Business Review - Telecity Group

Michael Tobin
Chief Executive Officer

Brian McArthur Muscroft
Group Finance Director

2007 was an exciting and successful year for TelecityGroup as we consolidated our position as the primary content and connectivity hub in key European strategic markets. In addition, we continued to deliver on the potential created by the integration of TeleCity plc, Redbus and Globix in 2006. The following highlights were achieved during 2007:

Revenue up 42.1% to £97.9m (2006: £68.9m)
Adjusted EBITDA* up 112.1% to £23.4m (2006: £11.0m)
Adjusted EBITDA* margin up 7.8 percentage points to 23.8% (2006: 16.0%)
Average revenue per occupied sq.m.up 12.0% to £2,586 (2006: £2,308)
Occupied space up 9.3% to 37,868 sq.m. (2006: 34,651 sq.m.)
Available fully fitted inventory in existing facilities expanded to 46,597 sq.m.
Cash flow from operating activities of £12.5m (2006: £3.6m)
Breakeven operating result (2006: loss £12.1m)
Pre-tax loss decreased by 50.8% to £7.8m (2006: £15.8m)
Continued strong demand from new and existing customers across diverse sectors
Began build of new data centres in London and Amsterdam, on track to open Q2 2008
Successful IPO raising net proceeds of £66.9m.

*Adjusted EBITDA is defined as earnings before interest, taxation, depreciation, amortisation and exceptional items

the market

Demand for high quality network independent data centre facilities continued to increase in all our markets during 2007. This was driven by continued growth and adoption of internet-based services, and the knock-on effects this has in driving content, applications and day to day business and online leisure activities. In addition, an increasing and diverse range of industries are recognising the benefits to be gained by outsourcing their data centre requirements. This sustained demand, coupled with the limited supply of new network independent data centre space, resulted in constrained supply and strengthening market prices. top

strategy

The key elements of TelecityGroup's strategy are to maintain the Group's position as the leading content and connectivity hub for customers and network service providers in key strategic markets by providing high levels of connectivity and a wide choice of network service providers. To achieve this strategy the Group is focused on the following main activities:

growing the customer base by signing new contracts and renewing existing contracts priced towards prevailing market rates;
continued enhancement of revenue per customer by providing additional value added services such as engineering, connectivity, security and backup services ('Value Added Services');
capitalising on strong demand through expansion opportunities in both existing and new markets that meet the strategic investment return criteria; and
consideration of selective acquisitions as appropriate opportunities arise.

The successful implementation of this strategy during 2007 is reflected in the Group's results. These are the first results since our IPO in October 2007 which was successfully completed despite challenging market conditions. The results show that revenue has increased 42.1% to £97.9m (2006: £68.9m) and Adjusted EBITDA has increased 112.1% to £23.4m (2006: £11.0m). The main factors driving this strong performance are detailed below.top

Customers

TelecityGroup provides web, IT infrastructure hosting and connectivity solutions to an increasing number of organisations. Organisations seeking to reduce costs, improve service levels and focus on their own core competences have been turning to TelecityGroup as a reliable and trusted data centre partner.

In 2007 the Group was successful in winning significant new business. Contracts were signed with a range of leading companies in all of our markets while the existing customer base remained a key source of growth. This resulted in an increase of over 30% in our order book during the course of the year, providing the Group with good forward visibility of revenues. Customer additions included Microsoft, ITV, Thales, Banca Sara and a number of other high-profile broadcast and financial institutions, while important renewals or upgrades included agreements with Barclays, Hewlett-Packard, Bwin, Siemens, Akamai and Sony Computer Entertainment Europe. The Group was also successful in renewing contracts with existing customers at rates closer to prevailing market rates at the point of contract renewal.

The combination of increased contract pricing and the successful growth in sales of additional Value Added Services helped to improve our revenue per occupied square metre by 12.0% from £2,308 to £2,586 per annum.

The TelecityGroup customer base continues to be diverse across a broad spread of sectors, helping to minimise the impact of demand fluctuations of any particular one. The new customer agreements that were signed in 2007 spanned a wide range of sectors from software and IT, to investment banking and high street finance, as well as from our established connectivity, content and media markets.

This success in winning and retaining customers is reflected in a net increase of 9.3% in occupied space. At the end of 2007, occupancy was 37,868 sq.m or 81.3% (2006: 34,651 sq.m or 75.9%).

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Capacity Expansion

During the year data centre operators faced the challenge of securing suitable sites in key city locations which could offer the combination of highly secure physical access, high levels of power and telecoms connectivity to provide additional data centre capacity. TelecityGroup has established a strong track record in overcoming these barriers by nurturing and further strengthening our existing relationships with key utility providers, planning authorities and telecommunication network providers, all of which supports our position as the largest European provider of carrier neutral data centres and connectivity hubs.

Our ability to invest and deliver new space quickly has been received well by our customers. This new space has continued to attract interest from both new and existing customers who have demonstrated a desire to expand rapidly. For example, a high density hosting facility consisting of 40 racks delivering between 15 kilowatts ('kW') and 20kW per rack, which we opened in one of our London data centres in April, was built and sold out during 2007.

At the end of 2007 the Group had 46,597 sq.m of fitted out customer space (2006: 45,683 sq.m). A significant proportion of the Group's investment in 2007 was devoted to maximising the available capacity in terms of both space and power in our existing data centres. We have also been successful in putting in place all key planning elements necessary for two new facilities in Amsterdam and London, both of which are designed to deliver 2kW of customer power per square metre, well above the current industry standard. Construction of both facilities commenced during the year and they are on schedule to be ready for customers during the second quarter of 2008. On completion, the new data centres will add an additional 9,000 sq.m to the Group's overall footprint. More significantly, together with the other expansion projects to existing data centres, this will increase the Group's overall power capacity in Amsterdam and London by over 100%. top

Current Trading

Trading during the start of 2008 has remained strong and we have signed key new contracts as well as continuing to renew existing contracts at rates nearer to prevailing market rates. In spite of continued growth in demand, there has been limited increase in supply in the market resulting in robust pricing levels.

We believe that as an established part of the IT outsourcing chain our colocation proposition will continue to provide a cost-effective solution that the market requires as demonstrated by the continuing demand for our services; the increasing relevance of internet-based services in the broader economy should have the effect of mitigating any market sentiment about a possible slowdown. Furthermore, we continue to see a strong pipeline of interest for our products and services and net order wins that are significantly higher than in the prior year.

Construction of the new data centres in London and Amsterdam is on track for availability in the first half of 2008 and we are encouraged by the level of interest from both existing and new customers for the additional capacity we are bringing on-line. The high customer-power specification of these new builds will provide the Group with competitive advantage as the availability of power increasingly becomes the main component of pricing.top

Detailed Group Performance

In 2007, demand for the Group's services continued to grow in all markets in which we operate, with particular strength in London, Amsterdam and Paris. This, along with the full year effect of Globix (acquired in September 2006) and the improvements in pricing achieved on contract renewals, had a positive impact on the Group's financial performance. Globix is fully integrated within the business and hence is not reported as a separate segment.

Total revenue for the current year was £97.9m (2006: £68.9m) an increase of 42.1%. The increase is a result of new order wins and price increases across the Group's sites, as well as the full year effect of Globix. At the year end, occupied space was 37,868 sq.m (2006: 34,651 sq.m) and average revenue per square metre was £2,586 (2006: £2,308). Revenues from colocation and Value Added Services have increased by 39.6% and 49.1% respectively reflecting the Group's continued focus on selling additional services. In the near future it is expected that colocation revenues will grow more quickly than Value Added Services due to the significant amount of capacity provided by the new builds.

UK and Ireland ('UK&I') revenues totalled £63.4m for the year (2006: £40.6m), an increase of 56.2%. This was partly due to the inclusion of a full year's revenue for two sites added following the acquisition of Globix. Additional growth was generated by increasing occupancy at improved pricing levels reflecting strong market conditions experienced across the sector, and power upgrades at several of the data centres.

At the year end, occupied space was 20,873 sq.m (2006: 20,131 sq.m) and average revenue per occupied square metre was £3,036 (2006: £2,565).

Rest of Europe ('RoE') revenues totalled £34.6m for the year (2006: £28.3m), an increase of 22.0%. In addition to the strong market conditions experienced in all of the Group's markets, growth was generated by increasing occupancy at improved pricing levels. At the year end, occupied space was 16,995 sq.m (2006: 14,520 sq.m) and average revenue per occupied square metre was £2,033 (2006: £1,950).

Underlying operating costs have increased by £13.4m. In addition, the full year effect of Globix has contributed a further £6.4m to operating costs. Costs have increased, reflecting improved business volumes. An analysis of the underlying increase in operating costs is as follows:

Payroll costs have increased by £4.1m due to higher sales commissions linked to the growth in revenue, additional data centre staff in the UK and increased corporate costs as a result of investing in business development and operating as a public company.
Electricity costs have increased by £3.5m in line with increased occupancy and related colocation revenues, and movements in power prices. As power is generally recharged to customers this has a limited impact on the profitability of the Group.
The annual depreciation and amortisation charge has increased by £1.9m as the Group has continued to invest in its asset base.
Other costs have increased by £3.0m. Part of the increase is directly related to costs in connection with sales of Value Added Services. In addition, due to the corporate activity in the past and the IPO, there have been increases in legal and professional fees. Finally, as part of the continued focus on working capital and in particular a detailed review of the debtor book, there was an increased bad debt expense in the year of £2.5m.
Property costs have only increased slightly, by £0.9m, despite the high levels of revenue growth.

Operating exceptional items of £4.7m were incurred during the year. These comprised the following:

£2.9m of listing costs incurred as a result of the Group's flotation. These costs, together with a further £5.4m charged directly to the share premium account, primarily relate to professional fees paid to the Group's sponsors, lawyers and accountants.
£1.4m of costs were incurred during the final stages of the integration of Globix and Redbus, this integration is now complete.
£0.7m of costs were incurred in respect of the new builds in London and Amsterdam which relate to costs such as rent and rates during the build period.
Finally there is a credit of £0.3m to exceptional items following the reassessment of an onerous lease provision in respect of a site in Munich.

In addition, the Group has incurred £2.1m of exceptional finance costs. In preparation for the Group's admission to the London Stock Exchange, the Group restructured its borrowings and unamortised loan issue costs in respect of the previous debt were expensed. The new borrowings and facilities are described in more detail below.

Net finance costs have increased from £3.7m to £5.7m. During the year, the Group incurred interest on its long-term loans of £5.2m (2006: £4.2m). In addition the Group incurred other financing costs of £1.1m (2006: £0.1m), including an adverse movement on the fair value of the Group's interest rate swaps of £0.5m (2006: £0.4m gain). Finance costs have been offset by finance income of £0.5m (2006: £0.6m).

Tax remains a minimal expense for the Group due to the availability of losses and unclaimed capital allowances in excess of depreciation which are estimated at a total value of £139.9m (2006: £126.1m). The Group does not expect to pay significant amounts of tax in the foreseeable future.top

Detailed Review of Group Cash Flow

Cash flows from operating activities increased £8.9m to £12.5m (2006: £3.6m). The strong cash performance is primarily a result of the increased Adjusted EBITDA of £23.4m (2006: £11.0m) less non-IPO related exceptional items of £1.8m (2006: £7.7m), net interest payments of £5.7m (2006: £4.0m) and working capital, foreign exchange and other movements of £3.4m (2006: inflow £4.3m).

The Group has invested £24.1m (2006: £6.6m) in capital expenditure, £8.9m of which relates to a capital prepayment for equipment and works in respect of the Amsterdam new build. The remaining £15.2m primarily relates to the two new builds of £1.6m, fit-outs to existing buildings of £7.6m (2006: £1.2m) and general capital expenditure of £6.0m (2006: £5.4m).

Net proceeds of £66.9m were raised during the Group's flotation of which £36.9m was used to repay existing borrowings. £0.1m was raised through issue of shares before the Group's flotation taking the total cash raised through issuing shares to £67.0m in the year (2006: £0.3m).

In total the Group has generated £26.4m of cash during the year (2006: £0.7m outflow) increasing year end cash balances to £37.0m which will be used, along with the borrowing facilities described below, to finance the Group's planned capital projects.top

financing

During the year, the Group raised net IPO proceeds of £66.9m. This is after deducting all directly attributable costs of £8.3m relating to fees from the sponsors, lawyers and accountants.

In preparation for its admission to the public market, the Group restructured its borrowing facilities. At 31 December 2006 the Group had gross borrowings of £60.9m. Up to the IPO, the Group made net further draw-downs of £9.6m from this facility, primarily to finance capital projects. At IPO, borrowings of £32.8m were drawn-down under the new facility. These, along with part of the IPO proceeds were used to repay the borrowings under the old facility.

The new £125.0m facility, which is held jointly with Barclays Bank and HBOS, comprises a term loan of £30.0m and a revolving credit facility of £95.0m, £6.9m of which has been used to guarantee lease deposits on certain of the Group's data centres. This facility, together with the Group's cash balances, provide sufficient financing for all currently planned capital expenditure. Despite the reduced supply in the credit markets during the latter part of 2007, the Group secured this facility at a competitive rate, the margin being over one percentage point lower than that of the previous facility. The terms of the financing required that the term loan be drawn down immediately, although it was not needed at that time. It is expected that the planned capital projects will utilise the term loan during the first half of 2008. Under the terms of the facility, the Group is required to hedge the interest rate on part of the borrowings. It is the Group's policy to hedge the interest rate exposure on the majority of the borrowings.

The Group seeks to finance its business through an appropriate mix of debt and equity. Current and medium-term interest rates are monitored when evaluating the most cost effective sources of finance. The facility described above, along with the IPO proceeds, result in the Group having a strong liquidity position.top

discussion of balance sheet

The Group's intangible assets of £46.9m (2006: £47.1m) comprise acquired customer contracts and goodwill that arose during the acquisition of Telecity plc, Globix and Redbus. The carrying value of these assets has been reviewed during the year and no impairment is needed.

Capital expenditure of £16.9m (2006: £6.6m) has been incurred during the year. Off-setting these additions is the depreciation charge for the year of £17.4m (2006: £14.6m). As a significant proportion of the Group's assets are denominated in Euros, the strengthening of the Euro has given rise to a foreign exchange gain on property, plant and equipment of £4.7m (2006: £0.9m loss). This results in a year end carrying value of the Group's property, plant and equipment of £103.0m (2006: £98.8m).

Current trade and other receivables have increased to £36.7m (2006: £24.8m). This is primarily due to a capital prepayment of £8.9m, and associated recoverable sales tax, in respect of the new build in Amsterdam.

Provisions of £6.8m (2006: £7.2m) primarily relate to an onerous lease provision in respect of a property in Munich. A full provision is made in respect of this lease, however the Group continues to pursue options to mitigate the liability.top

Operational and Financial Risks

The Group's operations expose it to a variety of risks. The Directors regularly review these risks and the appropriate steps are taken to reduce or eliminate the risks and mitigate their potential impact. Below are listed the principal risks which the Directors consider could affect the Group but they are not intended to be an extensive analysis of all risks which may arise in the ordinary course of business or otherwise. top

Operational Risks

Business disruption risk. Any failure of the physical infrastructure or services of the Group could lead to significant costs and disruptions that could reduce revenues, harm the Group's business reputation and have a material adverse effect on financial results. The Group manages this through a series of back-up and safety systems.
Technology risk. The market for data centres and internet-related products is characterised by continued evolution in technology, evolving industry standards, changes in customer needs, heavy competition and frequent new product introductions. The Group manages this by developing new products and modifying or improving existing products in a timely and cost-effective manner. The Value Added Services which the Group offers include engineering, connectivity, security and backup services.
Capital expenditure risk. Due to the increasing demand for the Group's services, substantial management effort and financial resources are employed by the Group in fitting-out and upgrading new data centres. In addition, the Group periodically upgrades and replaces the equipment in its premises. Although the Group has budgeted for expected fit-out and equipment expenses, additional expenses in the event of unforeseen delays, cost overruns, unanticipated expenses, regulatory changes, and increases in the price of equipment may negatively affect the Group's business. The Group manages this by utilising internal and external personnel with the appropriate level of skill and experience. In addition, detailed project appraisals are performed and kept up to date in respect of all major capital projects.

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Financial Risks

Credit risk. The Group has implemented policies that require appropriate credit checks on potential customers to be performed before sales are made. Rigorous procedures have been put in place to ensure that customers pay on a timely basis. Due to the high number of customers there is no credit concentration risk.
Foreign currency risk. The Group faces currency exposures on the translation of the trading results and net assets of its overseas subsidiaries. Following a review of the options available in respect of mitigating the currency risk arising on these balances, the Group did not undertake to hedge these exposures in 2007.
The year end and average exchange rates used when translating the results for the year to Pounds Sterling are 1.356 and 1.454 respectively for Euros and 12.762 and 13.479 respectively for Swedish Krona.
Had the year end and average exchange rates been 5% weaker, then the loss for the year would have increased by £0.2m and the net assets increased by £1.2m. Had the year end and average exchange rates been 10% weaker, then the loss for the year would have increased by £0.3m and the net assets increased by £2.3m.

The Group hedges against the risks arising from transactions in foreign currencies by entering into forward foreign currency contracts where appropriate.

Liquidity and capital risk management. The Group has built an appropriate liquidity risk management framework for the management of the Group's short, medium and long-term funding and liquidity management requirements. The Group manages liquidity risk by maintaining adequate capital reserves and banking facilities and by continuously monitoring forecast and actual cash flows and matching the maturity profiles of financial assets and liabilities. At 31 December 2007, the Group had finance leases amounting to £1.3m (2006: £1.4m) and had borrowings from the Group's bankers of £33.0m (2006: £60.9m). This loan, along with the IPO proceeds, is being used to finance the Group's capital expenditure projects. The Directors are satisfied that the current capital and financing arrangements are adequate for the Group's operations and planned capital investment.
Interest rate risk. The loans described above incur variable interest rates based on LIBOR, which the Directors consider to be appropriate. The Directors manage this risk by taking out interest rate swaps to ?x the interest rate. At 31 December 2007 the fair value of these swaps was a £0.1m liability (2006: £0.4m asset).
Cost risk. The main area of exposure relates to the price of electricity and its consequential impact on the Group's pricing of its services. The Group uses consultants to monitor price changes in electricity and negotiate fixed-price term agreements with the power supply companies.

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Key Performance Indicators (‘KPI’s’)

The Group uses a number of KPI's to measure performance which are set out below. These KPI's have been chosen as they are considered to be the main factors underpinning the Group's performance. The capacity of our existing facilities is a constraining factor to growth, as such the Group monitors both fitted out space and occupancy. In addition, the amount of revenue generated per square metre is used to measure the income generation of the available space.top

	Year ended 31 December 2007	Year ended 31 December 2006
Revenue (£'000)	97,916	68,893
Adjusted EBITDA (£'000)	23,352	11,008
Total fitted out space (sq.m)	46,597	45,683
Occupancy (sq.m)	37,868	34,651
Revenue per sq.m (£/sq.m)	2,586	2,308

KPI Graphs, Average revenue per occupied sq.m, Growing occupancy

Summary

The Group has achieved a great deal during the year and we are confident about the Group's future prospects. We look forward to reporting again in 2008, when our two new builds will have delivered significant inventory which we expect to be generating additional business for the Group.

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