Digital Realty Trust Inc (DLR) 2012 Q3 法說會逐字稿

Hello, my name is Regina and I will be your conference operator today.

At this time I would like to welcome everyone to the Digital Realty 2012 third quarter earnings call.

All lines have been placed on mute to prevent any background noise.

After the speakers' remarks there will be a question-and-answer session.

(Operator Instructions)

I would now like to turn the conference over to Ms. Pamela Garibaldi, Vice President of Investor Relations and Corporate Marketing.

Ma'am, you may begin.

Thank you.

Good morning and good afternoon everyone.

By now you should have received a copy of the Digital Realty earnings press release.

If you have not, you can access one in the Investors section of our website at www.digitalrealty.com or you may call 415-738-6500 to request a copy.

Before we begin, I'd like to remind everyone that the management of Digital Realty may make forward-looking statements on this call.

Forward-looking statements are based on current expectations, forecasts and assumptions that involve risks and uncertainties that could cause actual results to differ materially.

You can identify forward-looking statements by the use of forward-looking terminology such as believes, expects, may, will, should, pro forma, or similar words or phrases.

And by discussions of strategy, plans, intentions, future events or trends or discussions that do not relate solely to historical matters, including statements related to rents to be received in future periods, lease terms, development and redevelopment plans, supply and demand data for data centers, data center sector growth, targeted returns, cap rates, acquisitions, leasing and investment activities, capital markets, and finance activities, debt maturities and covenant compliance, expectations about the Company's growth, financial resources and success, and the Company's future financial and other results including the Company's 2012 guidance and underlying assumptions.

For a further discussion of the risks and uncertainties related to our business, see the Company's annual report on form 10-K for the year ended December 31, 2011 and subsequent filings with the SEC, including the Company's quarterly reports on form 10-Q.

The Company disclaims any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

Additionally, this call will contain non-GAAP financial information, including funds from operations or FFO, adjusted FFO or AFFO, core FFO, earnings before interest, taxes, deduction and amortization or EBITDA, adjusted EBITDA, net operating income or NOI, and cash NOI.

Digital Realty is providing this information as a supplement to information prepared in accordance with GAAP.

Explanation of such non-GAAP items and reconciliations to net income are contained in the Company's supplemental operating and financial data package for the third quarter of 2012, furnished to the SEC and available on the Company's website at www.digitalrealty.com.

Now I'd like to introduce Michael Foust, CEO and Bill Stein, CFO and Chief Investment Officer.

Following Management's remarks we will open the call to your questions, which will be limited to one per caller.

If you have additional questions please feel free to return to the queue.

I will now turn the call over to Mike.

Thank you, Pamela.

Welcome to the call, everyone.

I will begin today's call with an overview of our operations as well as an update on activity in our major markets.

After my remarks, Bill will discuss our 2012 guidance, third quarter financial results, and recent capital markets activities.

Following his remarks, we will open the call to your questions.

While slow economic growth in the US and abroad has delayed the decision making process of many enterprise customers, based on our strong sales funnel and the investment opportunities we see in the market, we are very optimistic about the growth prospects and the near and long-term outlook for our business.

In fact, we are on the offensive.

Taking advantage of our strong balance sheet and financial resources to continue to both expand our portfolio through new development and leasing, and to be the consolidator in the industry, consistently making accretive investments of strategic data center portfolios and individual properties.

Our deep team of professionals continues to execute this broad growth strategy that is unique in the data center sector.

Turning first to our leasing activity.

During the quarter we commenced leases totaling approximately $26.9 million of annualized GAAP rental revenue, including approximately $800,000 of colocation revenue.

Year-to-date, as of September 30, 2012, lease commencements totaled $82.6 million of annualized GAAP rental revenue.

As stated in our earnings release this morning, we lowered the high end of our leasing guidance range to between $130 million and $150 million for the year.

The revised range includes our backlog of leases scheduled to commence in the fourth quarter of 2012, totaling approximately $29.2 million of annualized rental revenue.

In addition, our 2013 backlog of leases scheduled to commence currently totals nearly $35 million of annualized GAAP rental revenue.

Consistent with what we discussed on our last call, the decrease from the high end of guidance primarily due to the prolonged sales cycle, which has made the timing of signings and therefore the timing of commencements difficult to predict.

However, we continue to experience sustained growth in leasing activity.

For example, the revised range of $130 million to $150 million represents a 31% to 51% increase in annualized GAAP rental revenue over last year's commencements of $99 million.

And 2011 was 30% higher over 2010 commencements.

This is a continuation of the strong trend in growing year-over-year commencements.

We believe this projected increase remains impressive by any measure and reflects growing demand for our products despite the macroeconomic environment.

This compares very closely to what we experienced in 2008 when demand for our data center space continued to increase despite the state of the economy at large.

This positive trend is confirmed by a research report published by IDC last month, which identified the impact of economic uncertainties over the last several years in the US data center market.

The report stated, quote, organizations began to eliminate smaller less efficient server rooms and servers closets, while owners of larger data centers re-evaluated the scale and scope of IT systems housed in their data center.

The report went on to say, quote, the reduction of more limited data centers and the rapid expansion of larger data centers primarily built by a service provider will accelerate in the coming years, driven by three major forces.

One, efforts to extend the use of virtualization to the next phase with denser more finally tuned converged systems.

In other words this means that organizations are migrating toward automated pre-configured IT systems that the older enterprise-owned data centers can't support.

Second, growing investments in data center assets to deal with the content explosion that is reshaping many industries from media to healthcare to energy.

And thirdly, a shift to cloud architectures in the private area and business models in the public area that encourage greater use of third party data center facilities and assets.

We also believe that these macro trends in our industry, along with the steady progress we've made in our leasing during the year and our current prospect funnel belies the negative sentiment surrounding our sector.

In fact, we are currently tracking approximately 2 million square feet of demand.

This demand represents prospects in our sales funnel to whom we have made proposals that we believe have a 30% or greater likelihood of signing.

In terms of new lease signings, we signed a strong volume leases for over 228,000 square feet of data center space including co-lo and this totals 16.4 megawatts of IT capacity.

This IT capacity exceeds last quarter's volume of 12.3 million megawatts, as well as our prior four quarter average of 12.5 megawatts.

Excluding co-lo, the weighted average lease term was 116 months.

The US was by far our strongest region, accounting for approximately 211,000 square feet of data center leases signed in the quarter.

This includes 87,000 square feet of Custom Solutions, which we formerly referred to as Build-to-Suit, Custom Solutions in Houston at an average annual GAAP rental rate of $65 a foot.

It's important to note that the lease rates for Custom Solutions space vary project by project, depending upon the engineering specifications and the type of improvements required by the customer, and should not be made in a direct comparison to our TK Flex, Turn-Key Flex product.

For our Turn-Key Flex space we leased 124,000 square feet in the United States at an average annual GAAP rental rate of $142 per square foot.

The rental rate is largely in line with our prior four quarter US average of $145 a foot.

The slight decrease is largely due to leases signed in markets with lower development costs such as Houston, as well as in leases in Northern Virginia which might be in the most competitive market in the country.

We also completed leases in Phoenix and Silicon Valley, where we signed a new lease with a newly completed Turn-Key POD at our 1100 Space Park property in Santa Clara.

Turning to Europe.

We signed two small Turn-Key Flex leases in London totaling 10,000 square feet, one in our Red Hill facility and the other at the newly commissioned facility in Chessington.

The average annual GAAP rental rate during the quarter was $198 per square foot for that small amount.

No leases were signed or commenced during the quarter in the Asia Pacific region.

However, we do have a significant amount of active requirements there with leases signed already in October.

As we've said, lease rates and activity can vary widely market by market and region by region.

That is why we focus on cash return on investment targets of between 11% and 14% for our spec development.

Even without Singapore, which historically contributed to the high end of the range, the quarterly cash return on investment for TKF leases signed in the third quarter was a strong 13%.

ROI for our Turn-Key leases has been trending up in 2012.

For example, second quarter ROI was up 60 basis points over first quarter, and third quarter ROI was up 80 basis points over the second quarter average.

The expansion of our colocation offering is on track as we continue to build our leasing and deployment team to address opportunities.

Leases signed for co-lo space during the quarter totaled $1.3 million of annualized GAAP rental revenue, bringing our year-to-date total to approximately $3.4 million.

In prior quarters leasing activity from our co-lo offering was primarily driven by our 365 Main Street facility in San Francisco.

However, we saw an increase during the quarter in signings in certain of our Internet gateway data centers and other select DLR facilities as we gain momentum in those additional markets.

Turning now to our lease renewal activity.

In response to concerns around renewal rates we're including both cash and GAAP numbers in today's call.

We signed approximately 26,000 square feet of Turn-Key and Powered Based Building space at renewal rates that were up 15.7% on an GAAP basis and up 7.6% on a cash basis.

This includes approximately 14,000 square feet of Turn-Key space, an average GAAP rental rate per square foot of $127, which is up 16% on a GAAP basis and 7.8% on a cash basis.

On a square foot basis, 62% of expiring Turn-Key space was renewed in the second quarter, with an average lease term of 45 months on the renewals.

With so little rolling during the quarter, the lower than average renewal rate was primarily due to one customer that reduced a space in one property in favor of consolidating into new and expanded space in another DLR facility.

So we deliver a lot of flexibility to our tenants with multiple property solutions that often end up being very accretive for our shareholders.

Portfolio occupancy increased in the quarter to 94.2% compared to 93.5% in the second quarter.

The increase was driven by, one, the addition of over 75,000 square feet of space that was leased from our existing operating portfolio.

Secondly, the 99% leased Sentrum portfolio, and that's 99% net of redevelopment space.

Three, a second 94% leased property entering the portfolio upon acquisition.

Fourthly, lease space that was converted from our redevelopment inventory.

These additions were partially offset by the lease termination noted above and vacant space converted from our redevelopment inventory into our operating portfolio.

The same-store occupancy also increased to 93.4% from 92.9% in the second quarter.

Third quarter same-store NOI was relatively unchanged at $181.4 million, compared to $181.6 million in the previous quarter.

Excluding the non-data center Solyndra building in Fremont, third quarter same-store NOI for the Data Center Portfolio was $181.8 million, up 0.7% from $180.5 million in the previous quarter.

Same-store cash NOI, which we define as same-store NOI adjusted for straight line rents and adjusted for non-cash purchase accounting adjustments, was $161.8 million in the third quarter and that is an increase from $161.1 million in the second quarter.

Again, excluding Solyndra Building, third quarter same-store cash NOI for the data center portfolio was $162.2 million, up 1.3% from $160 million in the previous quarter.

I would now like to renew some of the supply and demand trends we are tracking in our US major markets.

We define supply as our best estimate of data center space that is either built-out or under construction.

Moving east to west, in the New York, New Jersey Metro we're currently tracking approximately 34 megawatts of potential demand.

This compares to 24 megawatts of available supply.

A healthy situation.

We currently have 1.6 megawatts of built-out supply in New Jersey with three 1125 kW pods under construction, as well as we have a capacity to accommodate virtually any requirement with our existing redevelopment inventory.

In Northern Virginia, we're tracking nearly 30 megawatts of potential demand.

This compares to approximately 27 megawatts of available supply.

We currently have 1 megawatt of supply built with three 1125 purpose-built data centers pods to be delivered in the second quarter of 2013.

And a new building that's currently under construction at our digital Ashburn Campus.

Dallas remains a very active market for us with limited available built-out supply.

We've identified approximately 26 megawatts of demand, compared to about 9 megawatts of supply.

Our current built-out supply totals 1.5 megawatts.

The construction of two new buildings continued on our Richardson Campus during the quarter, with the first two 1125 kW Turn-Key Flex data centers to be delivered in January of 2013.

So once again, we have very little exposure and we're working hard to bring on new supply to meet this demand that we're seeing in Dallas as well as other markets, including Virginia and New Jersey.

Silicon Valley demand has increased for the third quarter in a row with nearly 37 megawatts identified.

This compares to nearly 29 megawatts of supply.

We currently have about 5.1 megawatts currently under construction.

Turning now to our acquisition program, which remains central to our business model, and a key component of our growth strategy.

We will close approximately $1.4 billion of new acquisitions in 2012.

As we discussed in our last call, the completion of the Sentrum Portfolio demonstrates our ability to source, fund and complete accretive transactions that add stable, long-term income.

In addition, it delivers the opportunity to expand our global customer base and further enhance our operating scale and the depth of our technical and operations talent.

In addition, we continue to identify attractive single property acquisitions, such as the 286,000 square foot data center and office complex we closed recently in Aurora, Colorado.

The property consistent activities of three interconnected buildings and includes approximately 170,000 square feet of data center space.

It is currently 94% leased to two customers with a weighted average lease term of 10 years.

It's located near our Englewood, 8534 Concord Center Drive facility, in the suburban area, and expands our presence in the Denver market, contributing to our revenue stream of long-term, stabilized leases.

We remain committed to maintaining our dominant position as the market consolidator and we're currently tracking property acquisitions totaling more than $600 million globally.

Finally, I'll briefly review our growing development program.

We continue to ramp up construction to build out supply in select markets to meet current demand.

We have increased our design and construction team from 40 to over 50 professionals since last year.

Current development activity includes 468,000 square feet of Turn-Key space that is 31% pre-leased, 190,000 square feet of Custom Solutions space that is 100% pre-leased, and approximately 1 million square feet of Power Based Building, PBB space, for future inventory in key markets.

Detailed information on our development activity by market can be found on pages 20 and 29 of the third quarter supplemental package.

We are investing more this year in new construction than we have in our history.

We expect development spending to continue at this pace or higher going forward.

We believe that our disciplined investment management approach and superior balance sheet allows us to better manage market risk by diversifying our capital deployment across geographies and product types.

Our strategy is both unique in the marketplace and a critical component to our continued success.

We attribute that success to the team of dedicated real estate and technical professionals who continue to drive the growth of our business.

Year-over-year our team has maintained committed to excellence and innovation, delivering superior data center solutions to our customers while achieving attractive returns from our investment program.

This in turn continues to drive solid earnings growth for our shareholders.

As I said in my opening remarks, we're very optimistic about our growth prospects and the long-term outlook for our business.

I will now turn the call over to Bill.

Thank you, Mike.

Good morning and good afternoon, everyone.

I will begin my remarks today with a detailed discussion of our updated 2012 guidance, followed by a review of our financial performance and capital markets activities.

Please note that all per share results are on a diluted basis, diluted share and unit basis.

As stated in today's earnings release with better visibility towards our year end results, we are narrowing our 2012 FFO guidance range to between $4.40 and $2.44 (sic - see press release) per share, increasing the low end by $0.03 and reducing the high end by $0.04.

Furthermore, we now expect FFO and core FFO, which includes items that do not represent ongoing expenses or revenue streams, to be identical for the year.

As a result, this guidance represents expected FFO growth of 8.4% to 9.4% over 2011 FFO of $4.06 per share.

Reflected in the revised FFO per share range are the following assumptions, which have been updated since our last call.

We narrowed our range of revenue recognized from Digital Design Services to between $8 million and $9 million.

The high end of our development and redevelopment capital expenditures was reduced by $100 million to between $700 million and $800 million.

Our previous guidance also assumed losses from early extinguishment of debt of $30 million to $31 million related to the Sentrum acquisition.

After further research, it was determined that the appropriate accounting treatment was to record such cost as part of the acquisition, since Digital never intended nor was required by the contract to assume the debt and the related swaps.

The purchase price was adjusted to reflect the debt extinguishment and this treatment does not impact FFO.

Finally, as Mike mentioned in his remarks, we reduced the high end of our leasing assumptions range by $20 million to between $130 million to $150 million of annualized GAAP rental revenue contributed from the commencement of leases.

The updated range includes the year-to-date commencements of $83 million, $29 million backlog from signed leases that we expect to commence in the fourth quarter, and what we expect to sign and commence between now and the end of the year, based on our current sales funnel, which per this guidance will range between $18 million and $38 million in the fourth quarter.

Consistent with last year, and given the $20 million range in fourth quarter leasing guidance, we plan to provide 2013 guidance in January.

Let me now turn to the quarter's financial results.

As stated in today's earnings release, third quarter 20[12] FFO was $1.13 per share, up 11.9% from the third quarter of 2011 FFO of $1.01 per share, and up 3.7% from the second quarter 2012 FFO of $1.09 per share.

Adjusting for items that do not represent ongoing expenses or revenue streams, third quarter 2012 core FFO was the same as reported FFO at $1.13 per share.

Adjustments to FFO in the third quarter included non-core revenues of approximately $1.1 million, consisting of fees associated with the early termination of two leases.

These non-core revenues were offset by certain items that do not reflect ongoing expenses, consisting of $500,000 in transaction expenses, the majority of which was related to the Sentrum acquisition, and $923,000 in non-core expense adjustments relating to intangibles associated with the lease terminations mentioned previously.

The Sentrum purchase agreement contains a contingent consideration clause or earn-out.

This obligation expires in July 2015.

In accordance with Generally Accepted Accounting Principles an acquirer is required to recognize the fair value of such contingent consideration as additional purchase price.

At the acquisition date we accrued an $88 million liability related to the pending consideration.

Any future changes to the fair value of this contingent consideration will be reflected in earnings.

We've also recorded a $106 million deferred tax liability for the Sentrum Portfolio, as of the acquisition date, to reflect temporary differences between book and tax bases for items contained on the balance sheet to account for the tax effects of this business combination.

The deferred tax liabilities will be amortized over the lives of the underlying assets.

These liabilities are recorded in the line item, accounts payable and accrued liabilities.

Adjusted Funds from operations or AFFO for the third quarter of 2012 was $115.6 million, up from $101.2 million in the previous quarter.

The diluted AFFO payout ratio for the third quarter of 2012 was 82.5%, down from 85.4% in the last quarter.

Adjusted EBITDA at quarter end of $200.5 million grew by 30% from $154.3 million in the third quarter of 2011, and by 10% from $182.2 million last quarter.

As you review the balance sheet, you will see that accrued -- that account receivables increased by approximately $55.4 million from December 31, 2011, to $146 million at September 30, 2012, primarily due to the Sentrum acquisition, which accounts for about $40.1 million of the increase, as a result of quarterly rents that were billed in September and are due in October.

The remainder relates primarily to tenants in newly acquired properties and developed space coming online.

Accounts payable increased approximately $300.9 million from December 31, 2011, to $616 million at September 30, 2012, due primarily to the deferred tax liability and the contingent consideration recorded in conjunction with the Sentrum acquisition that I mentioned earlier.

The remaining increase primarily relates to construction and other property-specific accruals across the portfolio.

Turning now to the income statement.

Net operating income increased by $22 million to $211.8 million the third quarter of 2012 from $189.7 million last quarter.

Overall, this increase was primarily due to incremental revenue from new leasing and acquisitions.

Looking down the income statement, tenant reimbursements increased to $78.9 million in the third quarter, from $60.4 million in the previous quarter.

This $18.5 million increase is largely driven by seasonal fluctuations in utility costs and subsequent reimbursements which are higher in the summer months and an additional $3 million of non-utility reimbursements associated with the Sentrum acquisition.

The decrease in other revenues reflects termination fees relating to the Solyndra lease, which was recognized in the second quarter.

On the expense side, rental property operating and maintenance expenses increased to $106.7 million, from $87.6 million in the previous quarter.

The $19.1 million increase is largely driven by a $15 million increase in utility expense during the period, of which approximately $6 million relates to the Sentrum acquisition and the remaining relates to seasonal summer increases in usage and rates.

These utility expense increases are offset by higher reimbursements.

The balance of the $4.1 million relates to costs other than utilities, of which $1.7 million relates to the acquisition of the Sentrum portfolio.

NOI margins decreased third quarter versus second quarter by approximately 170 basis points, due to the loss of NOI at the Solyndra property this quarter, resulting from its bankruptcy, and the seasonal increase in utility reimbursements and expenses which inflates total revenue.

The decrease in equity and earnings of unconsolidated joint ventures was due to a $2.3 million gain associated with the disposition of a non-core property in the second quarter.

Tax expense decreased to $710,000 from $1.2 million in the second quarter, primarily due to a true-up of non-cash-deferred taxes.

Lastly, preferred stock dividends decreased to $9.8 million from $10.3 million, due to the conversion of 1.87 million shares of Series D convertible preferred stock into common stock during the third quarter.

Finally I'd like to review our recent capital markets activities, liquidity, and important credit metrics.

Over the last few months we have executed interest rate swaps, converting approximately 75% of the term loan balance from floating to fixed rate.

As of today, the all-in weighted average interest rate on the term loan is 2.325%.

This is consistent with our strategy of minimizing our financial risk while seeking to achieve the lowest possible cost of capital, given market conditions.

Year-to-date we've raised approximately $2.4 billion of new capital, which includes the $300 million US dollar unsecured notes offering, as well as a $300 million commitment increase on the global revolving credit facility completed during the third quarter.

On September 24, we completed the issuance of $300 million of ten year, unsecured notes at Digital's lowest coupon rate to date of 3.625% and a yield of 3.784%.

The coupon is 162.5 basis points lower than the 10 year coupon on our March 2011 unsecured notes issuance, and 87.5 basis points lower than the five year coupon on our July 2010 unsecured notes issuance.

This debt issuance further reduces our embedded cost of capital and improves spreads on investments.

We've also positioned ourselves for additional financial flexibility in future periods.

Certain covenants were modified to align the most recent indenture with the covenants included in our global revolving credit facility and multi currency term loan.

Modifications included a cap rate reduction from 9% to 8.25%, as well as an increase in the cross payment default cross acceleration threshold from $50 million to $75 million.

We also added language that excludes unconsolidated joint ventures from the calculation of total unencumbered assets.

Under the terms of this indenture at September 30, 2012, incremental debt capacity would be increased by $450 million.

We have almost $1.3 billion of immediate liquidity, which includes approximately $79 million in short-term investments and funds that can be drawn on our global revolving credit facility.

If this liquidity were fully utilized, we would remain in compliance with all covenants contained in the global revolving credit and term loan facilities, our Prudential Shelf Facility and other unsecured debt.

During the quarter we repaid a consolidated secured loan totaling $52.8 million.

In 2013, we have $226.8 million of ongoing principal amortization and debt maturities with a weighted average cost of 6%, which we plan to retire initially with proceeds from the revolver but will eventually replace with additional long-term unsecured debt and/or preferred stock.

Our net debt to adjusted EBITDA ratio was 5 times at quarter end, up from 4.6 times at the end of the second quarter.

Our GAAP fixed charge ratio was 3.7 times, compared to the previous quarter at 3.4 times.

And our weighted average cost of debt, including interest rate swaps, was 4.35% at quarter end, down from 4.67% as of last quarter end.

As a reminder, we manage leverage based on two key metrics, fixed charge coverage and debt to EBITDA.

Our plan is to maintain fixed charge coverage ratios in excess of the high twos, and debt to EBITDA in a range of 5 to 5.5 times.

As always, we welcome your comments and greatly appreciate your continued support.

Operator, we would like to open the call to questions at this time.

(Operator Instructions)

Jamie Feldman, Bank of America-Merrill Lynch.

Thank you very much.

I guess the big question here is how can we get comfortable with the remaining commencement guidance in the fourth quarter?

I know you laid out your pipeline of $29 million backlog.

Can you talk about the rest of it and where you stand on these leases and why we should be comfortable that you're going to hit that number?

Sure.

We've gone -- as I mentioned, the funnel is very full with prospects and prospects that -- to whom we've made proposals.

That was that 200 million -- I'm sorry, 2 million square feet of proposals.

And if we look at our prospects that we're negotiating leases with currently, that makes us very comfortable that we're going to achieve well within that range.

So from the amount of activity we're seeing, which is in excess of what we achieved in the third quarter, we're very comfortable with the amount of transactions that we're actively working to sign up and commence.

I guess a little more color.

Can you characterize where they are in the process, I guess as we're just thinking about what's to come, certainly the fiscal cliff is on people's minds, business decision making seems to be slowing down.

Why wouldn't these wait until next year?

I think what folks have -- maybe are in this environment are having trouble understanding, is that these are requirements that have to be in place now.

They have to be in place for customer requirements, in a lot of cases it's cloud providers and IT service providers who have customer contracts that they need to get up and running.

So they need to get this space going.

It's enterprise, some enterprise customers who have requirements, expansions, new applications that are going to save money and raise productivity that they need to get up and running early in 2013.

I can't give you the actual names of the customers, but many of these are repeat customers of ours that we have relationships with and we're actively negotiating leases.

So we're very comfortable that we're working on real deals with major international companies.

I'm looking at major cloud providers and managed service providers, international financial companies, system integrators who are providing space for international financial firms, international tech and Internet based businesses.

So it's a very wide range of customers that we're engaged with currently.

Okay.

And then just a final follow-up on the same topic, when you think about the second quarter earnings release and the guidance you gave them and now you're at the lower end, what's kind of changed in that number to get you to the lower end?

Well, I'd say we brought down the top end but we didn't lower the lower end.

We're very confident that we're going to be well within the range, with a substantial backlog of signed leases going into 2013 in addition.

Based on the activity, our folks are -- on the leasing side, I think I can safely say as busy as they've ever been.

Are these leases that got pushed out or some have fallen out of bed?

I assume you thought when you gave the second quarter number that the midpoint was the reasonable point you'd hit.

Yes, it's timing.

It's timing, just I'm looking at one particular lease as an example and the tenant and us all thought it was going to be signed in the second quarter and it's going to be signed next month.

So it's really not a matter of requirements not there.

In some cases it's a matter of timing.

Jamie, there's one deal that I know that was done away, that was pretty good size.

Okay.

I guess --

Right, in Dallas.

I'm sorry.

I was going to say, in the Southwest where because of the timing, our building wasn't going to be done in time and we thought that their timing was going to be a little more flexible, but we didn't have the capacity built yet.

Okay.

So does this suggest your 2013 -- some of the stuff getting pushed back, that you actually feel better about lease signings next year than you did three or four months ago?

Or commencing next year?

I think we've always been confident.

I think perhaps market observers haven't appreciated and we haven't done as good a job as maybe perhaps we could at that.

Demand for data center space of all sorts continues to expand at a pretty good clip, and that's what IDC is seeing.

That's what other firms like Forrester and Gartner are seeing, so we're comfortable and we've been very positive about the near-term and long-term growth of the business.

Okay.

Thank you very much.

Chris Caton, Morgan Stanley.

Sir, your line may be on mute.

Thanks.

I wanted to follow up on Jamie's line of questioning.

You gave demand in the market across I think four markets, New York, Virginia, et cetera, it added up I think to 127 megawatts.

I think compared to second quarter, that was 143, so I was hoping you could comment on the ins and outs of that funnel in terms of leases that are getting signed and new demand that's kind of coming into the funnel, how are those trending?

And then the users, how are they thinking about pricing as they kind of hang out in terms of trying to make a decision?

Where was their thinking on pricing three, six, nine months ago and where do they think they'll ultimately sign?

Sure.

On the demand side, from our polling of the market, a couple things.

There was some absorption, so customers got signed leases.

Also, we changed our methodology a little bit.

We were including federal government requirements, all in Northern Virginia, because that's what we were marketing to the different departments.

And so we've spread that out now to the actual locations, now that we have some better visibility as to where they want to be.

Thirdly, there were a few customers that, or prospective customers, that didn't move ahead, mostly in private equity backed co-lo companies.

But largely, I think it was absorption and how we were looking at our federal government program.

Thanks.

And then just on the pricing, how has their expectation on rate changed over kind of year-to-date in terms of in some of these markets?

I think customers typically are looking at -- because leases are long, they're looking at kind of average rents over time periods.

I would say generally that as I've been saying for the past several quarters, Northern Virginia's probably the most competitive and the market where we've seen the most decline in rents, though it really hasn't had much effect on our returns as we continue to get more effective.

Other markets, we're seeing the lease rates relative -- pretty stable year-over-year.

I think we've expressed that out of our 32 markets, some softness in Silicon Valley, some softness in Virginia and some softness in New Jersey.

But we're attaining good returns and other markets are pretty stable at very high returns for us, as we noted earlier.

Thank you.

Emmanuel Korchman, Citi.

Yes, it's Michael Bilerman here with Manny.

I just want to go back to the pipeline a little bit.

If we dial ourselves back a year to this call, the forward backlog for 2012 at that point was $37 million, this year it's $35 million, even though the portfolio has grown substantially in size.

So I sort of want to understand that a little bit in context of the sort of ramp.

And then when we think about what's still needed to not only sign, but actually commence in 2012, to hit the revised guidance you've put out, you're talking $20 million to $40 million of annualized rents.

It's still a big number.

Obviously it's nice to have backlog of $29 million that you already know, but that's still a very large number relative to your history.

And so what's unclear to us is there a couple of big leases in there that you got one $5 million, you got another one at $2 million, that gives us more confidence that we're going to get to those numbers.

And then just as a third part of that, we ended the second quarter, you talked about having a $41 million backlog for this year.

You commenced $26 million in the third quarter and now you have a backlog of $29 million.

Maybe you can just help us understand how that backlog -- how much came into the third quarter and how much went into the fourth quarter?

Generally, the leasing activity has been consistently growing in terms of requirements and we're seeing a lot of fourth quarter business that we've been engaged with for quite a while and folks are working hard on both the customer side and our side to get leases completed in the fourth quarter.

Like I said, our sales teams are busier than they've ever been.

We've got a number of large, relatively large leases, spread broadly across the portfolio that make us confident that we can -- in addition to the backlog that's signed and in place, that the funnel will allow us to make that range of commencements.

I think also folks get a little too wrapped up about does something commence in November or does it commence in February.

We're talking long-term leases here and that have long-term contribution to earnings.

So while we're confident of making our range, I think people get a little hung up on 60 to 90 days swings in activity.

Michael, the total backlog for this year and subsequent years is over $78 million.

So there's $29 million in Q4, but --

Right.

But this time last year you gave a figure of $37 million for 2012 which would be comparable to the $35 million for 2013.

So for something that should be accelerating I would have assumed at this point next year the pipeline would be even greater than it would not a little bit less.

Now, I don't know if that's because you have so much more coming in the fourth quarter relative to where you were last year, but I was just trying to bring it up as a point of reference.

And to Mike's comment about, yes, I think we all understand that long-term leasing's important but you also have to understand from the Street's perspective you started at $145 million to $180 million.

$145 million to $180 million became $130 million to $170 million.

$130 million to $170 million became $130 million to $150 million.

We can all understand that things take longer to occur, but at some point there is some element of, well, are things falling out of bed or are they just being pushed and if they're being pushed there's a immediate hit to the growth rate.

Yes, Michael, we've got -- that $35 million of backlog will very likely be much higher by the time we get to the end of the year for 2013.

So we're talking about the backlog as it exists today in October.

By the time we hit December, that backlog going into 2013 will certainly be larger.

Hopefully it doesn't come from the $20 million to $40 million that you still have to sign and commence this year moving into next year.

The last question is just on the 2 million --

Once again, Michael, I think you're really missing the point.

This is -- I mean we're talking about near-term leasing and the amount of activity is there and we're executing on it and it's fully 30% to 50% higher than last year in terms of commencement.

I think folks are losing sight that growth is there and it's been -- and it continues to be demonstrated.

The 2 million square feet funnel that you talk about, obviously the dollars associated with that would be completely different if it was Turn-Key or Powered Base Building.

What is the annualized rent related to that 2 million square feet?

I don't have that number.

I don't have it.

I don't have it calculated.

But it's a much higher majority now of Turn-Key spaces versus Powered Base Building.

The mix is clearly shifted for folks wanting the fully fitted-out solution, which --

Like a $200 million -- Right, so like a $200 million potential number.

I haven't added it up, but it would be substantial, yes.

Okay.

Thank you.

Jon Atkin, RBC Capital Markets.

Yes.

I'm interested a little bit in the co-lo business, and maybe give us an update on how you see that growing over time, as well as your propensity to sign tenant deals with co-lo and hosting companies.

Is that a type of tenant group that you would emphasize differently going forward in favor of other verticals?

And then during the prepared remarks you talked about I think October leasing in Asia-Pac and can you maybe talk about recent trends in Singapore, Australia, Hong Kong in that context?

Sure.

In terms of the co-lo business, we're focused on our existing buildings, switching Internet gateway buildings and other buildings where we have the high concentration of networks that is very attractive to the co-lo.

And where we have in place staff that we can leverage to very cost effectively bring that smaller footprint, higher touch business online across several buildings in the portfolio.

So that is going at pace.

We're making sure we're doing it in a very methodical way, so we have a high level of customer service that folks expect.

What's interesting is, if you look at a lot of the customers for co-lo, they are cloud providers, managed hosting providers, content distribution.

We're seeing folks that are doing gaming, online gaming with hand-helds.

There's a lot of really interesting applications that don't take a lot of space, and that's a good set of customers for our co-lo business.

I'm sorry, the -- oh, the other question about Asia-Pac.

Yes, we had a little bit of a lull in terms of signings, but not reflective of any decrease in the amount of business we're pursuing.

And we're seeing a lot of increased requirements from folks that are providing cloud services, managed services in the region.

So we're seeing those requirements being signed in Sydney and Singapore and it's still early days in Hong Kong.

We're a ways off.

But we have interest in Hong Kong, preliminary interest from both those sorts of folks, as well as -- especially for corporate enterprise and Internet companies, international Internet companies looking for additional space in both Hong Kong as well as in Singapore.

So we're very positive about the activity in Asia-Pac in general.

Thank you.

Vincent Chao, Deutsche Bank.

Hi, everyone.

Just maybe a follow-up on the Asia-Pac discussion and in the context of keeping the development pipeline going.

Just wondering if you could update us on Japan and progress that's being made there?

Yes.

I mean, we're -- our team's looking very hard at the Japan market.

Certainly Tokyo as well as Osaka.

While we don't have anything to announce as yet, we're looking very hard at opportunities because we do see a significant amount of demand especially from international firms with whom we have relationships who need expansion space or they need business continuance in areas outside the Tokyo region.

So it's something -- it's a market region in Japan that we're looking at very actively.

Okay.

And is that sort of the next step in Asia?

I would guess yes, with the focus that we're giving it, and certainly conversations on possible ventures in China as well.

But Japan is really on the front burner at the moment in terms of new markets.

Right.

That's what I meant.

Okay.

Thank you.

Ross Nussbaum, UBS.

Hi.

Here with Gabe Hilmoe.

A question on your rent spreads.

Can you give us a sense of how your in-place cash rents across the portfolio compare to the rents that you're either achieving on new and renewal leases or maybe in other words, what's the current cash mark-to-market on your portfolio?

I think there's a real question out there, given what DuPont announced yesterday.

Yes.

I mean, we have a very different portfolio than DuPont.

They have a much more limited portfolio geographically and a highly concentrated customer base in the Internet sector.

So it's really -- I'm not saying that's necessarily a bad thing but it's just it's different.

We have a much more diversified portfolio, so I don't have that calculation.

My estimate is we're probably up, I don't know, probably over all the portfolio, 5% to 10% would be the roll-up overall on rate.

On a cash basis?

Yes.

I would say so.

Because remember, we have a lot of leases that are legacy leases and leases in assets where we've done Powered Base Building leases many years ago.

Those, where the customer put the improvements in, that were originally leased as alternative use rents, now could see a significant uplift.

And that's been our experience with the PBB type leases, uplifts 10% to 15% for that component to the portfolio, historically.

Ross, we've had many over 20% uplifts on those PBBs and if you look at the lease rollover schedule, which I think is posted, you'll see there's a high concentration of PBB rolling over the next several years.

But across the blended portfolio you do think it's a positive mark?

Oh, definitely.

Okay.

The other question is, I wanted to try to go back on the question everybody's been asking about the backlog.

I just want to make sure I understand how you're defining it.

Are you defining the $29 million backlog as, those are leases that are already signed and set to commence this quarter?

Yes.

So in order to get to the $130 million to $150 million number for the full year to the midpoint of that there's another roughly $25 million of annualized lease revenue that would have to commence in addition to that backlog?

Is that roughly the right way to think about it?

Yes, $23 million, but close enough.

Okay.

My rounding's off.

Okay.

Last question is, you had mentioned at the beginning of the call your role as a consolidator and I guess the question would be how does your -- does the changing cost of equity capital influence how you think about the volume of activity that you would do going forward?

We're very bullish on the opportunities, and I think that something that the market has not valued highly enough when you look at the increase in stable, bottom line earnings that we've been able to deliver as a consolidator, and I think we'll continue to have a cost of capital advantage in the marketplace.

Along with, what's very important too is our technical expertise, that's very attractive to sellers because they know we understand the product, they know we have the wherewithal to close.

And that's going to continue to serve us very well and drive very stable earnings, increasing earnings as well as additional operating scale and many of these come with value-add opportunities as well.

So we're still quite bullish on our opportunities there.

Ross, the other point there is the portfolios that are out there, if they're large enough, they're looking to a possible public exit and clearly the multiples for the public exit have changed a fair bit in the last month.

If you assume that that will be trading to some discount to DLR and the other public companies.

Thanks, guys.

Rob Stevenson, Macquarie.

Good afternoon, guys.

Just a follow-up on Ross' question on pricing.

Where is pricing today, in rough order, for older seven to ten year old Turn-Key space in a market like Northern Virginia, as the leases there roll versus where you're putting people in on a price-point basis for brand-new space that you're bringing online?

We don't have much of that because our portfolio is pretty new in that market.

But I would say on renewals, you'll continue to see a high renewal activity at -- we would expect close to market rents.

Unless the tenant has a fixed uplift in their renewal option.

But we don't see much difference because in our portfolio, and we've seen this in other markets, where we have tenants renewing leases on ten year old space and that space is extremely functional.

Especially since we've seen -- we have not seen much of an increase in terms of power densities.

So folks, in terms of UPS, usually where you have to upgrade the space is adding more UPS, which we'll do from time to time especially if it's telco space that we want to turn into enterprise data center.

But the space is very functional, especially with the corporate enterprise or for your cloud and managed services, IT co-lo companies, they want space in that 100 watts to 120 watts a foot.

We built space in excess of 200 watts a foot for customers who want it but we think that space is very competitive.

Okay.

So you're saying that the perception out there that while new space, brand-new space may be something on the order of $130, that this perception that ten year old space as it renews is going down to $90 or $80 on a comparable basis is incorrect from what you've seen through your portfolio?

That's absolutely not -- that is incorrect.

It's absolutely not the case.

Okay.

Just for Bill, the $29 million of backlog, does that include what you guys have signed in October?

No, it doesn't.

Okay.

That would be additional.

Okay.

Is there a number that you guys have out there for October that you could give us?

You know, we really don't disclose quarter end data.

We certainly have signed leases since the quarter commenced but we don't disclose that information.

Okay.

Thanks, guys.

We could, it's just it gets messy when you start talking about partial quarters.

A little confusing.

George Auerbach, ISI Group.

Bill, you mentioned within the accounts payable and other accrued liability, a liability you recorded from difference in GAAP and cash, I guess book basis on the center portfolio?

What was the amount of that liability and for NAV purposes, should we view that as a sort of non economic liability?

The deferred tax liability is $111 million.

That's timing differences between GAAP and tax.

Is that not a real liability that we should sort of back out for NAV purposes?

That will be amortized, that liability will be amortized over the term of the lease.

Okay.

I guess early -- I'm sorry.

Cash is going to go out the door to pay taxes, but the tax going out the door to pay the taxes on a cash basis will be different than the expense that's recognized.

Okay.

And I guess the last question on the backlog from me, early thought on the '13 commencement outlook?

This year is sort of in the $130 million to $150 million range.

Could you just give us a sense, early thoughts on next year, is that number the same, higher or lower than the '12 number will be?

I think we'll certainly be at least on par.

It's probably -- I mean, it's early yet but we're thinking it should be a little higher.

Also on the development spend line, I think this year's $700 million to $800 million, early thoughts on next year?

It's going to be on pace.

We're kind of going as fast as we can.

And so I think it will be very similar.

Just look at the quarter --

Thank you.

Jordan Sadler, KeyBanc.

Just figured I'd follow up on George's question there.

Any early thoughts on FFO for next year?

That's a joke.

( Laughter ) Seems to be a big disconnect, Mike, between your tone and view of the world, the demand set, I mean for your product, and for what's going on in the technology sector relative to everything else in the world, and the stock's performance.

Your stock's down 25% from the peak three months ago.

I mean, we look at, everybody on this call, a lot of people on the call look at real estate from all walks of life.

The demand argument seems almost indisputable, on some level, for your space relative to everything else we have to look at.

Why is -- what's the disconnect here?

I mean, what seems to be the problem, do you think?

I think folks would be well served spending more time looking at the secular technology drivers that drive demand for growth in IT applications, growth in broadly IT services, what their companies are doing in terms of consolidating all these disparate data centers in a closet and getting them into new modern facilities.

Looking at a lot of the basic research that folks like IDC, Forrester, Gartner, Tier 1 Research, these folks do deep dives into these secular demand drivers and specifically about demand for data center space broadly.

So if you look at the growth in folks that are providing managed services, cloud services, content distribution.

Many, many who are customers and growing customers in addition to the enterprise sector, I think you'll see a lot of that information pretty clearly communicated and defined out there and I think maybe folks haven't dived into that information.

That would be very worthwhile.

Well, so I think -- I'm with you.

I understand the demand side.

But the market is suggesting something else, right, that there are other issues and they're keying off of things that are actually going on in the world, right?

DFT's report yesterday, I know you guys are very different.

Your report today, even though demand is -- I think you said stronger than ever and busier than ever for your sales guys, your commencement guide is down for the second quarter in a row.

That's not something we have come to expect from Digital Realty Trust and that's because of your track record that you've established.

So what's changing that we're sort of getting this negative stimulus if you will in the most recent months?

You mentioned the elongating of the sales cycle 90 days ago or so, but I mean, is they anything else out there?

Is it supply?

Is capital just more available?

Well, I mean, certainly there's more competition in certain markets but a big driver for us is that our -- in particular, the Asia-Pac market, we've had a couple of slow quarters and that is -- in terms of lease commencements and signings and that's picking up.

So I think Singapore and Australia probably have had a bigger effect and I think that's -- you're talking about a small data set of deals and we'll see the activity in Asia of signings and commencements pick up here over the next three to four months based on what we're working on.

Jordan, our plan assumed that Jurong, our initial lease plan, assumed that Jurong would be basically full at the end of this year.

It's probably going to be full mid next year.

So that's a six month delay.

We've got tenants that we're negotiating with and engaged with for almost the entire building there and we've got good activity on the new Sydney building and so we feel good about the activity.

It's just the timing is a little different than we initially anticipated at the very beginning of the year.

I mean, you guys are consolidating the space, right, you're the consolidator of the space, the biggest player in the space in terms of network neutral data centers in terms of controlling real estate.

And there's a couple other public players and some increasingly better capitalized smaller players, but not that many new players, from what I can tell, and you're going to be buying some of these guys that are already out there.

Don't you have the ability -- I step lightly here -- to sort of control price?

It's all about supply and demand.

Demand we know.

Supply is all about you and another guy.

Well, and there's --

And one of the other guy is only in four markets.

And you know, you have competitors in all the markets, many of the markets, that we're at a premium over, but they're keeping their lease rates flat.

And also remember too, there comes a point where you just can't keep going up on rate because customers will start to consider alternative build to suits for themselves and go back to the owner occupied model.

So we want to be mindful that we want to get deals done and not have folks reconsider owner occupied.

And we do a lot of business --

That's not what IDC is saying.

Right?

You read it.

I mean -- and we haven't heard of a lot of the bigger guys even building for their own account, recently.

But people will consider -- you don't have infinite pricing or else we'd have Los Angeles or distribution space at $50 a foot.

You know, I mean, it's not an infinite upward trend.

And there are competitors.

You've got folks like CyrusOne out there and they compete on price.

Some of the other folks that you mentioned compete on price.

We compete on quality of service and quality of service and high five 9s uptime and our deep professional staff for liability security.

So we're able to achieve a bit of a premium.

But you know, you've got a whole world of corporate services, tenant rep brokers and their job is to represent their customers aggressively and that whole real estate world.

So you just can't price all the time with a continuous upward trend.

But we're at very attractive 13% average unlevered returns on costs this past quarter, so we're pretty happy in the type of returns we're achieving on our developments.

Thank you.

I'll yield the floor.

I'd like to make a clarification on the signed and commenced for the quarter.

Midpoint's $28 million.

$18 million, $38 million, midpoint's $28 million.

Jonathan Schildkraut, Evercore Partners.

Thank you for squeezing me in.

Actually most of my questions have been asked and answered.

I would actually like a little bit more color on how the backlog works.

Historically or traditionally I would have imagined that you have a backlog number.

You do some signings -- that goes into the backlog.

You have commencements -- that comes out of the backlog.

That math doesn't seem to work.

If you could just explain how this backlog works, it would be really helpful.

Thanks.

That is how it works, yes.

We define backlog as signed leases.

We usually refer to prospects as our prospect funnel.

So backlogs are our signed leases and then once those leases commence then they're out of the backlog.

Okay.

Because last quarter you said you had $41 million in backlog, and you pretty much signed and commenced the same amount of leases and now you have $74 million in backlog.

Is it that the $41 million in backlog was only reflective of 2012 and there was always a separate 2013 backlog?

Yes, it's kind of continuous process.

All right.

Great.

There's been a lot of speculation that New York Stock Exchange is going to look to unload its two buildings, I guess one over here in New York and one in the UK.

And I was wondering if you had any perspective on that and whether those would be attractive assets?

You know, conceptually they would be attractive assets.

Always one has to look at comparison to replacement cost, because both -- our understanding is both of those assets would have a considerable amount of vacant space, vacant space that also -- that also needs to be built out.

Our understanding, there's a lot of shell space.

So any investment in properties like that, you'd have to be able to have a view that you could build out the space and be competitive in the market with other space, including space that we would build.

So kind of the -- I think a big question there on the investment thesis would be can you be in at -- all in at an attractive basis that would make you competitive leasing out the vacant space.

All right.

Thank you for taking the questions.

I will now turn the conference over to Michael Foust for closing remarks.

Great.

Thank you everyone and thanks for the great questions and comments.

As always, we're available to discuss and we very much value your observations and comments on the market and our business.

I do want to congratulate our team here at Digital, we're doing a terrific job and working hard to take advantage of the opportunities here.

So thank you Team and once again, thank you all for your time.

Appreciate it today.

Ladies and gentlemen, this does conclude today's conference call.

Thank you all for joining and you may all disconnect.