Cencora, Inc. (COR) Q3 2014 Earnings Report, Transcript and Summary

Greetings, and welcome to the CoreSite Realty Corporation Third Quarter 2014 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Derek McCandless, General Counsel for CoreSite Realty Corporation. Thank you, sir. You may begin.

Thank you. Hello, everyone, and welcome to our third quarter 2014 conference call. I am joined here today by Tom Ray, our President and CEO; 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 may 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 page 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 discuss highlights of our financial results, review our sales results for the third quarter, update our view of market conditions and provide insight into our view of our near-term growth opportunities. Jeff will then present a detailed review of our financial results and balance sheet position, and provide an update on our outlook for the remainder of the year. The third quarter reflected continued execution and ongoing momentum throughout the organization, resulting in solid revenue and earnings growth. Total operating revenue increased 16% year-over-year, led by another quarter of 20% plus growth in interconnection revenue, coupled with 17% growth in power revenue. Q3 adjusted EBITDA of $32.9 million reflects a 20% increase year-over-year, while our adjusted EBITDA margin increased 130 basis points to 46.6%. Q3 FFO per share and unit increased 17% year-over-year to $0.55. Regarding new and expansion TKD sales. In Q3, we executed 118 leases, representing annualized GAAP rental revenue of $7.6 million. This was comprised of approximately 54,000 square feet, at an average GAAP rental rate of $141 per square foot. This GAAP rental rate on new and expansion leases is in line with our trailing 12-month average. Third quarter sales were well distributed amongst smaller and midsized leases, with spot [ph] and midsized leases exceeding 2,000 square feet, and no lease exceeding 1 megawatt of power capacity. Driven by the execution of midsized leases, our average lease size executed in Q3 was 459 square feet compared to the trailing 12-month average lease size of 309 square feet. Regarding the geographic distribution of sales in the third quarter. Our strongest markets in terms of annualized GAAP rent signed in new and expansion leases were Silicon Valley, New York, Chicago and Los Angeles. In the New York market, and more specifically NY2, we were pleased to see the funnel activity we discussed with you last quarter convert into executed leases in Q3. Specifically, we executed 5 new and expansion leases at NY2, including what we believe is a valuable midsized lease with a leading global network service provider. With this leasing, as of the end of Q3, we were approximately 60% leased in Phase 1 of NY2. In Northern Virginia, where we expect to deliver our VA2 facility into service this quarter, we continue to see healthy demand activity as it relates to both available capacity of VA1 and the capacity under construction at VA2. As we shared with you in the past, we are looking to maximize occupancy at VA1 in anticipation of delivering the first phase of TKD capacity at VA2. To that goal, in Q3, we executed 10 new and expansion leases at VA1 as we work to fill in the smaller spaces that remain in the building. As of the end of Q3, we had approximately 50,000 square feet available for lease at VA1 comprised of a range of products from a single cabinet up to 14,000 contiguous square feet. Turning to the performance of our verticals. Our network and cloud verticals together accounted for 68 new and expansion leases in the third quarter, correlating to 58% of leases and 38% of annualized GAAP rent signed, as we continue to focus on enhancing our portfolio of network-dense, cloud-enabled data centers. Our digital content vertical was strong again in Q3, representing 20% of leases signed and 50% of the annualized GAAP rent. Further, in the third quarter, we added 39 new logos to our customer base, with particular strength across the network, enterprise and cloud verticals. Regarding our interconnection product line. In the third quarter, we continued to see solid performance in net additions of fiber cross connections, with particular strength in Los Angeles, Silicon Valley and Northern Virginia. Across the company, fiber cross-connect volume increased 20% year-over-year, with total interconnections growing by 11%. Both statistics reflect small increases over our trailing rates of growth. Regarding sales staffing. We are now substantially staffed, taking into account normal churn in terms of frontline reps onboard with the company. We believe that our execution in meeting our goals with regard to sales staffing reflects enhanced focus upon the fundamentals of running our business, and the greater simplicity that focus brings. Related, we've also seen improvements in sales productivity, as new hires ramped into their established quotas. Looking more broadly at our efforts to simplify our business and increase the productivity of our sales and marketing teams, we're pleased with our progress thus far this year. Specifically, over the first 3 quarters of 2014, our average quarterly sales in terms of annualized GAAP rent from new and expansion leases represents a 60% increase over our 2013 quarterly average, and is approximately double our average over the second half of 2013. Turning now to our view of the markets. Our outlook is substantially consistent with what we discussed last quarter. We've seen a pickup in demand activity in the New York, New Jersey market, although there remains a large supply of available capacity in that market. We are seeing rents solidify in the Bay Area as sublease space has been absorbed and demand has remained robust. The downtown Chicago market is exhibiting increasing rents as near-term supply remained somewhat limited. We continue to see Los Angeles, Boston and Miami as substantially consistent with last year. We've been more optimistic regarding the Northern Virginia market in recent quarters as our analysis of the market continues to suggest that available inventory could be absorbed by current demand in the market. While we've yet to see large leases executed to backfill sublease space in the market, market data suggests that larger leases may be executed in the fourth quarter. We will continually watch for contractual absorption of this sublease capacity. As we look ahead, we believe we continue to have a strong opportunity to drive internal growth from our current portfolio. Related, we currently plan to construct additional capacity in existing facilities in 5 of our markets over the coming year. Specifically, we anticipate building additional TKD capacity in each of Boston 1, which is now in preconstruction, Denver 1, Chicago 1, New York 2 and Virginia 2 by the end of 2015. Our plans for these projects total 130,000 square feet of additional capacity at an aggregate incremental cost of approximately $50 million to $60 million, correlating to a range of $380 to $460 per square foot. This reflects our ability to leverage off of existing core and shell infrastructure, and we believe enables us to drive premium returns on capital from these projects. Our ability to continue to grow our company at cost bases that we believe are attractive highlights the value of the growth opportunity embedded in our platform. Specifically, in total, we believe that we have the ability to more than double the amount of sold net rentable square footage in our portfolio solely from land and buildings we currently own, and in aggregate, at a cost basis that we believe will be highly attractive. In particular, we believe we have created significant embedded value at NY2 and VA2. We estimate that together, these 2 facilities enable us to build an additional 20 to 25 megawatts of salable capacity, with an associated investment of between $90 million and $120 million of incremental capital, all at highly attractive yields on incremental investment. We believe that our opportunities at NY2 and VA2 are augmented by our opportunities at our Coronado campus in Santa Clara, where we are currently entitled to build an additional 311,000 square feet. At LA2, where we can construct an additional 200,000 square feet. In Boston 1, where we can develop an incremental 73,000 square feet, in addition to the 15,000 square feet now under construction. We continue to evaluate the timing and associated capital requirements associated with these follow-on investment opportunities, with our next phase of construction at each location to be determined over the coming year as we lease up existing capacity. Further, even though we plan to construct additional capacity at Chicago 1 over the coming year, based upon trailing sales in our current funnel, we anticipate that our inventory availability will become constrained in Chicago over the next 12 to 18 months. As such, we will evaluate potential next steps in the Chicago market as we assess our broader strategic and growth plans, all relative to the strong internal growth opportunity inside our existing asset base. As always, we remain focused upon driving occupancy in our available TKD space, which, including the 3 megawatts to be delivered at VA2 by the end of this year, represents 21% of our current portfolio. In addition, we will continue to work to increase revenue and cash flows from currently leased capacity as we look to increase interconnection and breakered power revenue inside our current footprint. With that, I'll turn the call over to Jeff.

Thanks, Tom, and hello, everyone. I'll begin my remarks today by reviewing our Q3 financial results. Second, I will update you on our development activity. Third, I will provide an update regarding our balance sheet and liquidity capacity. And fourth, I will update our outlook on guidance for the full year. Our third quarter data center revenues were $68.5 million, a 7.5% increase on a sequential quarter basis and a 16.7% increase over the prior year quarter. Our third quarter data center revenue consisted of $57 million in rental and power revenue, up 6.5% sequentially and 15.4% year-over-year; $9.2 million from interconnection revenue, an increase of 6.7% sequentially and 23.2% year-over-year; and $2.3 million from tenant reimbursement and other revenues. Office and light industrial revenue was $2 million, substantially consistent with the previous quarters. Q3 lease commencements represented $6.1 million of annualized GAAP rental revenue, comprised of approximately 45,000 square feet at an annualized GAAP rental rate of $135 per square foot. Renewals in the third quarter totaled approximately 55,000 square feet at an annualized GAAP rental rate of $219 per square foot, and represented mark-to-market rent growth of 3% and 10.6% on a cash and GAAP basis respectively. We continue to expect full year cash rent growth in the range of 1% to 4%. Churn in the third quarter declined to 1.2%, in line with our expectations of 1% to 2% per quarter. Our backlog of projected annualized GAAP rent from signed but not yet commenced leases is $9.2 million, and $11.9 million on a cash basis. We expect approximately 45% of the current GAAP backlog to commence by the end of the first quarter of 2015, with another approximately 25% commencing through the end of 2015. If you recall, there was roughly 30% of the backlog associated with a new lease at SV3, which is expected to commence in the second quarter of 2016, coinciding with the surrender of the space by our customer that is currently occupying the computer room. Our third quarter FFO was $0.55 per diluted share and unit, an increase of 17% year-over-year and an increase of 7.8% sequentially when adjusting for the previously disclosed onetime items realized in Q2. Q3 adjusted EBITDA of $32.9 million reflects an increase of 19.6% year-over-year and an increase of 8.1% sequentially, again, when adjusting for the previously disclosed onetime items recognized in Q2. In the third quarter, our adjusted EBITDA margin expanded 130 basis points year-over-year to 46.6%. This represents Q3 annualized revenue growth flow-through to adjusted EBITDA of 55% year-over-year. As part of our 2012 acquisition of Confluent, the former Confluent owner was entitled to earn payments associated with CoreSite entering into new customer contracts and renewing and expanding existing contracts during the period beginning upon the date of acquisition and ending on an agreed-upon calculation date of January 1, 2015. During the third quarter, we agreed to accelerate the calculation date to September 1, 2014, and discharge the remaining payment obligations. As a result, in the third quarter, we made a payment of $9.3 million to the former Confluent owner associated with the above-referenced agreement, of which $8.1 million is a reduction in year-to-date AFFO, with the remaining $1.2 million reflected in our Q4 2013 results. We do not anticipate making any further payments associated with this agreement. Sales and marketing expenses in the third quarter totaled $3.8 million, approximately 5.4% of total operating revenues, down slightly compared to last quarter. We expect sales and marketing expenses for the full year to be approximately 5.5% to 6% of total operating revenues. Our third quarter G&A expenses totaled $7.1 million, correlating to 10.1% of total revenues, in line with the previous quarter. We expect G&A expenses to be approximately 11% of revenue for the full year. As shown on Page 18 of our supplemental, we spent and expensed $2.2 million during the third quarter related to ongoing repairs and maintenance, relatively in line with the average amount spent over the trailing 12-month period. As of September 30, 2014, our stabilized operating data center portfolio was 86.4% occupied. Including leases executed at the end of Q3 but not yet commenced, our stabilized data center occupancy rate would be 88.9%. Including pre-stabilized space, our total data center portfolio was 81.2% occupied at quarter end. I will now discuss our recently completed and ongoing development activity across the portfolio. As Tom mentioned earlier, we are encouraged by our leasing activity at NY2, with Phase 1 approximately 60% leased as of the end of the third quarter. Specifically at NY2, we currently have $43.6 million on our balance sheet as completed turnkey data center capacity, plus $65.6 million as construction in process related to the core and shell space in which we have the opportunity to develop incremental turnkey data center capacity. Regarding VA2, at the end of Q3, we carried $74.9 million of construction in process related to the asset. And we anticipate investing an incremental $5.1 million in the fourth quarter to complete Phase 1, comprised of the core and shell plus 3 megawatts of turnkey data center capacity. As we have previously discussed, as we complete development projects, we realize a reduction in our run rate of the capitalization of interest, real estate taxes and insurance, resulting in a corresponding increase in operating expense. As a reminder, we have a included the percentage of gross interest capitalized on Page 20 of the supplemental. Turning to our balance sheet. We remain focused upon maintaining the liquidity and available capital to support our growth and fund investment opportunities, and we believe we are well-positioned to execute in that regard. Specifically, as of September 30, 2014, our ratio of debt to Q3 annualized adjusted EBITDA was 2.3x. Including preferred stock, our ratio was 3.2x, with approximately 1.6 turns related to fixed rate debt plus preferred stock and 1.6 turns related to variable rate debt. We continue to target a stabilized ratio of debt plus preferred stock to annualized adjusted EBITDA of approximately 4x. As of September 30, 2014, we had $205 million drawn on our credit facility, with approximately $192 million of available capacity. Finally, excluding these previously disclosed onetime items, we are increasing our guidance for FFO per diluted share and unit to a range of $2.12 to $2.16 from the previous range of $2.07 to $2.15. Including the onetime items, the updated 2014 guidance of FFO per diluted share and unit is $2.16 to $2.20. As we discussed last quarter, our non-real estate depreciation expense increased by approximately $600,000 sequentially in the third quarter, due to the accelerated depreciation of certain IT systems. Over the next 3 quarters, we expect an incremental expense of $400,000 to $500,000 per quarter, resulting in total non-real estate depreciation of approximately $2.5 million per quarter through the second quarter of 2015. After which, we expect this to normalize at approximately $1 million to $1.5 million per quarter. We will provide further detail when we issue our 2015 guidance with fourth quarter earnings. When excluding the net $0.04 benefit from the true-up of real estate taxes in the second quarter and the impairment charges recorded through the first half of the year, the midpoint of our new guidance is $2.14 per share and unit. The $0.03 increase in organic guidance reflects our expectation for increased revenue and adjusted EBITDA for the remainder of the year. We now expect total operating revenues of $268 million to $272 million compared to the previous range of $265 million to $270 million. Adjusted EBITDA is now expected to be $129 million to $133 million compared to the previous range of $127 million to $132 million. A detailed summary of all 2014 guidance items can be found on Page 21 of the earnings supplemental. I would remind you that our guidance is based on our current view of supply and demand dynamics in our markets, as well as the health of the broader economy. We do not factor in changes in our portfolio resulting from acquisitions, dispositions or capital markets activity other than what we've discussed today. Now we'd like to open the call to questions. Operator?

[Operator Instructions] Our first question comes from the line of Jonathan Atkin with RBC.

So a couple of questions for Jeff, and then maybe one for Tom. The guidance, you lowered the top end of guidance for data center revenues, but then your overall EBITDA guidance is higher. So I wondered if you can kind of take us through what's driving that? And then cross-connect, as a portion of incremental revenue, seemed to have dropped a bit from the prior quarter. And is there going to be some lumpiness around that metric? Or is there a normalized trend to think about in terms of cross-connect or interconnect growth?

Hey, Jon. 2 things in response to your questions, I guess. In terms of the guidance revenue, if you look at our revenue guidance for total revenue, as well as our data center revenue, if you look at the midpoints of those 2 numbers today, that difference is about $8 million, which is where it should be and in line with what we believe it will end up. When we gave previous guidance earlier this year, that difference was only $5 million, and it should have been corrected. And this quarter, we corrected that to make sure it was in line with where we need the -- where we think it's going to be coming out.

I can pick up the cross-connect thing for a second. Jon, it's Tom. I think what you'll see is that cross-connect growth relative to our base of installed smaller transactions remains very, very steady. And the oscillation of cross-connect revenue toward new bookings and total new signed revenue really turns on how much activity we have in larger deals. So the core of the cross-connect business relative to the business that generates those cross-connects is remarkably consistent. And in quarters where we signed more larger deals, then cross-connect revenue, as a percent of what got signed, will be smaller. And in quarters where we signed fewer big deals, that ratio will go up.

Great. And then the mix of metered versus breakered-amp power, how is that trending sequentially? And then, I guess, my final question for Tom mainly would be that you talked about embedded value in both NY2 and VA2, but really down to Virginia for a moment. What is it that makes the VA2 an attractive site versus some of the Ashburn-based competitors?

Yes, I mean, I think the value in VA2 sits in the network density and the cloud density at VA1, so the buildings are physically connected. And so the 6 years of building a good business inside our Virginia campus adds that value to VA2. I mean, it's the same as VA1. So we -- we've delivered a new building or we're delivering a new building on top of an existing, very healthy, very connected business. What was the other part of the question, Jon?

Metered versus breakered.

Metered versus breakered. I don't know if we...

We have not -- Jon, we have not typically disclosed what that number is. Historically, what we've guided people towards is when you look at our lease distribution table in our supplemental, typically those breakered revenue models will be in existence in our smaller deployments. And when you look at those deployments that we have today that are less than 5,000 square feet, that equals about 50% of our annualized rent. It gives you some guideline in terms of what that is today.

I'd look it up very much like cross-connects, Jon. If you look at our -- if you go to the lease distribution table and look at the smaller leases, I think our experience this year is that the breakered revenue, in our cost structure associated with that revenue within those small leases, has remained very consistent. No real changes. And in quarters where we signed more larger deals, you'll find a greater mix of metered power in those quarters.

And my last question is just new market expansion. There's a couple of thoughts on the map where they're very well-established or emerging or increasing in importance from a colo and retail standpoint. Dallas and Pacific Northwest kind of stand out. And where do you kind of stand on potential new market entry?

No real change. Anything you've heard from us over the years, Jon, we -- we value our equity very, very dearly. So we look at our near-term expansion as opportunities that are funded by debt are more attractive, and opportunities to invest where we already have a book of business. And we have turned investing in depth rather than breadth. Opportunities to invest where we already have a book of business, we already have boots in the ground, we already have good visibility, we have scale. And as such, we have lower expenses for follow-on investment. That's our top priority. And the other -- the component for us is we don't feel a need to get into new markets. It would be nice over time, but there's no pressure here. We have a nationwide platform, a couple of limited dots that we're not in. We don't think that impacts us from a competitive positioning perspective to land the best business in North America. So we'll go where it's smart, when it's smart. We don't feel any pressure to do anything. And generally speaking, we still favor depth over breadth.

Our next question comes from the line of Jordan Sadler with KeyBanc.

Question on the sales organization, Tom. Can you maybe talk about the progress that you've made in the third quarter and just year-to-date? And if you're content with sort of the productivity you're seeing and how ramped we are overall? And then maybe the momentum you see into the fourth quarter?

Sure. Look, I think what we've -- this year, we've just been doing what we said we were going to do, nothing beyond that. We had strong objectives for the year. We wanted to move sales up quite significantly. And again, they're running at a 60% or greater quarterly pace on new and expansion rents signed compared to all of last year. And last year trailed down, so we're running almost double the rate average this year over the second half of last year. So we were pleased with the -- with what we view as a very strong turn. So we're pleased with the trajectory. And we are, by no means, content with the position. We believe we can do better. And we are just focused on getting stronger every quarter. So that's our goal. We've identified a couple of areas where we think we can get stronger as a company, and we'll have to see how that plays out over the quarters ahead. So I would view us as on track. And as we say here at CoreSite, we remain privileged to have more good work to do.

Okay, that's helpful. Are there additional bodies that needed -- need to be added to explore these additional areas of opportunity? Or you've got the bandwidth internally? And just on the momentum, you still feel good seasonally as you set up into the fourth quarter? Or just overall dynamic. You touched on a couple markets, but I guess I'm thinking a little bigger picture.

Sure. We don't expect to spend materially more dollars on field reps and sales next year than the run rate currently, that will go up a little bit but not dramatically. And I think in terms of momentum going into Q4, I guess I would answer it similarly to with what I've answered about breakered and interconnection. There's a kind of a fundamental book of business that is -- has become more predictable and larger this year, and we feel pretty good about that repeating. And then, in our business model, there is -- there are those larger transactions that lay on top of that. And it's very difficult to predict those from quarter-to-quarter. But in general, the markets remain healthy, and our team is in place. And so, we're just going to keep doing our jobs.

And then, I guess I was -- you had a comment on Virginia, Northern Virginia, perhaps in particular that you haven't yet seen the leases executed to sort of suck up the demand, but you were optimistic. I kind of feel like in the last couple of days up between some of the Yahoo! space being backfilled in Ashburn, 14 megawatts or so, and a 12-megawatt lease in Richmond, which I guess, debatably not Northern Virginia, or the same market. Are those not on your radar in terms of competition or supply?

No, they are. The key there is, in our view, that the Richmond leasing, we don't think has much bearing on our business. The absorption in Northern Virginia does, and we were encouraged to see transactions get signed. So if -- our scripted comments, at times, are pre-recorded. In some days, a 2-day gap makes a difference. But we were pleased to see the information with the Yahoo! sublease signing this morning.

Okay. You faked us out there for a second. Your voice sounds remarkably the same. Live, that is. Hey Jeff, last one, and then I'll get off. On debt, I'm looking forward to 2015. Can you talk about sort of the plans for the outstandings on the revolver? Should we look for you to term some of this out?

Yes, Jordan, I think today, we sit with about $205 million outstanding on that credit facility. So it's about 50% utilized. And obviously, we continue to look at incremental capital needs in line with our business plan. And it's something we continue to look at very closely. And we'll look to term some portion or all of that credit facility here in the near future. I think in terms of amounts, you can kind of look at what we've done historically. We've termed out about a single turn of our adjusted EBITDA. It will probably be in line with something like that. We would like to maintain the flexibility and the capital structure, which is something we continue to favor as we look at our options to term some of that out.

Our next question comes from the line of Barry McCarver with Stephens.

Just a couple, I think you've already covered most of it. But on the interconnection business, do you have an idea of the average number of cross-connects, particularly at those smaller customers where we see the most velocity there, and maybe what the opportunity is?

We do have a very good idea. We've disclosed in the past the number of deployments that have x number of cross-connects. I think, last quarter we said 60...

It's right at -- if you look at 3 or more, it's right at 63% in terms of revenue, and then 83% at 5 or more, Barry.

Inversed. 85% have 3 or more -- 83% of the revenue have 3 or more, and 65% have 5 or more interconnections.

5 or more.

Yes. We study our cross-connects pretty deeply. And if there are other specific disclosures that might be helpful, we're happy talk offline and figure out what we can do.

Okay. And then secondly, Tom, you were talking about the ability to add more capacity with your current assets of building and land. And I think you mentioned an opportunity of 20 to 25 megawatts with a CapEx of around $90 million to $100 million. Doing the math there, kind of $4 million to $4.5 million per megawatt. Is that the fully embedded number? Because that seems really attractive cost to build.

That's an incremental number. So we've really tried to explain to people that we've made a very significant investment, particularly VA2 and NY2 in building the core and shell, and prebuilding a reasonable amount of infrastructure associated with those core and shell. So yes, we believe the incremental investment and return on that investment is highly attractive. And with the number of megawatts available for that, we think it's quite significant.

Our next question comes from the line of Jonathan Schildkraut with Evercore.

Just a follow-up on Barry's question about sort of the incremental build-outs that you're talking about. This has been, I guess, an opportunity for you guys for a while. You had this redevelopment space. What kind of incremental yields should we be thinking about as you deploy the capital in your existing markets? And then as a second question, you do have a lot of construction activity or planned activity as we head into 2015. We've certainly seen the leasing velocity improve this year as you've highlighted, Tom. But how important is it to have available inventory in order to drive sales?

I think it's -- I don't think that dynamic has changed a bunch. We've said ever since we came out that sales in the colo business really require existing inventory. And for larger transactions, pre-leasing is more accepted. It happens more often. So our fundamental business here remains in the colocation world and trying to drive ARPU and profit per dollar of invested capital. And we get our best returns in our colo business. And as we've said in the past, there are times, especially when deliver a new larger facility where we will go into the market and hit some wholesale leases to drive cash flow more quickly, and then, hopefully, recycle that inventory over time. But I think because that is our core business, you will continue to see us work to maintain some degree of inventory in our markets. But we build modularly just like the rest of the guys. We don't see any advantage in having $200 million of unsold capital in any given market at any given time. So I hope that provides the guidance you're looking for.

Yes, I mean, could you give us a little color on the incremental returns and the capital that you're targeting?

Well, I guess at a high level, Jonathan, I'd say we messaged to the street that we work to beat a 12 on a stabilized cash basis. And if you look at the front half of that has stabilized at a 6 or 7, you can look at a 17 or an 18 on the back end. And there have been a number of times where we've materially exceeded our 12. So we'll continue to work to do that. But the back half of sales or the, frankly, the return on everything after the first phase tends to be significant.

Absolutely. If I can squeeze in one more question here. You started to breaking out some of the cabinet metrics not too long ago. And the MRR per cabinet has been very consistent in terms of its progression, 7%, 7%-plus growth on a year-over-year basis each quarter. And yet, when we look at some of the leasing, the pricing per square foot tends to move around dependent on, I guess, footprint size, as well as facility and market. And I was just wondering how it is that we get such a consistent return in terms of the growth on MRR, but the underlying pricing can move around so much?

One component is the pricing data that we provide is generally in terms of square footage. So depending on the market and depending on the density, that can vary a great deal. And -- I'm sorry, it's also rent. I mean, the key there is that the pricing data is rent. And the MRR per cabinet includes power and interconnection. So there are times when you look at an opportunity and have a little bit lower rent, and you'll make more profit on other components of the mix. And that's what shows up in the MRR per cabinet statistic.

Jonathan, just to add to that. When you look at the MRR per cabinet information, that is essentially a same-store pool, so that amount of square feet does not vary from quarter to quarter. So that amount is staying very consistent. It gives you a very good view in terms of what type of revenue growth we are being able to generate off of essentially the same square feet, same invested dollars.

Our next question comes from the line of Colby Synesael with Cowen and Company.

2, if I may. The first one is you mentioned, I think, 58% of leases this quarter coming from both cloud and network. And obviously, just -- beyond just CoreSite, that's a broad trend we're seeing in the industry in terms of being an area for growth. How aggressive have you had to be on pricing for those particular types of deals, especially what we'd rather, I guess, refer to as those magnet-type of customers that one would hope will ultimately bring in other customers behind them, perhaps in those other cases [ph]? And then my second question had to do with cross-connects. As, broadly speaking, the world gets more connected. Are you seeing demand for cross-connects in what we'd refer to, or as you call it, Tier 2, Tier 3-type markets, or at least here at your flagship facilities is starting to pick up to the point where some of the value add you've already built in some of your markets like LA as an example, could actually start to be replicated in a broader grouping of facilities?

Well, I think that our cross-connect business just continues to exhibit, not only very consistent growth in revenue, but also a consistent growth in fiber count. And I'd say the shape of that is -- has also remained very, very consistent. We do believe that more equipment, more routers are going to be pushed further into the edge of the network. But I think, sincerely, I think that's a net add to the marketplace. Our cross-connect volume and our global gateway facilities has remained very constant. It has grown in a very consistent and healthy rate. So I think that the push of -- into edge deployments into these Tier 2 markets is real and it's going to continue to happen. But I think it's supported by a tremendous volume of fundamental demand. So I don't know if that helps, but our statistical data to-date shows our global gateway buildings continue to add cross-connects at the same rate as they have for quite some time.

And I guess, this does relates to the pricing with cloud?

Yes, I mean, again, I don't think there's been a huge change on that over the 15 years we've been doing this. There are certain deployments where you know that they're going to bring other deployments to the building or they're going to generate a lot of cross-connects. And those deployments, I think, have always been hotly contested in the marketplace. So I haven't seen pricing on those gem anchors really change. I think the -- as we've said for quite some time the last several years, I think pricing on the non-gems, the pricing on the less differentiated deployments has gone down quite materially over the last 4 years. And while that has been playing out, our business has grown very nicely. Our MRR per cabinet has gone up. And we just stand by the numbers that we've been disclosing and that we've been generating.

Our next question comes from the line of Dave Rodgers with Robert W. Baird.

Tom, maybe a question for you to start. With regard to kind of the development activity you talked about for next year. '13 was a pretty broad year across the portfolio in spending. I think this year has been a much more narrow year. As you go back to spending more broadly, I guess, I want to understand any distinguishing features between the idea that -- is the market changing to give you more confidence? Or do you have maybe more confidence in the execution of the team and in the sense [ph] where your sales force is today to make those broader investments?

Honestly, it's much more simple than that, Dave. It's -- there are times when we're just running out of core and shell in a given market. And when we need to go build more core and shell, you see capital go out in a big lump. And then, you'll see us work through that core and shell over a few years, and then you'll have another step function of capital. So it really just turns on market by market, inventory availability and there's just -- there's no more science to it than that. I mean, there's rocket science in looking at are we leasing well? What is our ARPU? And what is our profitability per kilowatt? So we say yes and no to customer opportunities based on those metrics. And we say yes and no to more core and shell development based on those characteristics. But we like Virginia. We like New York. We like Santa Clara. We like LA. We like Chicago. We like Denver. And when we're out, we build more, and those tend to be lumpy.

Okay, that's helpful. And then with regard to NY2, you had talked before you even constructed the asset that potentially you'd go to a mid-market or a larger customer to backfill some of that space for some periods of time. It sounds like in the quarter, you did sign a mid-market tenant to fill some of that. Was that the extent of which we should expect larger customers to be put into NY2? Do you see doing more of that? And what's kind of in the funnel right now that could be in the near term that would continue that trend of maybe larger or middle-market customers filling in that space?

Yes, I think we'll continue to look for those opportunities. And in Q3, our largest transaction at NY2 is an exceedingly valuable transaction. It's a very large deployment from a very reputable global carrier. The rent, the GAAP rent, appears low because it has a ramp in it. But the stabilized cash rent on that deal is highly attractive, and it's a very strategic deal. So we'll do all of those we can do. And I think over the next -- probably through this year, we'll still be opportunistic about some larger wholesale looking opportunities. We just -- we have 18 megs still to go.

Yes, quite a bit of wood to chop, but great progress so far. I wanted to ask about Chicago, I guess, or maybe the opportunity for midsized private M&A. I guess, as private equity firms have either become less aggressive or reduced their involvement in data, at least from what we've seen, maybe you're not seeing that. But has that happened? Are there some kind of mid-market M&A opportunities like in a Chicago that would help you expand? Or is that going to be purely organic? And are you really focused on the organic expansion?

No, I'd say we're clinical in what we focus on. And again, not to beat a dead horse here, but our view just haven't changed. We -- as we've look at M&A, Chicago would be a good place for us to add some local -- locally grown capacity, if you will. At the same time, our standards for deploying our capital in that direction haven't budged. When an asset doesn't bring a densely interconnected cash or rent roll to table or it doesn't have something unique, we do pay attention to price per kilowatt because we can build on our own without buying. And if an asset is priced appropriately for the rent roll you're buying, we're very open to acquiring. And if an asset is priced appropriately with a great rent roll, we're very open to buying. But we just remain disciplined around how we deploy our capital.

Our next question comes from the line of Emmanuel Korchman with Citigroup.

Jeff, maybe you can -- and maybe I misunderstood your comments in the beginning on the Confluent acquisition. It seems like those amounts are very big compared to what you've paid for the portfolio, and also what looks like rent coming out of the Denver assets that were acquired with it. Can you help us understand how -- what those numbers actually represent and how you get there?

I'll dive in on this, Manny. I think at a high level -- so if you recall, the business that we bought in Denver is, by leaps and bounds, the most interconnected business along the front range or in this greater Rocky Mountain region. So rent tells a smaller part of the story with the value of the business than it might in a lot of other markets. At a high level, we're almost 3 years past the acquisition date, and we look back and we believe we bought that business at around 6.5x multiple on current cash EBITDA. So we're very pleased with the price we paid. We're very pleased with the asset. Extremely grateful to Mr. Gardner and his work in helping build it before we got together and after we got together. And it just couldn't have worked out better.

And that 6.5x [indiscernible], the dollars that Jeff mentioned in the beginning of the call plus the $3 million, that was initially put in the business?

Yes.

That's right. Yes.

Yes, if you do just a current look back at the whole enchilada, everything we paid, and then look at the current adjusted EBITDA in place, it worked out very well for us. And we feel for everybody in the transaction.

Great. As you think about both expansion in your current markets and enter into new ones, how do you underwrite how much of the business is going to be sort of wholesale-esque and more retail and colo? How do you think about splitting up facilities?

Well, we think about it on an IRR basis. So we look at our trailing fill rate based on colocation, and we make a forecast based on that. We usually think we can continue to garner a little bit more market share as the years go by. That's been our experience and we hope to continue that. And then, you look at -- then you make a decision on how much you think you'll fill with that colo. And then, you look at the rest of the inventory that's available. And then, you just do an IRR calc based on if we fill it now at a lower rate, and it takes longer to recycle it back at high rates, where is the optimal IRR? So it's all just math.

Our next question comes from the line of Matthew Heinz with Stifel.

Just looking for an update on the progress of your cloud ecosystems. And I was hoping you could shed some light on your recent conversation with sort of magnet cloud customers. And in particular, what you're hearing from them in terms of the pace of overall hybrid cloud adoption? And then secondly, how are you approaching the enterprise vertical from a marketing perspective? Or maybe trying to educate them on how you're connectivity solutions can aid some of those hybrid deployments?

Well, taking the last part first, we could just hire you in our marketing department. What we do is try to educate them. So with the Open Cloud Exchange and with -- we think the importance of private interconnections and private network connection from the enterprise to the cloud service provider, we feel very well positioned for that in our product set in terms of our offering, the exchange inside the buildings, and in terms of our network partners that bring people in. So we just try and educate them. And then, as to how the cloud ecosystem is coming along, we just, well, I guess, we'll point to continued consistent growth of the cloud signings. And we very much appreciate the value of the top 4 or 5 largest cloud service providers. We have people on those accounts. We've had very good success in penetrating them and providing value to them in a mutually beneficial fashion. So I just think we're focused on what you would hope we would be focused on, and just trying to drive more and more of those deployments into our buildings as more and more of them come to market. They're not all deployed in the market yet. So we've -- we feel like we captured our fair share and we're going to keep working to do that.

And I guess we can talk numbers on that consulting arrangement a little later on.

Yes, sounds good.

Mr. Ray, we have no further questions at this time. I would now like to turn the floor back over to you for closing comments.

Thank you very much. And thanks to everybody for taking the time to be on the call and to learn more about the company. Look, at a high level, we're pleased with how far we've come this year. And we are very encouraged by the sales and marketing progress. We do feel like we can do more, and we're going to keep working on it. And the bottom line is we've been here for a very long time just trying to rewrite returns to our shareholders. We're working hard, we work to do the right thing, and we're going to keep doing that. So we'll continue to push productivity and look forward to talking to everybody in another quarter and seeing most of you at NAREIT.

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