CoreSite Realty Corporation (COR) CEO Paul Szurek on Q4 2018 Results - Earnings Call Transcript

CoreSite Realty Corporation (COR) Q4 2018 Earnings Conference Call February 7, 2019 12:00 PM ET

Company Participants

Carole Jorgensen - VP of IR and Corporate Communications

Paul Szurek - President & Chief Executive Officer

Steve Smith - Chief Revenue Officer

Jeff Finnin - Chief Financial Officer

Conference Call Participants

Jonathan Atkin - RBC Capital Markets

Jordan Sadler - KeyBanc

Nick Del Deo - MoffettNathanson

Aryeh Klein - BMO Capital Markets

Richard Choe - JP Morgan

Erik Rasmussen - Stifel

Colby Synesael - Cowen & Company

Frank Louthan - Raymond James

Dave Rodgers - Robert W. Baird

Nate Crossett - Berenberg

Michael Funk - Bank of America

Lukas Hartwich - Green Street Advisors

Robert Gutman - Guggenheim Securities

Operator

Greetings and welcome to the CoreSite Realty's Fourth Quarter 2018 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the presentation. [Operator Instructions] As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host Carole Jorgensen, Vice President and Investor Relations and Corporate Communications. Thank you. You may begin.

Carole Jorgensen

Thank you. Good morning and welcome to CoreSite's fourth quarter 2018 earnings conference call. I am joined here today by Paul Szurek, President and CEO; Steve Smith, Chief Revenue Officer; and Jeff Finnin, Chief Financial Officer.

Before we begin, I would like to remind everyone that our remarks on today's call may include forward-looking statements as defined by Federal Securities Laws, including statements addressing projections, plans or future expectations. These statements are subject to a number of risks and uncertainties that could cause actual results or facts to differ materially from such statements for a variety of reasons. We assume no obligation to update these forward-looking statements and can give no assurance that the expectations will be obtained. Detailed information about these risks is included in our 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 supplemental information that is part of the full earnings release, which can be accessed on the Investor Relations pages of our web site at CoreSite.com.

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

Paul Szurek

Good morning and thank you for joining us. Today, I will share our key accomplishments for 2018, provide an annual overview of our business, and service models and share our 2019 priorities. Steve will then cover our sales results and initiatives to strengthen our market position and Jeff will take your financial results and our 2019 financial guidance.

Our 2018 annual financial accomplishments showed another solid year of growth including revenue growth of 13%, FFO per share of $5.06, reflecting an increase of 14.2% or 11.9% growth after adjusting for 2017 one-time non-cash charge, and declare dividends of $4.14 per share, reflecting 15.6% growth. We achieved one of our primary sales goals of substantially growing no logo acquisitions. Annualized gap rent sold to new logos in 2018 increased 81% over 2017, and we added many important new companies to our customer communities.

We also made significant progress on restoring our development pipeline in 2018. We placed in service nearly 172,000 net rentable square feet including data centers completed in Reston and Washington DC. We expect two new buildings under construction to come online in mid 2019 in Santa Clara and Northern Virginia, two of our biggest markets, and we proactively pursue further development in Santa Clara. In January, we entered into a contract for approximately 4 acre property adjacent to our existing campus to prepare for continued growth in that market.

On the operational front, we delivered an approximate 7% improvement in power utilization efficiency on a same-store basis, compared to 2017 due to wise investments in new infrastructure and an ongoing program of operational improvements. We also achieved our highest uptime as a company, what we call seven 9s of reliability, thereby improving customer experience and reducing our operating costs. We also rolled out significant product improvements this year. We upgraded our open cloud exchange to an SDN architecture, which makes it significantly easier for customers to provision cloud interconnection and enables us to add additional features in a more agile manner.

We also piloted and put customers in our first inter-market connectivity product and expanded our blended IP product. We also experienced some challenges in 2018. Our overall sales fell short of our goals. We underestimated the challenges selling when our occupancies were high and therefore capacity constrained, leading us to miss out on a number of good opportunities due to lack contiguous space. We expect this challenge will be mostly remedied as our SB8 and our VA3 Phase 1B buildings come online this year. We also expect to complete our LA1 expansion midyear, which will provide further opportunities.

Construction commencement at our LA3 data center project in Los Angeles is still on hold due to delays at the Los Angeles Department of Water and Power, and designing the power fleet for new facility, but we expect that design to be completed soon. On balance, 2018 was a solid year with much heavy lifting across our company to position us well for future years. Looking forward to 2019 and beyond, I would like to remind investors of the key components of CoreSite's items business model. Simply stated, we concentrated our activities in eight large metropolitan edge markets, which are rich in consumers and enterprises and where our extensive customer communities provide an outstanding platform for digital activities and transformation.

Our campuses are characterized by major interconnection nodes and numerous cloud on-ramps, which anchor large, energy-efficient, highly flexible data centers where the widest possible range of customer deployment sizes and densities can be accommodated and where customers can interconnect with each other via short run, dark fiber or virtual connections providing the maximum performance bandwidth, reliability, flexibility and security. Our primary target customers include first enterprises in these markets through our moving to co-location to reduce the data service costs while increasing uptime and performance, and interconnecting to a powerful hybrid cloud and network ecosystem.

Second, companies with edge needs in these markets; third, companies exchanging data traffic at these key internet points; and finally, companies who value deployments in these markets as part of a larger performance and cost strategy built around wide area network realignment. The flexibility of our model is shown by the range of leases we can accommodate. Our smallest new and expansion sales in 2018 was 1 critical kilowatt in our largest was 3 megawatts, and we have added significantly larger leases in the past years when we have more capacity to sell. We believe this speaks to the diversity of how we can drive revenue as we add new capacity. We leverage our service model to focus our leasing efforts on higher value deployments where there is a greater need for the components we offer compared to less differentiated offerings in the marketplace.

Our 2019 priorities include; first, to translate new construction and a more abundant sales including to larger scale deployments in our edge markets; second, to continue to focus on acquiring additional new logos; third, to continue to bring new connectivity and customer service products online to increase sales from new and existing customers; and fourth, to continue to deliver great customer experience and ongoing operational efficiencies. We believe these priorities and our other operating objectives will continue to drive value for our customers and employees and shareholders.

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

Steve Smith

Thanks, Paul. I would like to start with a summary of our quarterly sales and leasing results and then spent some time on product enhancements.

Turning to our sales results. For the quarter, we had sales of $4.2 million of annualized which included 16,000 rentable square feet at an average GAAP rate of $259 per square foot, comprised entirely of our core retail co-location sales. While our sales and scale and hyper-scale leasing were below our goals for the quarter, our performance included excellent growth to new logo additions, solid pricing and strong renewals. So, let me walk you through a few of these in more detail. We have discussed in prior calls, the goal of substantially growing new logos acquisitions in order to achieve greater diversity of our base, enhance our ecosystem and provide a platform for future organic growth. And we’re seeing some solid traction in that regard. Here are few highlights.

The annual GAAP rent for new logo additions in 2018 increased 81% over 2017. In addition, the average weighted monthly lease term for 2018 new low winds increased by about six months for new logos in 2017 and the majority of these 2018 logos were driven by process with ongoing logo growth for cloud and network providers. Pricing was also an important focus for us. For the quarter pricing on a new and expansion leases was consistent with a trailing 12 month average on a per kilowatt basis driven by continued execution in the core retail co-location space, which typically supports, better pricing and profitability.

Moving to scale leasing as Paul mentioned our capacity constraints impacted our sales opportunities primarily sells the scale co-location, which we believe will be addressed by our ongoing property development in our presale activity for projects nearing completion. We also have several markets for available inventory where we look to execute better and driving scale leasing. Renewals are another key aspect of the health of our business during the fourth quarter of customer renewals were strong with annualized GAAP rent of $22.5 million. Rent growth of 3% on a cash bases and 7% on a GAAP basis and rental churn of 1.9% for the quarter, which is better than expected.

So the fundamentals of our business remain strong with increasing growth from new customers at logos signing with CoreSite, existing customers including key strategic accounts choosing extend their term and expand their space with us, and core retail co-location pricing levels remain firm. Additional focus going forward will be on executing well in the skill segment as those opportunities align with our value proposition and available capacity. In my role as Chief Revenue Officer, we're evaluating opportunities to evolve or offerings in order to deepen our customer value or providing additional forms of revenue to the Company. We have been working directly and through partners with the goal of making it easier to customers to continue the digital transformation journey.

As such, there are several steps, we have delivered this year and look to expand as we go forward. In 2018, we upgraded open cloud exchange with SDN architecture; enabling easier on-boarding to cloud and SaaS providers as well as paving the way for future development; added Microsoft Azure Express Route private connectivity in our Silicon Valley and Northern Virginia markets; enabled enterprises with direct private connectivity between VMware and AWS in four markets including Boston, Denver, New York and Northern Virginia; introduced AWS' logical redundancy offering, a second native point of connectivity to AWS Direct Connect at our Silicon Valley campus; provided dedicated access to the Oracle cloud infrastructure in Northern Virginia and Washington DC campuses; enabled inner market connectivity; expanded the flexibility of our blended IP product and formalize the launch of our solution partner program to extend our reach and value through our ecosystem to help customers along their journey from IT assessment to transition services to ongoing support and management.

I hope this gives you a sense of our ever evolving customer centric initiatives in our data centers. We’re focused on the collective value of our solutions to customers as we enable them to execute against their business plans and grow the relationships among each other. Technology is driving higher expectations in all companies to make it easier and faster to do business with them. We believe, we are key resource for enterprises upgrading their technology to better support their business in the future. Enterprises that can drive a better digital experience for their employees, customers and suppliers should win in their respective industries. We expect to be the cornerstone of how they successfully deliver digital transformation.

With that, I will hand the call up to Jeff.

Jeff Finnin

Thanks, Steve, and Hello everyone. Today, I would like to share some highlights of our 2018 financial performance, review our detailed fourth quarter financial results, update you on our property operations and development, and provide you our financial guidance for 2019.

Looking at our financial results. Our full year 2018 results included 13% revenue growth, 14.2% of FFO growth per share, or 11.9%, after excluding a 2017 non-cash charge related to our preferred stock redemption. And adjusted EBITDA growth of 12.5% while maintaining an adjusted EBITDA margin of 54.4%, and declare dividends of $4.14 per share or 15.6% growth.

In 2018, we successfully access the capital markets and amended and expanded our credit facility which provided us $250 million of additional liquidity while extending our debt maturities as attractive rates. We were also an early adopter of the new lease and revenue accounting standards. So we've had that in our rearview mirror since the beginning of 2018.

Moving to our fourth quarter financial results. Our total operating revenues were $139.1 million for the fourth quarter, which was in line with the third quarter and reflected a 10.5% increase year-over-year. Operating revenues consisted of a $118.3 million of rental power and related revenue, $18 million of inner connection revenue and $2.8 million of office wide industrial and other revenue.

Interconnection revenue increased 1.8% sequentially and 10.9% year-over-year. FFO was $1.26 per diluted share and unit in line sequentially and an increase of 15.6% year-over-year or 6.8% growth after excluding the 2017 non-cash charge related to our preferred stock redemption.

Adjusted EBITDA of $74.6 million increase 1.1% sequentially, and 8.5% year-over-year. Adjusted EBITDA margin was 53.6% up 57 basis points from the prior quarter and down 100 basis points year-over-year, primarily due to the new lease accounting requirements that we implemented in 2018, higher power rates and increase property taxes.

Sales and marketing expense totaled $5.4 million for the quarter or 3.9% of total operating revenue. For the year sales and marketing expense was $21 million or 3.9% of operating revenues in line with 2017.

General and administrative expenses totaled $10.5 million for the quarter or 7.6% of total operating revenues. For the year, general and administrative expenses were $14.1 million essentially in line with our guidance. These expenses represented 7.4% of total operating revenues for 2018, compared to 7.8% in 2017.

In the fourth quarter, we commenced 23,000 of net rentable square feet of new and expansion leases at an annualized GAAP rent of $192 per square foot which represented $4.4 million of annualized gap rent.

Moving to backlog as of year-end projected annualized gap rent from signs, but not yet commenced leases was $9.9 million and $14.3 million on a cash basis. We expect substantially all of the GAAP backlog to commenced during the first half of 2019.

Turning to our property operations and development. Fourth quarter same-store monthly recurring revenue per cabinet equivalent was $1,537, reflecting a 1.6% sequential increase and a 6.3% increase year-over-year. Q4 same-store turnkey data center occupancy was 90.7%, an increase of 60 basis points sequentially. We ended the quarter with our stabilize data center occupancy at 92.8%, an increase of 40 basis points sequentially.

During the fourth quarter, we completed construction and placed into the pre-stabilize pool 25,000, net rentable square feet for our DC2 data center. We have a total of 271,000 square feet of data center capacity in various stages of development across the portfolio. This includes ground-up construction and VA3 Phase 1B of the and SB8 Phase 1, which together total 108000 square feet with $118 million incurred to date of an estimated $246 million.

Data center expansions at LA1 and LA2 which together total 45,000 square foot with $9 million incurred to date of an estimated $34 million. And preconstruction of LA3 and CH2, which together represent 118,000 square feet with $39 million incurred to date of an estimated $250 million to complete the first phases of these projects. Collectively, these projects total $166.4 million invested as of the end of the fourth quarter of the estimated $530.2 million required to complete the projects. For more details on our development projects please see page 19 of the supplemental information.

Turning to capitalized interest. The percent capitalize in the fourth quarter was 17.9% in the full-year percentage was 13.6%. For 2019, we expect the percentage of interest capitalized to be in the range of 20% to 24%, which is elevated compared to 2018 based on our development pipeline.

Turning to our balance sheet. Our ratio of net principal debt to Q4 annualized adjusted EBITDA was 3.8 times as of the end of the fourth quarter, we had $236.2 million of total liquidity, consisting of $233.6 million of available capacity on our revolving credit facility and $2.6 million of cash.

As a reminder, we announced last quarter that we expect to access the capital markets for $350 million to $400 million in the form of additional debt to term out the outstanding balances our credit facility. We expect the majority of the financing to be completed in the first half of 2019. As I stated last quarter, we are comfortable with modestly increasing our targeted debt to adjusted EBITDA ratio to 4.5 times.

I would now like to address our 2019 guides. For context, it's important to note that our guidance reflects our view of supply and demand dynamics in our markets as well as the health of the broader economy. We do not factoring changes in our portfolio resulting from acquisitions, dispositions, or capital markets activity other than what we have discussed today. And bear in mind that our guidance reflects coming into the year with constraints capacity due to high occupancy and significant new capacity expected to be available mid-year and beyond.

As detailed on page 23 of our fourth quarter supplemental information, our guidance for 2019 is as follows. Total operating revenue is estimated to be $580 million to $590 million, based on the midpoint of guidance which represents 7.5% year-over-year revenue growth which reflects the timing of our development pipeline in the current level of capacity entering the year.

Connection revenue is estimated to be $74 million to $77 million. This reflects 8.3% growth at the midpoint. General and administrative expense is estimated to be $42 million to $44 million, representing 7.4% of total operating revenue at the midpoint.

Net income is estimated to be $104 million to $109 million, representing $2.15 to $2.25 per share of net income to common shares, or $2.20 at the midpoint. Adjusted EBITDA is estimated to be $316 million to $321 million.

And at the midpoint reflects a 54.4% adjusted EBITDA margin and 7.6% year-over-year growth. FFO is estimated to be $5.21 to $5.31 per share in operating unit. At the midpoint this reflects 4% growth. As a reminder, this guidance reflects the plans of debt financing that I mentioned earlier.

Other guidance includes rental churn, which is estimated to be 6% to 8% for the full year. Cash rent growth on data center renewals estimated at 2% to 4%. And capital expenditures which are estimated at $400 million to $450 million, including data center expansion of $380 million to $415 million, non-recurring investments of $5 million to $10 million, tenants improvements of $5 million to $10 million, and recurring capital expenditures of $10 million to $15 million.

That concludes our prepared remarks. Operator, we would now like to open the call for questions.

Question-and-Answer Session

Operator

Thank you. At this time, we'll be conducting a question-and-answer session. [Operator Instructions] Our first question comes from Jonathan Atkin with RBC Capital Markets. Please proceed with your question.

Jonathan Atkin

So I was interested in Steve's comments about better execution on scale leases going forward. And if you could maybe elaborate a little bit about what that looks like apart from having inventory to sell, what is it on the execution side that you think can drive better success? And then on the product side, you mentioned the OCX, the Open Cloud Exchange SDN offer. Is that something that you're offering because you can in anticipation of potential customer demand or are you seeing meaningful takeaways already you've kind of ramp that products and active customer interest or is that more on the come? Thank you.

Paul Szurek

Great. Hey, Jonathan. Thanks for the question. As it relates to better execution, I think, you'll hear me say that consistently regardless of our results. But I do think we can and should do better, especially in the scale leasing and really across the board. As it relates to scale leasing with the inventory that we have today, there are a few pockets where we have availability to sell scale deals today albeit a few.

And I just think there is always areas where we can execute better as far as how we are aligning to the market, making sure that the market is aware of our -- our availability out there, how we're ensuring that our value is driven throughout the organization is making those decisions and that we position us in the most favorable light to win. So that's really just how do we ensure that those aspects come together and we continue to just try to get better in that regard.

As it relates to your question around OCX and SDN, it really just sets the platform up for us to be able to provide those capabilities and automating the provisioning of logical circuits across our OCX. We have seen some initial interest and we are encouraged by the future of what that can provide us, not only for intra-market, but also inter-market and some additional enhanced services as we go forward. So it's really just kind of setting the stage for the future.

Jonathan Atkin

Yes. So if I could just follow up on that. Are there any sort of use cases that you could maybe illustrate in a generic fashion, that would be driving that demand? And then a last one, perhaps for Jeff. You mentioned the PUE improvement. How would you translate that into kind of margin lift? So on a same-capital basis without the benefit of cross-connect growth, what kind of margin lift would you have seen the PUE improvement that you referenced in the script? Thanks.

Paul Szurek

Sure. So just to give you a couple of use cases, a great use case that we've already seen some demand for is where customers may be deployed in one market, but need access to a native on-ramp -- cloud on-ramp in another market, where they can access our Open Cloud Exchange, logically provision that circuit to gain access within our Open Cloud Exchange on the other end in different market and get that native connectivity. So that's a pretty common request, I would say.

Another that it would be -- a pretty typical use case would be where our customers are deployed in more than one market, where they may have an active, active type of environment or perhaps want to just load share their requirements between different markets and they can share those from a connectivity standpoint and be able to turn those up and down, based on the amount of demand and amount of traffic that they need. So just a couple of examples for you.

Now I'll let Jeff to answer your other question there.

Jeff Finnin

Jonathan, I would say that -- excuse me, in general, that PUE uplift contributed about 60 basis points to 70 basis points to our adjusted EBITDA margin during the year. And so those are some of the things that Paul has kind of messaged as we think about operational improvements during 2018 and that our team is continuing to focus on as we head into 2019.

Operator

Our next question is from Jordan Sadler with KeyBanc. Please proceed with your question.

Jordan Sadler

So Paul, in your opening remarks, you mentioned that the slower sales will likely be mostly remedied, I think, as it relates to additional capacity. And I'm just curious, is there something else beyond the additional capacity that you're focusing on to increase the sales effort?

Paul Szurek

Really just two things. One is the continuous improvement that we strive for that Steve mentioned and they do a great job here in Mali and the rest of the team and diving into every opportunity from the previous quarter, lessons learned, how do we change our approach for future opportunities. And we've seen a lot of success from that continuous improvement. The other thing is what you guys have seen happen in this space since it was created is that you have different waves and cycles of user demand.

And one year, we see a lot of scale sales in our markets and then those get filled up. And then in subsequent years, there's less of that. But then as those fill up, the cycle comes back. So I think having the capacity is a prima facie requirement for winning those deals. And I feel good about what we see out there in the industry in general and pipelines in general.

Jordan Sadler

Is there anything you could add vis-a-vis the cycle, where you think we are in terms of what types of customers have been slower to lease, which may be coming around in 2019.

Paul Szurek

So every side of the edge cycles are different than undifferentiated or hyperscale cycles. We had a big edge cycle in 2015 and 2016. It started tapering off in 2017 and 2018. But we're seeing good signs going forward for that, that's not a promise of anything, but I do feel good about where we are in the edge cycle.

Jonathan Atkin

And then along those lines, I was curious regarding the interconnection revenue growth assumption or guidance of 8.3%, is it obvious moderation from what you did in '17, but also from the pace in 4Q of 10.9% growth, down 8.3 for the year. Is there anything else embedded in there in terms of consolidation or churn that you could point to?

Jeff Finnin

Yes. Jordan. I would say that all of those items you mentioned, whether it's some of the consolidation just some of it associated with some churn are all embedded into those estimates. But I think if you look at the past two to three years, you can see that has decelerated by 200 basis points to 300 basis points per year, largely driven off of the volume growth.

To the positive side, what we continue to see is customers that migrate from a certain volume to a higher volume product which obviously increases price. And so while you may not see volumes, our overall volume increase from a per unit basis, overall pricings continue to go up just as they migrate to a higher priced product, we continue to see that, but all of that has been embedded into that -- those estimates. As you point out, the midpoint is about 8.3%, the range is somewhere around 6% to 11% and we'll just see how we perform as we work through the year.

Jonathan Atkin

Okay, thank you. Hey, Jeff, just while I have you there. The commencements, I noticed you didn't provide any specific commentary for the year. Is there any number that's embedded at the midpoint here that you could point to beyond the backlog you talked about?

Jeff Finnin

Yes, I mean the -- obviously the backlog as I mentioned, you got about $9.9 million call it $10 million that we've got visibility into for next year. And the remaining of those commencements are going to be largely dependent upon our leasing results and some of that is dependent upon our construction deliveries. And so, we'll continue to update as we work through the year. In terms of trying to estimate that, I would just point to whatever our high-level revenue guidance is, and our churn estimates, and make some estimates on estimated timing of leasing and commencements of -- gets you there based on the high-level revenue guidance we've provided. And we'll continue to update you guys as we progress during the year.

Operator

Our next question comes from Nick Del Deo with MoffettNathanson. Please proceed with your question.

Nick Del Deo

First one is for Steve. You noted the revenue booked from new logos in 2018 was up 81% versus the prior year, which is a pretty substantial change. Can you talk about some of the specific initiatives you undertook to help drive that results? And were there particular selling point you found to be particularly effective in getting new enterprises on board?

Steve Smith

Sure. Well, thanks, Nick. Thanks for the question. I mean, yes, there was one area that we did see some good traction on, I think, is an important aspect. We've mentioned it on prior calls, where that was a key focus area for us even, I would say, more than a year ago where we wanted to really provide more diversity across our base, be less reliant upon our existing customer base for our future growth and just enhance the ecosystem, and that's been the real impetus for this whole initiative.

But there's been really a concerted effort both from our sales, marketing, product teams, our channel team really across the board to ensure that we drive the right messaging, the outright outreach that we align our incentive plans, all of those kind of things to ensure that we really motivate all over is in the water toward -- rolling toward those new logos. So, I'd say, it's really kind of a combined effort there as well as just looking at the industries that we've -- that have been adopting CoreSite, those that value our value proposition.

And really trying to get better at identifying through internal as we call it customer knowledge of those customers that tend to buy from us, and how do we target more of them to just get smart about where we spend our money and where we spend our time to better attract those logos. So it's really just a combination of all those things.

Nick Del Deo

Okay, that's helpful. Then maybe one on Santa Clara specifically. Note that's historically been a very good market for you guys in part, because it's hard to bring new capacity online, it seems like there has recently been a spike in projects under development there with a lot of capacity in various stages of development. How do you see that influencing that market over the next couple years? And are you confident you can get your desired returns on SV8 and the facility you plan on building on the parcel you just acquired?

Paul Szurek

This Paul, Nick. We feel good about Santa Clara market. There is always room for more participants in that market. But we like our campus ecosystem, the value that it drives, the performance that it drives, that's why we are -- despite those new participants in the market, we're continuing to look to expand that campus, as I mentioned in my prepared remarks.

Operator

Our next question comes from Aryeh Klein with BMO Capital Markets. Please proceed with your question.

Aryeh Klein

Paul, I think you mentioned earlier that LA3 construction has been delayed a little bit more. How does that impact your previous outline for 2020 growth as it relates to revenue, EBITDA and FFO? Do you still feel comfortable returning to the double-digits there?

Paul Szurek

I do. And I don't expect this to be a significant delay, although it's a bit of a disappointment. And let me just be clear, I have a lot of sympathy for these power companies that got to manage these grids, and I'm guessing there's more sensitivity around this today than there was in the past. So I get it, they want to get it right, we want them to get it right, and we're hopefully very close to resolving that and being able to start construction in the first half of this year. So it shouldn't meaningfully move from where we were expecting it in the past, but it could be a quarter or two maybe slightly more from what we had previously.

Aryeh Klein

Okay. And then, as far as you mentioned the positives from new logo growth, what are you seeing from existing customers? How are they growing their footprints and do you still feel confident about that side of the business?

Paul Szurek

It was a little bit lighter in 2018. And I would refer you back to my -- the comments I made earlier about cycles of demand in various areas. I think we'll see that be better in 2019.

Operator

Our next question comes from Richard Choe with JP Morgan. Please proceed with your question.

Richard Choe

Hi. I just want to get a little bit more color, I guess, you have completed projects, pretty stabilized but completed it in Virginia, New York, in D.C., it seems like they've been pre-leased but the commencements haven't kind of come in. Can you give us a little more color on when they will start commencing and when we can see revenue coming from those projects? And I have a follow-up.

Paul Szurek

Some of them have already commenced and there's revenue in them, others will commence over this quarter and the next coming quarters. Just want to give you a little bit of detail there, Richard. VA3, 1A is a pure co-location asset, so it doesn't really accommodate scale. And those take a wild lease up, but it's leasing up frankly handsomely right now. DC2 was really completed late in December, it had its first tenant signed up earlier this month. And so that's a very new asset and those new co-location assets tend to take -- they're more linear in their lease up whereas scale assets tend to be lumpier in their lease up.

Richard Choe

And giving the development table for 2020 and knowing it's little early. If you look at the megawatt numbers, they're relatively similar to the amount you're doing in 2019, should we expect there might be a little bit drop off in CapEx, but it really seems like the CapEx level for -- going into 2020 should probably be equal to 2019, would that make sense?

Jeff Finnin

Yes, just broadly speaking if you look at the megawatts for '19, we're looking at delivering about 19 megawatts, and 2020, it's only 12. And so I think, keep that in mind, I do believe 2019 would be elevated as compared to where we think 2020 will be at least as we sit here today. That may change based upon ultimate sales and absorption trends as we kind of work our way through 2019 and obviously will provide some detailed color around that as we get closer to to the end of this year. But I wouldn't expect it to be higher than what we're expecting for this year. If anything similar or slightly down based on where we sit today.

Operator

Our next question comes from Erik Rasmussen with Stifel. Please proceed with your question.

Erik Rasmussen

Yes, thanks for taking the questions. Just a kind of back-to-the-scale location, that obviously continues to be challenged and finished the year with roughly half the amount that you signed last year. So, given your guidance for 2019 and the capacity expansion plans you've talked about, would you say the 2018 was the trough and we'll see scale colo higher in 2019? Here, we're just trying to understand your comments about new leasing opportunities given a lot of the construction and development plans you guys have. Then I have a follow up.

Paul Szurek

So, yes, obviously our guidance implies very strongly that we expect 2018 to be a trough. And the the requirement of increased sales is you have to have capacity to sell, and it has to be the right capacity in the right markets. Our trademark has been, as I mentioned in our comments that we've been able to accommodate deployments from as small as a cabinet or sometimes even less all the way up to substantially larger requirements 8 megawatts, 9 megawatts and even occasionally a powered shell. We just didn't have anything like that kind of capacity to accommodate, accommodate those types of opportunities in 2018, but we will in 2019 and continuing further into 2020.

Erik Rasmussen

And then maybe in terms of your new development and construction projects, at this stage, how conservative do you think your development completion timeline is the one chart on 19 there, it seems that VA3 did slip the Q2. What were the factors there and then where do you see the major hurdles to hit your overall timeline on that chart. Thank you.

Paul Szurek

So we try actually -- and maybe we've taken the wrong approach to this, but we try to be really straightforward based on the documentation that we have in place. So when we're in the permitting phase for going off the advisor's estimates of how long it takes to get permits in a particular jurisdiction, I think, going forward, we're going to categorize that as pre-construction and not be as detailed as on in terms of when we will get permits, because it is very hard to predict in these markets.

And then in terms of construction, we go based on what the delivery date in the construction contract is in terms of when we expect delivery. Now those delivery dates can change based on weather changes, we've got a certain amount of allowances and contracts, and sometimes, there are unanticipated field conditions that can drive the delays. That's primarily what's going on with VA3 in terms of sliding from late in the third quarter to call it mid second quarter is a combination of site conditions and weather conditions in the Virginia market.

Operator

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

Colby Synesael

When we met with you guys at NAREIT in, I think, it was early November, it seemed like you guys thought pretty good about the pipeline for a scale deal at VA3 and that you're tracking various opportunities, and obviously, you didn't sign anything during the quarter. Curious if those opportunities are still there, they've gone elsewhere? And if the the delayed opening had had anything to do with it? And then also as you look to get that anchor scale deal with VA3, how are you thinking about pricing? I know in the past, even though the pricing has come down, are you willing to do deal at what you perceive now as the market -- the market clearing price or are you going to kind of hold in there and taking at the price that you want? Thanks.

Steve Smith

Hey, Colby. This is Steve. I'll take a shot at this and then Paul can chime in anything that I might miss here. But I would just tell you, as far as the overall pipeline is concerned for pre-leasing, whether it'd be in Virginia or in the Bay Area, activity still remains strong. We are having multiple conversations and we're still positive with the outlook. As far as any individual deals are concerned, not sure exactly which individual deals we're in discussion. But I would tell you that even customer requirements, especially of that size, move all over the place based on their dates, and when they want them or whether or not they remain a real opportunity. So the overall market in the pipeline still remains strong and we're optimistic about where we can go with it.

As it relates to pricing, we feel like we've underwritten the asset to where we can still absolutely execute against it and meet the returns that we underwrote. The market clearing price, I would say, there's not necessarily a market clearing price. So I think there's a lot of variables that go into what prices in any given market, but maybe especially in Virginia as to what customers value, whether or not they're willing to pay for it and how much scale they're looking to bring on board. So we feel like, based on the value, the ecosystem, the scale and size and the level of redundancy that we have built into the asset that we'll be able to meet the market.

Colby Synesael

Great. And then maybe just one for Jeff. You've taking your leverage target up from what has historically been sub-4 and this year it's 4.5 and in response to, I think, Richard's question, you noted that you expect CapEx next year to be down, but maybe similar. Once model would assume then that your leverage continues to go up as you go into 2020. Do you see that you just can't be taking up your leverage target further or are there other actions that you're likely to take?

Jeff Finnin

Yes, good morning, Colby. Those are items, it's going to be very dependent upon ultimately based upon our EBITDA growth in terms of where that leverage ultimately gets too. But more specifically, to your question, our leverage at 4.5 which we've messaged to, we continue to have those conversations with our Board when we meet and assess where we want to take that leverage, but that is one option that we would look at. There are other options that we need to consider based upon many factors in terms of the economics out in the marketplace. And so it's one lever we can pull, not the only lever. We just got to evaluate those with our Board as we work our way through the year and see how the lease-up is coming and ultimately the EBITDA growth associated with it.

Operator

Our next question is from Frank Louthan with Raymond James. Please proceed with your question.

Frank Louthan

So going forward, do we -- are we looking for more growth in the sales team or is it really just more -- is having some more inventory available to kind of -- to kind of get the to get the sales up? And then can you walk us through some other rent per the -- rent per square foot kind of have seemed to tick up a little bit in the quarter. What sort of the nature of the mix of those leases that was driving that uptick sequentially? Thanks.

Steve Smith

Hey, Frank. This is Steve. As it relates to the sales headcount, we had a couple of open positions, few open positions, I would say coming out of 2018 that we have now filled a couple of markets, for example, Chicago, where we have obviously new building coming on board where we expect to have better traction there and be prepared for that building coming online and just adjusting a few heads here and there.

But overall very consistent with where we've been in prior quarters and prior years. So I wouldn't expect any significant changes as far as total number of heads or dollars associated with them. As it relates to the rent and per square footage piece of it, I'll just give you those -- give you my perspective and then hand it up to Jeff. But the uplift was primarily driven just from increased density that we saw in the fourth quarter, whereas as we saw some of those smaller deals that were also more dense that drove the square footage dollar up in that quarter.

Jeff Finnin

Frank, the only thing I'd add to that is Steve did make a reference in his prepared remarks that our pricing on a per kilowatt basis was consistent with the trailing 12 months coming into the fourth quarter, and so that gives you a better sense for that density to drive some of that increase on a per square foot basis.

Frank Louthan

And how do you see that going forward? Is that just sort of anomaly in the quarter or it is the fact you had little more of the smaller deals versus some larger Hyperscale deals or you think you're able to take that density advantage going forward and drive some higher rents as we look out in our models?

Paul Szurek

I think it is pretty variable. I think we've seen that over time as that densities have crept up. So I think that trend will probably continue. I think Q4 was probably a little bit higher elevated primarily because of the fact we had just --such a concentration in retail and the smaller deployments. But I think in that segment and even in the skilled segment, you're seeing densities creep up a little bit.

Operator

Our next question comes from Dave Rodgers with Robert W. Baird. Please proceed with your question.

Dave Rodgers

Yes, hey guys. Maybe for Steve and tying on some comments that Paul had made earlier as well, but when you look at your completed pre-stabilized projects, the nearly 150,000 square feet, it sounds like a large portion of that not really colo scale available. So I was kind of curious, what the percentage of that portfolio is kind of leasable for scale colo? And then compare and contrast that to kind of what's under construction of the full out development pipeline, is all of that colo scale available? And then the third part of that question, just to be more confusing, is the 5,000 square feet that you use for the bottom of the scale colo portion of your business, is that too small? And is just the scale colo today for you needing to be substantially larger than kind of that low end of the bar?

Steve Smith

Yes, I'll give you a little bit of color on the scale versus retail. We don't necessarily break it out as far as which sites are specifically suited one for the other. But I would say in general, Paul kind of mapped this out earlier in his comments around our initial phase at VA3, which is primarily geared toward colo, the DC2 facility, which recently came online, is more colo oriented. Obviously the LA1 15th floor that we'll be building out this year, will be more colo-oriented.

As you look to our newer build, it's probably easier to look at them has been able to accommodate either, retail or scale or wholesale. Just on the modular fashion and you have a fresh floor plate that you can grow from. So, I think if you look at the next phase of VA3 for example, SV8, LA3, CH2, those are all able to accommodate both retail and scale or hyperscale.

Paul Szurek

Dave, this is Paul. I just -- I would point you to page 13 of the supplemental. And I think you can kind of get the picture that it's a combination of tight occupancies and the market spread of where we had capacity like Santa Clara 97.3% occupied, I think you can easily interpret what that means for the ability to handle scale there. NY2, 77% occupied, more capacity to handle scale, but a less strong market, and I think that sort of illustrates the dynamic that we've been working through in 2018 and we'll be solving in 2019.

Dave Rodgers

And then maybe a second question. I don't know, Jeff or Steve. But with regard to the Interconnect business, do you have any additional color or clarity commentary around the switching -- the larger switching gear of the customers and maybe any impact that you're able to kind of see now as we've gotten deeper into that process?

Jeff Finnin

Yes, Dave. I would just add that we saw, obviously, some of that occurring in 2018. I would say it moderated in the fourth quarter. What that looks like going forward is obviously, we have estimates associated with it and we'll continue to monitor, customer movement and/or changes as we work through the year. But I can't put a number on it for you, but it is, we did see it moderate in the fourth quarter.

Operator

Our next question comes from Nate Crossett with Berenberg. Please proceed with your question.

Nate Crossett

How do you guys think about land holdings in the long term? Obviously your product is dependent on having good locations and a lot of the markets you are in are tighter markets in terms of available supply. So how should we think about how you're positioning the land bank for the longer term? And maybe are there any new markets that are potentially on the table?

Paul Szurek

Nate about the land bank. And I think the new parcel we put under contract in Santa Clara illustrates our approach that we -- as we said the last several quarters, we need to be more proactive than we have been in the past about acquiring, entitling and getting shovel-ready land for expansion in key markets. And so we had a rush to get the SV8 land, the CH2 land and the VA3 land in position to develop, to acquire and put -- it get in a position to develop.

And we don't want to fall short like that again in the future. So we are active in all of our major markets to look for additional opportunities to expand. Land availability, property availability in these markets is the -- the supply can be somewhat a femoral. So you have to be in the market all the time looking for it, working on it, striving for off-market deals when you can -- and making them work in terms of connectivity and power and proximity. So again, look at the new land we have under contract in Santa Clara as an example of that. And I apologize, I forgot the second half of your question.

Nate Crossett

Yes, are there any new markets that could be on the table? And maybe just your thoughts on U.S. like are you always going to be only U.S. or are you open to expanding kind of internationally?

Paul Szurek

So let me try to answer this one. When we sit down with our major customers, really all the way down to the top 20 or 30 customers, the primary thing they value about us is that we keep expanding and these infill edge markets, where we exist. Because they have tremendous needs, they foresee significant needs during the future and they realize it is hard to proactively expand in those markets. That doesn't preclude us from going into other markets, when we can find the right conditions. And believe it or not, we do consistently look at opportunities, but we just haven't found the right ones. I think that would be more of a domestic thing if and when it happens, international may happen in the future, I wouldn't rule it out, but it's not something that we're focused on at this time.

Operator

Our next question is from Michael Funk with Bank of America. Please proceed with your question.

Michael Funk

Just a few for -- if you could. First you mentioned earlier the other waves in cycles in the industry. Just curious how you're thinking on positioning CoreSite is so called skate to where the puck is going strategically based and where you see the market? Second part of the question is somebody asked earlier how you're feeling about -- about the kind of scale demand in general. I guess the freight is slightly differently versus where you stood a beginning of 2018, do you feel better or worse about about scale demand? And then finally in the last piece of the question would be any kind of commentary on build cost and what you're seeing there on an absolute basis, and then just trajectory too? Thank you.

Paul Szurek

I would say we feel just as good about secular long term and intermediate-term and really even short-term demand at today as we did at the beginning of 2018. Using your hockey analogy, we just want to camp out in front of the goal, because we know that's where all the pucks ultimately end up. And having capacity in major metro infill markets that is crucial for low latency, high-performance applications for consumers and businesses, and as well as the Internet peering points, is a core part of our strategy and it's served us very well so far and we feel -- we still feel very good about that.

In terms of build costs, I think they have come up, obviously a little bit more, I would say than general overall inflation over the last couple of years. It varies significantly market-to-market, labor costs are probably the most variable dynamic. Our design team does puts a lot of work into not constantly, but regularly updating our designs to create a more efficient and cost effective way to build to offset some of those costs. Our construction management team works very hard to keep them in line and our equipment procurement team consistently works through our supply chain to try to offset some of that, but you're still seeing some construction cost inflation.

Jeff Finnin

Thanks, Michael.

Operator

Our next question comes from Lukas Hartwich with Green Street Advisors. Please proceed with your question.

Lukas Hartwich

Given the comments that leasing was held back by a lack of contiguous space, can you provide a little more color on frictional vacancy for the current portfolio?

Paul Szurek

I'm sorry, on what vacancy?

Lukas Hartwich

Frictional, is there -- I think you're in the low '90s right now, is there -- is that kind of a natural state, it's hard to get above that given the lack of contiguous space?

Paul Szurek

I mean, really, again, I'd go back to the my response to an earlier comment. It really varies by market, but yes, there are markets where we are so tight in the -- or buildings that we're so tight that. And -- I think when you get above 91%, 92% you see this a lot more where you just don't have those contiguous spaces where you can handle 1 megawatt deployment much less 2 megawatts, 3 megawatts, 4 megawatts.

Steve Smith

The only thing I would add to that is that I think our model does lend itself, in some cases, to tighten that up on occasion, because we do sell smaller deployments that in the right floor plate will allow us to fill that in tighter with smaller deployments, whether they are networks, smaller enterprises or the otherwise. So I think our model as opposed to being just focused on hyperscale where the -- either you have it or you don't, that's another reason why are we focused on trying to bring in more logos and get more diversity across our install base, so that we can fill in some of those other pockets.

Operator

Our next question comes from Robert Gutman with Guggenheim Securities. Please state your question.

Robert Gutman

So coming into 4Q, you'd expected I think 100 basis points of churn, extraordinary churn from the customer that churned about 70 basis points in the prior quarter. Net-net, the turnover came in lower sequentially, and I'm looking at guidance which is 6% to 8% for 2019. And I think you've prior set 2% to 2.5% per quarter through '19, which would be 8% to 10%. So how -- what's the color there on how your perspective on churn has changed? Secondly, if you could provide the number for new logos, which I think we have in prior quarters. And I have one follow up.

Jeff Finnin

I saw your note this morning. So I appreciate you raising the question. Just to give you some color on the fourth quarter, first of all. As Steve alluded to, our churn in the fourth quarter was better than anticipated. We had a good outcome ultimately with the customer we were renewing the fourth quarter. And while they did churn some level of their space, it wasn't as a high as what we anticipated. So I think, overall, that was good news.

In terms of 2019, the commentary I provided last quarter which is consistent with where we sit today is -- and we would expect elevated churn from somewhere between 2%, 2.5% in each of the two first quarters, so just the first half of the year. Second half of the year, we would expect that to be returning back to normal levels. So just factor that in, that should explain your question related to the guidance for the year.

Robert Gutman

Thanks. And a...

Jeff Finnin

Does that make sense?

Robert Gutman

Number of new logos -- yes, that's great. Thank you, and about the new logos, number of new logos?

Paul Szurek

What was the question around the number?

Robert Gutman

I think we've had a number, it was 27, 28 in the prior quarters.

Paul Szurek

Yes, sure.

Robert Gutman

So what was the number of new logos for the fourth quarter?

Paul Szurek

Yes, it was 32 this last quarter.

Robert Gutman

Great. And the last thing is that with DC2 coming on at the end of the fourth quarter, rental expense was pretty flat quarter-over-quarter. Should we expect that to be higher in the first quarter and then the impact -- your view on EBITDA margin through the year?

Jeff Finnin

Yes, great point Robert. The DC2 did come online very late in the fourth quarter. And so you will see an uptick here in the first quarter associated with that rent for that particular data center. And in terms of the adjusted EBITDA margins, if you look at our guidance, you can see that it's very flat compared to where we ended 2018. I think the implied EBITDA margin is at 54.4%, right in line with where we ended 2018.

Operator

Our next question is from Jordan Sadler with KeyBanc. Please state your question.

Jordan Sadler

Just a quick follow-up on the revenue growth guidance of 7.5%, Jeff, the total operating revenues. Do you have a breakdown of rental revenue versus power revenue growth?

Jeff Finnin

I don't, George. What I would utilize though, you can see where those percentages came out for the full year of 2018, I would use that same pro-rata allocation as you will look at your estimates for 2019. I don't think those are going to be moving meaningfully.

Jordan Sadler

Okay. So a similar split, I think, I had -- rental revenues were up 11% versus '17 for power something like that to a similar...

Jeff Finnin

Yes.

Jordan Sadler

Spread? Okay.

Jeff Finnin

I think that's fair.

Jordan Sadler

Okay. And then I was just coming back to the interconnection question. It sounds like maybe that cycle of equipment upgrades maybe slowing a little bit. I'm not sure if I read that correctly in your commentary, but what does longer term growth look like in terms of interconnection revenue in your mind sort of three to five year?

Jeff Finnin

Yes, I think, just maybe to clarify as it relates to some of the items that were impacting churn for the interconnection growth, I'm sorry in 2018. We alluded to some of the consolidation taking place inside the portfolio as one aspect of it, the second being some of the migration from 10 gig to 100 gig. And on the second, the migration, and there's only a minority of customers that really is applicable to.

And so it's hard for us to ultimately forecast when it makes sense from their perspective based on the volume of traffic they are moving through those switches. It is something that we watch and try to make estimates on. I don't know if it's going to moderate for next year or not, but it's something we continue to watch. But just keep in mind, I think, it really is only applicable to a minority of our customers that we haven't based today. And then I've missed the last part of the question, second part.

Jordan Sadler

I guess I'm just thinking like what does organic growth look for -- look like in the interconnection business three years or whatever as opposed -- you've seen this 200, I don't know, are we moderating by 200 basis points a year for the next three years or are we going to level off here at 8% is I guess sort of -- and I don't know if you can break that down between price and volume. I mean is price stable in cross connects or are the SDNs eroding price?

Jeff Finnin

Yes. No, that's a great question and that's in area that we continue to focus and put a lot of energy into in terms of evaluating how best to monetize the value of the ecosystem that's there today and how to balance that with customer expectations. And as Steve alluded to, we're looking at various products that might enhance that, we're going to continue looking at it. I wish I could give you a definitive number and where that heads. Clearly, we would like to see it moderate rather than continuing to decline and we got to figure out ways to make sure that happens.

Steve Smith

The only thing I'd tell you Jonathan is, if you look at the -- just the broader industry and technology as a whole, interconnection is not reducing, it's accelerating if anything. So the amount of interconnected things out there just continues to grow. And so I think that provides a good opportunity for the industry and for us as well and how we monetize that. We have physical versus logical interconnection, I think, is playing out as we speak and that's why we've made some of the investments around the OCX and providing the additional capabilities there. But I guess to answer maybe an embedded question that you had there around SDN eroding any pricing around physical cross connects, we have not seen that as of yet.

Jeff Finnin

Jordan, one more thing I've to add as you think about longer-term growth. And that is, I do believe that the interconnection revenue growth is fairly correlated to the volume of kilowatts we're selling and the type of deployments that we are selling. And so keep that in mind as you think about the growth in the outer years. I do think it's little bit -- it's more correlated with the volume of kilowatts that we're selling.

Jordan Sadler

That's fair. And no erosion in prices kind of what I heard on the physical cross connects.

Jeff Finnin

I think that's accurate.

Operator

Ladies and gentlemen, we've reached the end of the question-and-answer session. At this time, I'd like to turn the call back to Paul Szurek for closing comments.

Paul Szurek

First, thank you all for being on the call. Appreciate the interest and the good questions. One of the -- I forget which one of you and I apologize for that, but one of the analyst reports that came out overnight, mentioned that they were glad to have 2018 behind us, and for CoreSite. And I certainly appreciate that sentiment because it has been a year of transition from using up the native capacity that we had since IPO and moving into a new development phase of the Company.

I honestly feel very good about what the team accomplished in 2018. And I'm not referring to myself, I probably have a longer list than any of you guys of things that I could have done better. But the people that I work with here had a really remarkable 2018 in terms of putting together the building blocks for future growth.

From the construction progress that we made, the new land that we've entitled and started into the permitting and development process. The operational excellence and the high levels that we achieved in that and frankly greater efficiencies, the better power efficiency and there are a lot of other smaller building blocks throughout the organization in terms of IT and other areas that are really going to collectively be important as we go forward.

So it was from the outside, it was a year of a lot of work, a lot of grinding work, but I feel good about what the team accomplished and I'm very excited as we move forward into 2019 and beyond. So thank you very much for your interest and we'll talk to you next quarter.

Operator

This concludes today's conference. You may disconnect your lines at this time, and we thank you for your participation.