American Tower Corp (AMT) — Q2 2017 Earnings Call Transcript

Thank you. Good morning, and welcome to CoreSite's second quarter 2017 earnings conference call. I'm joined here today by Paul Szurek, President and CEO; Steve Smith, Senior Vice President, Sales and Marketing; and Jeff Finnin, Chief Financial Officer. Before we begin, I would like to remind everyone that our remarks on today's call may include forward-looking statements as defined by Federal Securities Laws, including statements addressing projections, plans, or future expectations. These statements are subject to a number of risks and uncertainties that could cause actual results or facts to differ materially from such statements for a variety of reasons. We assume no obligation to update these forward-looking statements and can give no assurance that the expectations will be obtained. Detailed information about these risks is included in our 2016 Form 10-K and other filings with the SEC. Also, on this conference call, we'll refer to certain non-GAAP financial measures such as funds from operations. Reconciliations of these non-GAAP financial measures are available in the supplemental information that is part of the full earnings release, which can be accessed on the Investor Relations pages of our website at coresite.com. And now, I'll turn the call over to Paul.

Good morning. And thank you for taking the time to join us today. I'm glad to share our second quarter financial and operating results, as well as update you on our markets and our outlook on supply and demand. Financial results for the second quarter were strong again with year-over-year increases in revenue of 23%, while adjusted EBITDA and FFO per share grew 27% and 24% year-over-year, respectively. Very strong leasing volume of $11.9 million in annualized GAAP rent signed in Q2 included a significant expansion with a Fortune 500 customer in the Los Angeles market and several other key deployments. Overall, it was an unusual quarter for leasing with existing customers representing 95% of new and expansion sales, reflecting the organic growth needs of customers in our markets and an increase in the percentage of sales in the funnel related to larger deployments. Correspondingly, retail collocation sales were $4.9 million, 18% below the trailing 24 month average. We saw a similar pattern in Q1 2016 when we had another surge in sales of larger deployments. Going forward, we believe these scale deployments and the services they represent are key components of our cloud-enabled data center product. They will continue to increase the attraction of our data centers to enterprises and networks and lay the foundation for continued successful campus expansions. These deployments illustrate the importance of network density plus scalable solutions in large edge markets, which characterize our national data center platform. We also continue to see a steady influx of new logos joining the CoreSite ecosystem each quarter with 31 new logos entering our customer base in Q2. Net of customer churn, we added 18 new logos. Across our markets, demand remains consistent and absorption, over the last two years, has exceeded our forecast; while supply remains generally in balance or in a couple of markets constrained. Given the strong demand and the organic growth inherent in our existing customer base, we currently have a number of projects under construction to enable us to continue to meet customer demand across our markets, as well as working through the process of planning new data centers in markets that are most inventory constrained. In Los Angeles, the 47,000 square-feet that we commenced construction on during the first quarter is now 62% preleased as a result of Q2 leasing. In order to maintain available capacity in the market and keep up with overall strong demand, we have commenced construction of an incremental 39,000 square-feet of turnkey datacenter space at LA2. Consistent with what I mentioned earlier, we are accelerating the initial development plans for LA3. On land we already owned, adjacent to LA2, but which is not yet entitled and permitted for construction. We have commenced the permitting and entitlement process for this asset. In the Bay Area, absorption continues to outpace historical levels while supply remains limited across the market and occupancy levels are elevated. We are optimistic about the funnel in this market for both larger footprint requirements that need the performance and connectivity to support edge notes and for performance and geographic sensitive retail collocations. As it relates to the land on a contract for SBA, we are substantially complete with our due diligence and anticipate closing in mid Q3. Please keep in mind that we currently estimate the first phase of capacity of SBA would come online approximately 18 to 22 months after we close on the land purchase based on our expectations around timing for permitting and entitlements. Regarding Northern Virginia and DC, demand and absorption continue to be strong. Occupancy rates remain high in this market and a number of data center providers have land to develop new capacity, primarily for wholesale deployments and some had commenced construction. Although we believe the majority of the new construction is preleased. We are under construction on a total of 53,000 square feet across the market with development in Downtown DC, expansion of VA1 and initial development at VA3. We see good activity in the sales pipeline and continue to have discussions with customers for preleasing opportunities at VA3, where we expect to deliver 25,000 square feet or 3 megawatts of turnkey datacenter capacity in the fourth quarter. We also expect to commence construction in the third quarter on Phase 1B, a 58,000 square-foot building of 6 megawatts plus a centralized infrastructure building to serve the entire VA3 property at an estimated cost of $85 million. In Denver, we are nearing completion of the first phase of expansion of DE1 and expect to place into service 8,200 square feet of turnkey capacity in Q3. Supply across this market remains limited, and we see good opportunities to support customer demand. During the second quarter, we signed a midsize prelease with a company that will be a valuable addition to our ecosystem. Finally, in the New York New Jersey market, we saw an uptick in both square footage and annualized GAAP rent signed in Q2. This marks the third straight quarter of increasing sales in this market and that trend should continue a bit longer. NY2 again accounted for the majority of new and expansion leasing in this market, as well as all of the new logo growth in the quarter. Enterprise activity was strong, accounting for 88% of the annualized GAAP rent signed here, with all of the new logos signed in the quarter within this vertical. In closing, we are pleased with our financial performance and sales results in the second quarter, especially our securing of key ecosystem building blocks, which provide a strong impetus for growth in 2018 and beyond. We continue to believe the flexibility of our platform, our network density and cloud on ramps, and our vibrant ecosystem, make CoreSite uniquely positioned to capture demand in a world of increasingly data-intensive applications. With that, I will turn the call over to Steve.

Thanks, Paul. I'll begin by reviewing our overall new and expansion sales activity during the second quarter, and then discuss in more detail, our vertical and geographic results. In Q2, we signed 119 new and expansion leases, totaling $11.9 million in annualized GAAP rent, comprised of 52,000 net rentable square-feet at an average GAAP rate of $208 per square foot. Note that this rate excludes revenue associated with contractually reserved data center space across our platform. Our ability to support evolving customer IT workloads from traditional enterprises with hybrid and multi-cloud requirements to high-density large scale deployments, coupled with access to hundreds of network and cloud service providers, continues to differentiate CoreSite. We are encouraged with the increasing value of this ecosystem as we add more new customers that contribute to the overall attractiveness of our platform. As Paul noted, new logo growth was strong again in Q2, and we continue to be pleased with the quality of applications and customers that are coming to CoreSite data centers. Included in this quarter's new enterprise logos is a consulting and technology services company, two financial services organizations, our retail ecommerce site, an international consultancy specializing in data analytics and an international online commerce and payments ecosystem. Additionally, existing customer expansions, which have historically accounted for 70% to 80% of sales on a quarterly basis, continue to be a strong source of growth. This includes customers that either increase their current deployment or expand through additional markets. During the second quarter, we have some powerful examples of customers expanding their applications and/or infrastructure closer to the edge. First, a large public cloud customer expanded with us in New York and is deploying infrastructure to establish a metro ring around the New York-New Jersey market so that customers can distribute traffic more efficiently to and from their edge sites. The same customer will be deploying a number of applications in our Denver market, representing their first deployment in this area of the U.S. Second, a large content company expanded its existing environment with us in Los Angeles, as well as established a new deployment with CoreSite in Northern Virginia. Both expansions were part of this customer's ongoing efforts to increase capacity at the edge to support existing customers and new initiatives, such as streaming video and TV applications. Lastly, a digital media company expanded with us in New York to support high-performance video streaming of sporting events. Overall, we continue to see growth in cloud deployments throughout the portfolio as data-intensive use cases appear to be increasing. With the expansions of existing customers and the new customer activity contributing to the vibrant interconnection density of our data centers. In Q2, interconnection revenue grew 18% year-over-year, reflecting total volume growth of 12%, including 16% growth in fiber cross connects. With respect to the vertical mix within our ecosystem, during Q2, network and cloud customers each accounted for 9% of annualized GAAP rent signed. Specific to the cloud vertical, we continue to see good traction with four new logos, including an international infrastructure as a service provider and a global provider of online business solutions. Additionally, we signed an expansion with a cloud contact center provider, as well as an expansion within an edge cloud platform serving digital businesses. The network vertical saw strong activity during the quarter, which was the result of both new customer growth, as well as expansions. We had five new logos join our ecosystem, including an international communication solutions company and a global virtual phone number provider. Additionally, we signed expansions with six Fortune 1000 network customers during the quarter. Network demand was broad-based with new and expansion leases signed in every one of our markets. As it relates to our enterprise vertical, this vertical accounted for 82% of annualized GAAP rent signed in the second quarter. Our enterprise vertical, which represents approximately 50% of our embedded base, captures not only pure enterprise deployments but also includes cloud deployments that may reside within an enterprise company. Looking at Q2, performance across the vertical was strong, led by strategic content expansions for compute catching nodes at the edge, as well as expansions with six Fortune 1000 companies. As Paul discussed, we executed a larger expansion with an existing Fortune 500 customer for their edge compute deployment at LA2. In addition, we signed an expansion of our strategic content customer’s network PoP in Boston and another strategic content customer’s edge nodes in Los Angeles and Northern Virginia. Lastly, we executed an expansion of a Fortune 20 customer's online video streaming services in Silicon Valley. From a geographic perspective, our strongest markets in terms of annualized GAAP rent signed in new and expansion leases during Q2 were Los Angeles, Silicon Valley, and Northern Virginia-DC. Collectively, these represent 84% of annualized GAAP rent signed in the quarter. As I touched on earlier, demand in Los Angeles was impacted by the expansion of an existing Fortune 500 content company. Apart from that specific lease, demand was led by the enterprise vertical, followed by networks and cloud providers. Stabilized occupancy across the Los Angeles campus was 92.9% at the end of Q2, up 40 basis points from Q1. Activity across the Bay Area was strong, led by the enterprise vertical or by cloud deployments. Our network dense access in the Silicon Valley market continues to be attractive for enterprises with two new logos signed this quarter. Stabilized occupancy across our Silicon Valley campuses decreased 50 basis points to 95.8% due to some modest churn at SE1 and SE4. In Northern Virginia-DC, demand continues to be weighted toward smaller enterprise deployments from both existing customers and new logos. We saw good demand from cloud customers with three new logos in this market. Stabilized occupancy across Northern Virginia-DC now stands at 95.4%, a decrease of 100 basis points on a sequential basis, reflecting some customer churn at VA1. To wrap up, we continue to be pleased with the sales performance in the quarter, and we'll continue to focus on driving added value across our operating portfolio by attracting synergistic deployments to our data centers. I will now turn the call over to Jeff.

Thanks, Steve, and hello everyone. My remarks today will begin with a review of our Q2 financial results, followed by an update on our development CapEx and our leverage and liquidity capacity. I will then conclude my remarks with an update on our 2017 guidance. Q2 financial performance resulted in total operating revenues of $117.9 million, a 2.6% increase on a sequential quarter basis and a 22.7% increase year-over-year. Q2 operating revenue consisted of $97.3 million in rental and power revenue from datacenter space, up 2.3% on a sequential quarter basis and a 23.5% year-over-year increase. Interconnection services revenue contributed $15.3 million to operating revenues in Q2, an increase of 5.6% on a sequential quarter basis and 18.1% year-over-year. Tenant reimbursement and other revenues were $2.3 million, while office and light industrial revenue was $3 million. Q2 FFO was $1.10 per diluted share in unit, a decrease of 2.7% on a sequential quarter basis and an increase of 23.6% year-over-year. This sequential decline reflects the final expiration of our original full building customer's lease at SV3, as well as the financings executed in April. In addition, we saw an acceleration of decreased power margin in the quarter that we typically see in Q3. Q2 FFO also includes a benefit equal to approximately $0.01 per share related to a real estate tax accrual true up. Adjusted EBITDA of $64.8 million increased 0.6% on a sequential quarter basis and 26.7% over the same quarter last year. Our margins expanded again this quarter with our adjusted EBITDA margin expanding to 54.4%, measured over the trailing four quarters ending with and including Q2 2017. This represents an increase of 220 basis points over the comparable year-ago period. Related, trailing 12 months revenue flow through to adjusted EBITDA and FFO was 65% and 56% respectively. Sales and marketing expenses in the second quarter totaled $4.4 million or 3.7% of total operating revenues, down 100 basis points year-over-year. General and administrative expenses were $9.5 million in Q2 or 8.1% of total operating revenues, a decrease of 110 basis points year-over-year. For the full year, we continue to expect G&A expense to be approximately 8% of total operating revenues, in line with the year-to-date level. Now, turning to our same-store metrics. Q2 same-store turnkey data center occupancy increased 320 basis points to 91.1% from 87.9% in the second quarter of 2016. Additionally, same-store monthly recurring revenue per cabinet equivalent increased 6.1% year-over-year and 2.1% sequentially to $1,470. Turning to renewals. In Q2, we renewed approximately 83,000 total square-feet at an annualized GAAP rate of $156 per square foot. Our renewal pricing reflects mark-to-market growth of 2.6% on a cash basis and 6.5% on a GAAP basis. As a reminder, we expect cash rent growth of approximately 3% for 2017. Churn in the second quarter was 2.6% and included 170 basis points of churn related to the final lease expiration of our original full building customer at SV3. We commenced 26,000 net rentable square-feet of new and expansion leases at an annualized GAAP rent of $256 per square foot, which represents $6.6 million of annualized GAAP rent. We ended the second quarter with our stabilized datacenter occupancy at 93.8%, a decrease of 90 basis points compared to the first quarter, primarily due to 33,000 square-feet of turnkey capacity at NY2 that moved into the stabilized operating portfolio from pre-stabilized at 51% occupancy. Year-over-year, stabilized datacenter occupancy increased 180 basis points. Turning now to backlog. Projected annualized GAAP rent from signed but not yet commenced leases was $11.6 million as of June 30, 2017, and $20.2 million on a cash basis. We expect approximately 40% of the GAAP backlog to commence during the second half of 2017, with the remainder expected to commence in the first quarter of 2018. Turning to our development activity. As Paul mentioned, we had a number of projects under development at the end of Q2 with a total of 162,000 square-feet of turnkey datacenter capacity under construction as of June 30, 2017. This includes development and expansion projects in Northern Virginia, Washington DC, Los Angeles, Denver, and Boston. As of the end of the second quarter, we had spent $31.3 million of the estimated $121.9 million required to complete these projects. The percentage of interest capitalized in Q2 was 12.3%, and the year-to-date amount is 11.2%. For 2017, we expect the percentage of interest capitalized to be in the range of 10% to 15%. Turning to our balance sheet. As of June 30, 2017, our ratio of net principal debt to Q2 annualized adjusted EBITDA was 2.9 times; including preferred stock, the ratio was 3.3 times. As of the end of the second quarter, we had $368 million of total liquidity, consisting of available cash and capacity on our revolving credit facility. This increased level of liquidity reflects the two financing transactions completed in April, resulting in an incremental $275 million in available liquidity, as well as the fact that we had no borrowings outstanding on our credit facility at the end of the second quarter. As it relates to our dividend, during the second quarter, we announced an increase in our dividend to $0.90 per share on a quarterly basis. At this level for the remainder of the year, we would pay a dividend of $3.40 per share equal to approximately 77% of FFO based on the current midpoint of guidance. The $0.90 per share quarterly dividend represents a $0.10 or 12.5% increase over the prior quarterly dividend. We took the opportunity to raise the dividend again six months after the last increase to more accurately reflect the recent performance of the company and our sustainable cash flow levels. In addition, over the last 6.5 years as a public company, we have grown more comfortable with our visibility into the business, allowing us to increase the FFO payout ratio from the historical level of 60% to 62% to approximately 75%, which is more in line with the REIT industry average payout. Now, in closing, I would like to address our updated guidance for 2017. I would remind you that our guidance reflects 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 have discussed today. As detailed on page 23 of our Q2 earnings supplemental, our guidance for 2017 is as follows. Total operating revenue is now estimated to be $473.5 million to $483.5 million compared to the previous range of $472 to $482 million. Based on the midpoint of guidance, this implies 19.5% year-over-year revenue growth. Keep in mind that our revenue guidance is dependent upon the power product composition of deployments within our portfolio and how quickly the larger metered power deployments install their infrastructure and ramp into their associated power requirements. As it relates to interconnection revenue growth, we now expect the 2017 revenue growth to be in line with the higher end of the range of 13% to 16%. Adjusted EBITDA is now estimated to be $257.5 million to $262.5 million, an increase of $1 million based on the midpoint of current and previous guidance. This correlates to 22.4% year-over-year growth based on the midpoint of the range and an adjusted EBITDA margin of approximately 54.3%, and revenue flow through to adjusted EBITDA of approximately 61%. FFO is estimated to be $4.39 to $4.47 per share and OP unit. This midpoint of $4.43 per share represents an increase of $0.03 per share and implies 19.4% year-over-year FFO growth compared to the $3.71 per share we reported in 2016. As we mentioned last quarter, we expect the first half and second half FFO per share to be generally balanced based on our expectation of relatively flat sequential growth until Q4, with growth resuming that quarter and into 2018, reflecting the full contribution from the cumulative effect of new and expansion leasing. In addition, as I mentioned earlier, in Q3 we have historically seen a seasonal impact related to higher power costs, amounting to approximately $0.01 to $0.02 per share. As it relates to our guidance for capital expenditures in 2017, we are decreasing the total expected investment to a range of $250 million to $290 million, from the previous range of $280 million to $310 million. The decrease is based on our outlook for the timing around datacenter expansion investment related to some of the larger development projects across our portfolio. We now expect datacenter expansion investment of $211 million to $239 million compared to the prior range of $241 million to $259 million. Additionally, as we discussed last quarter, we commence spending on the project to replace our chiller plant at LA2, which is recorded as recurring capital and deducted from AFFO. While this impacts sequential AFFO growth, we continue to expect this investment to generate a return on investment that is substantially higher than our overall stated return objectives.

First question regarding the funnel, it sounded like, Paul, in your opening remarks, you talked about an increase, and that related to some larger scale deals. Can you maybe offer a little bit more insight in terms of the flavor, the nature of the requirements that you’re seeing out there?

Jordan, putting it as simply as possible, these are higher density requirements but a lot of data in them, and a lot of data being either exchanged or pushed out of the network. There is obviously tremendous operational and cost advantage for processing that much data and moving that much data through interconnection as opposed to other ways of doing it from further out data centers.

Are these cloud service provider oriented, or is it just more enterprise?

I think it’s a mix. And Steve can shed some more light on it, primarily cloud and content and to a lesser extent, enterprise.

I would say that cloud, content, and even enterprise are becoming more and more susceptible to the tolerance of latency, which is becoming less and less by consumers, suppliers, and customers in general. As that expectation of the general consumer becomes more real-time, companies are having to solve for that, and that involves moving computing data closer to the edge.

Just thoughts on some of the competition that you’re seeing from, if at all, and it may actually be complimentary based on what you’re seeing of the FDNs? I mean, is that helping facilitate some of these lower latency requirements, or are they, I guess, complimenting your efforts, or are they intersecting in another way?

I think they’re generally complimentary to our efforts. Again, the types of deployments that have to go to the edge really have volumes of data that they’re exchanging at much quicker pace that require close interconnection as opposed to having to go through different forms of networks, whether they are FDN, metro fiber, or other ways of moving traffic around between data centers. Steve, anything you'd add to that?

No, I'd just echo that. As far as being complementary, I think anytime you give customers choice and the ability to access other environments within our data center, that's a good thing for those customers. It's a good thing for the end customer. Ultimately, that ends up being a good thing for us because we typically have that compute within our databases. So we have many of those SDN providers that have built their networks into our data centers. That gives not only customers immediate access to those deployments that are there but also customers that are introduced may want to access environments in other places that give them choice and flexibility as well. So, so far, we've seen it to be very complementary.

And then lastly, on SV8. How do you expect that product to orient itself and be presented to the market? Will that be an opportunity to sign another larger scale deal, do you think? And is there an opportunity to prelease that so far in advance, or will that be more of an extension in the campus and you'd look to build that out a bit more gradually, and just be a source of inventory?

Well, predicting that far out is never precise. So I think the simple way to answer it is, it's going to be an extension of a campus. If you look at that campus, historically, it has periodically had opportunities for preleases, and there's every reason to believe that that activity may be available when we bring SV8 to market. Otherwise, we'll continue the mix of scale deployments and transactional deployments that have characterized that campus so far.

One of the follow-up, obviously, a lot of questions this quarter around enterprise and the strength in enterprise; and I just wanted to maybe understand better if there was a shift in terms of how you're thinking about it internally from enterprise as a cloud customer or cloud being categorized now under enterprise in the sense of what the customer is doing in that space. I guess maybe the broader question is, are you seeing a slowdown in the cloud activity and enterprise is taking over, or is it one quarter doesn't make a trend? Just any color there would be helpful.

Just to give you a bit of clarity there, and maybe it just doesn’t help on the clarity, because I think what you're seeing is that many content customers are also cloud customers and many cloud customers are also content customers; and that leads open to traditional enterprise even. So what you're seeing is a lot of customers leveraging technology differently that bleeds those verticals a bit. So I think that's part of what you're seeing as far as how we categorize them. But as far as overall demand in the marketplace, we're still seeing very strong demand from the traditional enterprise; it's collocating. We do see greater adoption as you've seen from the cloud providers and those enterprises going to the cloud, but we still see plenty of runway for those enterprises to come into our data centers. Especially as you like to medium to large enterprise, there will be plenty of opportunity ahead of us that’s not necessarily a feasible or a very quick journey for them to move entirely through that model.

With regard to revenues and maybe a follow-up on the prior question. Paul, you talked in the prepared comments, I think, as well as in that answer about higher density. Are we seeing that come through the average rate, has it been masked in any way? And maybe for Jeff, how much of that was reserved capacity that you recorded in the quarter in terms of signings?

The reserved capacity was not material. And obviously for accurate disclosure, we’ve excluded that from the rate category. Density does have some impact on the rate per square foot, and we like and have set ourselves up to accommodate higher density requirements for that purpose. We tend to look at pricing overall on a quarter-to-quarter basis; we break it out by categories of deployment size and markets and density. When you look at all of that together, the net pricing seems to be about 11% quarter-over-quarter. So there is more than just increased density that’s driving the price increases.

Dave, just to clarify, as Paul just related to that 11% increase would strip out some of the wholesale deals we did. Because those just aren’t comparatively quarter-to-quarter. That 11% is on a trailing compared to the trailing 12 months basis.

Maybe last from me. I think the one market you didn’t talk about, Paul, in the comments, if I missed it, was Chicago. Is it just that you’re not seeing the opportunity, the ability to get into more land there? Or are the opportunities just in LA with the resurgence there just taking precedence in your mind?

No, we continue to look for expansion capacity. In Chicago, we expect that over the next couple of three years, our customers in our existing Chicago facility are going to need that and will drive other opportunities. We continue to work on some opportunities there, and we just don’t have anything that is ready to announce. But that’s a good market, and we’ve got a good data center that’s performing well in that market.

It seems there are several projects that have been delayed from this quarter, with some now expected to open in 2018 instead of the previously planned 2017 timeframe. I'm interested in whether this is just coincidental or if there's another reason for the number of delays this quarter. Also, considering the capital expenditures for the projects aimed for 2018, I'd appreciate your insights on what CapEx might look like next year. It appears it could decrease again compared to 2017. Additionally, it seems everyone is waiting to see when the anchor tenant deal, expected to launch in the fourth quarter this year, will be finalized. You mentioned a strong pipeline, so can we expect to see something in the third quarter? Thank you.

I think it’s mostly coincidental that some projects got pushed back a quarter, and I think it’s partly coincidental that we had so many projects going on at the same time. One of the attractions of our markets is that the regulatory and entitlement process creates barriers to entry. Although that’s a pain in the neck in the short-term, it sometimes takes longer to get permits and entitlements than it does in other markets. We’ve all seen that in every real estate product that creates value for the long term because the local government provides one of those barriers to entry to new products. So that’s mostly what we have seen with these deployments. I don’t view it as a big deal, but we just try to keep everybody informed about it.

The other question was related to 2018 CapEx. And Colby, I guess the thing that I would think about, as you think about CapEx levels for 2018 is just take a look at the more recent three-year trend in terms of what our annual CapEx has been. That’s going to give you some level of insight into what that might possibly be for 2018. But at this point, we’re just not ready to give any specific guidance on 2018 CapEx.

And I wouldn’t draw too many conclusions though. We do have, as you know, a couple of larger projects that, depending on when permitting and entitlement is completed, could start construction in 2018 at some point as well that we mentioned in both the press release and in our scripts.

And then, Colby, if I wrote down your question correctly, your third question was related to VA3 and how are we doing in terms of progress for lease up for developments coming online there. And Paul and Steve could probably give you some color on that.

I want to highlight that VA3 consists of two parts. One is the 3 megawatt expansion of an existing computer room, which is aimed at handling transactional and smaller deployments. The other is a larger 6 megawatt facility that is intended for more extensive deployments. While I can't predict the future with certainty, I can say that we are engaged in many promising discussions. I anticipate that we might have some announcements later this year if these conversations continue to progress well.

So a couple of questions. One on markets that you’re in that a lot of your peers are, Dallas and Portland, and just kind of an update on how you view the pros and cons of inorganic growth, maybe greenfield to brownfield developments in those metros. Secondly, probably for Steve, but just maybe an update on sales headcount trends and how much of your leasing recently has been due to direct versus indirect sales channel contributions? I was curious about SV3 in the backfill; the prospects of backfill. Is that going to be scale deployments retail and how the technical attributes to that site compare to SV7?

Let me take the first and the last question and then Steve will address the second one. We look at every opportunity that makes at the triage to expand into other big markets. The thing that we repeated in the past and is worth completing here is that we really like big markets with a lot of business activity. Our current eight markets are 20% of the U.S. population, 27% of U.S. GDP and have a much higher level of business activity and data-intensive activity than the typical market. There are other markets that meet those categories. Our business model, as you know, is successful primarily because we're able to marry up a network dense node with scalable interconnection ability within the campus or building environment. That makes the screen a little bit finer for new opportunities, but those are the opportunities that, like our current portfolio, create the best long-term sustainable value. So that's what we look for. So far, we've seen only Denver work to expand into or have that opportunity, but we continue to look for that in other areas. I do think we can bring some tools to the tables that are not generally out there. We have, in a couple of three instances, been able to create network dense nodes where they did not exist before. That's an opportunity we might bring to bear in another market if we can find the right price point and size to enter and have visibility to scale at attractive returns. So I hope that helps answer that question. On SV3, I just want to remind you that we didn't actually have a tenant move out of SV3; that is the payments from the original tenant at SV3 that they paid out as part of their moving out of that space. SV3 is pretty fully occupied right now. Technologically, it's in the same category as everything else on the Santa Clara campus.

Thanks, Paul. Just to answer your question relative to sales headcount and trending, we’ve been roughly at the same headcount with a little bit of fluctuation throughout the year and for the last year-and-a-half, I guess. Overall, we haven’t had any major changes as far as headcount is concerned, a few changes here and there as you would expect in any sales organization. But overall, we've been fairly stable and are really just working towards getting our talent better each year, our skill level better each year, and just get better utilization out of the people that we do have, which kind of leans through the second part of your question, which I think was around direct versus indirect and channel. That ratio typically is up 10% to 20% of our overall sales as far as the indirect channel is concerned. We do look to try to leverage that, getting additional value and getting deeper and wider within our accounts and markets. We'll continue to do that, but that's strictly opportunistic and that's off-pay our resources that we try to leverage and represent itself, and as the value presents itself. So it continues to be a focus and we’ll leverage it as best we can.

And then last question is on artificial intelligence. I don't know if this ties into the power density comments earlier or not. But to what extent are you seeing that as a current absorber of market capacity overall for the industry or driving RFP activity, or is that kind of more on the come? And do you see that from what you understand that AI, is that performance-sensitive, meaning that it needs house in major metros, or is it maybe less performance-sensitive, more computing-sensitive in secondary markets? Thanks.

Jonathan, I’ll start with that, and then Steve can chime in if he has anything to add. I think that product category is in early stages, but there are definitely elements of it that are data and compute and performance-sensitive, where the insights generated from the AI algorithms lose value if there is too much latency and are responding and reacting to so much data exchange that interconnection is valuable. At this point, I can't really predict how large that opportunity becomes, but it does seem promising at this point for the future.

And I would agree with you, Paul. Depending upon how AI is defined, I think if you look at some of the most obvious examples, such as automated vehicles and so forth, that is latency-sensitive, and these make decisions quickly and react quickly. We’ve had several examples of startups and so forth that are deploying in our data centers because of the need for low latency, as well as scalability. You just have to look deeper as to the use case and the need for that latency. Inherently, as you look at intelligence and being able to make smarter decisions quicker, that brings with it the need for low latency and speed.

In light of the high growth in interconnection year-over-year, I was wondering if you could provide some incremental color on some of the applications that are driving that. And just some greater detail on whether true sustainable at this level as it's really above our guidance range for the year?

Rob, it's Jeff. Let me just give you some commentary about that. As you probably saw, obviously, the revenue this quarter was up 18.1% year-over-year. If you look at the underlying volumes where we’re seeing particular strength are those deployments where people want to be connected to the cloud environments. If you just look at the overall volume increase going to and connecting with our cloud customers, it's probably 3x what it is in general of the portfolio overall. It gives some idea of what's going on there. Obviously, in some of the commentary I gave around guidance, our initial guidance range of 13% to 16% for the year, given that we’re year-to-date at 16%. We expect that to be at the upper end of that range. But we’ll see how the second half of the year migrates here.

You mentioned a couple of markets that seem to be somewhat constrained. What are the pricing trends in those markets? How long do you anticipate this situation will last? Are you observing any irrational behavior from competitors in your markets? How would you describe the mindset of some of the competitors you come across?

Let me address the second question first. We have not seen any irrational behavior. Just to give an example of market, Northern Virginia has seen the most development activity. As I mentioned in my remarks, there is significant new development going on there, but most of it, to our knowledge, is preleased. I suspect there are probably some leases out there that we’re not aware of that take the member up higher. But even if you look out going forward, the amounts in that market that are under construction are preleased, or what we think we know about that might move the vacancy rate. There is no other change in absorption that might move the vacancy rate by the end of the year, early next year from maybe 8% to 11%. So not a huge move. Given our funnel in that area, my guess is there is probably more leasing going on than we are aware of in other areas with other companies. So not seeing any place in any of our markets where development behavior concerns me. In the constrained markets, there has been some pricing uplift. I think that’s reflected in our overall number of 11% that Jeff and I cited to you earlier. But the pricing uplift is measured as opposed to dramatic. There is a phenomenon that goes into the data center industry that we see from time to time, which is that sometimes markets have to have a little bit of supply or latent supply in order to attract more demand. So constrained markets tend to see things balanced out a little bit more than you would in other real estate markets where people just don’t have any choice about when they move into something.

I'm not sure if you already touched on this. But you mentioned the $30 million guidance on lease commencements for this year. If my guess is correct, you are about 22, if I include the backlog that you expect to realize. Is that a conservative number? And then secondly, can you just let us know what the timing is around the LA3 property and when you’re going to bring that online? Thank you.

Andy, let me take the first part of that question and then Paul can add some commentary on the second one. But you’re right. We have given some earlier guidance around commencements for the year of about $30 million. You can look at where we are year-to-date at 15.7 and we said the backlog about 40% of that would commence. So you’re directionally fairly close in terms of where we expect or at least what we have visibility into. We’re right around 20, just north of $20 million. While we believe, obviously, we’ve got the second half of the year, we’ve got some visibility into what we think that will be. If I had to give an amount, I would say it would be at or slightly ahead of the $30 million guidance we gave earlier this year. Hopefully, that helps.

In terms of the next building in LA, it’s a little bit hard to predict just because again that’s one of those infill markets where the path of entitlements and permitting is not clearly definable. I would say that best case, it would be first quarter of 2019. When it actually comes on board in 2019 and when we actually start it, depends on that permitting process and frankly, the continuation of strong demand in the Los Angeles market.

Just have a couple of questions, if I could. First, when you look at the cost of building out new datacenter development over the last few years, do you see that as inflationary in terms of the component cost versus technology, which is generally deflationary? Just want to get a sense of how do you look at those build costs over time. And then secondly, if you could just talk a little bit further about what you described as demand closer to the edge. What's that doing to demand for markets away from the edge? How does that affect pricing and value for those types of markets versus the ones that you're seeing more favorable demand?

The cost of building has remained stable with modest inflation for components, although labor has seen significant inflation. This impact is more pronounced in data centers, which require more equipment compared to other products. Despite this, we haven't encountered major issues. We continue to make improvements in our processes and designs thanks to Brian Warren, our SVP of Engineering, Construction, and his team, which helps us maintain competitive kilowatt pricing. Currently, we don’t view any significant areas of concern. Demand drivers are becoming increasingly focused on latency, particularly for products serving consumers and businesses, such as ecommerce and video streaming. Additionally, the increasing volume of data needing fast processing and exchange is becoming as crucial as latency itself. This creates engineering challenges when processing data further from the edge or network nodes, especially when relying on Internet connections or WAN processes. Even a delay of 10 milliseconds can hinder performance significantly. This data intensity has contributed to the demand we've seen in larger scale deployments at edge nodes, alongside performance sensitivity. We've also observed that some customers are relocating their deployments from lower-cost areas to our data centers to tackle the cost and inefficiencies related to data exchanges outside of interconnected environments.

I would agree with that Paul. Mobile traffic is also a huge contributor to that as you see more and more mobile devices. It doesn’t matter where you walk down the street or in airplanes or anywhere else, everyone’s got a mobile device. You see a lot of video streaming that’s happening on those, which drives this huge amount of data. Having that data and throughput closer to where those mobile networks interconnect is also critical in order to get that performance level up, whether it's a content provider or cloud provider, or even an enterprise. There’s a balance that they work, and it’s a math equation on their end to figure out latency relative to constants and support to that deployment. You have seen, even in some cases, some of these other providers moving into secondary markets where it justifies that cost and expense. In the markets that we're in, it’s a fairly easy math problem to compute, given the number of eyeballs and networks and demand that’s there for them to establish those points of presence.

I'm curious just about the engineering challenges. Maybe for some of the order or more highly connected edge co-lo sites as you're referring to, the power density requirements are going up. Do you feel that some of these order buildings are properly equipped to handle denser requirements, not only now but where you anticipate they could go? What impact did this have overall on economics across the industry because we see upward pressure on maintenance or upgrade expenditures for new power and cooling systems as this trend potentially continues and accelerates?

Well, I think the old carrier hotels and the traditional network dense nodes and office buildings are always going to have their core and faithful customers who will deploy in those environments, equipment of density that those environments can handle. However, they are constrained; that’s why we developed the campus model to interconnect with some of our network nodes directly. For loading requirements in some of those older office building, they don’t allow for as much density, the heavier racks, heavier servers. They are also harder to cool efficiently. They are not raised for environments, so you’re flooding the computer rooms with cold air there generally. There is not as much as you can do with hot and cold aisle containment; although we do as much as we can in our facilities like that. As the actual data intensity and the amount of cache of storage and compute that you need at the edge grows along with those network nodes, the scalable options that we provide in our campus environments, where they are purpose-built, are raised for environments; it’s easier to put in cold aisle containment, we can drive PUE down. The fur loading is not an issue that we try to explain and maybe haven’t done a good job of communicating. That’s driven a lot of our growth is our ability to provide that type of more efficient, denser environment close to these traditional network nodes where target create that kind of density and that kind of power and cooling efficiency. However, we still continue to see strong demand for deployments of smaller types of broader enterprise networks, and some of the companies that use networks extensively in those network nodes in those traditional carrier hotel buildings.

Matt, in regard to the second part of your question, in terms of capital costs for recurring maintenance, the important aspect to think about is if you just look at us historically, our recurring CapEx has been anywhere between 1.5% to 2% of revenues. While that’s all you and the street have visibility into, we continue to think about the best way to think of that on a per kilowatt basis. Having said that, we don’t give visibility into that, so it's hard for you guys to gauge what that’s going to be. But I would think, as we look forward and based on some of the experience we’ve seen for 2017, a range as a percentage of revenue of 1.5% to 2.5% is probably a reasonable range to think about for CoreSite. I don’t think that helps meaningfully, but it is something that we think about in terms of the go-forward modeling, et cetera. So hopefully, that helps.

I would like to add on that, because as Steve mentioned earlier about the core chiller replacement in some reports. Again, we did not have to replace all those chillers that we’re replacing this year. Those are multiple units of chillers that could have been replaced over the next two to four years, which would have kept our CapEx expenditures in line with historical averages. However, we had the opportunity to do something totally different, which was to combine all of them. Instead of replacing them with more small chillers, combine all of them into a single large chiller plant that serves other space as well and is so much more power efficient. The return on investment on just rolling these into this bigger project is probably higher than anything else in our portfolio. If we followed the traditional method of replacing them, each of them as they got to the end of life, we would not have that opportunity to achieve that power efficiency because there are still physical limitations on how power-efficient a smaller chiller can be. I know that to be pure on the AFFO count, and we put that in the right bucket for recurring CapEx. But it has a tremendous return associated with it and continues our path in the pursuit of more power efficiency.

I just like to close by thanking my colleagues for another good quarter. Steve, Jeff, and I know we're very fortunate to have an outstanding team that works hard every day to take care of our customers and create value for our shareholders. I’d like to thank all of you that are on this call for your interest in the company, and thank you especially to those who asked questions so that we have the opportunity to answer them. I hope you all have a great rest of your day. Thanks.