a reporting unit below its carrying amount, including sales of properties defined as businesses for which the relative size of the sold property is significant to the reporting unit, that could impact our goodwill impairment calculations.
For our annual impairment evaluation, we have the option of performing a qualitative or quantitative goodwill impairment analysis. A qualitative analysis, Step zero, analyzes the macro-economic environment in which we operate for any significant changes such as deterioration in the market that the Company operates or overall financial performance such as declining cash flows. Also, entity specific changes are analyzed such as change in management, strategy or composition of reporting unit.
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Notes to Consolidated Financial Statements - (continued)
A quantitative analysis, Step one, requires the Company to estimate the fair value of the reporting unit and compare the fair value to the carrying value to identify whether the value of the recorded goodwill is impaired. Changes in certain assumptions could have a significant impact on the impairment test for goodwill under Step one. The most critical assumptions are projected future growth rates, operating margins, capital expenditures, tax rates, terminal values and discount rates. These assumptions are subject to change as our long-term plans and strategies are updated each year. If the fair value is below the carrying value the Company estimates the fair value of all the assets and liabilities of the reporting unit and compares them to the carrying value to determine the amount of the impairment, Step two.
During the fourth quarter of 2016, we applied Step zero and determined that it is more likely than not that the fair value of the reporting unit is more than the carrying amount and therefore determined that the two step method for goodwill impairment testing was not necessary. During fourth quarters of 2015 and 2014, we performed a detailed, quantitative assessment. Based on the Company's annual assessment of goodwill, no impairment has been recognized through December 31, 2016.
Long-Lived and Intangible Assets-Intangible assets represent purchased assets that lack physical substance, but can be separately distinguished from goodwill because of contractual or other legal rights or because the asset is capable of being sold or exchanged, either on its own or in combination with a related contract, asset, or liability. Intangible assets with finite lives consist of trademarks, customer relationships, and a favorable leasehold interest.
Rent and Other Receivables-Receivables consist principally of trade receivables from customers and are generally unsecured and due within 30 to 120 days. Unbilled receivables arise from services rendered but not yet billed. Expected credit losses associated with trade receivables are recorded as an allowance for doubtful accounts. The allowance for doubtful accounts is estimated based upon historic patterns of credit losses for aged receivables as well as specific provisions for certain identifiable, potentially uncollectible balances. When internal collection efforts on accounts have been exhausted, the accounts are written-off and the associated allowance for doubtful accounts is reduced.
At December 31, 2016, there were no customers with receivables that made up 10% of the Company's outstanding accounts receivable balance. The Company had receivables with one customer that made up 10% of the Company’s outstanding accounts receivable balance at December 31, 2015.
Deferred Leasing Costs-Deferred leasing costs are presented with Other assets in the accompanying consolidated balance sheets. Leasing commissions incurred at the commencement of a new lease are capitalized and amortized over the term of the customer lease. Amortization of deferred leasing costs is presented with Depreciation and amortization in the accompanying consolidated statements of operations. If a lease terminates prior to the expiration of the lease, the remaining unamortized cost is written off to amortization expense. As of December 31, 2016 and 2015, deferred leasing costs were $23.3 million and $14.2 million, respectively.
Deferred Financing Costs-Deferred financing costs include costs incurred in connection with issuance of debt, including our senior notes, term loans and revolving credit facilities. These costs include deferred financing costs associated with our revolving line of credit and are presented in the balance sheet as a direct reduction from the carrying amount of the debt liability. These financing costs are deferred and amortized to expense over the term of the instrument and are included as a component of Interest expense.
Lease Financing Arrangements-Lease financing arrangements represent leases of real estate where we are involved in the construction of structural improvements to develop buildings into data centers. When we bear substantially all the construction period risk, such as managing or funding construction, we are deemed to be the accounting owner of the leased property and, at the lease inception date, we are required to record at fair value the property and associated liability on our consolidated balance sheets. These transactions generally do not qualify for sale-leaseback accounting due to our continued involvement in these data center operations.
Revenue Recognition-Colocation rentals are generally billed monthly in advance, and some contracts have escalating payments over the term of the contract. If rents escalate without the lessee gaining access to or control over additional leased space or power, and the lessee takes possession of, or controls the physical use of the property (including all contractually committed power) at the beginning of the lease term, the rental payments by the lessee are recognized as revenue on a straight-line basis over the term of the lease. If rents escalate because the lessee gains access to and control over additional leased space or power, revenue is recognized in proportion to the additional space or power in the periods that the lessee has control over the use of the additional space or power. The excess of revenue recognized over amounts contractually due is recognized in Other assets in the accompanying consolidated balance sheets. As of December 31, 2016 and 2015, straight-line rent receivable was $67.6 million and $44.7 million, respectively.
Revenue is recognized for services or products that are deemed separate units of accounting. When a customer makes an advance payment or they are contractually obligated to pay any amounts in advance, which is not deemed a separate unit of accounting,
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Notes to Consolidated Financial Statements - (continued)
Deferred revenue is recorded. This revenue is recognized ratably over the expected term of the lease, unless the pattern of service suggests otherwise. As of December 31, 2016 and 2015, Deferred revenue was $76.7 million and $78.7 million, respectively.
Some of our leases are structured on a full-service gross basis in which the customer pays a fixed amount for both colocation rent and power. Other leases provide that the customer will be billed for power based upon actual usage which is separately metered. In both cases, this revenue is presented as Revenue in the accompanying consolidated statements of operations. Power is generally billed one month in arrears, and an estimate of this revenue is accrued in the month that the associated costs are incurred. We generally are not entitled to reimbursements for real estate taxes, insurance or other operating expenses. Generally, we receive an administrative fee when we manage the meters for our customers.
Certain customer leases require specified levels of service or performance. If we fail to meet these service levels, our customers may be eligible to receive credits on their contractual billings. These credits are recognized against revenue when an event occurs that gives rise to such credits. Customer credits were immaterial for each of the years presented. A provision for doubtful accounts is recognized when the collection of contractual rent, straight-line rent or customer reimbursements are deemed to be uncollectible.
Sales and Marketing Expense-Sales and marketing expense is comprised of compensation and benefits associated with Sales and marketing personnel as well as advertising and marketing costs. Costs related to advertising expense were $4.1 million, $2.2 million and $2.9 million for the years ended December 31, 2016, 2015 and 2014, respectively.
Depreciation and Amortization Expense-Depreciation expense is recognized over the estimated useful lives of real estate applying the straight-line method. The useful life of leased real estate and leasehold improvements is the lesser of the economic useful life of the asset or the term of the lease, including optional renewal periods if renewal of the lease is reasonably assured. The residual value of leased real estate is estimated as the lesser of (i) the expected fair value of the asset at the end of the lease term or (ii) the expected amount of the unamortized liability at the end of the lease term. Estimated useful lives are periodically reviewed. Depreciation expense was $157.7 million, $117.8 million and $95.8 million for the years ended December 31, 2016, 2015 and 2014, respectively.
Amortization expense is recognized over the estimated useful lives of finite-lived intangibles. Finite-lived intangibles include trademarks, customer relationships, favorable leasehold interests, trade names and deferred leasing costs. As of December 31, 2016, the estimated remaining weighted average useful life of trademarks and customer relationships were 9 and 12 years, respectively. In addition, we have a favorable leasehold interest related to a land lease that is being amortized over the lease term of fifty-one years. The trade name is being amortized over three years. Deferred leasing costs are amortized over three to five years. Amortization expense was $26.2 million, $23.7 million and $22.2 million for the years ended December 31, 2016, 2015 and 2014, respectively.
Transaction and Acquisition Integration Costs-Transaction costs represent incremental legal, accounting and professional fees incurred in connection with consummated and potential business combinations. Transaction costs are expensed as incurred and do not include any recurring costs from our ongoing operations. Integration costs represent incremental costs to integrate a consummated acquisition.
Income Taxes-The income tax provision consists of an amount for taxes currently payable and an amount for tax consequences deferred to future periods. CyrusOne Inc. has elected to be taxed as a REIT under the Internal Revenue Code of 1986, as amended (the Code), commencing with our initial taxable year ending December 31, 2013. Provided we continue to meet the various qualification tests mandated under the Code, we are generally not subject to corporate level federal income tax on the earnings distributed currently to our stockholders. If we fail to qualify as a REIT in any taxable year, our taxable income will be subject to federal income tax at regular corporate rates and any applicable alternative minimum tax, and we may not be able to qualify as a REIT for four subsequent taxable years.
While CyrusOne Inc. does not pay federal income taxes, we are still subject to foreign, state and local income taxes in the locations in which we conduct business. Our taxable REIT subsidiaries (each a TRS) are also subject to federal and state income taxes to the extent they earn taxable income.
Deferred income taxes are recognized in certain entities. Deferred income taxes are provided for temporary differences in the basis between financial statement and income tax assets and liabilities. Deferred income taxes are recalculated annually at rates then in effect. Valuation allowances are recorded to reduce deferred tax assets to amounts that are more likely than not to be realized. The ultimate realization of the deferred tax assets depends upon our ability to generate future taxable income during the periods in which basis differences and other deductions become deductible and prior to the expiration of the net operating loss carryforwards.
The Company and its subsidiaries file income tax returns in the U.S. federal jurisdiction as well as various foreign, state and local jurisdictions. The Company's previous tax filings are subject to normal reviews by regulatory agencies until the related statute of
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Notes to Consolidated Financial Statements - (continued)
limitations expires. With a few exceptions, the Company is no longer subject to U. S. federal, state or local examinations for years prior to 2012, and we have no liabilities for uncertain tax positions as of December 31, 2016 or 2015.
Foreign Currency Translation and Transactions-The financial position of foreign subsidiaries is translated at the exchange rates in effect at the end of the period, while revenues and expenses are translated at average rates of exchange during the period. Gains or losses from translation of foreign operations where the local currency is the functional currency are included as components of other comprehensive (loss) income. Gains or losses from foreign currency transactions are included in determining net income.
Comprehensive Income (Loss)-Comprehensive income (loss) represents the change in net assets of a company from transactions and other events from non-owner sources. Comprehensive income (loss) comprises all components of net income (loss) and all components of other comprehensive income (loss).
Earnings Per Share-Basic EPS includes only the weighted average number of common shares outstanding during the period. Diluted EPS includes the weighted average number of common shares and the dilutive effect of stock options, restricted stock and share unit awards outstanding during the period, when such instruments are dilutive. Diluted EPS also includes the dilutive impact of shares issuable under the forward sales agreement using the treasury stock method.
All outstanding unvested share-based payment awards that contain rights to nonforfeitable dividends are treated as participating in undistributed earnings with common shareholders. Awards of this nature are considered participating securities and the two-class method of computing basic and diluted EPS is applied. The forward contract entered into in August 2016 is not a participating security.
Stock-Based Compensation-In conjunction with the IPO, our board of directors adopted the 2012 Long-Term Incentive Plan (LTIP), which was amended and restated by our stockholders on May 2, 2016. The LTIP is administered by the compensation committee of the board of directors, or the plan administrator. Awards issuable under the LTIP include common stock, restricted stock, stock options and other incentive awards. See Note 17 for additional details relating to these awards.
Share-based compensation expense is based on the estimated grant-date fair value. CyrusOne Inc. recognizes share-based compensation expense on a straight-line basis over the requisite service period for time-based awards and on a graded vesting basis for performance-based awards. We adopted ASU No. 2016-09, Improvements to Employee Share-Based Payment Accounting (Subtopic 718) in the fourth quarter of 2016 and elected to account for forfeitures as they occur. Prior to the adoption of this ASU, CyrusOne estimated forfeitures based on historical activity, expected employee turnover, and other qualitative factors which were adjusted for changes in estimates and award vesting. Expenses for an award are recognized by the time they become fully vested.
CyrusOne Inc. uses the Black-Scholes-Merton option pricing model to calculate the fair value of stock options. This option valuation model requires the use of subjective assumptions, including the estimated fair value of the underlying common stock, the expected stock price volatility, and the expected term of the option. The estimated fair value of the underlying common stock is based on third-party valuations. Our volatility estimates are based on a peer group of companies. We estimate the expected term of the awards to be the weighted average mid-point between the vesting date and the end of the contractual term.
For interim and annual periods, we use our year-to-date actual results, financial forecasts, and other available information to estimate the probability of the award vesting based on the performance metrics.
Fair Value Measurements-Fair value measurements are utilized in accounting for business combinations and testing of goodwill and other long-lived assets for impairment and disclosures. Fair value of financial and non-financial assets and liabilities is defined as an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. The three-tier hierarchy for inputs used in measuring fair value, which prioritizes the inputs used in the methodologies of measuring fair value for asset and liabilities, is as follows:
Level 1-Observable inputs for identical instruments such as quoted market prices;
Level 2-Inputs include quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (i.e., interest rates, yield curves, etc.), and inputs that are derived principally from or corroborated by observable market data by correlation or other means (market corroborated inputs); and
Level 3-Unobservable inputs that reflect our determination of assumptions that market participants would use in pricing the asset or liability. These inputs are developed based on the best information available, including our own data.
Business Segments-Business segments are components of an enterprise for which separate financial information is available and regularly viewed by the chief operating decision maker to assess performance and allocate resources. Our chief operating decision maker, the Company's Chief Executive Officer, reviews our financial information on an aggregate basis. Furthermore,
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Notes to Consolidated Financial Statements - (continued)
our data centers have similar economic characteristics and customers across all geographic locations, and our service offerings have similar production processes, deliver services in a similar manner and use the same types of facilities and similar technologies. As a result, we have concluded that we have one reportable operating segment. As of December 31, 2016, one customer represented approximately 10% of our revenue, with that customer representing 13% of our annualized rent.
5. Recently Issued Accounting Standards
Accounting Standards Update (ASU) No. 2014-09 (ASU 2014-09), Revenue from Contracts with Customers (Topic 606)
On May 28, 2014, the Financial Accounting Standards Board (FASB) issued ASU 2014-09, which supersedes the revenue recognition requirements in Topic 605, "Revenue Recognition" and most industry-specific guidance. The core principle of ASU 2014-09 is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. On July 9, 2015, the FASB deferred the effective date of ASU 2014-09. The new revenue standard is effective for fiscal years, and interim periods within those years, beginning after December 15, 2017 (January 1, 2018 for CyrusOne) and allows either a full retrospective adoption to all periods presented or a modified retrospective adoption approach with the cumulative effect of initial application of the revised guidance recognized at the date of initial application. We are beginning to evaluate the adoption alternatives and the impact of ASU 2014-09 on our consolidated financial statements. Our initial evaluation is that revenue from base colocation services, which is a majority of our revenues, would not be impacted by the adoption of this standard and therefore, we are inclined to adopt the modified retrospective approach. Our initial conclusion may change when we complete our evaluation.
ASU No. 2015-17 (ASU 2015-17), Income Taxes (Topic 740)
In November 2015, the FASB issued guidance which amended the balance sheet classification requirements for deferred Taxes. The ASU requires an entity to classify all deferred tax liabilities and assets as noncurrent in the balance sheet. This guidance is effective for financial statements issued for annual periods beginning after December 15, 2016, including interim periods within those fiscal years. Early application is permitted. The Company adopted this standard in the fourth quarter of 2016 and applied it prospectively to all deferred tax assets and liabilities. The adoption had no effect on our consolidated financial statements because we have a full valuation allowance for our deferred tax assets.
ASU No. 2016-01 (ASU 2016-01), Financial Instruments-Overall (Subtopic 825-10)
In January 2016, the FASB amended its standards related to the accounting of certain financial instruments. This amendment addresses certain aspects of recognition, measurement, presentation and disclosure. The new rules will become effective for annual and interim periods beginning after December 15, 2017. Early adoption is not permitted. We are in the process of evaluating the impact the amendment will have on the consolidated financial statements.
ASU No. 2016-02 (ASU 2016-02), Leases (Topic 842)
On February 25, 2016, the FASB issued ASU 2016-02. Lessees will need to recognize on their balance sheet a right-of-use asset and a lease liability for virtually all of their leases (other than leases that meet the definition of a short-term lease). The liability will be equal to the present value of lease payments. The asset will be based on the liability, subject to adjustment, such as for initial direct costs. For income statement purposes, the FASB retained a dual model, requiring leases to be classified as either operating or finance. Operating leases will result in straight-line expense (similar to current operating leases) while finance leases will result in a front-loaded expense pattern (similar to current capital leases). Classification will be based on criteria that are largely similar to those applied in current lease accounting. The standard is effective for CyrusOne beginning January 1, 2019. Early adoption is permitted. The new standard must be adopted using a modified retrospective transition, and provides for certain practical expedients. Transition will require application of the new guidance at the beginning of the earliest comparative period presented. We are beginning to evaluate the impact of ASU 2016-02 on our consolidated financial statements and timing of adoption.
ASU No. 2016-09 (ASU 2016-09), Improvements to Employee Share-Based Payment Accounting (Subtopic 718)
In March 2016, the FASB issued guidance which simplifies several aspects of the accounting for employee share-based payment transactions for both public and nonpublic entities, including the accounting for income taxes, forfeitures, and statutory tax withholding requirements, as well as classification in the statement of cash flows. This guidance is effective for annual periods beginning after December 15, 2016, including interim periods within those annual reporting periods. Early adoption is permitted. The Company adopted the guidance in the fourth quarter of 2016 with effective date of January 1, 2016 and elected the actual forfeiture rate which had an immaterial impact to our financial statements.
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Notes to Consolidated Financial Statements - (continued)
ASU No. 2016-10 (ASU 2016-10), Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing (Topic 606)
In April 2016, the FASB issued ASU 2016-10 in response to an issue communicated by the Transition Resource Group for Revenue Recognition (the TRG), a group which was formed by the FASB and the International Accounting Standards Board (IASB), (collectively, the Boards), whose objective is to inform the Boards of any issues that could arise with the implementation of a converged standard on recognition of revenue from contracts with customers. ASU 2016-10 does not change the core principal of the guidance in Topic 606, but adds clarification around identifying performance obligations and licensing.
The amendments in this update affect the guidance in ASU 2014-09, Contracts with Customers (Topic 606), which is not yet effective, and therefore follow the same effective date and transition requirements. ASU 2014-09 is effective for CyrusOne on January 1, 2018 and allows either a full retrospective adoption to all periods presented or a modified retrospective adoption approach with the cumulative effect of initial application of the revised guidance recognized at the date of the initial application. We are currently evaluating the impact of ASU 2016-10 and ASU 2014-09 on the company consolidated financial statements.
ASU No. 2016-12 (ASU 2016-12), Revenue from Contracts with Customers (Subtopic 606)
In May 2016, the FASB issued guidance which amends certain aspects of the Board's new revenue standard, ASU 2014-09. The amendments include the collectibility of revenue, presentation of sales tax and other similar taxes collected from customers, contracts containing noncash considerations, and contract modifications and completed contracts at transition. The effective date and transition provisions are aligned with the requirements of ASU 2014-09 (as described above). We are currently evaluating the full impact of the new standard.
ASU No. 2016-13 (ASU 2016-13), Measurement of Credit Losses on Financial Instruments (Subtopic 326)
In June 2016, the FASB issued guidance which requires a financial asset measured at amortized cost basis to be presented at the net amount expected to be collected. The amendments affect entities holding financial assets and net investment in leases that are not accounted for at fair value through net income. The amendments affect loans, debt securities, trade receivables, net investments in leases, off-balance-sheet credit exposures, reinsurance receivables, and any other financial assets not excluded from the scope that have the contractual right to receive cash. The guidance is effective for annual periods beginning after December 15, 2019. Early adoption is permitted. We are currently evaluating the full impact of the new standard.
ASU No. 2016-15 (ASU 2016-15), Classification of Certain Cash Receipts and Cash Payments (Subtopic 230)
In August 2016, the FASB issued guidance which addresses the diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. This update addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice. The guidance is effective for annual periods beginning after December 15, 2017. Early adoption is permitted. The Company adopted the standard in the fourth quarter of 2016 with effective date of January 1, 2016. The adoption of the standard had no effect on our consolidated financial statements.
ASU No. 2016-18 (ASU 2016-18), Restricted Cash (Subtopic 230)
In November 2016, the FASB issued guidance which addresses the diversity in the classification and presentation of changes in restricted cash on the statement of cash flows. The amendment requires that a statement of cash flows explain the change during the period in the total of cash. The guidance is effective for annual periods beginning after December 15, 2017. Early adoption is permitted. We are currently evaluating the full impact of the new standard.
ASU No. 2017-01 (ASU 2017-01), Business Combinations (Topic 805)
In January 2017, the FASB issued guidance which clarifies the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The definition of a business affects many areas of accounting including acquisitions, disposals, goodwill and consolidation. Under this new guidance, the Company expects most acquisitions of investment property will meet the definition of an asset and, thus, be accounted for as asset acquisitions. Consistent with existing guidance, transaction costs associated with asset acquisitions are capitalized while transaction costs associated with business combinations are expensed as incurred. The guidance is effective for annual periods beginning after December 15, 2017. Early adoption is permitted. We are considering the early adoption of this standard in the first quarter of 2017.
CYRUSONE INC.
Notes to Consolidated Financial Statements - (continued)
6. Acquisitions and Purchase of Fixed Assets
Cervalis
On July 1, 2015, CyrusOne LP acquired 100% of Cervalis, a privately-held owner and operator of data centers for $398.4 million, excluding transaction-related expenses, in an all cash transaction. Cervalis has four data center facilities and two work recovery facilities serving the New York metropolitan area. CyrusOne LP financed the acquisition with proceeds of CyrusOne Inc.'s June 2015 common stock offering and CyrusOne LP and CyrusOne Finance Corp.'s July 2015 6.375% senior notes offering as well as drawing under CyrusOne Inc.'s Revolving Credit Facility. The acquisition of Cervalis enhances the geographic diversification of CyrusOne, provides access to a high quality enterprise customer base and strengthens our product portfolio. The goodwill recorded for this acquisition relates to the incremental value that Cervalis brings to the existing CyrusOne operations. The customer relationships intangible is expected to be amortized over fifteen years. This acquisition was accounted for as a business combination. For the year ended December 31, 2015, transaction and integration costs related to the Cervalis Acquisition were $12.9 million.
The consolidated financial statements include the operating results of Cervalis from the date of acquisition. The following table summarizes the estimated fair values of all assets acquired and liabilities assumed at the date of acquisition:
The acquisition of Cervalis in July 2015 resulted in an increase in revenue of $37.7 million for year ended December 31, 2015.
The unaudited pro forma combined historical results of CyrusOne, as if Cervalis had been acquired and the financing transactions had been consummated as of January 1, 2014 are:
These amounts have been calculated after applying CyrusOne's policies and adjusting the results to reflect changes to Depreciation and amortization to property and equipment, amongst others, and amortizing intangible assets had been recorded as of January 1, 2014. These pro forma combined results of operation are presented for informative purposes only and they do not purport to be indicative of the results of operation that actually would have resulted had the acquisition occurred on the date indicated, or that may result in the future.
CYRUSONE INC.
Notes to Consolidated Financial Statements - (continued)
CME
On March 31, 2016, CyrusOne LP purchased CME Group's Chicago-Aurora I data center in Aurora, Illinois for $131.1 million, including transaction related costs, in an all cash transaction. This acquisition was accounted for as an asset acquisition. CyrusOne LP financed the purchase with proceeds of CyrusOne Inc.'s March 2016 common stock offering. The purchase enhances the geographic diversification of CyrusOne, provides access to a high quality enterprise customer base and strengthens our product portfolio. The transaction adds to CyrusOne Inc.'s existing data center platform an approximately 428,000 square-foot facility data center serving the Chicago metropolitan region. In addition, CyrusOne acquired approximately 15 acres of land directly adjacent to the data center for future development.
On April 1, 2016, the CME Group entered into a 15-year lease for data center space at the Aurora facility. The agreement is expected to enhance the range of services available to the Company and CME Group's mutual customers through connectivity, hosting and data offerings.
In addition, during the year ended December 31, 2016, the Company purchased four properties for development for approximately $54.5 million.
CYRUSONE INC.
Notes to Consolidated Financial Statements - (continued)
7. Investment in Real Estate
A schedule of our gross investment in real estate follows:
CYRUSONE INC.
Notes to Consolidated Financial Statements - (continued)
In addition, Construction in progress was $407.1 million and $231.1 million as of December 31, 2016 and December 31, 2015, respectively, as we continue to build data center facilities.
For the year ended December 31, 2016, our capital expenditures were $731.1 million, as shown on the statement of cash flows. This included the purchase of the Aurora Properties for $131.1 million, the purchase of four properties for development in Northern Virginia - Sterling, Chicago - Aurora and Phoenix - Chandler II for approximately $54.5 million and $545.5 million for other developments primarily in Northern Virginia - Sterling, Phoenix - Chandler II, San Antonio, Dallas - Carrollton and Houston - Houston West III. For the year ended December 31, 2016, we recognized Asset impairment and loss on disposal of $5.3 million which related primarily to two properties, South Bend-Crescent, a leased facility, and Cincinnati-Goldcoast, an owned facility.
For the year ended December 31, 2015, our capital expenditures were $17.3 million for the purchase of Austin III facility and $217.2 million for other development as shown on the consolidated statements of cash flows. The significant items included the development of additional square footage and power in our Northern Virginia - Sterling, Phoenix - Chandler II, Houston - Houston West III and Dallas - Carrollton data centers, and the purchase of Austin III in February of 2015. The total purchase price of the Austin III facility was $17.3 million, of which $3.3 million was allocated to Land and the remaining amount remains in Construction in progress as of December 31, 2015. For the year ended December 31, 2015, we recognized Asset impairment and loss on disposal of $13.5 million which related primarily to the exit of Austin I, which is a leased facility, and loss on disposal of certain other assets.
8. Notes Receivable
The carrying amount of notes receivable was $6.6 million and $2.5 million as of December 31, 2016 and 2015, respectively, and consisted of the following:
Each of the above notes are from different customers. Note 1 matures in February 2018, and the payments are approximately $300,000 per month. Note 2 matures in September 2021, and the payments are approximately $50,000 per month. Note 3 matures in October 2020, and the payments are approximately $12,000 per month. These notes are included in Rent and other receivables on the consolidated balance sheets.
9. Goodwill, Intangible and Other Long-Lived Assets
The carrying amount of Goodwill was $455.1 million and $453.4 million as of December 31, 2016 and 2015, respectively. As of December 31, 2015, the amounts recognized for Goodwill and Intangible assets were in connection with the acquisition of Cervalis, Cyrus Networks as well as prior acquisitions. For the year ended December 31, 2015, the additions relating to the Cervalis Acquisition were $177.2 million, $117.4 million, $2.3 million and $0.2 million for Goodwill, customer relationships, trade name and favorable leasehold interest, respectively. For the year ended December 31, 2016, the addition to Goodwill was due to a reclassification from Other assets as a result of a measurement period adjustment relating to the Cervalis Acquisition.
CYRUSONE INC.
Notes to Consolidated Financial Statements - (continued)
Summarized below are the carrying values for the major classes of intangible assets:
There were no goodwill or intangible asset impairments for the years ended December 31, 2016 or 2015.
Amortization expense for acquired intangible assets was $20.1 million, $18.5 million and $17.0 million for the years ended December 31, 2016, 2015 and 2014, respectively.
The following table presents estimated amortization expense for each of the next five years and thereafter, commencing January 1, 2017:
CYRUSONE INC.
Notes to Consolidated Financial Statements - (continued)
10. Long-Term Debt, Capital Lease Obligations and Lease Financing Arrangements
Long-term debt, Capital lease obligations and Lease financing arrangements presented in the accompanying consolidated financial statements consist of the following:
Credit Facility-On October 9, 2014, CyrusOne LP entered into a credit agreement (the Credit Agreement) which provided for a $450 million senior unsecured revolving credit facility to replace CyrusOne LP's $225 million secured credit facility, and a $150 million senior unsecured term loan. On June 22, 2015, CyrusOne entered into an amendment to the Credit Agreement and other loan documents governing its revolving credit facility and term loan facility. The amendment increased the size of the Credit Agreement's accordion feature, which gave the operating partnership the ability to request an increase in the total commitment under the Credit Agreement, from $300 million to $600 million. Immediately after entering into the amendment, the operating partnership exercised $350 million of this accordion feature and obtained commitments to increase the total commitment under the Credit Agreement from $600 million to $950 million, comprised of $650 million of commitments under the revolving credit facility (the Revolving Credit Facility) and $300 million under the term loan (the Initial Term Loan). In addition, the Credit Agreement contained an accordion feature that allows CyrusOne LP to increase the aggregate commitment by up to $250 million.
On March 17, 2016, CyrusOne LP entered into a first amended and restated credit agreement (the First Amended and Restated Credit Agreement) which amended and restated in its entirety the Credit Agreement, as amended previously. The First Amended and Restated Credit Agreement provided for an additional $250.0 million senior unsecured term loan facility (the Additional Term Loan, and together with the Initial Term Loan, the Term Loans) in addition to the existing $300.0 million Initial Term Loan and the existing $650.0 million Revolving Credit Facility. The First Amended and Restated Credit Agreement had an accordion feature under which CyrusOne LP may have requested an increase in the total commitments up to an amount not to exceed $250.0 million. Deferred financing costs of $2.1 million related to this amendment were recorded.
On November 21, 2016, CyrusOne LP entered into a second amended and restated credit agreement (the Second Amended and Restated Credit Agreement) which amended and restated in its entirety the First Amended and Restated Credit Agreement. The Second Amended and Restated Credit Agreement, among other things, increased the available commitments under the Revolving Credit Facility to $1.0 billion. Deferred financing costs of $6.6 million related to this amendment were recorded.
The Revolving Credit Facility is scheduled to mature in November 2020 and includes a one-year extension option, which if exercised by CyrusOne LP would extend the maturity date to November 2021. The Initial Term Loan of $300 million is scheduled to mature in January 2022. The Additional Term Loan of $250 million is scheduled to mature in September 2021. The Revolving Credit Facility currently bears interest at a rate per annum equal to LIBOR plus 1.55% and the Initial Term Loan and Additional Term Loan currently bear interest at a rate per annum equal to LIBOR plus 1.50%. As of December 31, 2016, the interest rate for the Revolving Credit Facility and the Term Loans was 2.31% and 2.26%, respectively.
As of December 31, 2016, there were outstanding borrowings of $235.0 million on the Revolving Credit Facility and aggregate borrowings of $550.0 million on the Term Loans. In addition, the Second Amended and Restated Credit Agreement contains an accordion feature that allows CyrusOne LP to increase the aggregate commitment by up to $300 million.
CYRUSONE INC.
Notes to Consolidated Financial Statements - (continued)
We pay commitment fees for the unused amount of borrowings on the Revolving Credit Facility and letter of credit fees on any outstanding letters of credit. The commitment fees are equal to 0.25% per annum of the actual daily amount by which the aggregate revolving commitments exceed the sum of outstanding revolving loans and letter of credit obligations. Commitment fees related to the Second Amended and Restated Credit Agreement were $1.6 million and $0.9 million for the years ended December 31, 2016 and 2015, respectively.
6.375% Senior Notes due 2022-On November 20, 2012, CyrusOne LP and CyrusOne Finance Corp. (Issuers) issued $525.0 million of 6.375% senior notes due 2022 (6.375% senior notes). The 6.375% senior notes are senior unsecured obligations of the Issuers, which rank equally in right of payment with all existing and future unsecured senior debt of the Issuers. The 6.375% senior notes are effectively subordinated to all existing and future secured indebtedness of the Issuers to the extent of the value of the assets securing such indebtedness. The 6.375% senior notes are fully and unconditionally and jointly and severally guaranteed by CyrusOne Inc., CyrusOne GP, and each of CyrusOne LP’s existing and future domestic subsidiary that guarantees other indebtedness of CyrusOne LP or any guarantor, subject to certain exceptions. Each such guarantee is a senior unsecured obligation of the applicable guarantor, ranking equally with all existing and future unsecured senior debt of such guarantor and effectively subordinated to all existing and future secured indebtedness of such guarantor to the extent of the value of the assets securing that indebtedness. The 6.375% senior notes are structurally subordinated to all liabilities (including trade payables), of each subsidiary of the Issuers that does not guarantee the 6.375% senior notes. The 6.375% senior notes bear interest at a rate of 6.375% per annum, payable semi-annually on May 15 and November 15 of each year.
The 6.375% senior notes will mature on November 15, 2022. However, prior to November 15, 2017, the Issuers may, at their option, redeem some or all of the 6.375% senior notes at a redemption price equal to 100% of the principal amount of the 6.375% senior notes being redeemed, together with accrued and unpaid interest, if any, to the date of redemption plus a “make-whole” premium. On or after November 15, 2017, the Issuers may, at their option, redeem some or all of the 6.375% senior notes at any time at declining redemption prices equal to (i) 103.188% beginning on November 15, 2017, (ii) 102.125% beginning on November 15, 2018, (iii) 101.063% beginning on November 15, 2019 and (iv) 100.000% beginning on November 15, 2020 and thereafter, plus, in each case, accrued and unpaid interest, if any, to the applicable redemption date. In addition, before November 15, 2015, and subject to certain conditions, the Issuers were permitted , at their option, to redeem up to 35% of the aggregate principal amount of the 6.375% senior notes with the net proceeds of certain equity offerings at a redemption price equal to 106.375% of the principal amount thereof, plus accrued and unpaid interest, if any, to the date of redemption; provided that (i) at least 65% of the aggregate principal amount of the 6.375% senior notes remained outstanding after the redemption and (ii) the redemption occurred within 90 days of the closing of any such equity offering.
In November and December of 2014, we repurchased a portion of our 6.375% senior notes with an aggregate face value of $150.2 million for a purchase price of $163.0 million, including accrued and unpaid interest. This resulted in a loss on extinguishment of debt of $12.8 million.
On July 1, 2015, the Issuers closed a private offering of $100.0 million aggregate principal amount of the 6.375% senior notes (New Notes) plus a premium of $3.8 million. The New Notes were issued as additional notes under the Indenture dated November 20, 2012 as supplemented by the first supplemental indenture dated July 1, 2015, and the New Notes have terms substantially identical to those of the 6.375% senior notes issued in November 2012. On December 29, 2015, all notes issued on July 1, 2015 were exchanged for registered notes that are freely tradable. As of December 31, 2016, the outstanding balance on the 6.375% senior notes was $477.3 million, including bond premium.
Debt Covenants -The Second Amended and Restated Credit Agreement requires us to maintain certain financial covenants including the following, in each case on a consolidated basis:
•A minimum fixed charge ratio;
•Maximum total and secured leverage ratios;
•A minimum consolidated tangible net worth ratio;
•A maximum secured recourse indebtedness ratio;
•A minimum unencumbered debt yield ratio; and
•A maximum ratio of unsecured indebtedness to unencumbered asset value.
Notwithstanding these limitations, we will be permitted, subject to the terms and conditions of the Second Amended and Restated Credit Agreement, to distribute to our stockholders cash dividends in an amount not to exceed 95% of our Funds From Operations (FFO), as defined in the Second Amended and Restated Credit Agreement for any period. Similarly, our indenture permits dividends and distributions necessary for us to maintain our status as a REIT.
The Company’s most restrictive covenants are generally included in the Second Amended and Restated Credit Agreement. In order to continue to have access to amounts available to it under the Second Amended and Restated Credit Agreement, the Company must remain in compliance with all covenants.
CYRUSONE INC.
Notes to Consolidated Financial Statements - (continued)
The indenture governing the 6.375% senior notes contains affirmative and negative covenants customarily found in indebtedness of this type, including a number of covenants that, among other things, restrict, subject to certain exceptions, the Company’s ability to: incur secured or unsecured indebtedness; pay dividends or distributions on its equity interests, or redeem or repurchase equity interests of the Company; make certain investments or other restricted payments; enter into transactions with affiliates; enter into agreements limiting the ability of the operating partnership’s subsidiaries to pay dividends or make certain transfers and other payments to the operating partnership or to other subsidiaries; sell assets; and merge, consolidate or transfer all or substantially all of the operating partnership’s assets. Notwithstanding the foregoing, the covenants contained in the indenture do not restrict the Company’s ability to pay dividends or distributions to stockholders to the extent (i) no default or event of default exists or is continuing under the indenture and (ii) the Company believes in good faith that we qualify as a REIT under the Code and the payment of such dividend or distribution is necessary either to maintain its status as a REIT or to enable it to avoid payment of any tax that could be avoided by reason of such dividend or distribution. The Company and its subsidiaries are also required to maintain total unencumbered assets of at least 150% of their unsecured debt on a consolidated basis, provided that for the purposes of such calculation their Revolving Credit Facility shall be treated as unsecured indebtedness, in each case subject to certain qualifications set forth in the indenture.
As of December 31, 2016, we believe we were in compliance with all covenants.
Notes Payable-The Company's note payable for approximately $1.5 million with a third-party for installation of electrical infrastructure at one of the Company's locations was repaid in July 2016.
Deferred financing costs-Deferred financing costs are costs incurred in connection with obtaining long-term financing. Deferred financing costs were incurred in connection with the issuance of the Revolving Credit Facility, the Initial Term Loan, the Additional Term Loan and 6.375% senior notes due 2022. As of December 31, 2016, and 2015, deferred financing costs totaled $22.2 million and $17.6 million, respectively. Amortization of deferred financing costs, included in Interest expense in the consolidated statements of operations, totaled $4.1 million, $3.4 million, and $3.4 million for the years ended December 31, 2016, 2015 and 2014, respectively.
Capital lease obligations-We use leasing as a source of financing for certain of our data center facilities and related equipment. We currently operate eight data center facilities under leases recognized as capital leases. We have options to extend the initial lease term on all but one of these leases.
Lease financing arrangements-Lease financing arrangements represent leases of real estate in which we are involved in the construction of structural improvements to develop buildings into data centers. When we bear substantially all the construction period risk, such as managing or funding construction, we are deemed to be the accounting owner of the leased property and, at the lease inception date, we are required to record at fair value the property and associated liability on our balance sheet. These transactions generally do not qualify for sale-leaseback accounting due to our continued involvement in these data center operations.
Interest expense on Capital lease obligations and Lease financing arrangements were $10.6 million, $7.8 million and $5.9 million for the years ended December 31, 2016, 2015 and 2014, respectively.
The following table summarizes aggregate maturities of total future value and present value of the minimum payments associated with our Lease financing arrangements for the five years subsequent to December 31, 2016, and thereafter:
CYRUSONE INC.
Notes to Consolidated Financial Statements - (continued)
The following table summarizes aggregate maturities of the Revolving Credit Facility and Term Loans, 6.375% senior notes due 2022 and capital leases for the five years subsequent to December 31, 2016, and thereafter:
The payment of interest on capital leases over the next five years and thereafter will be $0.9 million, $0.7 million, $0.5 million, $0.4 million, $0.2 million and $0.1 million, respectively.
11. Fair Value of Financial Instruments
The fair value of Cash and cash equivalents, Restricted cash, Rent and other receivables and Accounts payable and accrued expenses approximate their carrying value because of the short-term nature of these instruments.
The carrying value and fair value of other financial instruments are as follows:
The fair value of our 6.375% senior notes as of December 31, 2016 and 2015 was based on the quoted market price for these notes, which is considered Level 1 of the fair value hierarchy. The carrying value of the Revolving Credit Facility, the Initial Term Loan and the Additional Term Loan approximates estimated fair value as of December 31, 2016, due to the variability of interest rates and the stability of our credit ratings. The fair value of the note payable at December 31, 2015, was calculated using a discounted cash flow model that incorporates current borrowing rates for obligations of similar duration. These fair value measurements are considered Level 3 of the fair value hierarchy.
CYRUSONE INC.
Notes to Consolidated Financial Statements - (continued)
12. Noncontrolling Interest - Operating Partnership
Prior to the IPO, the operating partnership received a contribution of interests in real estate properties and the assumption of debt and other specified liabilities from CBI in exchange for the issuance of 123.7 million operating partnership units of CyrusOne LP to CBI. Subsequent to December 31, 2012, CyrusOne LP executed a 2.8 to 1.0 reverse unit split, resulting in CBI owning 44.1 million operating partnership units. On January 24, 2013, CBI exchanged 1.5 million operating partnership units for common shares of CyrusOne Inc.
After the IPO on January 24, 2013, CBI retained a noncontrolling interest in the operating partnership of 66.1%. The Company completed public offerings in 2014 and 2015 in which the proceeds were used to acquire the limited partnership interests in the operating partnership from CBI.
As of December 31, 2015, CBI owned approximately 9.5% of the Company’s common stock, and all of the operating partnership units of CyrusOne LP were owned, directly or indirectly, by the Company.
CyrusOne Inc. had no noncontrolling interests as of December 31, 2016, and CBI owned less than 5.0% of the Company's common stock. The following table shows the ownership interests as of December 31, 2015, and the portion of net income (loss) and distributions for the year ended December 31, 2015:
13. Dividends
We have declared cash dividends on common shares and distributions on operating partnership units for the years ended December 31, 2016 and 2015 as presented in the table below:
As of December 31, 2016 and 2015 we had a dividend payable of $33.9 million and $24.4 million, respectively. On February 23, 2017, we announced a regular cash dividend of $0.42 per common share payable to shareholders of record as of March 31, 2017. The dividend will be paid on April 14, 2017.
14. Customer Leases
Customer lease arrangements customarily contain provisions that allow either for renewal or continuation on a month-to-month arrangement. Certain leases contain early termination rights. At lease inception, early termination is generally not deemed reasonably assured due to the significant economic penalty incurred by the lessee to exercise its termination right and to relocate its equipment.
CYRUSONE INC.
Notes to Consolidated Financial Statements - (continued)
The future minimum lease payments to be received under non-cancellable operating leases, excluding month-to-month arrangements and submetered power, for the next five years are shown below:
15. Employee Benefit Plans
Currently, our employees participate in health care plans sponsored by CyrusOne, which provide medical, dental, vision and prescription benefits. We incurred $4.4 million, $3.1 million and $2.1 million of expenses related to these plans for the years ended December 31, 2016, 2015 and 2014, respectively.
CyrusOne offers a retirement savings plan to its employees. CyrusOne's matching contribution to its retirement savings plan was $1.5 million, $1.1 million and $0.8 million for the years ended December 31, 2016, 2015 and 2014, respectively.
16. Income (Loss) per Share
Basic income (loss) per share is calculated using the weighted average number of shares of common stock outstanding during the period. In addition, net income (loss) applicable to participating securities and the participating securities are both excluded from the computation of basic income (loss) per share.
Diluted income (loss) per share is calculated using the weighted average number of shares of common stock outstanding during the period, including restricted stock outstanding and shares contingently issuable under the Forward Sales Agreement (as defined below). If there is net income during the period, the dilutive impact of common stock equivalents outstanding would also be reflected.
On August 15, 2016, CyrusOne Inc. completed a public offering of 3.4 million shares of its common stock for $164.8 million, net of underwriting discounts of approximately $6.9 million. In connection with this offering, on August 10, 2016, CyrusOne Inc. entered into (a) a forward sale agreement with Goldman, Sachs & Co. (the Forward Sale Agreement) with respect to 3.4 million shares of its common stock, and (b) an additional forward sale agreement with Goldman, Sachs & Co. (the Additional Forward Sale Agreement, and together with the Forward Sale Agreement, the Forward Sale Agreements) with respect to approximately 1.0 million shares of its common stock in connection with the underwriters' exercise of their option to purchase these shares. This contract had no effect on our diluted share count at December 31, 2016.
CYRUSONE INC.
Notes to Consolidated Financial Statements - (continued)
The following table reflects the computation of basic and diluted net income (loss) per share:
(1) We have excluded 1.9 million weighted average shares of restricted stock, and 13.1 million of weighted average operating partnership units which are securities convertible into common stock from our diluted earnings per share as of December 31, 2015. These amounts were deemed anti-dilutive.
(2) We have excluded 0.8 million weighted average shares of restricted stock, and 34.3 million of weighted average operating partnership units which are securities convertible into common stock from our diluted earnings per share as of December 31, 2014. These amounts were deemed anti-dilutive.
17. Stock-Based Compensation Plans
Stock-based compensation expense was as follows:
In conjunction with the IPO, the board of directors of CyrusOne Inc. adopted the 2012 Long-Term Incentive Plan (LTIP), which was amended and restated on May 2, 2016. The LTIP is administered by the board of directors. Awards issuable under the LTIP include common stock, restricted stock, stock options and other incentive awards. CyrusOne Inc. has reserved a total of 8.9 million shares of CyrusOne Inc. common stock for issuance pursuant to the LTIP, which may be adjusted for changes in capitalization and certain corporate transactions. To the extent that an award, if forfeitable, expires, terminates or lapses, or an award is otherwise settled in cash without the delivery of shares of common stock to the participant, then any unpaid shares subject to the award will be available for future grant or issuance under the LTIP. The payment of dividend equivalents in cash in conjunction with any outstanding awards will not be counted against the shares available for issuance under the LTIP. The related stock compensation expense incurred by CyrusOne Inc. is allocated to the operating partnership. Shares available under the LTIP at December 31, 2016, were approximately 5.8 million. Shares vest according to each agreement and as long as the employee remains employed with the Company. The Company uses the Black-Scholes option-pricing model for time and performance-based options and a Monte Carlo simulation for market-based awards. The fair values of these awards use assumptions such as volatility, risk-free interest rate, and expected term of the awards.
Compensation expense is measured based on the estimated grant-date fair value. Expense for time-based grants is recognized under a straight-line method. For market-based grants, expense is recognized under a graded expense attribution method. For performance-based grants, expense is recognized under a graded expense attribution method if it is probable that the performance
CYRUSONE INC.
Notes to Consolidated Financial Statements - (continued)
targets will be achieved. Any dividends declared with respect to the performance and market-based shares shall be accrued by the Company and distributed on the vesting date provided that the applicable performance goal has been attained.
In March 2016, the FASB issued guidance which simplifies several aspects of the accounting for employee share-based payment transactions for both public and nonpublic entities, including the accounting for income taxes, forfeitures, and statutory tax withholding requirements, as well as classification in the statement of cash flows. The Company adopted the guidance in the fourth quarter of 2016 and elected the actual forfeiture rate, which had an immaterial impact to our financial statements.
The compensation expense for the year ended December 31, 2016 includes $0.8 million due to the acceleration of equity awards of a senior executive who left the Company. The compensation expense for the year ended December 31, 2015 includes $2.4 million due to the acceleration of equity awards of two senior executives who left the Company.
Founders Grants
On January 24, 2013, the Company granted one million shares of time-based restricted stock, which had an aggregate value of $19.0 million on the grant date. Holders of the restricted stock have all of the rights and privileges of stockholders including but not limited to the right to vote, receive dividends and distributions upon liquidation of CyrusOne. These shares vested on January 24, 2016.
2013 Grants
On April 17, 2013, the Company issued performance and market-based awards under the LTIP in the form of stock options and restricted stock. For these awards, vesting was tied 50% to the achievement of a non-GAAP performance measure (cumulative EBITDA targets, as defined in the agreement), over the 2013-2015 performance period, and 50% market-based performance measure (the total stockholder return (TSR), as defined in the agreement) at the end of the three-year period ending December 31, 2015. The portion of the awards tied to cumulative EBITDA was eligible to vest annually over a three-year period based on the Company attaining predetermined cumulative EBITDA targets. The cumulative EBITDA targets are based on the below scales. The scales are linear between each point and awards are interpolated between the points.
- Below 90% of performance target = 0%
- At 90% of performance target = 50%
- At 100% of performance target = 100%
- At or above 115% of performance target = up to 200%
The portion of the awards tied to TSR was eligible to vest at the end of three years if the TSR, during the three-year measurement period following the grant date, met or exceeded the return of the MSCI US REIT Index (Index) over the same period. The TSR targets are based on the below scales. The scales are linear between each point and awards are interpolated between the points.
- If CyrusOne's TSR is less than the return of the Index = 0%
- If CyrusOne's TSR is equal to or greater than the return of the Index = 100%; up to 200% if CyrusOne's TSR exceeds the return of the Index by 2%
- If CyrusOne's TSR exceeds the return of the Index, but is negative, any calculated vesting amount will be reduced by 50%
The stock option awards have a contractual life of 10 years from the award date and were granted with an exercise price equal to $23.58.
In addition, during the year ended December 31, 2013, the Company also granted from time-to-time a total of 4,361 additional time-based restricted shares which had an aggregate value of $0.1 million on the grant date. A portion of these shares cliff vested one year after the grant date and a portion vested three years after the grant date.
The holders of restricted stock shall have all of the rights and privileges of shareholders including the right to vote. As of December 31, 2016, there was no unearned compensation representing the unvested portion of the awards granted during 2013.
2014 Grants
On February 7, 2014, the Company issued performance and market-based awards under the LTIP in the form of restricted stock units. For these awards, vesting is tied 50% to the achievement of a non-GAAP performance measure (cumulative Adjusted EBITDA targets, as defined in the agreement) over the 2014-2016 performance period, and 50% to a market-based performance measure TSR, as defined in the agreement), as of the end of the three-year period ending December 31, 2016. The portion of the awards tied to cumulative Adjusted EBITDA vest annually over a three-year period based on the Company attaining predetermined cumulative Adjusted EBITDA targets and as long as the employee remains employed with the Company. The portion of the award
CYRUSONE INC.
Notes to Consolidated Financial Statements - (continued)
tied to TSR will vest at the end of three years based on the cumulative TSR over a three-year performance period. The market and performance-based awards will vest based on the same scales as the awards granted during 2013.
In addition, during the year ended December 31, 2014, the Company also granted from time-to-time a total of 46,313 additional time-based restricted shares which had an aggregate value of $1.0 million on the grant date. These shares cliff vested either one year after the grant date or will vest three years after the grant date.
The holders of restricted stock have all of the rights and privileges of shareholders including the right to vote. As of December 31, 2016, unearned compensation of the awards granted during 2014 totaled $0.1 million, with a weighted average vesting period of 0.1 years.
2015 Grants
On February 10, 2015, the Company issued awards under the LTIP in the form of options and restricted stock. The stock options are time-based and vest annually on a pro-rata basis over three years. Twenty percent of the restricted stock awards are subject to time-based vesting and eighty percent of the restricted stock awards are equally split between performance-based and market-based vesting. The performance-based metric is return on assets, which is a non-GAAP measure that is defined in the award agreement. The time-based restricted stock will vest pro-rata annually over three years. The performance and market-based restricted stock will vest annually based upon the achievement of certain criteria for each year of the three-year measurement period. The first two years are capped at 100% of the target with a cumulative true-up in year three.
The market and performance-based awards will vest based on the same scales as the awards granted during 2014.
In addition, during the year ended December 31, 2015, for various new employee hires, the following grants were made:
•8,157 shares of time-based restricted stock which cliff vest in three years from the date of each grant.
•29,424 shares of time-based restricted stock which vest annually from the date of each grant.
•12,719 time-based options which vest annually from the date of each grant.
•
11,711 shares of performance and market-based restricted stock, which vest annually based upon the achievement of certain criteria for each year of the three-year measurement period.
•
55,301 shares of performance-based (separate non-GAAP measure, as defined in the award agreement) restricted stock, which cliff vests in three years from the date of grant.
For the year ended December 31, 2016, the unearned compensation of the awards granted in 2015 totaled $2.2 million and the weighted average vesting period was 1.0 years.
2016 Grants
On February 1, 2016, the Company issued 641,097 shares of time, performance and market-based awards under the LTIP in the form of restricted stock. The grant date fair value of time and performance-based restricted shares was $36.99. The grant date fair value of market-based restricted shares was $43.66. The Company issued stock options on February 1, 2016. The stock option awards have a contractual life of 10 years from the award date and were granted with an exercise price equal to $36.99. The Company issued 222,461 options with a grant date fair value of $6.99.
The performance-based metric is return on assets, which is a non-GAAP measure and is defined in the award agreement. The time-based restricted stock awards generally vest pro-rata annually over a three-year period. The performance and market-based restricted stock awards vest annually based upon the achievement of certain criteria for each of the three-year measurement periods. The first two years are capped at 100% of the target with a cumulative true-up in year three. Certain employees were also awarded time-based restricted stock that cliff vest at the end of three years. The stock options are time-based and vest annually on a pro-rata basis over 3 years.
The market and performance-based awards will vest based on the same scales as the awards granted during 2015.
In addition, during the year ended December 31, 2016, for various new employee hires, the following grants were made:
•
5,894 shares of time-based restricted stock which cliff vest in three years from the date of each grant.
•
47,667 shares of time-based restricted stock which vest annually from the date of each grant.
CYRUSONE INC.
Notes to Consolidated Financial Statements - (continued)
As of December 31, 2016, unearned compensation representing the unvested portion of the awards granted in 2016 totaled $14.5 million, with a weighted average vesting period of 2.0 years.
Restricted Stock and Stock Option Activity
The following table summarizes the unvested restricted stock activity and the weighted average fair value of these shares at the date of grant for the year ended December 31, 2016:
The non-vested shares at December 31, 2014 were 1,739,642.
The following table summarizes the stock option activity for the year ended December 31, 2016:
The outstanding options at December 31, 2014 were 166,872.
The aggregate intrinsic value of options outstanding and options exercisable is based on the Company's closing stock price on the last trading day of the fiscal year for in-the-money options. The aggregate intrinsic value represents the cumulative difference between the fair market value of the underlying common stock and the option exercise prices. The total intrinsic value of options exercised during fiscal year 2016 was $1.3 million and 2015 was immaterial. There were no options exercised during 2014.
The aggregate intrinsic value of options outstanding at December 31, 2016 was $5.6 million. The aggregate intrinsic value of options exercisable at December 31, 2016 was $2.4 million.
Stock Option Assumptions
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Notes to Consolidated Financial Statements - (continued)
The following table summarizes the stock option assumptions for the years ended December 31, 2016, 2015, and 2014:
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Notes to Consolidated Financial Statements - (continued)
18. Related Party Transactions
CBI
Prior to November 20, 2012, CyrusOne Inc., CyrusOne GP, CyrusOne LP and its subsidiaries were operated by CBI. The consolidated financial statements reflect the following transactions with CBI and its affiliated entities, including Cincinnati Bell Telephone (CBT) and Cincinnati Bell Technology Solutions (CBTS). At December 31, 2015, CBI owned 9.5% of the outstanding common stock of CyrusOne Inc. and no operating partnership units, at which point it ceased to be a related party of CyrusOne Inc. As of December 31, 2016, CBI owned less than 5% of the outstanding common stock of CyrusOne Inc.
Revenues-The Company records revenues from CBI under contractual service arrangements. These services include leasing of data center space, power and cooling in certain of our data center facilities, network interface services and office space.
Operating Expenses-The Company records expenses from CBI incurred in relation to network support, services calls, monitoring and management, storage and backup, IT systems support, and connectivity services.
The following related party transactions are based on agreements and arrangements that were in place during the respective periods. Revenues and expenses for the periods presented were as follows:
Other Related Party Transactions
Our director, Lynn A. Wentworth, is a member of the board of directors of CBI, and serves as the chair of its audit and finance committee.
The spouse of one of our former directors, who served until May 2015, is a partner with Skadden, Arps, Slate, Meagher & Flom LLP (Skadden). For the years ended December 31, 2015 and 2014, CyrusOne paid Skadden an immaterial amount and $1.1 million, respectively, for services rendered.
In the ordinary course of its business, CyrusOne periodically pays brokerage commissions to real estate brokerage firms in connection with property transactions and tenant leases. The spouse of one of our former directors, who served until 2014, is a principal with Jones Lang LaSalle. In 2014, CyrusOne paid $1.0 million to Jones Lang LaSalle.
19. Income Taxes
CyrusOne Inc. elected to be taxed as a REIT under the Code, commencing with our taxable year ended December 31, 2013. To remain qualified as a REIT, we are required to distribute at least 90% of our taxable income to our stockholders and meet various other requirements imposed by the Code relating to such matters as operating results, asset holdings, distribution levels and diversity of stock ownership. Provided we continue to qualify for taxation as a REIT, we are generally not subject to corporate level federal income tax on the taxable income distributed currently to our stockholders. It is our policy and intent, subject to change, to distribute
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Notes to Consolidated Financial Statements - (continued)
100% of our taxable income and therefore no provision is required in the accompanying financial statements for federal income taxes with regards to activities of CyrusOne Inc. and its subsidiary pass-through entities.
We have elected to designate two subsidiaries as taxable REIT subsidiaries (each a TRS). A TRS may perform services for our tenants that would otherwise be considered impermissible for REITs. The income generated from these services is taxed at federal and state corporate rates. While CyrusOne Inc. and the operating partnership do not pay federal income taxes, we are still subject to foreign, state, and local income taxes in the locations in which we conduct business. Income tax expense for the years ended December 31, 2016, 2015 and 2014 were $1.8 million, $1.8 million and $1.4 million, respectively.
For certain entities we calculate deferred tax assets and liabilities for temporary differences in the basis between financial statement and income tax assets and liabilities. Deferred income taxes are recalculated annually at rates then in effect. Valuation allowances are recorded to reduce deferred tax assets to amounts that are more likely than not to be realized. The ultimate realization of the deferred tax assets depends upon our ability to generate future taxable income during the periods in which basis differences and other deductions become deductible and prior to the expiration of the net operating loss carryforwards. Deferred tax assets (net of valuation allowance) and liabilities were accrued, as necessary, for the years ended December 31, 2016 and 2015. Historically, we have recorded a full valuation allowance on our foreign net deferred tax assets related to our foreign generated net operating losses due to the uncertainty of their realization. In 2013 and 2014, management determined it was necessary to record a full valuation allowance on all of our domestic and foreign net deferred tax assets due to the uncertainty of their realization. Accordingly, at December 31, 2016 and at December 31, 2015, the net domestic and foreign deferred tax assets were zero.
The Company adopted ASU No. 2015-17 in the fourth quarter of 2016 and applied it prospectively to all deferred tax assets and liabilities. The adoption had no effect on our consolidated financial statements.
In 2016 and 2015, we paid all our dividends in cash. The following table summarizes the taxability of our common stock dividends per share for the years ended December 31, 2016 and 2015:
Common stock dividends may be characterized for federal income tax purposes as ordinary income, qualified dividends, capital gains, non-taxable return of capital or a combination of the four. Common stock dividends that exceed our current and accumulated earnings and profits (calculated for tax purposes) constitute a return of capital rather than a dividend and generally reduce the stockholder's basis in the common stock. To the extent that a dividend exceeds both current and accumulated earnings and profits and the stockholder's basis in the common stock, it will generally be treated as gain from the sale or exchange of that stockholder's common stock. At the beginning of each year, we notify our stockholders of the taxability of the common stock dividends paid during the preceding year.
20. Commitments and Contingencies
Operating Leases
We lease certain data center facilities and equipment from third parties. Operating lease expense was $7.5 million, $7.4 million and $6.7 million for the years ended December 31, 2016, 2015 and 2014, respectively. Certain of these leases provide for renewal options with fixed rent escalations beyond the initial lease term.
At December 31, 2016, future minimum lease payments required under operating leases having initial or remaining non-cancellable lease terms in excess of one year are as follows:
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Notes to Consolidated Financial Statements - (continued)
Standby Letters of Credit
As of December 31, 2016, CyrusOne Inc. had outstanding letters of credit of $7.1 million as security for obligations under the terms of the lease agreements.
Performance Guarantees
Customer contracts generally require specified levels of performance related to uninterrupted service and cooling temperatures. If these performance standards are not met, we could be obligated to issue billing credits to the customer. Management assesses the probability that a performance standard will not be achieved. As of December 31, 2016 and 2015, no accruals for performance guarantees were required.
Indemnifications
During the normal course of business, CyrusOne has made certain indemnities, commitments and guarantees under which it may be required to make payments in relation to certain transactions. These include (i) intellectual property indemnities to customers in connection with the use, sale, and/or license of products and services, (ii) indemnities to vendors and service providers pertaining to claims based on negligence or willful misconduct and (iii) indemnities involving the representations and warranties in certain contracts. The majority of these indemnities, commitments and guarantees do not provide for any limitation on the maximum potential for future payments that we could be obligated to make.
Purchase Commitments
CyrusOne has non-cancellable purchase commitments for certain services and contracts related to construction of data center facilities and equipment. These agreements range from one to two years and provide for payments for early termination or require minimum payments for the remaining term. As of December 31, 2016, the minimum commitments for these arrangements were approximately $171.2 million.
Contingencies
CyrusOne is involved in legal, tax and regulatory proceedings arising from the conduct of its business activities. Liabilities are established for loss contingencies when losses associated with such claims are deemed to be probable, and the loss can be reasonably estimated. Based on information currently available and consultation with legal counsel, we believe that the outcome of all claims will not, individually or in the aggregate, have a material effect on our financial statements.
21. Guarantors
CyrusOne Inc.
CyrusOne LP and CyrusOne Finance Corp., as “LP Co-issuer” and “Finance Co-issuer,” respectively (together, the Issuers), had $477.3 million aggregate principal amount of 6.375% senior notes outstanding, including bond premium, at December 31, 2016. As of December 31, 2016, the 6.375% senior notes are fully and unconditionally and jointly and severally guaranteed on a senior basis by CyrusOne Inc. (Parent Guarantor), CyrusOne GP (General Partner), and CyrusOne LP’s wholly owned subsidiaries, CyrusOne LLC, CyrusOne TRS Inc., CyrusOne Foreign Holdings LLC, Cervalis Holdings LLC, and Cervalis LLC (such subsidiaries, together the Guarantor Subsidiaries). None of CyrusOne LP's subsidiaries organized outside of the United States (collectively, together with CyrusOne Government Services LLC, the Non-Guarantor Subsidiaries) guarantee the 6.375% senior notes. Subject to the provisions of the indenture governing the 6.375% senior notes, in certain circumstances, a Guarantor may be released from its guarantee obligation, including:
•
upon the sale or other disposition (including by way of consolidation or merger) of such Guarantor or of all of the capital stock of such Guarantor such that such Guarantor is no longer a restricted subsidiary under the indenture,
•
upon the sale or disposition of all or substantially all of the assets of the Guarantor,
•
upon the LP Co-issuer designating such Guarantor as an unrestricted subsidiary under the terms of the indenture,
•
if such Guarantor is no longer a guarantor or other obligor of any other indebtedness of the LP Co-issuer or the Parent Guarantor, and
•
upon the defeasance or discharge of the 6.375% senior notes in accordance with the terms of the indenture.
The entity structure of each Issuer and guarantor of the 6.375% senior notes is described below.
CyrusOne Inc. - CyrusOne Inc. is the Parent Guarantor and became a separate registrant with the SEC upon completion of its IPO on January 24, 2013.
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Notes to Consolidated Financial Statements - (continued)
CyrusOne GP - CyrusOne GP is the general partner and 1% owner of CyrusOne LP and has no other assets or operations.
Issuers - The Issuers are CyrusOne LP and CyrusOne Finance Corp. CyrusOne Finance Corp., a wholly owned subsidiary of CyrusOne LP, was formed for the sole purpose of acting as co-issuer of the 6.375% senior notes and has no other assets or operations. CyrusOne LP, in addition to being the co-issuer of the 6.375% senior notes, is also the 100% owner, either directly or indirectly, of the Guarantor Subsidiaries and Non-Guarantor Subsidiaries.
Guarantor Subsidiaries - The guarantors of the 6.375% senior notes include CyrusOne LLC, CyrusOne TRS Inc., CyrusOne Foreign Holdings LLC, Cervalis and Cervalis LLC (the Guarantor Subsidiaries) agreed to provide unconditional guarantees of the issuers’ obligations under the 6.375% senior notes. The guarantee of each Guarantor Subsidiary is (i) a senior unsecured obligation of such Guarantor Subsidiary, (ii) pari passu in right of payment with any existing and future unsecured senior indebtedness of such Guarantor Subsidiary, (iii) senior in right of payment to any future subordinated indebtedness of such Guarantor Subsidiary and (iv) effectively subordinated in right of payment to all existing and future secured indebtedness of such Guarantor Subsidiary, to the extent of the value of the collateral securing that indebtedness. CyrusOne LLC, together with CyrusOne Foreign Holdings LLC, directly or indirectly owns 100% of the Non-Guarantor Subsidiaries.
Non-Guarantor Subsidiaries consist of wholly owned subsidiaries which conduct operations in the United Kingdom and Singapore, as well as CyrusOne Government Services LLC, a Delaware limited liability company and wholly owned subsidiary of CyrusOne LP.
The following schedules present the balance sheets as of December 31, 2016 and 2015, and the statements of operations and comprehensive income (loss) for the years ended December 31, 2016, 2015 and 2014, and the statements of cash flows for the years ended December 31, 2016, 2015 and 2014 for the Parent Guarantor, General Partner, LP Co-issuer, Finance Co-issuer, Guarantor Subsidiaries, and Non-Guarantor Subsidiaries.
The condensed consolidating statements of cash flows for the year ended December 31, 2015, includes the acquisition of Cervalis in July 2015. The results for Cervalis are included in the Guarantor Subsidiaries financial statements subsequent to the acquisition.
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Notes to Consolidated Financial Statements - (continued)
Consolidating Balance Sheets
CYRUSONE INC.
Notes to Consolidated Financial Statements - (continued)
CYRUSONE INC.
Notes to Consolidated Financial Statements - (continued)
Consolidating Statements of Operations and Comprehensive Income (Loss)
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Notes to Consolidated Financial Statements - (continued)
CYRUSONE INC.
Notes to Consolidated Financial Statements - (continued)
Consolidating Statements of Cash Flows
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Notes to Consolidated Financial Statements - (continued)
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Notes to Consolidated Financial Statements - (continued)
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Notes to Consolidated Financial Statements - (continued)
22. Quarterly Financial Information (Unaudited)
The table below reflects the unaudited selected quarterly information for the years ended December 31, 2016 and 2015:
(a) The basic and diluted income (loss) per share for 2015 was $(0.30) compared to $(0.33) due to the impact of the 14.3 million shares of common stock issued during the secondary offering in April 2015, and the 6.0 million shares of common stock issued during the secondary offering in June 2015.
23. Subsequent Event
On February 6, 2017, CyrusOne Inc. announced the execution of a definitive agreement to purchase two data centers located in Raleigh-Durham, North Carolina and Somerset, New Jersey for a total purchase price of $490 million, excluding transaction-related costs, in an all cash transaction. The transaction is expected to close in the next 30 to 45 days, subject to the fulfillment of customary closing conditions. These facilities add more than 160,000 colocation square feet and approximately 21 megawatts of power capacity to our portfolio. This transaction is expected to provide enhanced geographic diversification, establishing a presence in the Raleigh-Durham and expanding our footprint in the Northeast.
On February 22, 2017, the Company notified Goldman, Sachs & Co. that it has elected full physical settlement of the previously announced forward sale agreements entered into by the Company on August 10, 2016 relating to, in the aggregate, 4.4 million shares of the Company’s common stock. The Company expects settlement to occur on February 27, 2017. Upon settlement, the Company expects to issue and sell 4.4 million shares of its common stock to Goldman, Sachs & Co., in its capacity as forward purchaser, in exchange for net proceeds of approximately $211 million, in accordance with the provisions of the forward sales agreements.
ITEM 9.
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures
Under the supervision and with the participation of our management, including our Chief Executive Officer and the Chief Financial Officer (our principal executive officer and principal financial officer, respectively), we have evaluated our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) as of December 31, 2016. Based upon that evaluation, the Chief Executive Officer and the Chief Financial Officer have concluded that, as of December 31, 2016, the Company’s disclosure controls and procedures were effective in ensuring information required to be disclosed by the Company in reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC and is accumulated and communicated to the Company’s management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
Management’s Annual Report on Internal Control Over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting. Under the supervision and with the participation of management, including the Chief Executive Officer and Chief Financial Officer, management assessed the effectiveness of internal control over financial reporting as of December 31, 2016 based on the Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on that assessment, management has concluded that our internal control over financial reporting was effective at December 31, 2016, to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of our financial statements for external purposes in accordance with U.S. generally accepted accounting principles. Due to its inherent limitations, internal control over financial reporting may not prevent or detect misstatements.
Deloitte & Touche LLP, our independent registered public accounting firm, has audited our financial statements included in this Annual Report on Form 10-K and has issued its attestation report on the effectiveness of our internal control over financial reporting as of December 31, 2016.
Changes in Internal Control Over Financial Reporting
There has been no change in our internal control over financial reporting during the fourth quarter ended December 31, 2016, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
Not applicable.
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance
The information required by this item can be found in the Proxy Statement for the 2017 Annual Meeting of Shareholders and is incorporated herein by reference.
The Company has a Code of Business Conduct and Ethics that applies to all employees, including the Company’s principal executive officer, principal financial officer, and principal accounting officer, as well as to the members of the Board of Directors of the Company. The code is available at investor.cyrusone.com/corporate-governance.cfm. The Company intends to disclose any changes in, or waivers from, this code by posting such information on the same website or by filing a Form 8-K, in each case to the extent such disclosure is required by rules of the SEC or NASDAQ.
Items 11. Executive Compensation
The information required by this item can be found in the Proxy Statement for the 2017 Annual Meeting of Shareholders and is incorporated herein by reference.
Items 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information required by this item can be found in the Proxy Statement for the 2017 Annual Meeting of Shareholders and is incorporated herein by reference.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence
The information required by this item can be found in the Proxy Statement for the 2017 Annual Meeting of Shareholders and is incorporated herein by reference.
Item 14.
Item 14. Principal Accountant Fees and Services
The information required by this item can be found in the Proxy Statement for the 2017 Annual Meeting of Shareholders and is incorporated herein by reference.
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a)Consolidated Financial Statements and Schedules. The following consolidated financial statements and schedules are included in this report:
(1)FINANCIAL STATEMENTS
The response to this portion of Item 15 is submitted under Item 8 of this Annual Report on Form 10-K.
(2)FINANCIAL STATEMENT SCHEDULES
Schedule II-Valuation and Qualifying Accounts
Schedule III-Consolidated Real Estate and Accumulated Depreciation. The response to this portion of Item 15 is required to be filed by Item 8 of this Annual Report on Form 10-K.
All other schedules for which provision is made in the applicable accounting regulations of the SEC are not required under the related instructions or are inapplicable and therefore have been omitted.
(3)EXHIBITS
Exhibits may be obtained from us upon request at a charge that reflects the reproduction cost of such Exhibits. Requests should be made to the Secretary of CyrusOne Inc., 2101 Cedar Springs Road, Suite 900, Dallas, Texas 75201. Exhibits are also available, free of charge, on the SEC's website at www.sec.gov.
Schedule II.
Valuation and Qualifying Accounts
Schedule III.
Real Estate Properties and Accumulated Depreciation
The aggregate cost of the total properties for federal income tax purposes was $3,095.0 million at December 31, 2016. In addition, Construction in progress was $407.1 million as we continue to build data center facilities.
Historical Cost and Accumulated Depreciation and Amortization
The following table reconciles the historical cost and accumulated depreciation for the years ended December 31, 2016, 2015 and 2014.
The exhibits required by Item 601 of Regulation S-K are listed below:
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized, on the 24th day of February, 2017.
CyrusOne Inc.
By:
/s/ Gary J. Wojtaszek
Gary J. Wojtaszek
President, Chief Executive Officer, and Director
By:
/s/ Diane M. Morefield
Diane M. Morefield
Executive Vice President and Chief Financial Officer
By:
/s/ Amitabh Rai
Amitabh Rai
Senior Vice President and Chief Accounting Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the date indicated.