CoreSite Realty's (COR) CEO Tom Ray on Q2 2016 Results - Earnings Call Transcript

| About: CoreSite Realty (COR)

CoreSite Realty Corp (NYSE:COR)

Q2 2016 Earnings Conference Call

July 28, 2016 12:00 PM ET

Executives

Derek McCandless - General Counsel

Tom Ray - President and CEO

Steven Smith - SVP, Sales and Marketing

Jeff Finnin - CFO

Analysts

Michael Hart - Evercore ISI

David Rodgers - Robert W. Baird

Barry McCarver - Stephens Inc

Jordan Sadler - KeyBanc Capital Markets

Manny Korchman - Citigroup

Colby Synesael - Cowen & Company

Matthew Heinz - Stifel

Operator

Greetings and welcome to the CoreSite Realty Corporation Second Quarter 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Mr. Derek McCandless. Thank you. You may begin.

Derek McCandless

Thank you. Hello, everyone, and welcome to our Second Quarter 2016 Conference Call. I'm joined here today by Tom Ray, our President and CEO; Steve Smith, our Senior Vice President, Sales and Marketing; and Jeff Finnin, our Chief Financial Officer.

As we begin our call, I would like to remind everyone that our remarks on today's call include forward-looking statements within the meaning of applicable securities laws, including statements regarding projections, plans or future expectations. These forward-looking statements reflect current views and expectations, which are based on currently available information and management's judgment.

We assume no obligation to update these forward-looking statements and we can give no assurance that the expectations will be obtained. Actual results may differ materially from those described in the forward-looking statements and may be affected by a variety of risks and uncertainties, including those set forth in our SEC filings.

Also, on this conference call, we refer to certain non-GAAP financial measures such as funds from operations. Reconciliations of these non-GAAP financial measures are available in the supplemental information that is part of the full earnings release, which can be accessed on the investor relations pages of our website at coresite.com.

And now, I'll turn the call over to Tom.

Tom Ray

Good morning and thank you for taking the time to join us today. Before I dive into Q2 results, I’ll take a few minutes to share some thought about this morning’s announcement of my upcoming retirement in CoreSite. First, I would like to thank the investor community and our shareholders, for the support they have shown over our past six years as a public company. I also want to thank our Board for support of the investments we made, not only in our facilities, but also in our organization.

Finally, I want to thank my CoreSite colleagues, it’s been a privilege to have served alongside you over the past fifteen years. Being a part of this organization as it is grown and matured has been enormously joyful and fulfilling. And I’m humbled by what this team has accomplished in building a successful company and delivering on our commitments to our investors, customers and each other. I’m confident that the Company has a strong team in place and a solid platform for growth.

With that, I believe now is the right time for me to move on, and I look forward to spending more time with my family. Importantly, I feel confident leaving CoreSite in the capable hands of Paul Szurek and the deep bench of talent present through our all levels of the Company. Paul has been an active and engage member of our Board and he has the strong understanding of our strategy and management team. He brings over 25 years of executive experience in almost every aspect of real estate company governance, operations, developments and management. Much of it with largest public companies, and he possesses a strong skillset to ensure the CoreSite's current momentum and growth continue.

With that, I’ll now turn to our second quarter results. In Q2, our efforts and execution produced another quarter of solid financial and operational performance. Looking at Q2 2016 over Q2 2015, we reported 31% growth in FFO per share, driven by 18% growth in revenue and 26% growth in adjusted EBITDA. We continued to expand on margins with our adjusted EBITDA margin expanding to 52.2%, measured over the trailing four quarters ending with and including Q2 2016. This represents an increase of 283 basis points over the comparable period ending with and including Q2 2015.

With regard to leasing, during the second quarter we executed new and expansion leases totaling 48,000 square feet, representing $7.7 million in annualized GAAP rent, in correlating to an average annual GAAP rental rate of a $159 per square foot.

Regarding the compotation of our new and expansion lease in the quarter, lease executions were well distributed across our portfolio with our strongest signings in terms of the annual GAAP rent occurring in Silicon Valley, Los Angelis and Northern Virginia D.C. The number of leases signed in the quarter was well distributed across our three verticals as well, with our network, cloud and enterprise verticals representing 29%, 22% and 49% of leases signed respectively.

Transaction count in Q2 was strong with 171 new and expansion leases signed in the quarter, representing a record level of lease executions for our company. Steve will provide more color regarding the mix of leasing in the quarter, but at the high level, I'll note that 92% of new and expansion leases signed were from less than 1,000 square feet each. As we have discussed previously, performance sensitive retail collocation is the core of our business and we remain focused on increasing transaction counts in this segment. We are pleased with the progress we've made this quarter and will work to keep driving further improvement.

Leasing results in the second quarter may serve as a good representation at the shape of leasing going forward, with the bulk of transactions consisting of smaller deployments. Historically, 90% to 95% of our new and expansions transactions on a quarterly basis have been from leases less than 1,000 square feet. In the past, we participated in the wholesale segment on an opportunistic basis in two different scenarios. First, when we place a large amount of new capacity into service; and second when market conditions and pricing are favorable for us. We’ve seen a healthy level of wholesale leasing over the past 18 to 24 months, driven by our new developments in the Bay Area, New York-New Jersey, and Northern Virginia.

Looking ahead to the next 6 to 12 months though, it is unlikely we will replicate the trailing pace of wholesale leasing given that the majority of our current capacity is targeted toward our core collocation business. Regarding our interconnection services, Q2 interconnection revenue continue to show strong growth, increasing 22% over the prior year quarter. The strength in second quarter interconnection revenue was again driven first by strong growth in the volume of fiber cross connects and then by an attractive product mix including strong growth in logical interconnections.

Specifically Q2 reflected at 14.8% growth in total points of interconnection, driven by 21% growth in fiber cross connects and 32% growth in logical interconnection services including the CoreSite Open Cloud Exchange and our any two exchange for internet peering. Importantly, we continue to see indications of growing enterprise adoption of cloud services with cloud to network connections increasing strongly as cloud providers build up a backbone to support connections via private WAN architectures.

Related in Q2, we continue to make progress on enhancing our community of cloud service providers, signing 10 new logos across our platform. In addition, we announced several important wins with key public cloud providers, extending their reach and availability to a greater number of our customers. First, we announced the expansion of needed AWS Direct Connect deployments to our campuses in the Bay Area in Northern Virginia. With these recent expansions, AWS Direct Connect is now directly available in each of our big four markets with deployments in Los Angeles, New York-New Jersey, Silicon Valley and Northern Virginia.

Additionally, CoreSite customers can connect to AWS from our Boston facility via our CoreSite Open Cloud Exchange and can connect from the rest of our data centers via network service providers. Second, during the quarter, we announced direct access to the Google cloud platform in Chicago, Denver and Los Angeles. This is an important addition to our cloud service provider community and reflects our continued focus to provide our customers access to leading cloud providers in a secure, reliable and cost-efficient environment, streamlining their hybrid and multi-cloud architectures.

I'll now move onto provide our outlook for our key markets and segments. With regard to our collocation market segment, we continue to see consistent growth in terms of the pace of leasing while pricing remain stable to slightly up across our markets. Demand for performance sensitive collocations solutions remains well distributed among our key verticals of network providers, cloud service providers and enterprises.

Regarding the wholesale market segment, our outlook for supply and demand is substantially consistent with that of last quarter with the exception of the Bay Area. We see an increasing pipeline of new supply coming to market in the Bay Area over the next several quarters from a number of different data center providers. And we expect went rents to soften in the market over the next year. We will continue to closely monitor the supply demand dynamic across all of our markets including demand from hyper-scale cloud companies as we go forward throughout this year.

With regard to our development and SV7 at the end of Q2, we were 59% preleased and what we view as attractive rental rates, as it relates to our other markets New York-New Jersey wholesale market remain soft while supply and demand are more equilibrium in our other markets. With regards to growth, we believe that we have ample opportunity to continue to drive meaningful organic growth through the lease up of existing available TKD inventory across our platform to build out of additional TKD capacity in our existing powered shells and the new data center capacity currently under construction.

First, regarding existing available TKD inventory, we ended Q2 with approximately 300,000 square feet of operating data center capacity available per lease correlating to 18% of our leased data centers per footage at the end of quarter. This available capacity is currently well distributed across our footprint and included in available capacity is the recently completely build out of TKD capacity at VA2 and LA2 totaling 91,000 square feet across these two key markets. As of the end of Q2, we are nearly completion of construction on our largest development in the Bay Area with 230,000 square feet of TKD capacity at SV7. Together our operating data center capacity available for lease and our data center capacity under construction correlates to 31% of our leased data center capacity at the end of Q2, supporting future organic growth.

During the second quarter, we extended our lease on the remaining approximately 20,700 rentable square feet of office and data center space at our LA1 facility through 2022. The extended space includes 10,400 rentable square feet of undeveloped data center capacity to support continued sales momentum at the facility. As we near capacity within the existing stores, we anticipate developing the space to support new customer deployments as well as growth of existing customers requiring a presence at LA1. Following this more recent expansion, we now have more than 150,000 square feet leased at LA1 through July 2022 with three 5 year renewal options ensuring uninterrupted control of our rentable space through 2037.

In addition, we continue to evaluate our options regarding opportunistic external growth including the acquisition of additional land and/or data centers to leverage off of the scale we've already created. To that point early in the third quarter, we executed on lease providing for expansion at our DE1 facility, the 10-year lease with renewal rights of four 5 year extensions of fixed rental rates is for 23,000 square of shell capacity to support our build out of TKD capacity into remote basis. We expect to substantially complete construction of the initial phase of 8,000 square feet in Q1 2017 at a cost of 40 million. We will evaluate building out our additional capacity based upon leasing results in Phase 1.

While the cost per net rentable square foot is Phase 1 is relatively high, in that phase we will construct infrastructure design to support further build out in the remaining 1,500 square feet of shells space. This should enable us to build incremental capacities in follow-on phases at a unit cost substantially below that associated with the Phase 1. We are excited about expanding in Denver where we now have more than 70 network, cloud and IT service providers supporting a broader array of enterprises. We believe this expansion favorably positions us to continue to serve our current and new customers to value high performance collocation and interconnection solutions.

Looking forward to the rest of 2016 and beyond, we remain focused upon continuing to execute our business plan, keeping our eyes on five key areas; continuing to improve asset utilization by driving occupancy; strengthening the differentiated value proposition of our platform by continuing to add anchor networks and cloud providers; driving operational excellence across our organization; investing in expansion to support ongoing growth; and consistently and continuously working to increase returns on invested capital.

In summary, our financial and operating results for the second quarter reflect our focus and execution on the items I just mentioned as well as our commitment to delivering superior returns for our shareholders. We believe that our core business delivering performance sensitive collocations and interconnection solutions is strong and is a differentiator within the marketplace. And we will continue to work to strengthen the value of our communities of interest across our network reach, cloud-enabled data center platform.

With that, I'll turn the call over to Steve.

Steven Smith

Thanks, Tom. I'll start by reviewing our overall sales activity during the quarter. As Tom noted, Q2 new and expansion sales totaled $7.7 million in annualized GAAP rent, comprised of 48,000 net rentable square feet at an average GAAP rate of $159 per square foot.

Transaction count for the quarter totaled 171 new and expansion leases, 26% above the trailing 12 month average and 45% higher than the prior quarter. As Tom mentioned, Q2 was collocation concentrated quarter which is the primary focus of our efforts as a sales and marketing organization. To that point, new and expansion leasing consisting of 158 leases less than 1,000 square feet each, 12 mid sizes leases between 1,000 to 5,000 square feet each and one large lease greater than 5,000 square feet.

We are pleased with the sequential trend and transaction count as well as the strength in midsized leasing and we'll continue to focus on attracting smaller performance sensitive applications which were additive to our customer and service provider communities of interest. Related, we continue to diversify our customer base adding 31 net new logos this quarter, which were well distributed across our platform. In terms of verticals, new logos were also well distributed with 40% coming from network and cloud service providers 60% from enterprise customers.

Within our embedded days, we have also seen strong growth in general enterprise category including financial services and healthcare, increasing from 12% in Q2 2014 to nearly 19% in Q3 2016. As we see further adoption of collocation solutions for enterprise IT needs. Beyond our new and expansion leasing, our renewal activity in Q2 was also solid as renewals totaled approximately 70,000 square feet at annualized GAAP rate of $122 per square. This reflects mark-to-market growth of 5.2% on a cash basis and 9.4% on a GAAP basis.

Q2 renewals reflect a large multimarket customer which renewed approximately half of its base with us, and we expect the other half to trend up by the end of 2016. Churn in the quarter was 2.1%, which included 100 basis points of churn related to the restructured lease agreement with our original full building customer at SV3 as expected. As reminder, we continue to forecast approximately 190 basis points of churn related to the final exploration of this customer lease agreement in Q2 2017.

Regarding our vertical mix, during Q2 network and cloud customers signed 87 new and expansion leases representing 51% of our total transaction count. As Tom mentioned, specific to the cloud we saw AWS announced two new Direct Connect nodes at our Santa Clara and Reston campuses, further differentiating those markets with a secure high performance connectivity option for our customers. The addition of Direct Connect availability of these campuses is especially important due to explosive growth in these key markets, bolstered by the density of high-tech and start-up companies leveraging both collocation and cloud.

Beyond the AWS expansion during the quarter, we also entered into agreements with another cloud provider to expand its on-ramp services into additional markets, further enhancing the cloud community within the CoreSite platform. Additionally, during Q2 we signed leases for two new edge locations with the leading video platform for the gaming community, representing one of the most highly traffic websites. These applications reflect the value of our low latency, connectivity reached approach to servicing the market.

Regarding our network vertical, we saw strong performance with new and expansion leasing distributed across every market and almost every available building. In Q2, we signed two new Tier 1 IP network deployments with the leading international carrier as well as 15 new core network nodes and 7 expansions to existing major network nodes. All of this speaks to the long held strategy to drive CoreSite locations as leading points of interconnection.

Turning to the enterprise vertical, we continued to see solid momentum in the quarter with this segment accounting for 49% of new and expansion leases signed. Strength in this market was led by general enterprises and digital content including a leading global retailer, a large financial services organization, a large biotechnology company and 30 new logos.

From a geographic perspective, our strongest markets in terms of annualized GAAP rent signed in new and expansion leases in Q2 were Silicon Valley, Los Angeles, Northern Virginia DC, Chicago, and New York-New Jersey collectively representing 95% of annualized GAAP rent signed in the quarter and 86% of leases executed. As it relates to SV7, we are now 59% preleased and expect to open the building in the third quarter. We remain optimistic about our investment in SV7 given our strong leasing to date coupled with what we believe to be near-term opportunities to lease at attractive rates.

We all more cautious about the Bay Area looking past the coming three quarters in light of the pipeline of new construction we see in the market. In Los Angeles, demand remain steady and we continue to make good leasing progress at LA2 with 60% of leases and 84% our annualized GAAP signed into market during Q2 coming from this building. Over the last five years, we have increased customer count at LA2 from 75 to 175 and continue to strengthen the value of the campus with 20 native network and cloud service providers now deployed.

In terms of verticals, digital content was our strongest followed by network and cloud. Stabilized occupancy across the LA campus was 87.9% at the end of Q3, up 20 basis points compared to Q1 with approximately 18,000 square feet moving from the pre-stabilized pool to the stabilized pool.

In Northern Virginia DC, we continue to see good transaction volume among smaller requirements with 33 new and expansion leases signed below 1,000 square feet. Demand was driven by enterprise customers followed by networks and digital content with 16 new logos joining the campus.

As it relates to capacity across the campus, during the second quarter we completed construction on Phase 4 at VA2 with 48,000 incremental square feet now on a pre-stabilized pool, stabilized occupancy in Reston now stands at 97.5%.

In the New York-New Jersey market, we continued to see consistent demand for smaller requirements while the wholesale market remains somewhat soft. In Q2, we executed 13 new and expansion leases across our New York campus, with one 1,300 square foot lease and remaining 12 under 1,000 square feet. Leasing was driven by enterprise and network customers including the four new net enterprise logos.

In summary, we are pleased with our sales performance in Q2 as well as the progress we've made and increasing our transaction count to smaller collocation requirements. Q2 results were in line with our expectation given our focus on the performance-sensitive collocations segment of the business. As we look forward, we continue to view our position in the market favorably and are committed to executing against our strategic plan to create value for our customers, partners and shareholders.

With that, I'll turn the call over to Jeff.

Jeff Finnin

Thanks, Steve, and hello everyone. I'll begin my remarks today by reviewing our Q2 financial results. Second, I will update you on the development CapEx and our balance sheet and liquidity capacity. And third, I will discuss our outlook for the remainder of the year.

Q2 financial performance reflects total operating revenues of $96.1 million, correlating to a 3.9% increase on a sequential quarter basis and an 18.1% increase over the prior year quarter. Q2 operating revenue consisted of $78.8 million in rental and power revenue from data center space, up 3.7% on a sequential quarter basis and 18.5% year-over-year. I want to point out a few items related to data center rental revenue.

First as Steve noted, during Q2 another tranche of rental revenue related to our original full building customer at SV3 expired, reducing annualized GAAP rent by $1.9 million. The remaining $4.2 million in annualized GAAP rent related to this restructured lease agreement is scheduled expire in Q2 2017. Second, during the quarter we completed construction on SV6, the powered shell build-to-suit and that lease commenced as of May 1st.

Moving on interconnection revenue contributed $13 million to revenue in Q2, an increase of 1.8% on the sequential quarter basis and 22.2% year-over-year, and tenant reimbursement another revenues were $2.3 million. Office and light industrial revenue was $2 million.

Moving to earnings, Q2 FFO was $0.89 per diluted share and unit, an increase of 3.5% on a sequential quarter basis and 30.9% year-over-year. Net income for diluted share of $0.37 was flat with the prior quarter, an increase 68.2% year-over-year. Adjusted EBITDA of $51.1 million increased 5.4% on a sequential quarter basis and 26% over the same quarter last year.

Sales and marketing expenses in the second quarter totaled $4.5 million or 4.7% of total operating revenues. General and administrative expenses were $8.8 million in Q2, correlating to 9.2% of total operating revenues in line with our guidance for the year.

Regarding our same-store metrics, Q2 same-store turn-key data center occupancy increased 700 basis points to 88.9% from 81.9% in the second quarter of 2015. Additionally, same-store MRR per cabinet to equivalent increased 6.6% year-over-year and 1.2% sequentially to $1,478.

In Q2, we finished development of 48,000 square feet of turn-key data center capacity at VA2 in Reston as well as 43,000 square feet of turn-key data center capacity at LA2 in Los Angeles, which are both reflected in our pre-stabilized pool.

As we have previously discussed, we defined stabilization as the earlier to occur between 85% occupancy and 24 months after an asset is placed into service.

As of the end of the second quarter, 17,500 square feet of LA2 and 12,000 square feet at CH1 moved into our stabilized pool at 85.9% occupancy each. In addition, 23,000 square feet at VA2 moved into the stabilized pool at 100% occupancy.

Lastly, we commenced 158,000 net rentable square feet of new and expansion leases at an annualized GAAP rent of $55 per square foot, which represents $8.7 million of annualized GAAP rent. As I mentioned earlier, Q2 lease commencements include the 136,500 square feet build-to-suit as SV6 which impacted the rate this quarter.

We ended the second quarter without stabilized data center occupancy at 92%, an increase of 140 basis points compare to the first quarter with increases in occupancy at nearly all of our data centers. NY1 was our only data center to show a decline in occupancy from 76.7% in Q1 to 70.7 in Q2. This move out was due to a customer's application reaching end of life.

Turning now to backlog, projected annualized GAAP rent from signed but not yet commenced leases was $29.4 million as of June 30, 2016, or $33.8 million on a cash basis. Importantly, approximately 88% of our GAAP backlog relates to leases which will commence once construction is complete, reflecting the pre-leasing at SV7, approximately 75% or $22.1 million of our GAAP backlog is anticipated to commence in the late Q3 with a large portion depended upon completing construction at SV7, an addition 12% or $3.6 million is expected to commence in Q4.

Turning to our development activity, we had a total of 230,000 square feet of turn-key data center capacity under construction as of June 30, 2016, all of which is at SB7 in Santa Clara. We estimate as total investment of $190 million required to complete this project of which $151.6 million had been incurred at the end of Q2.

As shown on Page 23 of the supplemental, the percentage of interest capitalized in Q2 was 24.6%. For 2016, we now expect the percentage of interest capitalized to be between 20% and 25% based on improved visibility into the second half of the year and our development pipeline.

Turning to our balance sheet, as of June 30, 2016, our ratio of net principal debt to Q2 annualized adjusted EBITDA was 2.4 times. Including preferred stock, the ratio was 3 times, below our stated target ratio of approximately 4 times. This correlates to incremental debt capacity of approximately $205 million at June 30th based upon Q2 annualized adjusted EBITDA.

In addition, after we announced in mid June, we successfully raised a $150 million through a private placement bond offering. These bonds represent a diverse source of capital, and we're excited about the relationship that we developed with new investors during this process which provide us optionality for incremental capital to scale our operations in the future. We used the bond proceeds to fully repay the balance of our revolving credit facility, leaving the entire 350 million available to fund near-term growth.

Finally, we're increasing our 2016 FFO guidance to a range of $3.56 to $3.64 per share in OP unit from the previous range of $3.52 to $3.60 per share in OP unit, an increase of 1.1% based on the midpoint of both ranges. The increased guidance reflects our performance year-to-date, an increase approximately $0.01 per share in charges during Q3 associated with the management transition that was announced this morning. Therefore keep in mind, the Q3 results will be impacted by this charge as well as the estimated timing of completion of construction in customer commencements at SV7.

We now expect total operating revenue to be in the range of $392.5 million to $402.5 million compare to the previous range of $391 million to $401 million. We continue to expect generation and administrative expenses to be $35 million to $37 million correlating to 9.1% of total operating revenue. Adjusted EBITDA is now expected to be $205 million to $213 million, up from the previous range of $203 million to $211 million, implying an adjusted EBITDA margin of 52.6% for the full year.

All above guided metrics remain unchanged and a detailed summary of all 2016 guidance items can be found on Page 25 of the second quarter earnings supplemental. I would remind you that our guidance is based on our current view of supply and demand dynamics on our markets as well as the health of the broader economy. We do not factor in changes in our portfolio resulting from acquisitions, dispositions or capital markets activities other than what we've discussed today.

Now, we'd like to open the call to questions. Operator?

Question-and-Answer Session

Operator

We will now be conducting a question-and-answer session. [Operator Instructions] Our first question comes from Jonathan Schildkraut from Evercore ISI. Please state your question.

Michael Hart

This is Michael Hart on the line for Jonathan. I wanted to focus first on the interconnection revenue growth. It looked like it was a little slower this quarter and I was wondering if you could maybe give us some incremental color about sort of what drove that deceleration down from 1.8% sequential growth from 6% last quarter. And do you see any trends that have implications on your outlook for future interconnection growth?

Jeff Finnin

This is Jeff. I guess couple of things as you may recall from the first quarter, we had very strong growth, at my recollection it was somewhere around 24% so the change this quarter -- I should say the growth last quarter was strong and ultimately led to us increasing our guidance on the interconnection growth last quarter. My recollection is today our guidance related to interconnection revenue growth is 17% to 19% for the full year. I think based on our visibility today and performance in the first half, we would expect our overall growth this year to be at that top of that range or slightly ahead of it. So just keep that in mind as you factor in the rest of the year.

Michael Hart

And then I guess along those lines I think you talked a lot about the demand you’re seeing from cloud and enterprises for performance sensitive deployments which are presumably more interconnect rich. I was wondering when I said you’re seeing a sort of bridge with cycle where the incremental nodes you get from major cloud platforms are attracting additional enterprise and cloud customers, if you think that that could drive high teens or 20% interconnection growth in next year and beyond? Thank you.

Tom Ray

Yes, I think no change to our past comments over the last several quarters. For the larger public clouds that are more mature in the marketplace, we have seen consistent acceleration and that continues. And I’d say the larger main brand public clouds that are newer in rolling out into the marketplace certainly appear to be following the same trajectory of the larger clouds that came in earlier. So the signs are positive for the newer entrants. The momentum of the established folks is very, very solid and it's continuing. And so we’re optimistic that, that virtual cycle will continue. There is reason to have faith that it will.

Operator

Our next question comes from David Rodgers with Baird. Please state your question.

David Rodgers

Tom, sorry to see that announcement this morning, and certainly wish you all the best. You’ve done an incredible job with CoreSite over the last couple of year. I guess Jeff you mentioned in your comments about NY1 and the application kind of hitting end of life, I didn’t hear if there was any commentary about the impact of that might have had on power or cross connect revenues either sequentially from 1Q to 2Q or 2Q into 3Q, and any more color on that, that you can provide?

Jeff Finnin

Dave, I don’t think it's going to have a significant impact. Obviously, it's incorporated into our guidance for the rest of the year, but nothing significant that would stand out.

David Rodgers

Okay, that's good. I guess there's been a little bit of commentary out there about Akamai and maybe some churn or some issues with them in the data center business, any commentary around that that we need to be concerned about or aware of from the CoreSite perspective?

Tom Ray

Well, certainly nothing specific to Akamai. I think in the CDN space in general, the impact on the data center world is, I think, largely a shift. You see dedicated CDNs losing some share to other integrated providers, such as the telcos moving more to the CDN space, as well as enterprises becoming more active on their own CDN platforms. So, somewhere that information needs to connect to the rest of the world and the servers that host it and process it need a place to be fired up. So, I think the overall demand from CDN activities is in the marketplace, you know, continues to be meaningful and continues to grow meaningfully. I do think some of it could be in the hands of what historically were not traditional providers. And we’ll see how that space shakes out. But I think the activity of CDN remains very solid for the multicenter data center world.

David Rodgers

And I guess -- okay maybe lastly for me then. In terms of the volume of cross connects -- and I know you gave the guidance for that. It was up 15%, I think you said. In the quarter overall, if I got it right, fiber up 21%, logical up 32%, are you seeing greater erosion in copper, I guess would be the first question. And then I guess is logical accelerating? I guess we haven't normally seen that breakdown from you. So I guess now that we have that breakdown, how should we think about kind of that as a separate category in there?

Tom Ray

The rate of deceleration in copper has remained very consistent. It's kind of 3% annual decline and still in that, around that number. On the logical side, the logical can be a little bit more lumpy because it's a smaller base. So we’ve had quarters where it's been 50%, 52%. This quarter was in the 30s. I wouldn’t draw much from that. It's a strongly growing product set and I think the all signs suggest that it has the opportunity to continue to grow very strongly.

And on the fiber side, I saw somebody's note this morning saying hey, we really focus on the annual. And I would encourage people to do that. The Q-on-Q can have some, a little bit of lumpiness, not like the wholesale leasing. But in Q1, we had a larger move-in from one customer on fiber cross connection. In Q2, we had one customer turned down more than normal. And so there is two quarters just have a little bit of shift dissonance in them. We don’t read anything into that in a bigger picture, and we’ll leave it to everybody else to do what they think they need to do with that information.

Operator

Our next question comes from Barry McCarver with Stephens Inc. Please state your question.

Barry McCarver

Tom, first off, question for you, in your prepared remarks you mentioned little bit of excess supply in the Bay Area coming online in the second half of the year. I am curious if you could give some color around do you think some of your competitors are out there with spec builds? Or do you sense a rise in demand coming? I guess just on a scale one to 10. How concerned are you about the supply?

Tom Ray

Well, I think, there is a chunk of spec supply either on the drawing boards or permitted or breaking ground, ready to come into market. I think the volume of that isn’t frankly materially different than it's been over the average of the longer trail. So, I think the real question for the overall health in the Bay Area is this question of hyper-skilled demand, and we do think that will be lumpy, and if it continues unabated, as it has over the trailing 12 to 18 months, through the forward 12 to 18 months, probably going to see a steady healthy market.

If some of the hyper-skilled cloud guys have a full belly at the moment and slow down for a little while and that’s not backfilled in the next 12 months by other uses at that same volume, then I think supply may get a little out in front of take up, and we’ll see some softening and that’s that.

Barry McCarver

And then a question I guess for Jeff on the margins, I continue to be impressed with the way your Company is able to drive margins higher. Looking at data center utilization capacity utilization, it's about as high as I think it's been in several years, maybe ever. Kind of your thought on EBITDA margins beyond the next couple of quarters. Would you expect those to be a little flatter, given the amount of building activity you have going on?

Jeff Finnin

Barry, when we entered the year, our guidance suggested that our adjusted EBITDA margins would be relatively flat as it was compared to 2015. When you look at the performance year-to-date, we have continued to expand those margins. And in largely that, that margin expansion is coming because of the greater than expected growth from our interconnection business. I guess as Tom suggested that can be a little bit lumpy from quarter-to-quarter, but it's obviously something we continue to focus on and watch.

And if we can continue to expand those margins for the rest of the year, I think we’d be pleasantly pleased I guess in that outcome. It's something we’re watching closely. But the guidance as you sit here today suggest year-end, I guess, overall margins I think at 52.6% and that’s where the guidance is to give you some idea as you look forward.

Operator

Our next question comes from Jordan Sadler with KeyBanc Capital Markets. Please state your question.

Jordan Sadler

Tom, I guess, the announcement this morning caught us a bit by surprise. I assume others as well wish you well in the next stage for sure. But with all due respect here, I had one question on the topic. Any -- I guess because the lead time seems a little bit short. Should we expect any change in strategic direction at the Company?

Tom Ray

I don’t believe so, Jordan. I mean, you’ve seen the comments from Rob Stuckey and from Paul. And these are people who’ve been with company for a long time and guiding and helping form the strategy. The Board remains intact. The senior leadership team remains intact. And I think everybody is just looking forward to roll in the same direction and everybody believes in what the Company has accomplished in the past. So look, I’d be really surprised if there were anything off the beam going forward.

Jordan Sadler

And in terms of the appointment of Paul, it looks like that’s a permanent position. Can you confirm that? And then was there a broader process run was he just appointed as one of the permanent President and CEO?

Tom Ray

Paul is the permanently appointed President and CEO. And I think the process is -- it's internal to the Board. It’s I think very well considered, very well thought through. Our succession planning across the organization and in the CEO spot has been I think a constant effort by the Board and the leadership team. And very mindful of that practices and there you have it. I mean, I think the Board’s decision was enormously well considered and thoughtful, and Paul is the guy going forward.

Jordan Sadler

As far as any expansion opportunities that you outline in terms of the focus of the Company and new investment, you’ve got Denver, which you’ve identified you’ve done first quarter. And anything else in the till that you can point to? How difficult is it to procure additional land these days?

Tom Ray

Well, I think consistent with our comments on the trail. The areas that are of the highest consideration are North Virginia and the Bay Area. North Virginia I think leading that. We have less available inventory relative to our trailing absorption there than the Bay area. So, those are two of our largest markets. And obviously they are a key source of interest and opportunity going forward.

And as we’ve said in the past I think there are several opportunities in each market to continue a position and continue the platform for growth in the organization. And we’ve been working purposely as we’ve said and we’re optimistic about finding and executing upon additional growth opportunities for the organization. As I said last quarter, I am not concerned that we’re going to wake up and go gee, why don’t, we have any ability to grow in these markets. We’re conducting ourselves accordingly and we’ll keep everybody posted as anything definitely comes up.

Jordan Sadler

And one last if I may, just in terms of increasing asset utilization, driving occupancy higher, this has been a trend for several quarters now. And I am just curious there, in conjunction with your commentary of not really expecting you to do a lot of wholesale in the next six to 12 months. What is the objective here versus the lower occupancies and the greater availability that you used to run that, let's say, in the first three-four years, post IPO? Why are we running at higher level of occupancy?

Tom Ray

Really, circle back to what we shared on the IPO road show. We really look in terms of how many kilowatts or square feet are available in our inventory as opposed to what our occupancy percentage is. So, six years ago with a very small base in the market, 15% availability might have met, we have just enough to do couple of 1.5 meg deals and to continue to feed our co-location program. With a much bigger base in a given market, we might be able to accomplish those same growth objectives with a much higher occupancy ratio.

And so it's really about kilowatts and square feet than percent, and that the organization gets larger and we have more mass in markets and we’re getting more scale and efficiency by market. We have the opportunity to drive up our 50 percentage and I think that’s going to continue to be a focus for the Company.

Jordan Sadler

Thanks, Tom. I appreciate the years of insight and friendship and wish you the best.

Tom Ray

Thank you very much, Jordan. I appreciate for you as well.

Operator

Our next question comes from Manny Korchman with Citi. Please state your question.

Manny Korchman

Maybe similar to Jordan’s question a different. Any desire to go more wholesale, take advantage of the demand from the hyperscale side, use your experience and ability to build out the larger spaces and offer one-stop shop for customers at least for now? And then what to do with that part of the business going forward later?

Tom Ray

I think at a high level, circle back to what the strategy going forward I think it's very consistent with the strategy in the past. And as you’ve seen the Company’s trading behavior, we’ve hit the wholesale market when spot pricing was very attractive, or when we had new larger developments in any given market. And as I’ve talked in my prepared remarks about the next six to 12 months, we still have another big building hitting the market in that time frame.

Pricing is still favorable at the moment in the Bay Area, but we’ve done a fair amount of wholesale there. And I do believe supply is coming. So I think that the Company is going to continue to execute and work towards the same behavior that you’ve seen in the past. I am optimistic that there will be opportunities for wholesale in the future based upon the same criteria that we’ve applied in the past. And as you look at the next 6-12s we’re not in that position from an inventory perspective and we are in the markets to try and expand our opportunities for growth, and some of those moves up might have a follow on wholesale associate with them base on our trailing criteria.

Manny Korchman

Jeff, if we think about your development spend longer term looking forward as we try to model out a few more years. How should we think about that number?

Jeff Finnin

Well, I think if you look back over the past five plus years since going public, our average spend and total CapEx has ranged -- or on average is probably been around $140 million to $150 million. There are couple of years, 2016 been one, where we’re guiding to about $265 million where we clearly spent well more than that average. But I think that long-term average is something better to look at as you think about capital for 2017. And obviously we’ll give further and full guidance probably in connection with our Q4 call, probably in February. But I think that’s a good way to look at it based on what we’ve done historically.

Manny Korchman

Thanks Jeff. And Michael has question for you guys as well.

Michael Bilerman

Tom, it seems like yesterday we’re looking on the IPO, so I too share some thoughts and wish you well as you spend more time with your family. Just curious can you help us a little bit on the time line. What was the process that when did you notify the Board? I assume that this was something that you notified to the Board, because you wanted to retire. Maybe the Board notified you, but there want to be a change looking. What the timing of all this was and the interactions and the decision making process?

Tom Ray

It's been very collaborative, and I did reach out during this month. And say we should talk more seriously about succession over time, let's spend more time on it and no decision was made then. And I’ve been with this organization and with our Board for a very long time and wanted to support an orderly transition, give everybody lots of time. And so that was very collaborative process. And it really finalized over the last couple of days. So it's been a process of people who’ve worked together for quite a while, saying we would meet then, what’s big more about the future over the next year or two.

And we’ve got Paul in a great position. And I’d say from my perspective once you start thinking about that, I need to honour my commitment to give 110% to this organization as long as I am here and frankly fresh legs right now I think come and ensure that continuity of just incredible excitement and drive. And glad Paul is ready willing and able to take this forward.

Michael Bilerman

And then you’ve been advisor until next year. Are you going to remain on the Board of Directors? And if not, do you have a non-compete at all and what the tail of that is?

Tom Ray

I am going to remain as a consultant and advisor. I am very much looking forward to supporting the transition. I am not going to remain on the Board. And I do have a non-compete.

Michael Bilerman

And how long does that non-compete run till?

Tom Ray

12 months after the end of the consulting arrangement.

Michael Bilerman

And then just the backdrop here was, you may have mentioned you wanted to spend more time with your family, but is there -- I mean, is there something else that’s behind the decision?

Tom Ray

No, I just leave it at, and I am very excited looking ahead to spend more time with the family and I am very, very honoured and grateful for my time here with the organization.

Michael Bilerman

And then just in terms of the process of selecting, and a little bit to what Jordan was going after in terms of what process the Board ran. I am curious as your advice to the Board, and I am sure Peter having been involved with the Board for a number of years and as lead Independent Director has a lot of sense for what the Company does, but doesn’t carry to data canter experience day-to-day in terms of running the Company like you have. I am curious what your view was getting either an internal person that’s been doing -- promoted from someone within versus going out and getting someone with data center experience? Or emerging the Company is an alternative as well?

Tom Ray

Look, circling back to the succession planning process. It’s not an event it's a process and really I think for healthy companies it's a process that’s ongoing every year, year-after-year. And that’s been the case at CoreSite. We’ve been very thoughtful about succession in every senior part of the Company. As part of that, we have wonderful candidates internally right now, so Paul to continue mentor and groom, and terrific people with great skills and tremendous upside in their career.

So I think the Board was I think fortunate but you make your own luck. The Board has been thoughtful about CEO transition and succession for a long time. There are number of candidates and I know that they were very well considered in their selection of Paul. And as per my view I completely support Paul, and I am looking forward to helping him burn into the Company and taking to the next level and the next leg of its journey.

Michael Bilerman

I appreciate all the color. Just it's important I think as investors and analysts to understand how decisions are made, why decisions are made, what was considered. We certainly seen a lot of Board members become CEO, so then a process being run and that is somewhat of a concern from the investment community that we want to better understand. So I appreciate the openness.

Tom Ray

Thanks Michael. And thanks for your support and collegiality over the years.

Operator

Our next question comes from Colby Synesael with Cowen & Company. Please state your question.

Colby Synesael

I just want to echo congratulations, Tom, and best of luck. Two questions for you. You guys mentioned in your prepared remarks that the second-quarter leasing represented a good shape of leasing going forward. And I think the leasing numbers were little bit lower than what we've seen for the last few quarters. And I'm just curious: is that really indicative of a lack of supply that you might have relative to where the market opportunity is? Is it that the opportunity itself is actually perhaps lower than what it's been the last few quarters, or is it really maybe a shift perhaps in the strategy to some degree. Maybe I'll let you comment on that. And also I guess my second question is Tom, I'm assuming this is the last time we'll have you on an earnings call. And I'm just curious. How do you think of the health of the industry at this point or at this juncture, particularly in terms of where a lot of the demand has been coming from? And I guess even more specifically as it relates to the wholesale business? Thanks.

Tom Ray

Sure. As to the shape of leasing, we would again encourage everybody to think about our business the way we think about our business. And I don’t think there is any change in the strategy related to how we’ve been thinking about the business. And that is we have our core co-location business, and frankly Q2 was terrific. It was the total annualized GAAP rate on the Q2 was 21% above the trailing 12, very, very solid performance. I think our second highest posting in all-time. We had a highest posting of transactions recorded in all time and Steve and his team did a phenomenal job, executing on the business plan in co-location. In addition to that we’ve always maintained this opportunistic approach to wholesale leasing.

And if you look at our trailing wholesale leasing, most of our larger wholesale deals have been getting done Virginia and Santa Clara, where we’re lighter on inventory at the moment. And so we are active in looking for opportunities to grow further. I am confident in our ability to do that in those markets. But over the next six to 12 months, I think you’ll see a greater -- greater proportion of the mix will be in co-location. But the total dollars in that has been trending up nicely and the Company is very focused on trying to help support that continued. And I don’t believe, of course about the wholesale business.

So I think Paul is extremely well versed in this as is significant -- if you look at the number of the people in the management team, very capable of executing in that space and I think with more land and more buildings actually down the road, you will see the company maintain its strategy and see that lumpiness in wholesale growth and hopefully continued growth in co-location sales. And we’re extremely pleased with Q2.

Operator

Our final question comes from Matthew Heinz with Stifel. Please state your question.

Matthew Heinz

First question is for Tom. First off, just wanted to reiterate best wishes in the future and congratulations on everything you’ve achieved of course out over the years. I can appreciate that your reasons for retiring maybe personal. But I was just curious if there was any friction between yourself and the Board that may have accelerated this announcement.

Tom Ray

I think our relationship has been enormously professional and I think the record is clear for the enormously productive. I’ve been pleased and honored to be a part of this entire journey from suit to nuts. And we have smart caring committed professional people on the Board and in the organization. And together we’ve accomplished things that we feel good about.

Matthew Heinz

And then there is a follow up for Jeff. I was hoping you could just provide some more specific commentary on the drivers of your guidance increase, particularly on the revenue side. I think you had mentioned stronger year-to-date performance in the prepared comments. But just on the bookings, relative to trend, I can appreciate there is a difference in mix there. But was a little lower in dollar terms. And just curious if there any implied uptick there or what was the moving parts in the guidance?

Jeff Finnin

Good morning Matt. If you just look at the guidance, I’ll just walk you through the increases in revenue. If you look at it on a per share counts, we’re up $0.03 per share in the revenue guidance. That’s largely attributable to the interconnection product and the growth of that business that we’ve messaged. As I mentioned earlier, our guidance coming to this quarter was we expected growth of somewhere around 17% to 19% as you continue to think of the business and the next six months, we believe that that growth will be at the top end or slightly ahead of that, top end of that range. And so that’s largely attributing to the outperformance on the revenue.

Secondly on adjusted EBITDA and then FFO, you can see the increase is equal about $0.04 per share, which ultimately is our increase at the midpoint of guidance. And that’s largely because we’re contributing and have the revenue growth flow through higher than anticipated coming to this year, and that’s based on some product mix and getting better margins than what we anticipated through various of our products. And so all that combined leads you to the $0.04 increase at the FFO line.

Operator

This does conclude our question-and-answer session. I would now like to turn the call back over to Mr. Thomas Ray for closing remarks.

Tom Ray

Thank you. To wrap things up, I’d like to just take a minute to offer a few more words, and thanks to more of the people who helped CoreSite to become what it is today. Forgive me if it's a bit like in the county towards beach, but these people deserve our recognition. And I am going to take this brief moment as it presents itself. In addition to our investors, our coverage analyst and the Board, as I thank you at the beginning of the call, I’d like to thank the Carlyle Group, including Jim Attwood for his service to and support of the Company. And in particular Rob Stuckey, for making the founding investments in what became CoreSite, sharing the vision of what the Company could become, and giving me the opportunity to lead the organization.

My wife and then my family are changed because of that, and I am grateful. I’d also like to thank colleagues who helped forge this CoreSite and we moved on to forming, including Deedee Beckman, David John, Billie Haggard, John Savago and Rob Rockwood, among many others. And finally I’d like to thank the men and women of today’s CoreSite. I’ve learned a great deal from and have deeply enjoyed working with some of the best leaders I’ve ever known.

This includes our team members, Geoff Danheiser, Jeff Dorr, Jeff Finnin, Derek McCandless, Ryan Oro, Steve Smith, Dominic Tobin, and Brian Warren. As well as some long time and newer colleagues, Julie Brewer, Eric Brownfield, Therese Kerfoot, Matt Mill, and again many, many others, to each of you and many more talented and hardworking people who helped build this Company. It’s been my privilege and honor to serve with you to share CoreSite’s wonderful journey and to call you friend. I am better person for our time together, and I am grateful to and grateful for each of you.

With that, I’ll certainly turn over to Paul and I am confident he’ll bring extraordinary intelligence, strong business acumen, and principal guided leadership to the Company on the next leg of the security. Thank you very much and best wishes to all.

Operator

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

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