Cencora, Inc. (COR) Q3 2013 Earnings Report, Transcript and Summary

Greetings, and welcome to the CoreSite Realty Corporation Third Quarter 2013 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Derek McCandless, General Counsel. Mr. McCandless, you may begin.

Thank you. Hello, everyone, and welcome to our third quarter 2013 conference call. I'm joined here today by Tom Ray, our President and CEO; Jarrett Appleby, our Chief Operating Officer; and Jeff Finnin, our Chief Financial Officer. As we begin our call, I would like to remind everyone that our remarks on today's call include forward-looking statements within the meaning of applicable securities laws, including statements regarding projections, plans or future expectations. These forward-looking statements reflect current views and expectations, which are based on currently available information and management's judgment. We assume no obligation to update these forward-looking statements, and we can give no assurance that the expectations will be attained. Actual results may differ materially from those described in the forward-looking statements and may be affected by a variety of risks and uncertainties, including those set forth in our SEC filings. Also, on this conference call, we refer to certain non-GAAP financial measures such as funds from operations. Reconciliations of these non-GAAP financial measures are available in the supplemental information that is part of the full earnings release, which can be accessed on the Investor Relations pages of our website at coresite.com. And now, I will turn the call over to Tom.

Good morning, and welcome to our third quarter earnings call. Today, I'll begin by discussing key highlights of our financial results, as well as current market dynamics and our outlook regarding growth. Jarrett will then provide a more in-depth review of our sales results for the third quarter and update you on our performance and targeted verticals in geographies. Jeff will then present a detailed overview of our financial results, balance sheet position and update 2013 guidance. Our third quarter financial results reflect continued execution of our business plan. Top line growth continues to be steady, and earnings growth remains robust. Specifically, total revenue increased 5% sequentially and 13% year-over-year, while adjusted EBITDA and FFO both increased 17% year-over-year. Revenue performance year-to-date has been near the low end of our guidance, driven by a favorable mix of continued strong growth in our more profitable revenue line such as interconnection and breakered power, offset to some extent by a deceleration in revenue growth from metered power, which does not contribute materially to gross margin. Specifically, in the third quarter, interconnection revenue grew 6% from the second quarter and 20% year-over-year. Revenue from sales of breakered power grew 9% sequentially and 25% year-over-year. And rental revenue increased 3% sequentially and 12% year-over-year. Regarding new and expansion TKD sales in the quarter, annualized GAAP rental revenue signed of $4 million reflects a 25% decrease from the trailing 12-month average of $5.3 million. We attribute this to the fact that we did not sign any leases exceeding 5,000 square feet in the quarter. We ascribe this to normal lumpiness in the execution of larger transactions. In fact, we saw a meaningful number of larger opportunities in our funnel at the beginning of the third quarter, many of which we targeted to close in the quarter, but were still pending at quarter end. Many of those opportunities remain active. We saw a similar dynamic in the third quarter of last year. And this may point to some degree of cyclicality, although our Q3 sales this year are nearly double that of Q3 last year in terms of annualized GAAP rent. Regarding pricing, the average annual GAAP rental rates signed in Q3 was $170 per net rentable square foot for turnkey data center leases. We believe that when adjusted for lease size, geography and power density, this rate is substantially consistent with our recent trailing results. Regarding interconnection results, in the third quarter, we again saw solid organic growth in cross-connections, with fiber cross-connections growing 18% year-over-year and total cross connections increasing 10% year-over-year. We'll now offer insight into our thoughts regarding market conditions. With regard to overall market demand, despite quarterly variations in lease executions, we believe that net and gross absorption for 2013 will be consistent with that of the past several years in each of our markets. We also believe that demand in edge markets, driven by growth of performance-sensitive workloads, is outpacing growth in more remote locations, which is favorable for CoreSite. Additionally, we believe that CoreSite's share of the performance-sensitive market segment is growing as evidenced by a further penetration of the important network vertical. This is a key piece of our strategy. And we've signed 129 leases with network customers through the first 9 months of 2013, and networks have accounted for nearly 40% of new and expansion leases year-to-date. We believe that this success lays valuable groundwork to support public and private clouds, as well as enterprises leveraging off of cloud and network capabilities. With regard to supply, we believe that currently available supply and pipeline supply in the wholesale market will maintain continued pressure on rents for wholesale and other undifferentiated customer requirements. Of note, we continue to see lower rental rates for undifferentiated requirements in the Bay Area, Northern Virginia and New Jersey. Regarding the undifferentiated component of the colocation segment, we expect to see continued pricing pressure, partly driven by wholesale providers as they seek to adjust their business models to serve smaller customer requirements. More specifically, we've seen pressure on rents, interconnection services and power margins in the undifferentiated colocation segment as wholesalers seek to gain market share. However, we see market dynamics for undifferentiated colocation as having been poor for some time. We believe those dynamics are distinct from the dynamics associated with the performance-sensitive colocation segment. Looking more specifically at the performance-sensitive segment, we believe supply and demand remain substantially balanced in our markets. Specifically, both the capabilities related to tethering may support the disaggregation of certain customer requirements within an edge market. We believe that supply-demand dynamics in the performance-sensitive segment remain attractive. Specifically, we believe that overall demand in edge markets continues to accelerate, largely driven by mobility growth and cloud adoption. Additionally, we believe that the economics and human resource requirements associated with tethering make tethering a suitable solution predominantly for larger customer deployments and less so for smaller requirements. Further, we believe that the performance requirements of many workloads continued to benefit from the differentiated value of data center platforms offering robust, low-latency network solutions and valuable customer communities. As such, we believe that CoreSites market opportunity related to performance-sensitive requirements remains attractive, and CoreSite is well positioned to execute on that opportunity. Now I'll offer insight into our expansion activity and the status of the core projects we currently have under construction. Our build-to-suit at SV5 is on schedule to be completed this quarter, and we expect rents to commence by December. Keep in mind that this is a powered shell, and our customer will need to build out its own infrastructure before ramping up to a meaningful power draw in the second half of 2014. While the customers' ramp regarding power will not impact our earnings, it will impact top line revenue. At LA2, we are under construction on approximately 33,000 square feet to add capacity in response to steady demand, as occupancy at LA2 has increased from 75% to 87% this year. We've seen consistent demand from our content vertical in this market, and we see a solid sales funnel as we prepare to bring this new capacity online. Our NY2 facility in Secaucus remains on schedule to deliver our first computer room of TKD capacity toward the end of the fourth quarter and the next 2 computer rooms in Q1. Presales signed to date at NY2 include 6 networks that will serve the facility, plus additional leases signed with end users, totaling 8,000 square feet. Each of the end user leases was signed subsequent to the close of the third quarter. Further, we have additional leases up for signature at the asset, and we have a strong funnel of near-term opportunities. We note that we aim to continue our past practice supplied to new developments by working to both execute upon our strategy to serve performance-sensitive requirements and also sign larger leases to accelerate generation of cash flow in the early phases of leasing. As such, we expect that the rents we signed in the early part of the lease-up at NY2 will likely to be below the average rents we've recently been achieving across the rest of our portfolio. At our Reston, Virginia campus, we expect to complete the first phase of inventory in our VA2 development toward the end of Q2 2014. While this timing may result in a somewhat reduced pace of sales for us in the first half of 2014 relative to past years in Virginia, we will continue to drive sales in the remaining capacity of VA1. In summary, we believe our earnings growth in the quarter reflects systematic execution of our business plan. We continue to drive revenue most strongly in the areas where we believe we can generate the most attractive profits. Q3 sales were a bit lower than the trailing 12-month average, which we ascribed to normal fluctuations and executions of larger leases. We believe the outlook remains bright for our business and that we remain on a well-defined path to drive growth and increase returns on capital that we invest prospectively and that we have already invested. With that, I'll turn the call over to Jarrett.

Thanks, Tom, and hello, everyone. I'd like to start by discussing in more detail our sales activity during the quarter. In the third quarter, we executed 106 new and expansion turnkey data center leases, representing $4 million of annualized GAAP rent with an average rent of $170 per net rentable square foot. In addition, we added 21 new customer logos in the third quarter. And year-to-date, we have signed a total of 87 new customers, which is an increase of 9% over the first 9 months of 2012. Growth in multisite deployments continued in the third quarter, reaching a record 44 new and expansion leases signed with customers deploying in more than one location. This represents a 50% increase over the trailing 12-month average, which we believe is attributable to our vertical sales model and the investments in our sales and marketing staff embarked upon a year ago. Importantly, with 106 leases signed in the quarter, we continue to see strong transactional volume, the cornerstone to our effort to increase sales, supporting a more favorable product mix of cross-connections and power and the breakered-amp pricing model relative to base rent. Sales closed in the third quarter reflect and reinforce our strategy of building customer community in network-dense, cloud-enabled data centers supporting performance-sensitive applications. The networking cloud verticals drove the majority of our sales in Q3, representing 39% and 28%, respectively, of the leases signed. This dynamic further supports our strategy of creating high-value points of interconnection and supporting the best environment for our customers to maximize their growth. With our focus on the networking cloud verticals, we are also seeing a direct correlation in the growth in interconnection as an 18% year-over-year growth in fiber cross-connects. Our growing network density and diversity across our data center platform is one of the key decision factors for cloud service providers in choosing a data center partner. And we are seeing the greatest growth in interconnection coming from cloud providers. Cloud providers, along with social media, gaming and content providers, have a strong desire and need for interconnection. I'll now take some time to discuss our performance in our targeted verticals. Specifically in the network vertical, this quarter, we signed 41 leases, following a record number last quarter. Year-to-date, we have signed 129 leases with network customers, which is a 29% increase over the first 9 months of 2012. During the quarter, we made good progress in expanding our non-U.S. network community with over 1/3 of our network leases in Q3 coming from international network service providers. In that end, we announced that BICS, Belgacom International Carrier Services, one of the world's leading wholesale telecom service providers, selected our One Wilshire campus in Los Angeles, with the expansion of its global voice and mobile services footprint in North America. Like many other foreign-based networks, BICS chose CoreSite due to the ability to interconnect with the community of more than 275 networks and hundreds of other potential customers. Other key non-U.S. network signings during the quarter include FK broadband, a leading telecommunication provider in South Korea; TeliaSonera International Carrier, a primary telephone and mobile network carrier in Sweden and Finland; Hibernia, a provider of both subsea terrestrial networks throughout North America, Europe and Asia; and NTT Communication, the world's largest provider of telecommunication services, which entered and expanded its presence across 4 locations with CoreSite. NTT and TeliaSonera International Carrier are representative of the deployments we are winning with more frequency at CoreSite, multisite deployments across our North America platform, which help drive interconnection and attract other customers and enhance our community. To further enhance our diverse network product offering, we recently announced a newly established relationship with the London Internet Exchange, or LINX, targeted to provide direct access to a new Internet Exchange Point, IXP, called LINX NoVA, a set of the LINX peering exchange from our VA1 facility in Reston. We now have relationships with all 3 of the major European Internet peering providers, including AMS-IX and DE-CIX, as well as NYIIX in New York, which all joined our Open Internet Exchange when it was first introduced last year. In our cloud vertical, we signed 30 new and expansion leases, an increase of 30% compared to the trailing 12-month average. We expect to continue to see solid growth in our cloud vertical, as cloud adoption increases and as companies continue to realize the benefits of placing their application in the cloud. We believe we are well positioned to win deals with cloud service providers because of our flexible data center offerings, which allow providers to meet their capacity and power density requirements with cost-effective, scalable data center space. Meanwhile, our network density and diversity also helps to ensure the performance of these cloud providers' application. Since launching our Open Cloud Exchange offering in the first quarter of this year, we have seen good traction with the leading networks and cloud service providers joining our growing platform, allowing customers to enjoy secure performance-optimized connections and cloud service providers of their choice. Most notably, we recently announced the availability of AWS Direct Connect's sub 1G connections, which provide our customer connection speed of 50 meg to 1 gig, allowing more CoreSite customers to take advantage of the cost-savings and performance benefits of the cloud environments. AWS Direct Connect is now available in 5 CoreSite data center campuses across our portfolio, with deployments in New York and Los Angeles and extended connectivity to Boston, Silicon Valley, and Virginia. The relationship enables more of our customers to benefit from direct connectivity to AWS Direct Connect using optimal levels of flexibility and control. We expect key cloud deployments like AWS Direct Connect to help drive future enterprise customers to our facilities as they learn the value and benefit of secure, low-latency direct connections to hybrid IT solutions. In addition to AWS Direct Connect, in the third quarter, we expanded our relationships with key strategic customers including TW Telecom, Zayo, Reliance and XO Communications. In other verticals, we see strength in the content vertical where we had 20 leases representing more than 30% of GAAP rent signed in new and expansion leases. We had key wins from firms representing the entire content supply chain, including several leading movie studios, content delivery networks, internet TV platforms, online cloud gaming platforms and social media firms. The results in our SI and enterprise verticals came in below our expectations for the quarter. Deployments from system integrators can be inconsistent and often dependent upon sales cycles of their end users. We also believe the government shutdown had an impact on government agencies purchasing decisions during the quarter. As for enterprises, although sales were less than anticipated, we won a significant new customer deployment with Classified Ventures LLC, a leading online classified advertising firm that migrated to our facility in Chicago, as well as gaining a sizable expansion with an existing financial trading customer. Turning to geographic performance. Los Angeles was again our strongest market in terms of both volume of leases in GAAP rent signed in new and expansion leases. Digital content was the top vertical in terms of GAAP rent signed in Los Angeles, accounting for more than 50% of rent in this market, including leases with leading providers of gaming, entertainment and social media. Chicago was our next best performing market in Q3 in terms of GAAP rent signed in new and expansion agreements, driven by the enterprise vertical. Our New York market rounds out the top 3 in terms of GAAP rent in Q3. We signed 7 new in expansion leases at our NY1 facility led by the network, cloud and digital content verticals. However, we also had one large hosting customer move out of the facility in search of a low-cost, wholesale solution. This customer represented $1 million GAAP rent and 14% of the capacity at NY1. Therefore, despite solid leasing at the facility, we saw occupancy decline in 75.8% to 67.1%. I'll close by touching on our sales, marketing and operations team. Regarding sales and marketing staffing, we have seen good progress with the vertical sales model we implemented in mid-2012 as evidenced by the favorable trends in our product mix mentioned earlier. However, we had some recent turnover in our vertical sales team. As a result, we continue to identify additional resources to supplement the current sales team and currently have 3 open positions, 10% of budgeted headcount. Based on the tenure of our current sales team and related sales quota, there are approximately 2 quarters behind where we anticipated being when we embarked on this initiative a little over a year ago. For reference, we currently have 19 fully tenured sales reps or 66% of our budgeted headcount, with an additional 7 people in the ramp-up phase. In addition, we want to take this opportunity to thank Chris Ancell, Senior Vice President of Sales and Sales Engineering, who's departing CoreSite to pursue other opportunities. I want to thank him for his contributions over the past year. Chris played a key role in the initial transformation of our go-to-market sales model. This role is being filled internally on an interim basis as we conduct the search for a permanent replacement. I maintain full responsibility for the sales organization, and we remain focused on building a best-in-class sales organization and delivering a superior customer experience for our more than 750 customers. Turning to operations. We continue to deliver reliable operational performance across our portfolio, achieving 6/9 of uptime in the year to date. This is consistent with our reliability since becoming a public company. In august, we completed SSAE 16 Type 2 examinations, covering all 14 operational data centers across our portfolio, demonstrating our commitment to our customers surrounding operational excellence and security, environmental controls throughout our facilities. As we look to the remainder of 2013 and into 2014, we are optimistic, given our strong pipeline and commitment to executing against our strategic plans, to create value for our customers and shareholders. I'll now turn the call over to Jeff.

Thanks, Jarrett, and hello, everyone. Thank you for joining our third quarter call. I'll begin my remarks today by reviewing our Q3 financial results. Second, I will provide an update regarding our capital investments and our balance sheet and liquidity capacity. And third, I will update our guidance for the year. In the third quarter of 2013, we recorded revenue of $60.6 million, a 5.1% increase on a sequential quarter basis and a 12.8% increase over the third quarter of 2012. Year-over-year revenue growth in the third quarter was diluted to some extent by our whole building customer at SV3 reducing its power draw. Partly driven by this, our revenue from the sale of metered power declined 3% year-over-year. Our Q3 operating revenue consisted of $51.3 million in rental revenue from space and power, an increase of 5.3% as compared to Q2; $7.4 million from interconnection revenue, an increase of 5.5% over Q2; and $1.9 million from tenant reimbursement and other sources. As Tom and Jarrett both mentioned, we are pleased to see continued strong interconnection revenue growth and a shift in our mix as this product line has grown as a percentage of sales by nearly 80 basis points compared to the same quarter a year ago. Q3 commencements were strong, with leases representing $6.7 million of annualized GAAP revenue comprised of approximately 37,000 square feet, a GAAP rate of $180 per square foot. Performance on renewals in the third -- in the quarter was mixed, with solid cash and GAAP mark-to-market growth of 6.6% and 10.7%, respectively, but higher than average churn of 2.7%, bringing our year-to-date churn to an average of 2% per quarter at the higher end of our guidance range of 1% to 2% per quarter. Our backlog of projected annualized GAAP rent from signed but not yet commenced leases is $5.7 million. We expect approximately 70% of the backlog to commence in the fourth quarter of 2013, of which 80% is attributed to our build-to-suit at SV5. The remaining 30% is expected to commence evenly throughout 2014, slightly weighted to the second half of the year. Our third quarter FFO was $0.47 per diluted share and unit, an increase of 4.4% on a sequential quarter basis and a 17.5% increase year-over-year. Year-to-date, FFO per share has increased 18% compared to the first 9 months of 2012. Our year-to-date flow-through to adjusted EBITDA and FFO was 65.3% and 45.8%, respectively, leading to an expansion of our adjusted EBITDA and FFO margins of 279 and 143 basis points, respectively. The difference between the 2 margin expansions results from the additional interest expense and preferred stock dividends in the current year as we continue to increase leverage to fund our 2 large development projects in New York and Virginia. Sales and marketing expenses in the third quarter were approximately 5.3% of revenue, down 150 basis points sequentially and below the estimated range of 6% to 6.5% that we previously provided. This was primarily due to timing of expenses, and we expect this metric to return to the 6% to 6.5% level, depending on the timing of hiring around sales and marketing resources. Our G&A expenses were 11.7% of revenue, relatively in line with the previous quarter and slightly below our guidance of approximately 12% of revenue. We expect G&A expenses to be around 12% for the remainder of the year. Our operating expenses include amounts related to ongoing repair and maintenance expenditures, as shown on Page 18 of our supplemental. We spent $2 million during the third quarter in line with amounts spent in each of the previous 4 quarters. As of September 30, 2013, our stabilized operating data center portfolio was 80.6% occupied. Including leases executed but not yet commenced, our occupancy rate would be 82.2%. Development spending is expected to be approximately $60 million to $70 million in the fourth quarter, related to development capital expenditures, approximately $25 million higher than forecasted in our Q2 reporting. Taking this into account, we now expect our total capital expenditures to be in the range of $230 million to $240 million in 2013 compared to our previous guidance of $200 million to $225 million. The increase in development capital expenditure stems partly from an acceleration of capital previously planned for the later phases at VA2 and NY2 and partly due to increases in project scope at those developments. 2013 will represent our largest year of capital investment with a number of large development projects under way. As Tom mentioned earlier, we will be delivering 100% of the capacity at SV5 in Q4; the first phase of NY2 in Q4 and the beginning of Q1; and the first phase of VA2 toward the middle of 2014. Keep in mind that as capacity is delivered, the capitalization of interest, access and insurance associated with the development will be reduced unless a corresponding amount of operating expense will be absorbed by the delivered rooms. In addition, as we enter later phases of our ongoing IT systems initiatives, the capitalization associated with the investment to support the project will decrease significantly, and the cost will be absorbed into operating expenses. We anticipate entering those later phases and thus decreasing our capitalization in early Q2, 2014. Page 18 of our supplemental provides enhanced disclosure related to our development capital expenditures by breaking out the amounts attributable to data center expansion, nonrecurring investments and tenant improvements. Turning to our balance sheet. As of September 30, 2013, our debt to Q3 annualized adjusted EBITDA is 1.5x, and including our preferred stock, is 2.6x. We anticipate our leverage to increase as we continue to execute our capital spending plans. As we have discussed in the past, we target a stabilized ratio of debt plus preferred stock to annualized adjusted EBITDA of approximately 4x. As of September 30, 2013, we had $108 million drawn on our credit facility and approximately $290 million of available capacity under the facility. Finally, with respect to guidance, we are tightening our guidance for 2013 FFO per share and OP unit. We now expect FFO per share and OP unit for $1.80 to $1.84 compared to the previous range of $1.76 to $1.84. Please remember that this does not include any capital markets activity, property dispositions or investments beyond what we have discussed. On Page 21 of our supplemental package, you will find additional guidance information. We believe revenue will be slightly below the low end of the $237 million to $247 million range that we provided, principally due to the decrease in metered power draw we have seen from a large customer at SV3 throughout 2013. We estimate the impact of the lower metered power revenue to be approximately 1% to 2% of company revenue for the full year. As mentioned last quarter, we expect adjusted EBITDA to be on the high end of our guidance range of $105 million to $110 million, due to a favorable product mix reflecting increased revenue from the sell of power on our breakered-amp pricing model. Cash rent growth on renewals will fluctuate, depending upon the specific market and type of deployment. As we look to next year, we believe the cash rent growth may moderate from the amount seen in the year-to-date period of 3.6%, which is slightly below our previous guidance range. Our churn rate for the quarter was 2.7%, and our year-to-date amount is 5.9%. Year-to-date amount of 5.9%, or 2% on average per quarter, is at the high end of our guidance range of 1% to 2% per quarter. Now we'd like to open the call to questions. Operator?

[Operator Instructions] Our first question is from Emmanuel Korchman of Citi

Jarrett, maybe you could go back to your comment earlier about some attrition from the sales force, and now you're trying to replace heads. Could you give us some more color as to what might have happened? Was it performance-driven? Was it that they felt like the product mix was wrong? Sort of give us some color as to why those people are no longer with you.

First of all, thanks for the question. First of all, you would expect some normal churn in the sales organization tied to performance and opportunities or both, so this is built into our plan. We did ramp up the team. We wanted to provide some additional color for you on this call in terms of where we are in getting tenured reps and ramping up the sales engine. This is in the range of what we would normally expect based on performance or opportunities in the business.

And then, Jarrett, we'll stick with you for a second. On the NY1 occupancy drop, you mentioned that it was a large wholesale customer that had moved out. But it looks like it was an outsized portion of the rental income versus how much space was given up, which doesn't seem to sort of jive with the idea of a large wholesale customer moving out. Could you help me reconcile that?

Well, there's 2 components to it. On the rent side, again, we are -- the types of performance-oriented deployments that we're selling now include rent, power and cross-connect. So if you look at it from a rent side, yes, they were our larger opportunity in the hosting provider. When they approached us, we did not have the NY2 solution available in Secaucus, so we weren't able to serve both the network performance side and the larger power side of that business. So we decided to move to New Jersey. In terms of the rate, we did see -- and we are replacing those types of solutions with performance-oriented applications that include rent, power and cross-connect in total.

So Manny, if you look at our churn in the Q, and the move-out in NY1 was a meaningful component, there were 3 deals that moved out that represent about 2/3 of all the churn. And as we look at rent margin on power and cross-connect revenue, the sum of those revenue and profit streams with regard to power, some of those, for the trailing 12 months that we've achieved in the 3 buildings that these 3 moved out of, the trailing 12 was 59% greater than the rent, power profit and cross-connect revenue that moved out. So as to rent, 3, 4 years ago in NY1 when we signed this customer on a rent only model, that rent has moved out, and it was a reasonable rent. It was, in terms of profitability, substantially below what we've been achieving in the trailing 12 months in each building where these deals moved out. So hopefully, that gives some color around the churn.

And Jeff, just finally, on your point on the total operating revenue guidance coming down for '13, I think you mentioned that there was a 1% to 2% impact, sort of -- and maybe I missed on what that item actually was, but it doesn't get me to number that's below the range, it gets me to the bottom end of the range. So what else am I missing in that number?

Yes, Manny. Just picking up from where we left off last call, the guidance range that we gave in connection with Q2 was we guided towards the lower end of that revenue range -- of the original revenue guidance range, which was $237 million to $247 million. What I mentioned in my prepared remarks and is consistent with what we saw in the second quarter is that our customer at SV3, the revenue associated with their power revenue has decreased and -- which is on a metered power basis. We essentially said that the impact, the revenue impact from that particular decrease in draw was about 1% to 2% of our overall revenue. Well, ballpark, call it about $3 million.

Jeff, I think puts you at the low end of revenue guidance.

So that's 1% to 2% impact, and you're already at the low end rather at the midpoint.

That's correct.

So you get -- so you're $3 million effectively below the low end.

No, we can give it a new range. But that revenue negative variance on metered power from a single building customer puts you at the low end of the range from what Jeff said at Q2.

[Operator Instructions] And the next question is from Jonathan Atkin with RBC.

Just a brief follow-up on the topic of power deal. So the deals that you're signing now and the deals kind of in the pipeline, what would be the way to characterize the mix of metered versus breakered-amp?

Well, Jon, throughout the year, that mix has been increasing, filtered toward breakered-amp. And we've been disclosing the growth rate around sales of breakered power so that -- there's been clearly an increase in that, and it's been material. I think the deals signed in Q3 -- you have a significantly greater portion that was breakered than on our trail -- because we didn't sign any big deals in Q3. That was just a big deal lumpy quarter, and that's that. But across the year, the signings on the breakered model have grown substantially. And we will just encourage people to look to the growth rates and revenue from the sale of breakered-amp power that we've been disclosing to get a read on that trajectory.

Great. And then my question then on the rates of interconnection growth. Is there anything to suggest that it would deviate from kind of recent growth rates in terms of just the actual dollar volume of growth quarter-on-quarter? And then you said it would moderate or accelerate as you are -- if you have the LINX -- that relationship out of VA1 and then the other kind of European exchanges. On a broader scale, I think Open IX is coming into a site elsewhere in the Virginia markets. I'm just wondering if you can kind talk about the dynamics around that topic of interconnect.

You bet, Jon. I think there are 2 dynamics at play inside our interconnection revenue. One is we had a big, meaningful price increase that we implemented about a 1.5 years ago, plus or minus, so that led to a significant jump at that point in time. And I think you could pretty well see that over 1 to 2 quarter basis -- 1 to 2 quarter period. Since then, we had still consistent growth, and most of that growth is backed by or is driven by increases in volume. So we're working hard to make sure that the investment community understands, not only the trailing increase in revenue, but also the trailing increase in cross-connect volume. And over time, you should think that maybe you get a small increase in pricing, a colo-based cost of living, a 3%, plus or minus, increase in pricing over time, all of these being equal. And the rest of your growth rate and revenues are going to correlate to growth in volume. That's over time. In the near term, we believe our embedded cross-connect base still has greater than a 3% upside versus the market. And so we think there's still some running room there. And I don't expect the Open IX initiative to materially change that in the near term. So I hope that helps.

The next question is from Jordan Sadler of KeyBanc Capital Markets.

I wanted to see if you could expand a little bit on the pipeline. I think, Tom, in your prepared commentary, you mentioned that there were some larger tenants that you expected to sign during the quarter that ended up still in the mix at the end of the quarter. If you could sort of maybe characterize them, what kind of -- and give us a sense of scale in terms of what the pipeline actually looks like or the funnel, I think, as you described it.

Well, Jordan, I didn't think we disclosed post quarter that we did sign additional leases in NY2, for example. So those were deals that are fully closed in Q3 that did close in Q4 in the prepared remarks. So we've seen some of those larger deals delay in that new site, and we shared that script here. We do see continued growth. The larger deals...

So that 8,000 square feet of leases, that was the sort of larger, lumpier one that you were sort of referring to?

In the total, yes, there was the larger, lumpier one there. So that did not close in the quarter, but it did post quarter, saw it at NY2. We do see a lumpy Q3 for some reason. That seems to be the larger deals don't seem to get as close as -- and they're -- that many of those have moved into -- most of those have moved into Q4.

Is there anything going on in particular in the enterprise or system integrator verticals that are causing them to sort of come in below expectations?

It's really deal-dependent. Several are related to government -- a couple of them are government-related. They just got delayed in terms of funding, again, with the federal shutdown, and some of those opportunities are already in Q4. Largely, I think those are deals dependent on end users, so we don't have direct input. And it was a big shift that you see us doing. And we balanced out both the vertical, which we're getting great success on networking cloud vertical, and digital content, to start going a little more direct with the geographic enterprise focus. So we're doing both there to get more control and manage that to move away from some the system-integrated dependencies on end-user deals.

That's helpful. And Jeff, did you have a cash backlog?

Let me get that for you here before the end of the call, Jordan. I don’t have it right off top of my head.

The next question is from Stephen Douglas of Bank of America Merrill Lynch.

Two, if I could. I guess -- I mean, you mentioned the international customer wins that you got. And I'm wondering how big of a factor your cross-selling agreement with interaction was there. And then second, one of the questions we got a lot is about whether cloud is actually a good thing for your business. And I guess, I'm wondering if you're seeing any kind of uptick in interest from specifically the enterprise segment as a function of having the multiple customer wins in the cloud vertical that you've mentioned.

Well, in terms of the global business, Stephen -- we are seeing -- we've been spending more time directly, not really with interaction or -- it's really direct relationships we have with NTTs and BICS of the world. We are spending more time, ourselves, in Europe and Asia directly with the network providers they deploy here. And we're excited because they are choosing us and our sites to provide alternatives in new -- North American markets, and they're bringing larger deployment like the NTT example, that we use here. So that is a direct relationship and focus on the network side. And on the cloud side, we do see, again, benefits with these cloud service providers, the infrastructure and service providers to enterprises, and we see continued focus and growth. We went -- last year, we had a -- last quarter, we had a great quarter with 65 networking cloud deployments. Now with 71 this quarter. So we are absolutely targeting those networks in cloud where we believe the enterprises will want to connect. And they're setting up their service offerings in these sites across our platform.

The next question is from Dave Rodgers of Robert W. Baird.

Maybe Tom or Jarrett, earlier in the year, we talked about a lot of strategic customer signings, just a couple in particular that were fairly large, but brought the rate down as they became a little more high-profile. Can you talk about the deployment of those customers? Are they on track? And kind of how far along they are in their deployment? And the second part of that would be, relative to your expectations, how far along with the ancillary demand from the strategic deployments be at this point in time?

Well, you are seeing here the commencement data that we are deploying, and some of the larger and smaller deployments are going on, on a timely basis. The largest opportunity that we mentioned, I think, Jeff talked about in terms of the power with scale over the course of 2014 timeline, the very large ones do take larger time to deploy. The smaller opportunities and leases that we're signing and the midsized are coming in on a timely basis. And you can see that in the commencement data that we're providing.

And maybe then just a follow-up for Jeff, going back to your capitalization policies and kind of the guidance, maybe you're trying to kind of lead us to for the first half of '14. It sounds like day 1 completion of the development, all the OpEx is going to come on regardless of the occupied or lease percentage of those assets. I just wanted to expand on that a little bit in terms of what is the expected timing on some of the big -- I guess, your kind of big 3 developments are out there, big money drivers, in terms the uptake of that space? And how we should be thinking about that dilution on a monetary amount basis in the first half of next year?

Yes, Dave. Appreciate the question. Just let me dive into this because I think it is important to make sure people understand the amounts around it. And some of it is provided in the supplemental, and some of it is not. But let me just dive through the components. As you look at development, obviously, you've got capitalized interest, taxes and insurance. On Page 20 of our supplemental, you can currently see how much we've capitalized in interest year-to-date, which is about $3 million. On an annualized basis, it would equate out about $4 million. That equals about 60% of our year-to-date interest expense. So I think the best way to think about capitalized interest is if we were at 60% of it being capitalized year-to-date in 2013, we would expect that to moderate in 2014 as those developments complete and start to come online. And I think a better range would probably be somewhere in the 40% to 50% range rather than 60%. The other component of that is taxes and insurance. So the smaller amount -- and we don't typically disclose it, but just to give you some context, year-to-date, we've capitalized about $1.2 million through September. On an annualized basis, that's about $1.6 million. You would expect to be about a 50% reduction in that amount in 2014, given the timing of those developments coming online and what else might be in the pipeline in 2014. The third component, Dave, you didn't specifically ask, but let me touch on it because we -- it was categorized in those comments, and it's around some of our IT development and expenditures. As we've disclosed in the past, we are incurring some development dollars associated with our IT systems. And year-to-date, we've capped about $1 million of those costs through September 30 on an annualized basis. That's about $1.3 million. As we've said in our prepared remarks, we expect a development of that IT initiative to substantially be completed by, call it early Q2. And as a result, there'll be some development subsequent to that point, but we would expect those dollars also to decrease by about 50% in 2014.

You would expect some degree of that capitalization to put forward to expense.

Right, yes. Does that help, Dave?

It does on the expense side. And then with regard to revenues, anything that wasn't in your prepared comments that we should be thinking about in terms of the uptake of this space relative to the expenses coming on?

Yes, that's a great -- I think -- we typically model our stabilization period when we deliver space over about a 24-month period of time. And I think that's been fairly consistent. At times, we beat it. But I think that's a fairly good way to look at it in terms of the space that's being delivered. As we said in the prepared remarks, on NY2, we expect to bring on one of those computer rooms in December. The other 2 in early Q1, and so that gives you some idea on the timing of that particular development.

Dave, let me touch on this dynamic at a higher level for a moment. I think that our business is -- spans the spectrum, as we all talked about quite some time. We do smaller deals. We're very well practiced at them, and we have a good internal sales engine to execute them. That sales engine, frankly, is a little bit behind in terms of staffing and resource capability right now than we'd hoped. Q3 was kind of a one step forward, one step back quarter in terms of staffing, and we'll get over that. But we have that capability, and separately, we're practiced, if you will, wholesale guys. In Q3 and really in Q2 as well, you saw less wholesale sales at CoreSite. We have 2 big development projects coming online. We have NY1 coming at the end of this year, and VA2 coming in, in the middle of next year. And we just look at those, really, on an IRR basis. And there's some level of that inventory that's coming to market that we believe is smart to sell back into the wholesale funnel or just trying to give the Street a heads-up around that. And the reason we believe that is the incremental return on the incremental cost of developing new kilowatts inside this core foreign shelf that we just completed is fantastic. It's not as good as what we can do with that capacity over the long haul, but if, let's say, NY2 was little over 20-megawatt building, rather than systematically working through the whole thing with performance-sensitive colocation, we're going to drive the transaction engines steady and consistently, and we feel like that, that engine and its profitability in terms of breakered power and cross connections is accelerating. And we will work to go do some larger deals. So at this moment in time for Q3, you saw no larger deals in the company and a little bit softer overall revenue and sales growth because that dynamic -- but it's a dynamic we've been managing for over a decade. And there are -- the best business for us is the performance-sensitive colocation business. We're focused on it, and we keep executing on it. Separately, there had been times in the past where we have warehoused inventory with wholesale rents simply in order to get paid and generate cash flow, but with a view toward recycling that capital, that -- those kilowatts in a 5-year period, plus or minus. When you have a big building coming on, you orient a little bit more toward that. So we understand the concern in the marketplace. We understand it, we respect it. Our business is straightforward, and we're doing the same thing we've been doing in the past. The profitability of our colocation and transaction sales, we believe, are clearly increasing. We believe, year-to-date, we've shown fairly convincingly that we're making more money on less capital than we did before. And going forward, we'll see us tilt back and grab a little bit more of these wholesale deals. And we'll manage that dynamic on an intelligent cash flow IRR basis for our investors. So there are dynamics at play, and we want to just be very direct about them. And we're going to keep marching about our business.

The next question is from Tayo Okusanya of Jefferies & Company.

Thanks for the color around, again, the delineation between undifferentiated colo and as well as performance-sensitive, high-quality colo. Could you guys give us a sense of just how much of the undifferentiated stuff is still within your portfolio? And just from an innings perspective, where exactly you feel you are in regards to really moving to the performance-sensitive stuff?

You bet. Again, we've shared this in the past that we look at this issue in terms of how many cross-connects are in place per deployment. And we've seen that move in the right direction as well. So like the clinical data at this point, 83% of our revenue comes from deployments with 5 or more cross-connects, and 63% of our revenue comes from deployments with 10 or greater cross-connects. So that's our best read into what's performance-sensitive. And those ratios have increased over the last year since we've started talking about them. And I think that's probably the best way to look at it.

Okay, that's helpful. And then just a quick follow-on just in regards to Silicon Valley and the subleasing going on with Facebook. Could you just kind of give us a sense of what you're hearing regarding that, the impact of that on pricing? And what ultimately Facebook may do with that space, whether or not they get the space subleased?

Sure. I mean, look, the Bay Area is a tough market. It has been for 2.5 years. I don't know that it's materially tougher now than it was a year ago. There is a lot of space available to come back to the market via Facebook, but as with any real estate product, when lease terms get shorter on a remaining primary lease, and that primary tenant is working to sublease, cooperation with the landlord is valuable to help clear out that sublease inventory. To date, we really haven't seen much. I can't think of any offhand, but I might be wrong. If The Facebook sublease inventory gets resold, that's good and bad, right? I mean, if rates are -- I think are steady, that's not a great level, but they're steady over the last year, but you still have that shadow supply working its way back towards the market. Our objective is to -- if Facebook leases -- subleases its capacity on our portfolio, we understand that. If we have an opportunity down the road from here to make an intelligent deal with them where we can recycle that to colocation and not deploy capital to build another building on that site, just use that as -- use the Facebook inventory as a slot in our manufacturing schedule, if you will, for building product, we will take advantage of that opportunity. If we can't make -- if it's not rational for the parties to make an agreement before they roll -- we did structure their roll with us as 2.6 megs in the first year and another 2.6 in the second year, plus or minus. And the reason we did that is we've historically leased about 3 megs in our traditional product mix. 3 megs a year in the Bay Area, and that 2.6 is a pretty good fit with our retail operation. And we just don't plan to -- if all the Facebook stuff comes back to market in 2 years, I think wholesale rates will be pretty tough. They could get tougher. One could certainly see that scenario. We don't plan on reentering that space into that climate, and we've structured our lease accordingly.

The next question is from Michael Knott of Green Street Advisors.

This is John Luciani [ph] here with Michael. I was actually also going to ask about the cash leasing backlog. And also related to that, if you guys could tell how much of that is replacing in-place revenue?

Hey, John, this is Jeff. Yes, in terms of the cash backlog as of the end of the quarter, it's $10.2 million. About 45% of that will commence here in the fourth quarter, but the larger share of that is going to be coming from our customer on our build-to-suit development that were completed here in this quarter. The remaining 55% will come in rapidly throughout 2014. And I'm sorry, what was the second part of your the question, John?

The second part was how much of that is replacing kind of in-place revenue in a space that's already -- you're kind of replacing the tenant, not leasing space that's currently vacant.

Not much.

Yes, it's a great question. I agree with Tom. I don't think it's a substantial portion, but I don't have it specifically in the front of me, John. It's something we can do an analysis on and get back to you on, but I don't have this specifically in front of us.

The next question is from Jordan Sadler of KeyBanc Capital Markets.

Tom, I wanted to just follow up on your commentary regarding you're potentially focusing on or targeting some of the potential wholesale tenants for some of the new development. And I'm just curious, would that include -- what would the scope of wholesalers be? Would it include resellers?

I think that's unlikely, Jordan. I mean, we never say never. We're cash flow optimizing mindset here, but I think that's unlikely. I think these are -- it's substantially more likely that they'll be enterprise in cloud and network, from a network service provider's who, of course, also have growing MSP and cloud businesses inside their organizations. So they're taking larger footprints, but they're also interested in the -- being on top of their fiber paths and other parties' fiber paths, so I doubt they'll be resellers.

Okay. And then, could you just clarify regarding the rates that you are seeing initially at NY2 from the first few leases that are there? I think you said they'd be lower initially than the overall portfolio. Could you just clarify sort of what's going on there?

Yes, I just think that the early days of lease-up at NY2 were very heavily orient toward more wholesale-type requirements as we get traction going in that building. We feel good that we'll have plus or minus, and it could be a plus 10 networks contracted in that building when we open it. We feel good about the fundamental business plan we laid out when we made the decision to go there. And it's easier to kickstart a big new data center by nailing a couple of larger deals and putting cash flow in it. While we do that, we'll be moving to transaction engine. But in the early days, you'll see a greater weight, a greater product mix oriented toward wholesale. And throughout the course of the investment, you'll see that mix shift much more strongly over to performance-sensitive colocation if we're right about our thesis. So it's just the timing, approach. It's the approach to how you manage the lease-up of a new data center in a new market.

Okay, that's helpful. One more, if I may. Tom, this is more of a high-level question for you. Just obviously, the spaces in terms of stock performance, and maybe sentiment has become a bit washed out for a variety of reasons. And I'm kind of curious in terms of your thought process, in terms of -- how does that get cured? What is sort of the solution? And how long does it take? And can it be cured? And then at the same time, is there any opportunity in that for CoreSite?

Well, look. I mean, the ultimate cure -- for my view, the ultimate cure for stock price valuation is performance, the EBITDA and FFO and the FFO distributable to shareholders. So you cannot be cured, absolutely. Companies perform or they don't. And we live by those laws, and there you have it. We feel every bit as excited about our ability to grow earnings in this company as we did a year ago when sentiment is really high. So that's how we view the world. Are there opportunities? Well, look, I just look at it this simply, Jordan. If you can -- if the wholesale landscape gets to a point where you can buy wholesale products below the depreciated replacement cost of the asset, that can spell opportunities for anybody, just building a platform. That said, I don't see prices anywhere near that level, and we are not interested in buying somebody else's wholesale space at more than we can build it on our own. But yes, if there was such a level of distress in the wholesale segment, I think there'll be opportunity. I think the performance-sensitive colo business remains a steady, solid business. So I just don't see a huge amount of distress coming around that such that it would be meaningful valuation arbitrage. It would be great if I'm wrong, we'd like to be a predator in the jungle rather than a prey. There's no doubt that's how we're wired as human beings. I just don't really see that landscape, but we'll see.

Thank you. We have no further questions in queue at this time. I'd like to turn the floor back over to Mr. Ray for any additional remarks.

I just want to thank everybody for their time. Again, we appreciate that there a lot of questions out there in the marketplace right now. We're about our business, and honestly in most respects, we look at Q3 as another day on the job. And we're excited about the go forward. We're happy to follow up in any manner and talk more about the information that's already been publicly disclosed to help people understand it. And we look forward to seeing you again in the quarter. Thanks for your time.

Thank you. Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time, and thank you for your participation.