Cencora, Inc. (COR) Q1 2016 Earnings Report, Transcript and Summary

Greetings and welcome to the CoreSite Realty Corporation First Quarter 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mr. Derek McCandless. Thank you. You may begin.

Thank you. Hello, everyone, and welcome to our first quarter 2016 conference call. I'm joined here today by Tom Ray, our President and CEO; Steve Smith, our Senior Vice President, Sales and Marketing; 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 obtained. 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 Web-site at coresite.com. And now, I'll turn the call over to Tom.

Good morning and welcome to our first quarter call. In Q1, we continued to execute our business plan, resulting in solid financial and operational performance. Looking at Q1 2016 over Q1 2015, we reported 34% growth in FFO per share driven by 24% growth in revenue and 28% growth in adjusted EBITDA. We continued to expand our margins with our adjusted EBITDA margin expanding to 51.4%, measured over the trailing four quarters ending with and including Q1 2016. This represents an increase of 285 basis points over the comparable period ending with and including Q1 2015. With regard to leasing, during the quarter we executed new and expansion leases totaling 103,000 square feet, representing $22.5 million in annualized GAAP rent. Our average GAAP rental rate associated with this leasing was strong at $219 per square foot. This rate was influenced by power density and Steve will put this into context a bit later in the call. As previously announced, our Q1 leasing results include 80,000 square feet under one lease at our SV7 facility currently under construction. Regarding the rest of our new and expansion leasing in the quarter, lease executions were well distributed across our portfolio with our strongest signings in terms of annualized GAAP rent occurring in Los Angeles, New York, New Jersey and Boston. The number of leases signed in the quarter was well distributed across our three verticals, with our network, cloud and enterprise verticals representing 26%, 21% and 53% of leases signed respectively. Regarding our interconnection services, Q1 interconnection revenue exceeded our expectations, reflecting 6% growth over Q4 2015 and 25% growth over the prior year quarter. This growth in revenue was predominantly driven by greater than expected growth in volume of products generating more favorable unit revenues. Specifically, Q1 reflected 15.2% growth in total points of interconnection, but that growth was comprised of 21% growth in fiber cross connects and 35% growth in our logical interconnection product set. This growth was offset to a limited extent by a 3% decrease in volume of copper cross connects. The 21% growth rate in fiber cross connects exceeded our recent trailing growth rate for this product, which was 18% for calendar 2015 over 2014. We are pleased to see the growth rate of our fiber cross connects exceed our forecast for the quarter and we will continue to watch this metric as the year progresses. Regarding our activities around the cloud, we continued to make progress with key public cloud providers, signing several new and expansion agreements with these partners during the first quarter. Additionally, we believe that our platform is well positioned in terms of having network partners offer the latest in private LAN capabilities at our data centers which we believe creates differentiated value relative to most other data center solutions. Finally, we believe that our Open Cloud Exchange in combination with our collaboration with network and cloud providers around APIs supports enterprise adoption of cloud and the private LAN services connecting to the cloud. Supported by these capabilities, we expect to continue to see solid growth in our cloud vertical as enterprises leverage our network and cloud rich platform to accelerate cloud adoption, particularly with hybrid and multi-cloud architectures. I'll now move on to provide our outlook for our key markets. Our top line view of supply and demand is consistent with that of last quarter. With regard to the performance sensitive market segment, we continue to see consistent to slightly accelerating lease pacing and pricing, in line with growth over prior years. Demand remains well distributed among carriers, cloud companies and enterprise communities of interest. Regarding the wholesale market segment, we continue to believe that balance between supply and demand remains favorable in the Bay Area, less favorable in New Jersey, and is more at equilibrium in our other markets. More specific to the Bay Area, we see limited current supply of large blocks of capacity juxtaposed against consistent demand, resulting in firming wholesale rents. Reflecting these conditions, we've seen strong pre-leasing at SV7, the largest among our development of projects currently underway, and we elected to accelerate our TKD buildout in the remainder of that building. As such, we are now under construction on the entire 230,000 square foot facility which was 54% pre-leased at the end of Q1. Regarding our organic growth plans, we are energized by the growth capacity inherent in our portfolio comprised of both currently available capacity and new data center capacity currently under construction. Concerning currently available capacity, we closed Q1 with over 218,000 square feet of operating data center capacity available for lease, correlating to 15% of our leased data center square footage at the end of the Q. As we look at the availability of data center capacity across our platform, we are pleased with its distribution and we believe we have adequate supply in Los Angeles, New York, Chicago, Boston and Miami. This points us to the Bay Area and Virginia, which in turn points us to our pipeline of new capacity currently under construction. Specifically, we closed Q1 with 458,000 square feet of data center capacity under construction, with the majority of this construction in the Bay Area and Virginia. In a few minutes, Jeff will walk you through our specific current development projects and provide an overview of when we expect this capacity will be placed into service. Importantly, in the context of our growth plans, this pipeline of data center capacity currently under construction correlates to 30% of our leased data center square footage at the end of the first quarter. Together, our operating data center capacity available for lease and our data center capacity under construction correlate to 45% of our leased data center capacity at the end of Q1, providing the opportunity for continued strong growth. Looking ahead to the rest of 2016 and beyond, we remain focused upon continuing to execute our business plan, keeping our eyes on five key areas; continuing to improve asset utilization by driving occupancy; strengthening the differentiated value proposition of our platform by continuing to add anchor networks and cloud providers; driving operational excellence across our organization; investing in expansion to support ongoing growth; and consistently and continuously working to increase returns on invested capital. In summary, our operating results for the first quarter reflect the continued systematic execution of our business plan. We believe that our Company remains favorably positioned within our industry and that the supply and demand dynamics inherent in the performance sensitive segment of the data center market remain favorable. We remain focused upon further differentiating our Company and driving enhanced value to our customers by providing network-rich cloud-enabled data center solutions to support our customers' performance sensitive requirements. Finally, we believe we have a strong opportunity to grow and we are excited about working to execute upon that opportunity. With that, I'll turn the call over to Steve.

Thanks, Tom. I'd like to start by reviewing our sales activity during the quarter. As Tom noted, Q1 new and expansion sales totaled $22.5 million in annualized GAAP rent, reflecting a new record for our Company. Our sales total is comprised of 103,000 net rentable square feet at an average GAAP rate of $219 per square foot. The rental rate of $219 per square foot was influenced by power density. Specifically, power density in Q1 was approximately 32% above the trailing 12 month average. When adjusted for power density, our Q1 rental rate represents a 7% increase over the trailing 12 month period. Transaction count for the quarter totaled 119 new and expansion leases, comprised of 114 leases of less than 1,000 square feet each, four midsized leases between 1,000 and 5,000 square feet each, and one large lease at SV7 which was previously announced of 80,000 square feet. Q1 transaction count was below that of Q4 2015 and 19% greater than Q1 2015. We will remain focused upon this area of our business and we retain our objective to increase the transaction count in 2016 over that of 2015. Beyond our new and expansion leasing, our renewal activity in Q1 was solid as renewals totaled approximately 56,000 square feet at an annualized GAAP rate of $173 per square foot. This reflects mark-to-market growth of 3.7% on a cash basis and 9.2% on a GAAP basis. Churn in the quarter was 1.6%. Regarding our vertical mix, during Q1 networking cloud customers signed 56 new and expansion leases, representing 47% of our total. Related to the cloud, during the quarter we added valuable new logos including a SaaS database [indiscernible] provider for enabling hybrid cloud and a leading cloud-based healthcare company. We continue to see strong demand among cloud related requirements across our platform and particularly in the Bay Area. Regarding our network vertical, we saw solid performance across our portfolio with particular strength at our New York campus. In Q1 we signed three key new network deployments in our New York campus, including a large international network added at NY2. This brings the number of networks at or committed to serving NY2 to 23, providing strong network options for our cloud and enterprise customers. Turning to our enterprise vertical, we continued to see solid momentum in the quarter, with this segment accounting for 53% of new and expansion leases signed. Strength in this market was led by general enterprises and digital content, including an equity trading platform, two global healthcare organizations, a large online retailer and 24 new logos. We continue to focus on leveraging the growth within our network and cloud community to provide enterprises with industry-leading connectivity and cloud solutions restricting the foundation of our platform and [indiscernible] our data centers. From a geographic perspective, excluding the 80,000 square foot lease signed at SV7, our strongest markets in terms of annualized GAAP rent signed in new and expansion leases in Q1 were Los Angeles, New York and Boston. As it relates to SV7, we have accelerated and are now under construction on all 230,000 square feet, which is 54% pre-leased. We are optimistic about our investment in SV7 given the positive absorption trends in the market as well as the limited availability on large blocks of capacity in the market. In Los Angeles, demand remained steady. Importantly, our drive to increase the value of LA2 continues to bear fruit, with leasing at LA2 representing 56% of leases signed in Q1 across our LA campus. In terms of verticals, digital content was our strongest, followed by network and cloud. Stabilized occupancy across the LA campus was 87.7% at the end of Q1, down 160 basis points compared to Q4, as a result of 34,000 square feet moving from the pre-stabilized to stabilized pool. In the New York-New Jersey market, we continued to see improving demand for smaller requirements. In Q1 we executed 12 new and expansion leases across our New York campus, with one 5,000 square foot lease and the remainder under 1,000 square feet. Leasing at NY2 accounted for 58% of signings with NY1 accounting for 42%. Our enterprise vertical represented 42% of signings. Lastly, in Northern Virginia DC, we saw good transaction volume among smaller requirements with 17 leases below 1,000 square feet. We had a soft quarter in terms of total dollars leased due to lack of leases above 1,000 square feet, which we attribute to normal lumpiness associated with large leases. As it relates to capacity, during the first quarter we completed construction on Phase 3 at VA2 and anticipate completing construction on the remaining 48,000 square feet of Phase 4 in early Q2. Including the Phase 4 capacity under construction, at March 31, 2016 we had approximately 93,000 square feet available in Virginia, providing an attractive runway for growth in the market. As Tom mentioned, we have seen significant growth in our interconnection services year-over-year. We continue to see strong cross connect growth involving the enterprise and cloud segments, now representing approximately half of our installed interconnections with a growth rate nearly double that of our network to network interconnections. In summary, we are pleased with our sales performance in Q1. As we look forward, we are optimistic about the current market strength and our pipeline health and are committed to executing against our strategic plan to create value for our customers, partners and shareholders. With that, I'll turn the call over to Jeff.

Thanks, Steve, and hello everyone. I'll begin my remarks today by reviewing our Q1 financial results. Second, I will update you on the development CapEx and our balance sheet and liquidity capacity. And third, I will discuss our updated guidance for the year. Q1 financial performance reflects total operating revenues of $92.5 million, correlating to a 1.7% increase on a sequential quarter basis and a 23.9% increase over the prior year quarter. Our 1.7% sequential quarter growth in Q1 was compressed due to churn realized from the original full building customer at SV3 expiring at the end of the prior quarter, consistent with our guidance over the past year. Q1 operating revenue consisted of $75.9 million in rental and power revenue from data center space, up 1.6% on a sequential quarter basis and 24.7% year-over-year; $12.7 million from interconnection revenue, an increase of 6% on a sequential quarter basis and 24.7% year-over-year; and $1.8 million from tenant reimbursement and other revenues. Office and light industrial revenue was $2 million. Moving to earnings, Q1 FFO was $0.86 per diluted share and unit, an increase of 7.5% on a sequential quarter basis and 34.4% year-over-year. Adjusted EBITDA of $48.5 million increased 1.7% on a sequential quarter basis and 27.8% over the same quarter last year. Sales and marketing expenses in the first quarter totaled $4.2 million or 4.6% of total operating revenues. General and administrative expenses were $8.7 million in Q1, correlating to 9.4% of total operating revenues, in line with our guidance. Regarding our same-store metrics, Q1 same store turn-key data center occupancy increased 660 basis points to 87.2% from 80.6% in the first quarter of 2015. Additionally, same-store MRR per Cabinet Equivalent increased 6% year-over-year and 2.7% sequentially to $1,461. As a reminder, our same-store pool is redefined annually in the first quarter and only includes turn-key data center space that was leased or available to be leased to our colocation customers as of December 31, 2014 at each of our properties and excludes powered shell data center space. In Q1, we finished development of 14,000 square feet of turn-key data center capacity at BO1 in Boston, which is now reflected in our pre-stabilized pool. As of March 31, 2016, this space was 31% occupied. During the first quarter, we also finished construction on Phase 3 at VA2 comprised of two computer rooms. The first is a 25,000 square foot computer room which is in our pre-stabilized pool, and the second, a 23,000 square foot computer room moved directly to our stabilized pool as it was 100% occupied at the end of Q1. As we have previously discussed, we define stabilization as the earlier to occur between 85% occupancy and 24 months after an asset is placed into service. As of the end of the first quarter, two rooms at LA2 measuring 12,000 and 22,000 square feet moved into our stabilized pool at 42% and 76% occupancy respectively. In addition, 16,000 square feet of turn-key data center capacity at NY2 entered the stabilized pool at 73% occupancy. Lastly, we commenced 46,000 net rentable square feet of new and expansion leases at an annualized GAAP rent of $164 per square foot, which represents $7.5 million of annualized GAAP rent. We ended the first quarter with our stabilized data center occupancy at 90.6%, a decrease of 190 basis points compared to the fourth quarter, largely due to the addition of the turn-key data center capacity to our stabilized pool that I just discussed. Turning now to backlog, projected annualized GAAP rent from signed but not yet commenced leases was $31 million as of March 31, 2016, or $38.4 million on a cash basis, both approximately 2x greater than the levels a year ago. Importantly, approximately 94% of our GAAP backlog relates to leases which will commence once construction is complete, reflecting a significant amount of pre-leasing. Due to estimated construction completion dates as outlined on Page 20 of our supplemental, approximately 90% of our GAAP backlog commences in fiscal 2016 with approximately 20% or $6 million to commence in the second quarter of 2016, including rent associated with the powered shell built-to-suit at SV6. Another 70% or approximately $22 million is expected to commence in the back half of 2016, including a portion of the rent associated with the previously announced SV7 pre-leases. Turning to our development activity, we had a total of 458,000 square feet of capacity under construction as of March 31, 2016, consisting of both turn-key data center and powered shell space. We estimate a total investment of $253.6 million is required to complete these projects, of which $110.7 million had been incurred at the end of Q1. These amounts are comprised from the following projects. In Santa Clara, we had 230,000 square feet of turn-key data center capacity under construction at SV7. Given the recent pace of pre-leasing at SV7, we accelerated construction on all remaining phases in the building. As of March 31, 2016, we had incurred $58.5 million of the estimated $190 million required to complete this project and expect to complete construction during the middle part of 2016. Also in Santa Clara, we had 136,580 square feet of built-to-suit powered shell under construction at SV6. As of the end of Q1, we had incurred $26.9 million of the estimated $30 million required to complete the development and we expect to complete it in Q2 of 2016. In Northern Virginia, we had 48,000 square feet of data center space under construction in Phase 4 at VA2 and had incurred $5.6 million of the estimated $8 million required to complete this project as of March 31, 2016. We expect to complete construction of Phase 4 during the second quarter of 2016. Finally, in Los Angeles we had 43,000 square feet under construction at LA2 and had incurred $15.6 million of the estimated $18 million required to complete this project as of March 31, 2016. Construction at LA2 is expected to be completed in the second quarter of 2016. As shown on Page 23 of the supplemental, the percentage of interest capitalized in Q1 was 35%. For 2016, we expect the percentage of interest capitalized to be between 15% and 25%, weighted towards the first half of the year based on our current outlook and the development pipeline. Turning to our balance sheet, as of March 31, 2016, our ratio of net principal debt to Q1 annualized adjusted EBITDA was 2.4x. Including preferred stock, the ratio was 3x, below our stated target ratio of approximately 4x. This correlates to incremental debt capacity of approximately $200 million at March 31, 2016 based upon Q1 annualized adjusted EBITDA. Based on 2016 total estimated capital expenditures of $265 million at the midpoint, less the $71 million spent in Q1, we had approximately $40 million in uncommitted liquidity as of March 31, 2016. As a result, we expect to execute upon an additional debt financing in 2016 to increase liquidity. Timing is dependent on market conditions and the expected issuance amount is $100 million to $150 million. This debt issuance is included in our guidance which I will now discuss in more detail. We are increasing our 2016 FFO guidance to a range of $3.52 to $3.60 per share and OP unit from the previous range of $3.37 to $3.47, an increase of 4.1% based on the midpoint of both ranges. The increased guidance reflects the previously announced pre-lease at SV7, better than expected leasing across the remainder of the portfolio in Q1 as well as our current view of the pipeline. More specifically, we now expect total operating revenue to be $391 million to $401 million, compared to the previous range of $380 million to $396 million, driven primarily by our stronger than expected leasing results in Q1. In addition, we expect our interconnection revenue growth for 2016 to be 17% to 19%, up from our previous guidance of 15% to 17%, driven by higher than expected volume growth in the first quarter. We now expect adjusted EBITDA to be $203 million to $211 million, up from our previous guidance of $196 million to $202 million, implying a full-year 2016 adjusted EBITDA margin of 52.3% based on the midpoint of guidance. Remember that our guidance suggest a relatively flat margin compared to full-year 2015, reflecting the greater proportion of GAAP rent leased associated with our wholesale leasing over the trailing 12 month period. We expect capital expenditures to be $250 million to $280 million, up from the previous range of $210 million to $240 million, primarily reflecting the additional capital resulting from the accelerated construction of SV7. A more detailed summary of 2016 guidance items can be found on Page 25 of the first quarter 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 activities, 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 Jonathan Schildkraut from Evercore ISI. Please go ahead.

I guess let me start with some questions on demand. Breaking apart the larger footprint and the performance sensitive stuff, on the large footprint side I think for yourselves and industry-wide we've seen a fairly large increase in pre-leasing or built-to-suit, sort of the same thing. And Tom, I'd love to get your perspective on whether we're seeing sort of a secular change in the way the buyers are entering the market or if this represents just sort of incremental demand that is finding a difficult place getting a home given industry-wide vacancy rates. And then secondly, on the performance sensitive side, last quarter you eloquently described almost a virtuous cycle of cloud and enterprise demand that cloud brings in, smaller cloud providers bringing in enterprise, bringing in cloud, and you talked this quarter about the strong volume on interconnect, but I'd love to get any incremental color on that sort of virtuous cycle. Thank you.

Sure. As to the first question, Jonathan, I think that – and Steve will dive in here in a second as well – I guess I would say that I think the pattern of the industry is consistent currently with the last five years. We've seen – you saw the social guys come in strong five, six, seven years ago and need a fair amount of space in a reasonably short amount of time, and that created a favorable supply dynamic in some markets for the service providers. I think we are seeing the same thing right now with the large cloud guys, and I know you see that and write about it extensively. What we've seen over the last handful of years is, any given segment can be cyclical, or any given segment of demand, whether it would be social or cloud, would not surprise me if the cloud demand follows the path of the social demand from five or six years ago, but generally speaking we've also seen new segments and new customers, new demand sources come-in in the next cycle with any given segment. So, our general sense is that current climate seems to have some of the flavor of the social climate several years ago, but here we are again with a new segment and it would not surprise me if that pattern continues. Steve, any color around that, any thoughts?

Yes, Jonathan, and the thing I guess I would add is, when you look at the large cloud providers out there, they are providing a lot of their backend data centers on their own and what they are really deploying with us is typically more of their edge or network nodes and caching nodes that really kind of you answered that part of the question with your second question, which is they want to be as close as they possibly can to the enterprise just in order to maximize that experience and make it as seamless to them as possible. So that's what we see at least from the larger cloud providers, is that they are deploying those edge and network and caching nodes closer to the enterprise, which also lives in our data center. So I think that's part of it. And then I think you also see, and what we've seen, even over this last quarter, is the smaller cloud providers that are choosing to deploy it right in our data centers so that they can have that interconnection that we've invested in over the past several years as well as those other enterprise customers to connect to. So it's really kind of a combination of all those things, but the large compute from the big guys is still happening typically outside of our TKD space.

Our next question comes from Jonathan Atkin from RBC Capital Markets. Please go ahead.

So, Steve, just given what you just said about cloud edge node, from a nomenclatures perspective, is the SV7 pre-lease, is that considered performance sensitive or not?

Jonathan, it's Tom. I would think that that could go in a number of different locations. I think you need to go in the Bay Area, but I think that that application could backhaul a mile and not see a meaningful performance or economic degradation. Does that answer your question clearly enough?

Yes, I mean you defined performance-sensitive requirements versus non-performance-sensitive requirements. I just wondered in which bucket you will consider that piece of business.

I guess just I'll give you a little bit of color on it. My sense is, yes, it is performance sensitive and that's why they need to put it in Santa Clara in order to have the performance characteristics required of the applications that are driven out of that and to those enterprise customers versus backhauling it to someplace in the desert or someplace up north.

And [indiscernible] on a tradition at CoreSite of open communication, I'd probably come down on the other side, and it's just definitional, Jon. I think if you define performances, it's got to be within a certain metro or within a certain radius, limited radius of a point of interconnection, then I would fall right where Steve just fell. I would define performance sensitive as really needs to be inside a campus with a provider to obtain performance capabilities more because of economics. And under that definition, I would not call the large deployment performance-sensitive.

Okay, that's an interesting set of answers. And I guess then just moving topics to Open Cloud Exchange and I'm interested in the contribution to revenues from that platform, and then just anecdotally, what's the average number of cloud connections that a typical enterprise is taking off of that platform?

The revenue is inconsequential, it's tiny, and it's high-growth extremely small base from every metric, whether it's revenue or customers' reports or traffic. It's growing very well but it's very, very small right now on all measures.

Okay. And then I've got just two more. One is, based on where you see demand tracking and the development pipeline that you communicated, mostly in Jeff's comments, I just wondered which metros are coming up where you might need to make some decisions on additional off-campus or additional campus [indiscernible] locations within a given metro. You've got a lot of demand and you've got different levels of capacity remaining to develop, but then you've got to kind of square that with demand. So I just wondered if you could help us out. Will it be Virginia and Santa Clara where you may need to kind of make that decision sooner than Chicago or what would be the kind of the pecking order of markets?

I think, look, we feel good about our ability to grow earnings and our available inventory over the next call it 12 to 24 months depending on the market throughout the portfolio. I think you start to get out 12 or 24 months, you've got Virginia, Santa Clara, Chicago, where if you look at the trailing pace of net absorption relative to the amount of capacity we're bringing online, those metrics line up toward needing additional capacity. And I think probably each of those three markets is similarly situated in terms of timing. And so I just said on the last call, we are actively looking at expansion opportunities, we feel good about our ability to expand and we are working on picking the best ways to do it. As we said a quarter ago, we don't expect ourselves to be sitting here two years from now going, oh golly, if only we knew we needed more space in Santa Clara and Virginia. We realize where we are and we're working on it. But I think in the three of the largest markets in our portfolio, they are going to need some more capacity in the mid-term, Bay Area, Virginia, Chicago.

Got it. And then lastly, if you could just kind of refresh for us what your discipline is, what are the strategic criteria and the financial criteria around M&A and buying additional assets or platforms?

Pretty simple Finance 101 and Strategy 101 combined. The strategy has to be consistent with ours. We are not working to dramatically change the business we're in, so very similar business, complementary geographic reach. Obviously interconnection density is very important to us. And then the math needs to make sense, not only going in but over some period of time. There is positive arbitrage day one, you really have to look at a model for a good five years and feel good that things are accretive to the CoreSite shareholder over that timeframe. I mean that hasn't changed in forever.

The next question comes from Jordan Sadler from KeyBanc Capital Markets. Please go ahead.

First question regarding visibility, I think last quarter you might have sort of characterized the outlook through the first half as being consistent or very good relative to the prior couple of quarters. Can you maybe give is the crystal ball for the rest of 2016 as you see it today?

Sure, Jordan. This is Steve. The demand that we've seen come in at least for Q1 has been consistent. So I wouldn't say that there's a whole lot of surprises from the last call that we had, and as responsible for sales for Tom and our shareholders, I take it very seriously and we're out just laying it out every single day. So I wouldn't say that you will see any dramatic changes, but we have to work at it every single day and so far we see good system performance and we just try to get better at it every single day, but overall demand seems to be improving with the market and we anticipate [indiscernible] interest and taking more than our fair share of it.

And I would just layer on top of that, we want to encourage everybody to consistently think about our business as having this core more transactional colocation oriented business and some moderate degree of midsized sales and leases layered on top of that, and then an opportunistic approach to much larger leases layered on top of that. And I think if you look back over a two-year trail and you strip out a couple of built-to-suits and a recent large lease at SV7, that average probably gives you a better read of that core business. And so I think Steve said it all well, I just want to remind everybody that the kind of leasing we saw in Q1 has a large lease layered on top of that, and that's an extremely lumpy category for our Company, and you really need to think about the target as a trailing average excluding those opportunities.

That's helpful. I guess when looking at the transactions for the quarter and going back to prior conversations, I guess the thing I notice is, you previously were targeting sort of a growing number of transactions. Did we ebb a little bit here in the first quarter in terms of number of transactions, was that just the lumpiness of that business, or anything to report there?

I'll answer that, and then Tom obviously can add some color there, but as you look at Q4 to Q1, we did see a slight drop between those quarters. As you look at Q1 over Q1 last year, we saw an increase of about 19%. So we did see a good push towards the end of last year and I think there were some customers that were looking to get budgets in and close out business before the end of the year. So we saw a nice rise in that. And then as we come into Q1, we've also seen – I think we picked up on where that momentum left off, it's just we're now starting from a bit of a softer place just given it's a new year, a new market, and so forth. So, coming in at 19% ahead of where we were last year in the same quarter, we'd like to always do better but we're showing strength from where we were last year, and that's important.

Okay, thank you. Last one quickly on SV7, Tom, you decided to go with the rest of it speculatively or at least build out the rest of it and I assume that reflects obviously that you leased up a big chunk right after last quarter's report as well as what you've seen in the funnel there, but who are you targeting and how are the returns on that overall development affected by the larger collection of leases?

We are targeting, and I think growing the base of business at the Santa Clara campus with the target, and those are the cloud on-ramps, the private WAN network operators, all designed to bring in more of that enterprise user who finds differentiated value in our location. So that's the target. And I think that's continuing to move in the right direction. We have more networks than we had two years ago and three years ago and we have more on-ramps, we have more commitments from the larger public cloud guys, so we think that's moving in the right direction. As to the yield, we've always said, we do view wholesale leasing opportunistically and we did the first larger wholesale deal in SV7 as an anchor lease on IRR based math solely. The ramp was at market at a time when the market was fine, but we did that based on IRR math, and I would say, now the market has tightened considerably and the more recent wholesale leasing is more opportunistic in terms of yield and we are pleased with the return on where that asset is headed.

It's helpful. Thank you.

Our next question comes from Dave Rodgers from Robert W. Baird. Please go ahead.

Maybe just follow up on some of the earlier comments that Tom I think you said in your prepared remarks that interconnect has really exceeded your own expectations to start the year, and maybe to simplify it a little bit, where are you seeing it beat your own expectations? You know the customers you are bringing in, you kind of know the verticals that they are in. Are they just adapting much more quickly to the environment, are they taking more cross connects per customer? That was kind of the first question.

So where we were pleasantly surprised is really the core of the business, and that is net adds of fiber cross connects. The churn on the copper side has remained consistent and this Q was consistent with the trail. Adds in the logical interconnection set were pretty consistent with the trail. We really saw outperformance in net fiber adds. And honestly, it was very well distributed. There were a couple of specific carrier customers who added more than you might see in a given quarter, but we had pretty good growth across the business with regard to net adds of fiber. And sincerely, it outperformed our expectations and I think it's premature to dramatically write up our forecast of cross connect revenue growth from where we've been, [messing the history] [ph]. You saw that we increased guidance 2 points at the mid. But we're watching it and we're pleased, but I can't say this Q gives you enough information to define exactly what and why. It's just one Q and we have to keep assessing it.

And then maybe second question, I think I missed probably what was some commentary that you made during the prepared comments as well on the power density and how that impacted your rates. I'll go back and read that, but I guess in terms of the trend towards seeing greater power density, the demand to see that space, is that something you're seeing more regularly or is that just very unique in a couple of circumstances?

I think densities are going up in general and I think they have been, but adjusted for density, if you adjust to look at density on the trailing 12 or trailing 24 months…

Trailing 12.

Trailing 12 months, the rental rate per foot achieved in Q1 was 7% greater than the rental rate averaging over the trailing 12. So there was real rent growth on a power adjusted basis. And that lines up I think with the increase in MRR per Cabi. You saw a 6 point growth in MRR per Cabi. Of that, about half of that was due to increasing rent, 38% was due to cross connect per cabi and the rest was power, and that rent component reflects a 5.7% growth rate. And so on a power adjusted basis, we've picked up 7 points in Q1 over the trail. On an MRR per Cabi basis, that seems to line up pretty well looking back over the last year. And so I think that in the current environment, we're seeing that additional favorable pricing per unit.

The next question comes from Manny Korchman from Citigroup. Please go ahead.

Maybe if we could just go back to your comments on LA and I want to try to reconcile two things that you guys said. I think Tom in your prepared remarks, or maybe of Steve, you talked about strength in that market. You've also got new development there, which seems to be doing okay. But then I guess Jeff spoke about a couple of pre-stabilized developments coming into the stabilized pool at only in the 40% leased. And I was just wondering how do I sort of reconcile those two ideas that you've had a project on the books for 24 months per your definition that's only gone to 40% leased, but you're talking about a strong market with development there?

Yes, and that's such a good and fair question, Manny, and I've been talking about that with our general manager in LA as well. Look, the short strokes are, part of the soft occupancy in what's being transferred from the pre-stabilized pool in stabilized was under rights of first refusal and first offer with others and they didn't exercise them the way we thought they would have. So that sat on inventory that isn't occupied but we couldn't sell. I would also say that when we made the decision to move forward on the most recent build, the funnel was incredibly strong and we just hit bust on more of those opportunities than we expected. If I had perfect information, frankly I wouldn't have built that most recent tranche and it's a constant mathematical assessment and probabilistic assessment of the funnel of you don't want to run out of inventory, you don't want to be too long, and I think on this most recent whatever it was $12 million or $15 million build in LA, building another 20,000 feet, we jumped the gun and I would say that we're – I don't think we jumped it by much. We feel really good about the funnel in LA and in particular LA2, and we don't think this imbalance will last all that long. But yes, I think [indiscernible] on behalf of the Company on that call.

Great. And then if I look at your largest customer list here in the supplemental, you've got this footnote that's recurred from the last quarter on one of your digital content enterprise customers talking about having being in lease negotiations with them and then potentially vacating. With only four months left of average lease term remaining, you think that you'd have clarity sort of by now or is that one of those things that might go into hold over something else by the end of the year?

So there are already pieces of their position with us are in holdover and that wakes that four months down. They have leases in every single one of our markets. They are very broadly distributed geographically and they are very broadly distributed in terms of lease terms. So this isn't a lease that's set to roll in four months. It's a very, very different animal. And we do have I think now substantial clarity, and my guess is over a three-year period, plus or minus, somewhere between two and four, they will probably move out of half of their capacity. Some of that is in buildings where frankly rather that happens sooner than later, and some of that isn't, but there will be some move-outs in the near-term, I'd say probably half their capacity over a few years, and we think we have visibility with them and understanding hopefully going to documents that retains another chunk for a longer period of time. In general, I just want to talk about this concentration, the key to that question, Manny. Look, of our top 10 customers, they are represented by 53 different leases, and I'll introduce a term called customer buildings, we might have a customer in a building that has three leases in that building. If I count that as one, I've got customer X in building A, that's one; I've got customer Y in building B, that's two; these leases are spread across 36 customer buildings and two different buildings represent between 2% and 3% of our rent, five represent between 1% and 2% and 29 of those are less than 1 point. And so the point of that is, our top 10 list is very diversified geographically and in terms of term and even beyond buildings, number of leases. So this customer that we just spoke about a minute ago, I think is fairly representative of the meat of the portfolio around this issue, and I wanted to offer that data because it helps describe our business.

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

I'd like to just go back to the comments that Steve made in his prepared remarks on enterprise interconnect. Just wanted to clarify the enterprise to cloud connections at 50% of the total and that that was 2x the number of network to network connections, was that for the overall base or just for incremental bookings in the first quarter?

As far as the incremental bookings are concerned, the growth that we've seen has been in the enterprise to cloud and cloud to enterprise. That's where we've really seen the growth of that. The 50% represents the overall base. So as you look at the overall base of cross connects, that's where we are seeing those cross connects happen between clouds and enterprises.

And just an important clarification, the enterprise and cloud component are cross connects involving an enterprise or a cloud. They may involve a network on the other end but they are not network to network. That component of our business that involves a cloud or a network in the cross connect used to be far less, I don't remember the stats, and it's close to half now and it's growing at double the rate of our network to network business.

Okay, that's helpful. Thanks. And then as a follow-on, I was hoping you could compare the dynamics between single cross connects and Cloud Exchange ports for sort of the enterprise customer? Are you actively steering customers towards multi-cloud ports or is the demand for that type of product just kind of not very mature yet?

We're really trying to provide customers choice and options so they can dependent upon the flexibility, bandwidth, a lot of different factors, weigh into why they make one decision versus the other, but it's really about choice. Up until now and even including now, we see more and more customers still elect to go the cross connect route, but we're seeing a lot more interest and more take rate frankly around things like Open Cloud Exchange given the ability to change the connections on the fly, do it a little bit more dynamically and do it with better economics.

It has a lot to do with how the cloud provider is coming to market as well with regard to the interconnection. So Azure is coming to market via logical connections, and so they are on our OCX and that's how they are coming to market for their target market. AWS has a different coming-to-market model. Direct Connect is a cross-connect into their DX architecture. So how the cloud is coming to market plays a significant role and how the OCX fits in as well.

Helpful color. Thank you.

Our next question comes from Jon Petersen from Jefferies. Please go ahead.

I think in answer of one of the earlier questions, Steve talked about kind of the edge markets and how the cloud has been moving to be closer to customers. I was hoping you guys could expand on that a little bit and maybe talk about I guess the demand you're seeing, what sort of opportunity there might be for data center operators to play in those markets? I know you guys are in Denver and Boston, which might be considered edge markets, but are there other opportunities since that seems to be where there is a lot of growth right now?

Obviously. I don't think we want to get too specific around that. We don't want to say where we're doing really well or what Tier 2 markets we think of disproportionate and attractiveness.

You don't have to get specific. I'm just talking in general, because historically I mean it seems like at least all the public guys want to be in the Bay Area, LA, Chicago, Dallas, all the major markets, but are we going to see a shift in demand towards secondary market? You don't have to get market specific but just where you guys are seeing [indiscernible] trend?

Look, my view and I think the data supports it over the last 24, 36 months or so is that the global and regional gateways have retained their rates of growth and the Tier 2 markets are growing even faster, which is an advent over the last several years. It's as caching is pushed out to the edge and the router, the interconnect is pushed out to the edge, that is growing at a faster clip than the global gateways. The global gateways have not lost share or lost their growth rate. So I hope that helps, I hope that answers the question, but yes, we see a faster growth rate closer to the edge now than any other segment.

Okay, all right. And then just a question on LA, you guys talked about, you guys obviously had developments in LA2 and I know historically you've talked about moving, trying to move networks from LA1 to LA2, can you guys give us any numbers around how many networks are currently in LA2?

I don't have [indiscernible] we have several subsea cables there now. But that really speaks to the fact that it's a campus and we manage it as a campus. It's massive networks and massive interconnections distributed 11 blocks apart.

Just anecdotally, I will tell you that we are seeing more and more networks build directly into LA2. So I don't have the stat off the top of my head as to numbers, but it is increasing and we see more and more of those networks not only build into LA1 but also into LA2, and then that's also connected with our fiber [indiscernible] obviously.

And Steve made a note in his remarks that I think is meaningful for us anyway. This quarter we signed more leases in LA2 than we did in LA1. So that might sound like a little thing but it's actually a pretty big deal. So the rate of adds at least in this Q was higher over to LA2 and that trend toward that dynamic has been underway but it was gratifying to see it happen this quarter.

And obviously it's fair to say that's strategic, right, you guys are pointing customers towards LA2 since that's the building you actually own rather than lease?

We really do serve out of the campus and different needs have different requirements, but there is clearly a segment of demand that is well met at LA2 and is a good fit there.

Okay. And then just one more question, either for Jeff or Tom, whichever of you guys want to take it, a lot of your peers have been tapping the equity markets recently. Obviously you guys have stock trade at an extremely attractive multiple in terms of raising equity. Your debt to EBITDA is up to 3x. I know you guys have talked previously, I think your peak is 4x. But just kind of your thoughts around issuing equity in the near term just to give yourself a little cushion as you are increasing your development pipeline?

Go ahead, Jeff.

Jon, I think as you just pointed out, our leverage at the end of the quarter is 3x and basically a turn below our targeted leverage of 4x. As I gave some color on the call, when you look at our capital needs through the rest of this year, I did give some color around us looking at going out and tapping the debt markets for another $100 million to $150 million, and I think that gives us liquidity in the near-term as we look out in terms of where we're headed for the rest of 2016. I think to the extent that will change, it's really going to be driven by increased development and we increased our development spend this quarter, but going out and tapping the debt markets should take care of what we need for the remainder of this year.

Next question comes from Colby Synesael from Cowen & Company. Please go ahead.

I had a question on the cost to build. Can you just talk about how much you are spending maybe not on explicits but what you've seen in terms of the trend line for the cost to build out your facilities? Is that coming down and do you foresee that coming down even further perhaps over the next year or two? And then I guess as part of that question, returns, do you think that the returns for the business with pricing going up, the demand what it is, perhaps with the cost to build going down, that the returns are much greater now on the build that you're looking at doing versus what they were maybe just two or three years ago?

Look, I think as to the latter, yes, cost is down and in some markets rents in the bucket of rent and power and interconnect is increasing. So yields have improved in the current climate over that of three years ago in select markets. I'd say in other markets, yields have improved as well but predominantly on the cost side, on the basis side, rather than the numerator and the denominator. So our cost to build, I'm joined here by Brian Warren, our Senior Vice President of Engineering & Product, were probably down 15% one year and 10% the next, so probably an aggregate of 25% over the last couple of years.

And when you look at the design that you have in place on the new facilities to what you're building now, would you anticipate that to continue to trail off or come down or do you think that that kind of starts to stabilize around the rate to which you're at right now?

I think it's going to start to stabilize. We've had an initiative over the last couple of years to really make a push on this. I don't think that we're completely done, but I do think we've made large progress. It's a never ending review of every time you build, you look at the design, and can we do it smarter and can we design it more efficiently.

And I guess just the last follow-up to that is, as the returns in this sector do go up, one can make the argument that that could increase the desire for competition to move into the space, but the reductions that you're seeing in the cost to build, how replicable are those, how much of that is CoreSite special sauce, if you will, versus something that someone else will be able to come into the market and do the same thing and achieve the same low cost if you will on a per megawatt or a per square foot basis?

Not to eliminate exuberance but we just don't believe in special sauce with regard to construction, we just don't buy it. On a new build, in a new moment, somebody might have a little bit better idea, but ultimately these generators, concrete, steel, land, labor, these are big warehouses with power and cooling, and you design a product as flexibly as you can, you do build in a modular fashion with as big of swing to the bat as you can to get your efficiencies, but there's nothing special about that sauce. And I do think if you peel the onion around fully turn-key leased capitalized interest, land, everything, I think if you look at cost basis on an apples to apples, from an apples to apples viewpoint across the industry, I think that the lack of special sauce thesis might be validated.

Meaning that the returns are fairly similar across the space?

Meaning that the all-in cost structure is reasonably similar.

Got it. Okay, thank you.

Our next question comes from Jonathan Atkin from RBC Capital Markets. Please go ahead.

I wanted to actually touch on that very last topic in the context of average power density requirement increasing, and I wondered, is that more for wholesale or more for retail or is it kind of across the board in terms of power density requirements going up, and what implications does that have for the product [indiscernible] in future expansion?

I think it's more for wholesale but the retail component, if five years ago you never saw a requirement at 300 plus a foot, probably 10% of the market now on the colo business is that dense. Even then very unlikely for like the five cabinet or smaller deployment. I'm talking to Brian now. Have you seen power density change in the very small colo requirement?

No, not in the very small colo requirement. You do in the midsized requirements, kind of server based midsized requirements as these folks are pushing the densities up. But again that's, as Tom said, a smaller portion of the total TKD [indiscernible] right now.

So the product in terms of resiliency that you're delivering to the customers who are asking for it, has that changed at all?

We've gone down the past pretty extensively with if somebody wants to buy the +1 on an N+1 configuration and looking at productizing different pieces of resiliency, really how we've driven cost down is by simplification and standardization and replication. So, no, we certainly looked hard at productization of different pieces of the resiliency stack. We do work with customers who say, I want N on UPS and we might build to that, but that's still a fairly small part of our business. But look at a year ago, we did have a view of productizing different pieces of the capital stack that was out there, and candidly at the end of a lot of analysis, we didn't see huge returns on that relative to other dynamics that we are challenging. But there are consequences…

And cost to develop – so the improvements that you alluded to in the previous question are cost to develop going down. Was that on a per square foot basis with these 10%, 15% type numbers? I assume that's more square foot than megawatts, or is there anything in particular you had in mind when you gave those numbers?

We were communicating on a power adjusted basis.

Got it. Thanks very much.

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

Just one follow-up for Jeff on the model, does the high end of your guidance range assumes some leasing activity of the next phase of SV1? I'm just trying to get a sense of kind of what drives the delta between the midpoint and the high end of the range.

I think in general our guidance will include some assumed leasing across the portfolio. Whether or not it's specific to SV1 or not, but we would assume it's across the portfolio. Is there something specific in SV1 you're looking at?

No, I guess just sort of generally where you're expecting demand, but that kind of answers the question, more distributed across the portfolio. Thank you.

Thank you. I'd like to turn the floor back over to management for any closing remarks.

We want to thank everybody for being on the call and taking time, and again, working hard to understand the Company. Special thanks to employees and customers for another good quarter and continuing to help build a good company. I would offer that the management team here and our Board, we're being I think extremely thoughtful about the best ways to grow and drive returns for our shareholders, and this is an attractive time in the market and a good time for us to just keep building a better and better company and organization, and that's what we're focused on and we believe we have opportunities to keep doing that to get better, to get more profitable and to keep growing. So, thanks for staying on the story so far and we'll do whatever we can to help you guys understand us in any way possible. Thanks again.

Thank you. This concludes today's conference. Thank you for your participation. You may disconnect your lines at this time.