American Tower Corp (AMT) — Q3 2019 Earnings Call Transcript

Thank you. Good morning and welcome to CoreSite's Third Quarter 2019 Earnings Conference Call. I'm joined today by Paul Szurek, President and CEO; Jeff Finnin, Chief Financial Officer; and Steve Smith, Chief Revenue Officer. Before we begin, I'd like to remind everyone that our remarks on today's call may include forward-looking statements as defined by federal security laws, including statements addressing projections, plans, and 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 filings with the SEC. 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 simple information that is part of our full earnings release, which can be found on the Investor Relations page of our website at coresite.com. With that, I'll turn the call over to Paul.

Good morning and thank you for joining us. I'm going to briefly cover financial highlights and then focus most of my time on how our strategic initiatives are playing out in light of today's market and technological environment. Jeff and Steve will then follow with their respective discussions of financial matters and sales results and trends. Financial results for the quarter included operating revenue growth of 4.1% year over year, SFO of $1.28 per share, an increase of 2.4% year over year, and another strong quarter of sales at $14.4 million of annualized GAAP rent signed, including strong new logo revenue. This puts us on track to comfortably achieve a record year of sales. Moving on to our strategy fulfillment. Secular demand for data center space is strong and we forecast this strength to continue in the foreseeable future. Our strategy capitalizes on this trend by expanding our extensive customer communities of enterprises, networks, and clouds who interoperate with each other in our campuses to serve businesses and consumers in major U.S. metropolitan markets. We fulfill this mission by providing capacity and connectivity, including numerous cloud on-ramps, and reliability, along with the ease of use in serving our customers. Our strategy starts with data center capacity. We reinvigorated our construction and development activities beginning in 2016. These activities are now delivering plentiful sellable capacity at our campuses, while building a pipeline for sustainable and agile capacity additions in two to three years. With the delivery of FDA Phase One at the beginning of September, we are on track to deliver 224,000 square feet of new capacity this year, including Phase Two of SB8 in the fourth quarter. We are also on track to deliver an additional 196,000 square feet of new capacity next year. Some of the projects currently under development, and we have a sustainable pipeline for future years. In our existing buildings, we can quickly deliver incremental computing capacity of 550,000 square feet at projected higher margins compared to new ground-up development. In other words, we are shifting over the next 12 months from primarily ground-up development to primarily in-building development. We also have one million square feet of space we believe we can develop on existing owned land at SV9 in Santa Clara, NY2 in Secaucus, New Jersey, and in our Reston campus expansion, making it easier to be shovel-ready when demand is strong. As our sales results show, this additional capacity is crucial to meeting the customer demand we continue to see for community expansion and edge capacity in our major metro markets, especially for enterprises seeking the highest performance and most cost-effective, secure, and reliable colocation solutions for hybrid cloud IT architectures. An example of the type of demand our new capacity is addressing is our pre-lease of LA3 Phase 1 for 74% of the space a year in advance of construction completion. Although we are in early stages, we are also seeing a positive impact on colocation sales related to the additional connectivity products we offer to customers. These products are designed to accomplish several objectives for enterprises, including enabling more efficient provisioning of cloud access redundancy and enabling flatter optimized wide area networks to reduce customer operating costs while maintaining significant edge deployments. As mentioned last quarter, current market conditions present some temporary headwinds. Although the growth of public cloud has been a strong positive for us due to significant leasing to cloud providers and enterprises seeking powerful hybrid cloud solutions, to a much lesser extent, this trend has affected other sources of demand. We have higher-than-normal churn this year as a few longtime customers have gone through bankruptcy or gone out of business. To a lesser extent, some customer use cases are transitioning to the cloud, much of this fortunately cloud edge products located within our data centers. The strong secular data use trends have also drawn additional capital into the sector. While most of our markets are fairly well protected by high barriers to entry and our network-dense business model, Northern Virginia continues to be constrained. We believe our record sales would be even higher if supply and demand in Northern Virginia were more balanced. However, we have existing and potential capacity in Northern Virginia for when the market there strengthens. And of course, new multi-tenant development is generally a modest drag on earnings while stabilizing, but the available capacity enables us to meet fast-emerging customer needs and strengthen our campuses. On balance, we continue to believe that long-term data center demand trends are very positive for our campuses and will generally reward us for staying abreast of capacity and product needs. Therefore, we are confident that our major market network-dense proactive development and product optimization strategies will provide sustainable growth. With that, I'll turn the call over to Jeff.

Thanks, Paul, and hello everyone. Turning to our financial results for the quarter. Total operating revenues increased 4.1% year-over-year and 1.4% sequentially, primarily due to increased rental revenue related to new and expansion lease commencements and growth in interconnection revenue. We commenced 78,000 square feet of new and expansion leases for $15.7 million of annualized GAAP rent at an annualized GAAP rate of $200 per square foot, and our sales backlog as of September 30 included $25.3 million of annualized GAAP rent from signed but not yet commenced leases, or $28.4 million on a cash basis. We expect a majority of the GAAP backlog to commence in the next two quarters and the remaining amount in Q4 2020 following the completion of LA3 Phase 1. Total property operating expenses increased 2.9% year-over-year, primarily as a result of increases in rent expense from recently completed developments in our L.A. and D.C. markets where we leased some of our facilities. These property operating expenses also increased 4.3% sequentially, including the impact of increased rent expense I just mentioned and other increases resulting from seasonal power costs and other property operating expenses, partially offset by a property tax refund. General and administrative costs for the quarter were relatively flat year-over-year and decreased sequentially. This included the impact of a successful outcome related to a trial in Q3, including a minimum expected legal expense recovery of approximately $3 million, minimizing the negative impact from legal fees this quarter to $0.01 per share. Turning to adjusted EBITDA, net income, and FFO. Adjusted EBITDA was $77.9 million, reflecting a year-over-year increase of 5.6% and a 53.8% adjusted EBITDA margin. Net income per diluted common share was $0.47 per share, and FFO was $1.28 per diluted share, a $0.03 increase year-over-year and a $0.01 increase sequentially. Moving to our balance sheet. We ended the quarter with $388 million in liquidity, including $383 million available under the revolver and $5 million in cash. Leverage at quarter-end was 4.4x net debt to annualized adjusted EBITDA. We expect to meet our short-term liquidity requirements, including our anticipated development activity over the next 12 months primarily through utilization of our credit facility. We also anticipate addressing our 2020 and 2021 debt maturities before the end of this year by working with our lending partners and our credit facility to extend the maturity dates. Next, I'll recap some highlights of our first nine months of 2019. As Paul mentioned, we expect to bring more capacity to the market by adding 224,000 square feet into service in 2019. This new capacity provides us an opportunity for leasing and revenue growth by providing larger contiguous space for our sales team to compete for a larger set of customers' needs. This expanded capacity has led to new leasing year-to-date of more than $48 million in annualized GAAP rent. That's more than doubled the new leasing in the first nine months of 2018. Our sales team will continue working hard during the fourth quarter to maintain our momentum. Next, I'd like to address churn. Last quarter, we raised our guidance of annual revenue churn to a range of 9% to 11% for 2019, which compares to our typical historical range of 7.5% to 8%. Churn has resulted from various drivers over the years, primarily from integration related to M&A activities, bankruptcies, and end-of-life applications. Last quarter, we identified additional churn expected for the last half of 2019. Since our last call, we used a cross-functional team to further analyze our customer portfolio looking for emerging trends, vulnerabilities, and areas to address. This review identified customer characteristics to better pinpoint growth opportunities and risk of churn, and was a valuable process that our sales and customer service teams will use to augment our existing practices. Based on our historical trends and characteristics of churn, our remaining exposure to customer deployments with similar characteristics is not a meaningful percentage of our embedded base, and we expect almost all categories of churn to abate next year. However, we have sizable capacity relocating from the Bay Area market over the next two years and we are optimistic about our ability to release this capacity due to the strength of current market dynamics. Turning to our work ahead. We have accomplished a great deal in the first nine months and we are focused on continuing that momentum. Our scale pre-leasing executed at SV8 and LA3 in the second and third quarters respectively were key objectives for the organization and help derisk our development activity. As Paul mentioned, we've delivered strong leasing results, albeit without the contribution we expected in Northern Virginia, and still expect a strong finish to the year. As it relates to 2020, we will provide a detailed annual guidance on our fourth quarter call. However, I would like to leave you with a few thoughts. We feel good about the fundamentals of the business and our progress on our property development and pre-leasing. To provide some perspective as you update your models for 2020 and beyond, our accomplishments and challenges versus one year ago include some timing considerations. First, our property development at SV8 was delivered as planned. However, Phase 1 of LA3 and CH2, while also progressing well, are behind our timeline from a year ago due to issues like permitting and other impacts. Second, as a result of these changes, leasing of these properties also looks different from a year ago. We executed more pre-leasing than planned at SV8, which has pushed out the timing related to lease commencements at Phase 1 of LA3 and CH2, and scale leasing in Northern Virginia has been lower than expected. Lastly, our churn from 2019 will have carryover impacts on 2020 as we work to release our data center capacity. Before I hand off to Steve, I want to recap. We are executing on our previously discussed priorities related to bringing on capacity and increasing leasing. The business drivers and secular tailwinds from our services are strong, and we believe we are well positioned for the long term. With that, I'll turn the call over to Steve.

Thanks, Jeff. Today I'll start off with a summary of our quarterly sales results and then talk more about some sales wins and the business drivers behind them. Moving to our sales, we executed another very strong quarter of sales which is back-to-back with last quarter's highest sales quarter of the company. We delivered $14.4 million of annualized GAAP rent for new and expansion sales, including $4.5 million of core retail colocation sales, $9.9 million of scale leasing, including a large pre-lease at LA3, as well as other scale leasing and some impressive new logo wins with opportunities for future growth. Turning to a few highlights of our sales. They included 73,000 net rentable square feet reflecting an average annualized GAAP rate of $197 per square foot. Core retail colocation sales included pricing on a per-kilowatt basis in line with our trailing 12-month average. Looking at new logos, we won 36 new logos that reflect total annualized GAAP rent approaching 3x our trailing 12-month average, and include a weighted average contract term of 77 months versus the trailing 12-month average of 46 months. We're excited about the quality of these new logos and believe they will help drive future growth as their IT needs evolve. Attracting and winning new customers that value our platform remains a key area of focus, and it's great to see it continuing to bear fruit. Renewals are another key aspect of our leasing focus. During the third quarter, our customer renewals included annualized GAAP rent of $20.4 million reflecting a growing base of business and strong customer relationships. Our renewals represented rent growth of 4.2% on a GAAP basis and a decrease of 2.2% on a cash basis, which was impacted by the renewal of three long-term scale customers, and excluding these three customers, the remaining renewal volume reflected a positive 2.8% cash rent growth. Churn was 3.1% as anticipated. Next, I'll share some highlights of our sales wins and the related business drivers. As Paul mentioned, we are located in strong edge markets with uniquely positioned assets to serve highly connected workload environments. Customers in every segment are looking for help in their ever-changing IT journey as they interconnect their hybrid cloud and multi-cloud needs into seamless service for their end customers. Today's IT environment has greater innovation and less tolerance than ever for poor performance or latency with our applications. These factors seem to be only increasing in importance. Here's a glimpse of a few wins across sectors we signed this quarter: a multinational technology company specializing in cloud-related services that are latency-sensitive leasing space in our LA market; a global pharmaceutical organization further introducing and leveraging technology across their business units to serve their diverse corporate and R&D needs located in our Santa Clara market; a multinational company with businesses in consumer professional electronics, gaming, entertainment, and financial services in our L.A. market where performance is critical in supporting their gaming end users; and a large electronics company in our Boston market working to solve the needs of their multi-cloud environment. All of these customers are in different industries and deployed across various markets that are all leveraging the value of our interconnected platform to drive their business. Each are experiencing increasing data growth, heavy reliance on technology to develop new products and serve new customers, high-performance needs with no room for latency, and all of them rely on or support a hybrid multi-cloud environment. Technology continues to move at a frenetic pace and we continue to focus on winning and growing with these customers as we help them solve their IT challenges to address the changing dynamic needs of their industry and their business. We're pleased with our execution for the quarter and we look forward to further helping customers solve their IT challenges. With that, operator, we would now like to open the call for questions.

Thank you. So I had a question about Jeff's comments with regard to Santa Clara. So the sublease capacity that's being marketed now at SV7 for 9 megawatts, you refer to that as a relocation, but is that going to be a customer that leaves your roles entirely? Or are they relocating to a different CoreSite market? I'm assuming it's the former.

Jonathan, I appreciate your question. Let me clarify that I don't believe there is significant sublease capacity available. There could be some confusion in the local market. However, as Jeff stated, this tenant is relocating their operations to different areas, not our facilities. Their lease will expire partly at the end of 2020 and the remaining portion at the end of 2021. In previous instances in that market, we've found it beneficial to have the flexibility to re-lease that space, which can assist the tenant and allow us to find someone to move in sooner. Given the current market conditions, we are pleased to have this capacity.

Well, the tenant is marketing that as subleased space. And so I guess maybe just semantics, but this would be elevated churn for next year at least in that market.

So Jonathan, I don't want to get into any misunderstandings out there, but there is no right to remarket that space as sublease space.

Okay. But you mentioned the expirations, some in '20 and some in '21, and I hear you about Santa Clara being a very strong market, tight supply, and very strong pricing trends. But is it fair to say that you could see churn in the market over those two years? But your expectation is that you refill it and perhaps accretively. Is that a fair way to characterize it?

I think it's fair. Again, pricing and the ultimate replacement deployments will need to be worked out and whether that is slightly accretive or not we'll work out. But you've got the gist of my comments correct, which is it's a good data center, it's good space. We believe there's good demand in the market for it, and we are working proactively to retenant that.

Two more questions then or a question related to kind of new markets. So Council Bluffs is a market that CyrusOne just indicated that they want to build capacity for enterprise sort of hybrid cloud applications. And I was interested in kind of that how you continue to look at growth opportunities domestically into new markets and whether those types of opportunities are interesting to you. And then secondly, there's been very strong leasing in Europe, and then there's been a recent M&A transaction announced there. And I know you've addressed this in many meetings, as has your predecessor, but just an update on your thoughts on international expansion.

So we do continually look for new markets. And I'm guessing at some point down the road we will enter new markets. But so far we just haven't found the right mix. We do very, very strongly prefer, and I'd be surprised if we did anything outside of a major metropolitan market. And we want to be able to deploy our business model, which, as you know, depends very much on network density. So it's a high bar to jump, but we keep looking for it. Our views on international haven't changed, and we believe that the model that we pursued of going deeper and building larger communities and greater scale in major U.S. metro markets relative to the size of our company continues to provide us with as much percentage growth opportunity as I think is appropriate or needed for this property category.

Thank you very much.

Hi, good morning. This is Katie on for Jordan. You kind of touched upon this in your prepared remarks a little bit. Just want to go back to churn. It was 3% in the quarter, 10% at the midpoint for the year. Then you talked about this space to release in SV7. How should we think about churn on a go-forward basis for next year? Do you anticipate churn coming back down to your historical 6% to 8% levels?

Yes. As I said a little bit in my prepared remarks, based on the analysis we did and the items that led to our churn, we expect some of those items to abate, if not most of those items to abate as we go through 2020. However, some portion of that decrease is going to be offset with the item Paul just alluded to, some of the churn that will take place in Q4 2020. As Paul alluded, we've got time to work on backfilling that space, which is what we're planning on doing. But that's where we're headed for 2020.

And I would just add, Katie, that we're already actively discussing that space with potential prospects right now. So activity is strong. And as you know, that market is pretty tight right now, so that's a good thing for us.

Great, thank you. Two if I may. Jeff, in the past you guys had talked about getting to potentially double-digit growth in 2020. And it feels like in the last few quarters you guys may have walked that back and some of the comments you just mentioned now in terms of timing delays and then also the full impact of churn in '20 versus what kind of rolled through in 2019. Just curious if you can give us an update on whether or not that double digits is achievable. And then secondly, just going back to the California. This is one of the first times I think, at least that I'm aware of, a large 9-megawatt customer looking to vacate a third-party data center. And I'm just curious what your observations are around this trend and whether you think it's very specific to this customer or it's part of something broader going on. And maybe as it relates to California, with the rolling blackouts and the fires, do you think that that market's going to sustain the strategic value that it has had for many years?

Let me address your first question, and then I'll have Paul provide some commentary on the second. But as you mentioned, I did provide some items of reference in my prepared remarks as you guys look at updating models for 2020 and beyond. And as I noted or as I mentioned, primarily related to development completions that are further outlined in our supplemental. And then as you guys think about the timing of leasing and commencements. In addition, we've highlighted some of the Northern Virginia market challenges as well as some of the 2019 churn. We still have a lot to accomplish before year-end, and that will provide us some better visibility into 2020. But I think it is fair to say when we provided that guidance one year ago, a lot has changed. And we do not expect to hit double-digit growth for 2020. And so hopefully that helps clear up that question from that perspective.

Colby, this is actually the second time we've had a customer of this relative magnitude move out of that very same market. The last time was five, six, seven years ago, and the circumstances were very similar. I think we, and all of our peers, have seen this to some extent, that the so-called unicorns in their early stages ramp up very quickly in markets like this. And then as they become more mature, they start rationalizing things and moving things out as they discover more precisely what their latency needs are. Meanwhile, that market has continued to grow with much more mature and established business models and operations that are, however, leveraging new technology products, especially cloud-type products. We see that continuing notwithstanding the factors that you've mentioned, which, as you know, haven't really affected this particular area as much as some outlying areas are. And I know we all feel for the people in those areas. But so far, we continue to see very strong demand and need for space in this market and expect that to continue.

Thank you.

Great, thank you. Just wanted to touch on the churn in Boston. I assume that was similar to the churn that you discussed last quarter; it was kind of expected. Any thoughts on that being released? And then to the commentary about the steady pricing for KW. In your conversations you're having with clients now, do you expect that to persist? How does sort of the next few quarters of pricing look on that basis?

Let me address the first one, and then I'll hand it off to Steve for the second question. But you're correct; the decrease in occupancy in Boston is directly attributable to that churn, an event that we've been mentioning the last couple of quarters. And so that occurred as we anticipated. They vacated that space in August. And that computer room is ready to be released with very little, if any, additional capital needed to get that ready for lease. Steve on the second?

Yes, just to carry on with the Boston conversation. While it does give us more space back there, we are pleased with the market dynamics in Boston and have shown some good sales results and also see some pipeline there. So we're encouraged with what we see in Boston. As far as pricing on a per-kilowatt basis, as we mentioned in the comments earlier, on balance, they remain in check for most of our markets. And as we mentioned on prior calls, probably the only market that we've seen any material erosion has been the Virginia market. And even that we feel like it's pretty much stabilized and look to see some of that come back. Given our retail and enterprise sectors there, it's been pretty consistent over time. So overall things seem to be holding pretty well.

Right, great. Thank you very much.

Yes, thank you. The leasing activity has been quite strong. Over the past year, you have surpassed your 12-month average. The main factor driving this has been scale, along with a consistent retail presence. Are you noticing any shifts in your business that might indicate a trend towards more significant deals in the future?

As Paul mentioned, bringing on more capacity allows us to pursue larger market opportunities, which is beneficial for us, and we've already seen some positive results from that. With the increase in average deal size and contributions from new clients, along with the overall growth of the market, we're observing more mid- to large enterprises moving towards adopting multi-cloud and hybrid cloud solutions. This trend is opening up larger opportunities for us on average. Therefore, we believe our expansions into different markets position us well to take advantage of this opportunity.

In terms of what this means for pricing and cash rent growth, the scale and the customer base could lead to different dynamics. How do you plan to balance this?

Well, we're pretty judicious about how we approach each opportunity, and especially as they get larger, we do a lot of diligence around pricing and the yields that they deliver to that market and that specific facility. So we work through both timing as well as size and pricing and try to make sure that we make the right decisions to deliver the yields that we expect for ourselves and that our shareholders are expecting of us. So we continue to balance that.

Hey, thank you.

Hey, maybe first 1 for Steve. You've had a lot of success landing on-ramps for call it Tier 1 CSPs like AWS and Microsoft. You oftentimes highlight that in your presentations. How would you characterize your degree of success with call it Tier 2 or more specialized on-ramps? And do you feel like there are opportunities to grow that part of the business?

Yes, we have seen good success there. We don't necessarily publicly state those very often, and maybe we should do more of that. Obviously, most of the cloud business that happens there, especially public cloud, probably 80% of it happens among 4 players. So that's where the real focus is and that's where I think a lot of our customers are focused. But there are a lot of other services that are delivering those same type of on-ramps, and I expect to see more of those in the future as connectivity and low latency demands are driving better performance out of those platforms and customers looking for better performance out of them. Those on-ramps that deliver that performance will become even more important. So we pursue all of those and adding those to our platform and to our Open Cloud Exchange continues to be a focus, and we've been successful, but I always like to see more.

Okay, good. And I guess sort of back to the Bay Area, you guys seem pretty confident you'll be able to release any space that you need to at attractive rents. Can you comment on that in the context of the number of projects that are currently underway by other market participants in the Bay Area and likely to come online in the coming years?

So predicting when any or all of those projects will come online is kind of a perfect science in that market. But we don't believe any meaningful capacity is going to come online before this space is going to be released.

Okay, got it. Thanks, guys.

Good morning. So just as a follow-up to some of the hyperscale leases that you repriced downward in the quarter. Do you have a sense for what percent of leases or the rent today might be subject to reductions in the future either because of the deployment size or the customer size, just to try to ring-fence the future risk over time on pricing within the portfolio?

Hey Michael, can you clarify if you were asking about the entire portfolio or a specific market?

Just the broader portfolio please?

Yes. So first of all, the three leases where we had the significant mark-to-market, I'm not sure they'd classify more of scale, not hyperscale. As we look at our portfolio, and Jeff can correct me if I'm wrong, we don't see a meaningful amount of customers in those circumstances. There's always going to be some. Every quarter we have some mark-to-markets that are negative, and most of them are positive. Most quarters that result is positive. We don't see anything in our portfolio that would significantly change that.

Michael, I have a couple more points to consider as you look ahead. When I think about 2020, my estimate for the mark-to-market trend suggests it will be fairly consistent, perhaps slightly lower than what we expect to finish this year. As you may have noticed, we've adjusted our full-year mark-to-market forecast to 1% to 2%. It's important to keep this in mind when thinking about 2020. Additionally, I recommend looking at our lease expiration table, which you are familiar with. The pricing information we provide when those leases expire, on a per square foot basis, can give you some insight compared to the renewals and new expansion leases we are signing. This serves as another data point for your consideration.

Yes, I would like to provide some additional insight. As our organization and customer base mature, we assess each customer as their renewal comes up. We make sure to focus on retaining them while considering other options in the market, taking into account available capacity and overall demand strength. Overall, we do not perceive a significant risk, but we evaluate each situation independently.

Thank you.

Yes, thank you for taking the question. A couple if I may. You mentioned before that the churn and kind of throwing some resources out to analyze the portfolio. Hope you can give some more detail kind of on what your findings were, maybe ways that you found you can better manage clients. I think you also mentioned that it's part of the analysis that you maybe saw some opportunity to actually expand the business you're doing with existing customers in addition to predicting when they might churn.

Sure. Just to give you a little bit of color on what we did: in conjunction with a pretty broad team here within CoreSite, we took a look at the last five years of data in our customers and just the behavior of those customers, and worked through any kind of correlation of growth as well as risk of churn. We identified a small segment that might have some additional risk there. It didn't appear to be material, as Jeff mentioned in his remarks, but we did identify it. It allowed us to also just build a better view as to which customers are likely to grow with us as well and establish a bit of a more formal and deeper process around how we engage with those customers to give them a better experience, give us better visibility into the likelihood of them growing or churning, and make sure that we have the right resources around them to maximize that opportunity.

Great. One more quick question if I may. You mentioned, and thank you for the update, that you don't expect to achieve double-digit growth in 2020. Your comment was about a lot of change. Could you elaborate on the different factors that have changed over the past 12 months that are influencing your shift in perspective?

Yes, Mike. I believe the churn we've discussed certainly played a role in that. Northern Virginia was a significant factor as well. A big part of what influenced this was the timing of our development completions. Reflecting on where we were a year ago, we were making numerous estimates and assumptions regarding that. The timing has really been adjusted as we navigated through the development process, which, as Paul mentioned, has been challenging this year. We manage it to the best of our ability, but the final outcome remains uncertain. This is contributing to much of the situation. Looking ahead to the second half of 2020, where we anticipate many of our developments will be completed, some of which have already been pre-leased and many others we will continue to focus on leasing, our goal is to exit 2020 with a higher growth rate based on what we believe we can achieve in the next 12 to 15 months. That is our aim as we move forward from here.

Yes, Mike, I'd only add briefly that as we transition out of this phase of a lot of ground-up development by the end of next year, almost all of our new development, the vast majority of it will be just building out in new buildings, which is much easier to predict from a timing standpoint.

Thank you, guys, very much for the questions and see you guys in a few weeks at a rate.

Thanks, right. Our next question is from Jon Petersen, Jefferies. Please proceed with your question.

Great, thanks. Just maybe one more question on the Bay Area. I know you mentioned it's hard to predict what your competitors are going to do in terms of delivering product, but how are you guys thinking about the SV9 development and starting that in light of the upcoming space you're going to have over the next couple of years?

So the important thing is to get it shovel-ready, and we're vigorously in the process of that. As we've said, it typically takes about 12 months, give or take a couple of months, to go from acquisition to entitlement and permitting. By the way, that's for a data center the size of SV9. For larger campuses, there's a much longer process to get all of the necessary environmental and power approvals. We feel good about where we are in that process so far; it is going as we expected. After about 12 months, we should be able to start construction. Typically, construction in that market takes about 12 months. We'll be able to make that decision on starting construction based on what we see in the market and what we see in the SV7 retenanting. From the view we have of it today, we are likely to start that construction when we have the permits.

Okay. That's good color. And then a couple of your peers have achieved investment-grade ratings this year. I don't think that's something that you guys have aggressively pursued so far. But I'm curious what your thoughts are there. Obviously, there's some interest expense savings, but I think CyrusOne on their call just now was talking about some customers and how that was an important aspect in their underwriting of who to choose as a provider. So just curious any context or comments you might have around the possibility of getting an investment-grade rating and how that might position you?

Yes, Jon. I would just offer that, as you know and have seen over the last three years or so, we've accessed the private placement debt markets and those go through a different ratings process. But as we sit here today and when we issued each of those instruments, those were rated as investment-grade. We feel comfortable with the access to the capital we have and how it's been priced. Pricing on those instruments has been tighter than what we would have seen without the public markets just given the lending and the investor group in those instruments. We're comfortable with where we are related to that. Obviously, we continue to operate the business in a manner to get that investment-grade at more of a public level to the extent we ever go out in the public bond market. But that's probably not going to happen here in the near term, but it's something we continue to watch and manage the business around.

Sure. Yes, Jon, I've never encountered it as an issue in my customer interactions. If you examine our balance sheet and our leverage, you'll see that we are among the least leveraged data center providers in the market. Therefore, our financial strength has actually been an asset to us, not a hindrance.

Yes, okay. Makes sense. Thank you.

Thanks, Jon.

Thank you for taking my questions. First, last quarter you mentioned that customer commencements were slowing. Have you seen that stabilize? Secondly, regarding legal expenses, you previously provided guidance of $0.09 for the year. I understand that $0.04 has already been incurred, and I was unclear if you mentioned that another $0.01 had been incurred in this call. Will that extend into next year, or is $0.09 the final figure? Lastly, while it's early for guidance for next year, considering the expansion table and the increased CapEx this year, do you anticipate CapEx will remain at a similar level next year? Or, since you mentioned that second phase and second-tier developments are less costly, will that likely reduce CapEx for next year?

Rob, it's Jeff. Let me address a couple of your points and then I'll hand it over to either Paul or Steve to discuss the commencements. Regarding the legal situation, as I mentioned, we came through the third quarter as anticipated and resolved our dispute following the trial we regrettably had to undergo. The $0.01 reduction in FFO should be considered alongside a refund we've mentioned, which we currently estimate to be a minimum of $3.1 million. For the year, we anticipate this impact to be around $0.05 to $0.06 for 2019, with possibly more fluctuations as we move into 2020. Like most companies, we encounter legal challenges, but they are not nearly as significant as those we faced this year. On the topic of CapEx, I wouldn't expect our spending next year to be as high as it is this year. Paul highlighted some reasons for this. We have approximately $265 million left to allocate on projects currently under construction, with some of that being spent in the fourth quarter. If I had to estimate, I would say we should expect around $275 million to $300 million for the next year, which will largely depend on leasing absorption and other market factors. That should give you a sense of where we’re headed for next year. Now, about the commencements?

Yes. As far as commencements are concerned, we did see a little bit of slowdown there from last year as far as commencements are concerned. We have seen that moderate, but then we've also seen the deal sizes I mentioned earlier. The complexity within enterprises as they roll out their deployments take a little bit longer. So, but overall, we've seen that kind of stabilize.

Thank you.

Hey guys, this is actually David on for Lukas. I wanted to ask about the pre-leasing at LA3 and what drove that tenant to sign the lease so far in advance of delivery, and maybe if there are more attractive terms attached with that deal. And then if you could just also talk about your yield expectations on that project. Obviously when you bring LA2 and 3 online, they're going to improve. Just want to know if there's been any change in expectations there?

Yes, David, I can provide some insights regarding the pre-lease. We have confidentiality agreements with the customer, so I can't share many specific details about the lease itself. However, I can discuss the value of our position in that market, which is consistent with our standing in other markets. We offer large-scale capacity near one of the most connected buildings globally. This is a unique proposition that is increasingly appreciated by many customers. The low latency and scalable environment we provide have proven to be essential for numerous clients, including a significant customer that was planning for future capacity needs. While I can't share much more, I hope this gives you some clarity.

I understand. Regarding pre-leasing in general, the timeframe has significantly decreased over the past few quarters. Is there any indication that it might be increasing again, or was LA3 just a specific case?

Well, I think it's market by market, right? As there's more capacity in a given market like Virginia, there's less need for customers to sign to longer pre-leases ahead of time. In markets like L.A. and the Bay, they do. It's really market-by-market and also application by application or even customer by customer. But obviously with tight inventory, that always lengthens that behavior.

Hi, I wanted to follow up on your analysis of your customers regarding whether they might leave or continue to grow with you. For the customers you've identified as likely to leave, how do you plan on addressing that? Do you expect to retain them or focus on growing your other customers in the same deployment to fill the gap as they leave?

Well, of course, my preference is always to keep a customer, so that's job 1. As Jeff mentioned, the numbers of those customers is very small. I think we identified it as roughly 2% overall. Within that 2%, we expect to maintain hopefully all of them, but many of those are still under term. As we engage with them and get deeper into their business models and how they operate, then hopefully we'll retain as much or all of them as possible. But the process just allowed us to identify them, get a better operating model around how we engage with them, and hopefully that will bear some fruit as the final outcome.

And then regarding the Bay Area move-out, is that going to keep the churn elevated this 9% to 11%? Or is that part of the envelope of 7.5% to 8% of normal or just part of that, or is it too hard to say this far out?

Yes, Richard, if we look at our annual churn over the past several years, it has typically been between 7.5% and 8%. As I mentioned, we expect some of the factors driving it up this year to decrease next year, bringing us back to that normal range. However, the Bay Area customer situation may raise the churn slightly, potentially adding around 225 to 240 basis points in late 2020 and late 2021.

I'd only add to what Jeff has said that churn of this type in a market like that is generally a different quality of churn than the more widespread churn that is typically within our 7.5% to 8%. Again, alluding to what we've mentioned earlier about having a lot of lead time to retenant that space before maturity, and also having a lot of contiguous space to accommodate a wider range of customers.

Yes, 2 follow-ups. One, if you can maybe talk about the trajectory of channel mix as a portion of new logos in the most recent quarter and going forward. And then on LA3, are you anticipating that that new pre-lease is going to generate a lot of direct cross-connect demand because of the nature of the customer's deployment? Or is it more likely to be indirect over time, as perhaps there's enterprise hybrid attachments to that initial deployment?

Sure. Jonathan, this is Steve. As far as the channel mix is concerned, we've been really pleased with the channel growth over the year. As of last quarter, we saw that pick up even further. If you look at the collective mix, it ended up being about 16% of our total. If you back out the larger-scale lease that we mentioned earlier, it ends up being about 32% just in rough math. So that's a pretty good chunk and higher than what we've seen in prior years, and that's been ramping throughout the year. So that's good to see. As far as the LA3 pre-lease is concerned, again, not getting into too much of the details around that, but I think your final comments are around not only that deployment connecting to a network that's going to drive some interconnection, but also customers that will be connecting to that will also drive in their hybrid use cases will drive further interconnection is accurate.

And when a customer takes advantage of dark fiber between LA1 and LA2, for instance, does that count as a cross-connect that you monetize? Or do you sometimes just let them buy the fiber and then you're just collecting rent?

We typically count that as a cross-connect. In some cases, we've worked out specific arrangements for them to have dark fiber between the 2, but in 99% of the cases, it's through our cross-connect.

Thanks very much.

Thanks. Appreciate all the good questions. Before I move to my final comments, I do want to invite you to our L.A. campus data center tour and networking event on November 11 at the beginning of REITworld. Come join both our local and headquarters teams who will be hosting the activities. You can sign up with the link in our earnings press release or you can go directly to CoreSite's website to do that. Let me just close by reiterating we believe the market trends we discuss today will continue to reward us for creating a more proactive development and construction program. Going forward, our job is to keep meeting campus expansion needs and to continue growing the customer communities in our campuses. I feel very confident in the team that we have here, doing all the various aspects of those activities, and feel very good working with them going forward. Thanks to everyone for joining us today and thank you for your interest in CoreSite.