Digital Realty Trust Inc (DLR) 2017 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the Digital Realty Second Quarter 2017 Earnings Conference Call.

(Operator Instructions) Please note that this event is being recorded.

I would now like to turn the conference over to John Stewart, Senior Vice President of Investor Relations.

Please go ahead, sir.

Thank you.

The speakers on today's call will be CEO, Bill Stein; and CFO, Andy Power.

Chief Investment Officer, Scott Peterson; Chief Operating Officer, Jarrett Appleby; and SVP of Sales and Marketing, Dan Papes, are also on the call and will be available for Q&A.

Management may make forward-looking statements related to future results, including guidance and the underlying assumptions.

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

For a further discussion of risks related to our business, see our 2016 10-K and subsequent filings with the SEC.

This call will contain non-GAAP financial information.

Reconciliations to net income are included in the supplemental package furnished to the SEC and available on our website.

And now I'd like to turn the call over to Bill Stein.

Thanks, John.

Good afternoon, and thank you all for joining us.

The highlight of second quarter was, of course, the announcement of our agreement to merge with DuPont Fabros.

And I'd like to begin today by recapping the strategic merits of that transaction.

Our customers and the desire to better serve them through more offerings in more locations are the key reason and the primary strategic rationale for this deal.

This transaction is consistent with our strategy of offering a comprehensive set of data center solutions from single cabinet colocation and interconnection all the way up to multimegawatt deployments as represented here on Page 2 of our presentation.

At the far end of the spectrum, this combination significantly expands our hyperscale product offering and enhances our ability to meet the rapidly growing needs of the leading cloud service providers.

This deal is also consistent with our stated investment criteria shown on Page 3. The transaction expands our presence in strategic U.S. data center metros and the 2 portfolios are highly complementary.

The transaction is expected to be roughly 2% accretive to core FFO per share in 2018 and roughly 4% accretive to 2018 AFFO per share.

Last but not least, the combination continues to enhance the overall strength of the balance sheet.

DuPont Fabros owns a high-quality portfolio of purpose built data centers, as you can see from the profile on Page 4, and as evidenced by the 98% occupancy on the in-service portfolio.

The merger will benefit Digital Realty by bolstering its presence and expanding its product offering in 3 top tier Metro areas while DuPont Fabros will realize significant benefits of diversification from the combination with Digital Realty's existing footprint in 145 properties across 33 global Metropolitan areas.

In addition to world-class assets in high-demand metros, DuPont Fabros will also bring some outstanding team members and industry best practices that we look forward to leveraging.

Their culture of putting the customer first will complement our move towards becoming as customer-centric an organization as we've ever been.

Turning to the pro forma stack on Page 5. The combined company will be the ninth largest REIT in the index, with an equity market cap of approximately $24 billion and a total enterprise value of $33 billion.

The balance sheet impact will be leveraged neutral but given the exceptional credit quality of the customer base, the long lease terms and the high proportion of owned real estate, we would expect the combined company's unsecured debt profile should improve due to a broader investor base and greater liquidity that should, over time, result in an even lower cost of capital.

The benefits of this scale translate directly to operating efficiencies as shown on Page 6. DuPont Fabros has always run one of the tightest ships in the business and given the additional economies of scale and cost savings achieved through the transaction, the combined organization will have, by far, the most efficient cost structure and highest EBITDA margin in the data center sector.

DuPont Fabros is also unique in the data center sector in that it owns the dirt under all of its data centers.

The combined organization will likewise own the greatest percentage of real estate within the sector.

To sum it all up, we are very excited about this strategic transaction which will enhance our ability to serve our customers and hyperscale cloud customers in particular in the top data center Metro areas across the U.S. It will be accretive to earnings and cash flow in year 1 and strengthens our balance sheet.

The complementary nature of the 2 footprints, customer bases and product offerings provide mirror-imaged diversification and enhancement benefits and augment our ability to create significant long-term value for both sets of shareholders.

Along the lines of sustainable long-term value creation, I would also like to highlight the recent announcement that Digital Realty ranks sixth on the U.S. EPA's top 30 tech and telecom list of the largest consumers of green power and 12th on the national top 100 list of green power users.

We are proud of our sustainability initiatives, and we remain committed to manage our environmental impact and optimizing our use of energy and natural resources because we believe it's the right thing to do and because it matters to our customers.

Sourcing renewable energy is also important to many of our customers, including some of the world's largest consumers of data center capacity, and our ability to meet their needs for renewable and highly efficient data center solution sets us apart from our competitors.

Let's turn now to market fundamentals on Page 9. Construction activity remains elevated across the primary data center metros but leasing velocity remains robust and the industry has almost universally transitioned to a just-in-time inventory management approach, helping to keep new supply largely in check.

Our near-term funnel remains healthy, and we are currently chasing requirements from all of the leading cloud providers, including infrastructure as a service as well as PaaS and SaaS providers.

The size of these near-term requirements is generally smaller than some of the hyperscale deployments we saw in 2016.

But we see demand as broad-based and consistent, and we expect to see large requirements over the intermediate term.

In addition, vacancy rates remain tight across the board and supply constraints are building in top-tier Metro areas, notably, including Silicon Valley.

Competition remains intense, particularly for larger requirements and given the sector's recent history, any uptick in new supply bears watching carefully.

However, we are encouraged by the depth and breadth of demand for our scale, colocation and interconnection solutions.

And we believe tightening conditions bode well for long-term rent growth as well as the enduring value of infield portfolios like ours.

And now let's turn to the macro environment on Page 10.

While the timing and ultimate outcome of future policy remains uncertain, the current monetary, fiscal and regulatory climate is broadly supportive.

Economic activity continues to expand at a moderate pace but good enough to sustain continued growth.

In addition, a lot of expectations for the U.S. have recently been tempered somewhat, growth prospects in our global regions outside the U.S. have brightened of late.

Against a broadly supportive macroeconomic backdrop, a long-term secular shift to digital applications, such as cloud computing, machine learning, artificial intelligence and autonomous cars is driving robust data center demand.

We believe that we are particularly well positioned to capitalize on the favorable demand setup given our global platform, our comprehensive product offering and our fortress balance sheet.

And now I'd like to turn the call over to Andy Power to take you through our financial results.

Thank you, Bill.

Let's begin with our leasing activity here on Page 12.

Our total bookings for the second quarter were a little over $34 million, including an $8 million contribution from interconnection.

We signed new leases for space and power, totaling $27 million during the second quarter, including an $8 million colocation contribution.

We continued to leverage our competitive advantages to generate numerous second quarter wins.

We transacted in 20 of our 33 global Metro areas during the second quarter and the majority of our second quarter business was across multiple metros.

On the heels of the robust absorption in both Europe and Asia-Pacific during the first quarter, our North America region generated the lion's share of new leasing due to the timing of inventory coming online abroad along with strong second quarter signings on our campuses in Ashburn and Dallas.

The largest single deal was 4 megawatts and colocation and interconnection accounted for more than 40% of our total bookings.

We added 30 new logos during the second quarter, and we signed nearly 200 leases for space and power.

Including interconnection, we completed more than 800 transactions.

We continued to support the growth of various top cloud service providers across regions.

These wins include infrastructure as a service, PaaS and SaaS providers growing their footprint in multiple Metro areas.

Our multipronged strategy of serving enterprise customer demand, both directly and through various IT service providers and other partners, also continues to bear fruit.

We were able to directly support the growth of a longtime financial services customer with expansion of their footprint in Singapore.

Through our partner channel, we also added a top 3 U.S. money center bank as a first-time Digital Realty customer across 3 locations in North America.

We also built on our recent success in the health care vertical by landing a new hospital system with a partner on our Dallas campus.

The leading cloud service providers have recently announced the enterprise versions of their hybrid cloud offerings designed to be more conducive to supporting private data and security requirements.

These enterprise offerings should simplify hybrid cloud solutions and open new opportunities to serve enterprise customers either directly or through our partners in alliance program.

As mentioned last quarter, we see substantial opportunity for our partners in alliances program to create meaningful upside for our business over time.

Our partners and our customers value our focus on working with quality solution providers.

We feel good about our partner's growing ability to position our value proposition as part of their overall solution to their customers.

We are pleased with the progress during the second quarter, and we are encouraged by the momentum we are building.

In terms of integration, activities are proceeding as planned.

Our product rationalization workshops were held in June and we're now focusing on the steps necessary to create a consistent product portfolio and customer experience across all sites.

Ultimately, uniting all products, delivery models, operation support and billing under a common platform.

The teams are busy consolidating our back office systems, and we expect to have the 8 European assets we acquired on our new platform by the end of the year.

In terms of the financial results, we registered sequential gains in occupancy as well as revenues for the European acquisition portfolio for the second quarter in a row, reversing the trend of revenue declines that predated our stewardship.

With respect to DuPont Fabros, while it remains business as usual until the merger closes, integration planning is well underway.

Although this will be our largest acquisition to date, we expect a seamless integration after closing.

The DuPont Fabros portfolio consists of just 12 operating properties in 3 major Metro areas where Digital Realty has an existing presence.

In addition, DuPont Fabros has just 32 customers compared to 2,300 for Digital Realty.

Turning to our backlog on Page 13.

The current backlog of leases signed but not yet commenced stands at $64 million.

The weighted average lag between second quarter signings and commencements remain healthy at 6 months, in line with long-term historical averages.

Moving on to renewal leasing activity on Page 14.

We retained 72.5% of second quarter lease expirations and we signed a record $65 million of renewals during the second quarter in addition to new leases signed.

The weighted average lease term on renewals was over 8 years and cash re-leasing spreads were up a healthy 6.5% overall, with a positive mark-to-market across all property types during the second quarter, including another solid double-digit cash mark-to-market on PBB renewals and a consistent mid-single-digit mark-to-market on colocation renewals.

We do still have pockets of above market rents throughout the portfolio, and we currently expect to see a negative cash mark-to-market on our third quarter renewal activity.

On balance, however, cash re-leasing spreads were positive for the second quarter and we still expect cash re-leasing spreads will likewise be positive for the full year in 2017.

We continue to see gradual improvement in the mark-to-market across our portfolio driven by modest market rent growth and steady progress on cycling through peak financial lease expirations.

In terms of our second quarter operating performance, overall portfolio occupancy was down 30 basis points sequentially to 89.1% due primarily to recently completed development deliveries placed into service during the second quarter and 2 small expirations within our Internet Gateway billings in Dallas and Chicago.

Both of these footprints are currently being repurposed as colocation inventory and we expect to generate additional upside over time from lease of this space at meaningfully higher rents.

The US dollar softened somewhat during the second quarter although it also remains somewhat of a headwind relative to the second quarter of 2016 given the spikes following Brexit in June and the U.S. presidential election in November, as you can see from the chart at the bottom of Page 15.

As a result, while comps should begin to get easier in the second half of the year, FX still represented roughly a 150 basis point drag on the year-over-year growth in our second quarter reported results from the top to the bottom line as shown on Page 16.

Gain capital, cash NOI growth was 3.1% on a reported basis for the second quarter and 3.8% on a constant currency basis.

Core FFO per share grew by 8.5% on a reported basis and was up a little over 10% on a constant currency basis.

Core FFO per share was $0.05 ahead of consensus, although we do expect the quarterly run rate to step down in the second half of the year as shown here on Page 17.

In terms of the quarterly distribution, we now expect the first half will represent roughly 51% of full year results while the second half is expected to contribute roughly 49%.

As you may have seen from the press release, we are reiterating our guidance despite the $0.05 fee during the second quarter.

The primary reason we are standing pat on the full year guidance is the pending merger with DuPont Fabros.

In particular, the merger closing date remains uncertain whereas we expect to line up long-term financing as market conditions permit.

You may recall that we raised approximately $770 million on proceeds from a sterling bond issuance earlier this month whereas our guidance contemplated just $500 million of long-term debt.

We also expect to raise long-term financing in advance of closing the transaction.

We still expect to realize $18 million of annualized overhead synergies from the DuPont Fabros merger and we still expect the transaction to be roughly 2% accretive to core FFO per share in 2018 and roughly 4% accretive to 2018 AFFO per share.

However, these synergies will not be realized until 2018 and given the number of moving parts, we felt it best to leave guidance unchanged for the time being despite the outperformance in the first half.

With respect to AFFO, I would like to highlight again this quarter the long-term trend in straight-line rent as shown on Page 18.

This chart reflects several years of consistent improvement in data center market fundamentals as well as the impact of tighter underwriting discipline, which has driven steady growth on our cash flows and sustained improvements in the quality of our earnings.

The second quarter was particularly active on the financing front, with numerous steps taken to further strengthen our balance sheet over the past 90 days, which we've itemized here on Page 19.

In early April, we redeemed $182.5 million of high coupon preferred stock.

As mentioned on our last call, we booked a related $0.04 topic D42 charge during the second quarter, which is excluded from core FFO per share.

The preferred redemption was essentially funded, with $211 million of gross proceeds from settlement of the remaining forward equity offering we raised 1 year ago in conjunction with our inclusion in the S&P 500.

In May, we issued EUR 125 million of 2-year floating-rate notes to refinance borrowings under our line of credit.

The interest rate on these notes is Euribor plus 50 basis points or half the spread on our line of credit, for an all-in initial coupon of just under 17 basis points.

In late June, we refinanced and upsized the secured loan outstanding on the Westin Building, the premier Internet Gateway for the Pacific Northwest, which we own in a 50-50 joint venture partnership with Place Properties in Seattle.

This transaction led to a $3.3 million gain during the second quarter since total cash distributions from the refinancing and prior operations now exceed our investment basis in the joint venture.

The gain and the amount of excess distributions from the refinancing above our investment basis runs through the equity and earnings of unconsolidated JV line on the P&L.

Given the nonrecurring nature of the gain, it has been excluded from core FFO per share.

Last but not least, we raised a total of GBP 600 million sterling bonds or approximately USD 770 million in 2 tranches subsequent to quarter end.

The blended coupon on these tranches is just over 3% and the blended term is just under 10 years.

As mentioned earlier, this bond offering was contemplated in our original guidance given our recently expanded presence in Europe and consistent with our financing strategy of managing currency risk by issuing locally denominated debt to act as a natural hedge.

The amount of the raise was upsized, however, from 500 million at the midpoint of our guidance to 770 million.

We expect to use the excess proceeds to repay a portion of DuPont Fabros' debt in connection with the acquisition.

Of note, however, the 7-year tranche includes an SMR provision, which enables us to retire the debt at 101% of par in the event the DuPont Fabros transaction does not close by December 15, 2017.

Finally, as you can see from the left side of Page 20, we have a clear runway with nominal debt maturities before 2020 and no bar too tall in the out years.

We ended the quarter with fixed charge coverage above 4x and debt to EBITDA at approximately 5x.

Our balance sheet remains well positioned for growth, consistent with our long-term financing strategy.

This concludes our prepared remarks.

And now we will be pleased to take your questions.

Denise, would you please begin the Q&A session?

(Operator Instructions) We would like to take our first question from Jordan Sadler of KeyBanc.

I have a question and a follow-up.

Regarding the DFT acquisition, what is the most up-to-date expectation on timing?

Maybe a sense of where we are on the potential SEC review and shareholder vote?

And then, I'm curious, what -- how you're working with them vis-à-vis leasing pipeline, if there's any sort of crossover there to the extent that you're able to look to their inventory or if that's being kept completely separate?

Thanks, Jordan.

This is Andy.

In terms of timing, we are, right now -- we put our initial proxy on file at the beginning of July and we're running that final version throughout and solicit votes from both the Digital Realty and the DFT shareholders in the coming weeks.

And our best ballpark, I'd say, on timing of the actual final tallying of the shareholder votes and the meeting and, ultimately closing is -- would be, call it, late third quarter, early fourth quarter.

In terms of business planning, I can tell you there's a lot of activity going on, on the integration planning side, getting ready for the closing day 1 and beyond.

But with regard to competitive intelligence, chasing competitive deals, right now, up until this transaction is approved and closed, we have to act as 2 separate independent companies.

And we're not sharing any information of the sort.

Okay.

And then as a follow-up, I noticed that cross connect volume was a bit lighter in the quarter relative to the last few quarters in terms of new cross connects signed.

And at the same time, I noticed that you guys made this investment in June in Megaport.

So maybe, likely unrelated, but maybe you could address both items?

Sure, maybe I'll -- I think you were able to sneak 4 questions in here but let me tackle the cross connect volume and return.

So I would say, it was a slight bit under the previous quarter in volumes at cross connects but there's obviously a very -- numerous variations of products underlying the terminal fiscal cross connect.

So I think the better economic indicator is looking at the cross connect revenue line item on the P&L, which is up year-over-year, call it 20%, obviously, there's not enough -- there's an apples and oranges there from our acquisition in Europe that wasn't in the numbers.

On a more organic basis, just North America, the cross connect revenue was up, call it low teens.

So we're quite pleased with that number.

And then, I think your last and final question, was with regard to an investment we made, and maybe I'll ask Jarrett to chime in on that front.

Jordan, if you recall, we launched the product, the Service Exchange, in December.

It's on track and ahead of plan.

We're continuing to expand to 17 markets by early 2018.

We're still very supportive.

We wanted to take a different approach and integrate it into our product, integrate it into our portal.

We've enhanced the redundancy of the platform.

But we also wanted to remain open in terms of future opportunities, the open Service Exchange environment, to allow other options to come in.

But we ended up investing $8 million because largely, we wanted to really maintain close ties to that software development partner because it's integrated in our interconnection platform.

We have strong alignment with their management team and their board and we're staying very, very close in terms of the service development road map and also the go-to-market interest on behalf of our customers.

The next question will come from Colby Synesael of Cowen and Company.

Two, if I may.

First off, on leasing, obviously, the slowdown this quarter relative to last quarter came from international.

Can you just remind us when you'll be in better position with capacity in those international markets where you're seeing that demand so that you could potentially go after that and we could see a stronger number?

And then just more broadly, as it relates to that, just what are your expectations for leasing as we're sitting here now in the third quarter?

And then, just my other question had to do with additional M&A.

I appreciate from a size perspective that DuPont's a very large transaction but as you mentioned, fairly simplistic, hopefully, in terms of the integration.

To the extent that you see something out there that you want to go after that's large in nature, are you prevented from doing so or would you still have the ability to go after that?

Let me start off, Colby.

Jordan, I think, started a ask for 2, get 3 to 4 pattern here.

So we'll try go through these quickly.

Just 2. I counted 3, I'm sorry.

Your first question was on the signings and inventory timing.

So in the back of our financial supplement, we have our active development pipeline and in particular, you'll see, in Europe, in Frankfurt, Amsterdam and London deliveries of -- on a -- largely concentrated on our campuses, be it Crawley in London, the President in Amsterdam and also in Frankfurt, deliveries, call it late fourth quarter, early first quarter 2018, late fourth quarter of '17, early first quarter of '18.

So that's for our larger footprint.

That doesn't mean we're totally sold out in all those markets.

We do have incremental capacity in Dublin.

We do have -- we're not 100% leased in some of those campuses and we do have some capacity in our gateways but the larger footprint capacity inventory supply chain's coming on, call it back half of this year, early next year.

Your second question...

Color for the third quarter?

Colby, hi, this is Dan Papes.

First, you commented on the second quarter and perhaps being a little lighter.

I would like to just note that in the first half of 2017, we actually grew 17% year-over-year in total lease -- new lease signings versus first half of 2016.

And our colocation business grew 14% year-over-year in the first half 2017 versus 2016.

And that's after you adjust for the Telecity acquisition.

So it's strong first half and you kind of note the uneven nature of demand in this industry.

But when you look at the first half, it's something to feel pretty good about.

But as we look at the third quarter, we like what we see from a pipeline perspective and a demand perspective, both across the scale business and the colocation business.

I would just say, I kind of extend that even to the second half.

We like the pipeline.

Pipeline's one thing.

The other is executing on that pipeline, which we plan to do.

We've got a very strong team in place.

As I think you know, we restructured the team in the first quarter.

And we feel like we're well positioned now to have a strong second half and third quarter as well.

Now we're going about executing against that.

Colby, Scott here.

Your last question was on additional M&A.

Clearly, we're focused on integration right now of the existing acquisitions and getting the DuPont deal closed and integrated.

Very important for us to get that right as we move forward.

Certainly doesn't put us out of the game when it comes to considering and looking at other M&A opportunities and we will continue to evaluate those that are consistent with our strategy.

But we -- clearly, we'll consider integration issues as we contemplate any of these other opportunities.

The next question will come from Jonathan Atkin of RBC Capital Markets.

So just 2 questions.

One, I noticed a drop in rent from CenturyLink Softerra.

Are they consolidating their footprint?

Or is that just the impact of breaking out CenturyLink from Softerra where some of that kind of gets broken out separately?

And then, the second question is just a little bit on market color, and I'm interested in which Metros did you see the greatest kind of demand for interconnection and colocation bookings.

Sure, I'll start off on the first one.

So Softerra, CenturyLink, that's a product of the transaction where CenturyLink sold its colocation business, where they lease long-term from Digital Realty numerous other locations.

So Softerra now becomes a new top customer as a stand-alone business, albeit CenturyLink did remain in equity ownership in that business.

That business now being run by Manny Medina and his team, who has a long history with Digital, and we're looking forward to support that customer and its growth.

And in terms of activity with Softerra, going forward, I'm pretty sure we've actually had some business together in terms of renewals subsequent to the transaction, so all things full steam ahead.

CenturyLink is still a large customer with the sites that aren't in the top customer list.

They're just not a top 20 customer anymore and they still have numerous network deployments probably largely concentrated in our Internet Gateway facilities.

And then in terms of trends in signings, I don't have the by-market-interconnection size.

I could tell you some stats on the -- in terms of demand or the industry verticals.

Go for it, Jarret.

It's Jarrett.

Early trends, we saw some good momentum in the new campus in Ashburn with the colocation and the pull through there.

Our traditional markets were strong on the interconnection trend.

Chicago, New York, the gateways, Santa Clara, those big 3 markets in North America.

And then we're seeing pull through, early pull through on some of the colocation as part of the Service Exchange launch as well.

So those were kind of the core markets we saw some growth.

The next question will come from Paul Morgan of Canaccord.

I'll just stick to my 2 questions.

First, on the merger, have you had any -- I'm sure you have, but how have the customer conversations gone after the announcement?

And are there opportunities in specific markets that you had from those conversations that kind of -- from the perspective of revenue synergies?

And then my other question, this was partly asked earlier but it is a little bit slightly different.

You had $31 million in revenue kind of at the forward year this time last year and if you look at the commencements now, it's at $11 million.

And I'm wondering if any of that is related to just kind of changes in your enterprise time horizons when you're doing bookings or are there other factors that are kind of driving where you stand now versus where you stood this time last year?

Answer to your first question.

While the customer conversations have gone well, obviously, we have a very different offering than DuPont has on a global basis as well as smaller footprint offerings in the interconnection.

So there's been a positive reception in that respect.

Paul, let me just add to Bill's comments.

This is Dan Papes.

Our customers like DuPont Fabros and they like doing business with them.

One of the things Bill mentioned in his opening monologue was that we thought that DuPont Fabros would add to our customer, our efforts to become ever more customer-centric and DuPont Fabros has a reputation in the marketplace for being such.

And the feedback from our customers along those lines is, we like doing business with them and that will help us like doing business with you guys even more.

Our customers are also especially, obviously, our largest scale customers like to know that we will have, if and when the merger closes, that we're going to have the inventory that they need in the markets in which they're growing.

One of the reasons obviously that we pursued the merger was because of the quality markets they're in, the quality products they have and the quality products that they're building.

So the feedback we're getting from the market is from our customers and some of our potential customers is universally positive.

And then Paul, on your second question, just to frame it.

I think you're referring to our roll-forward of our backlog table on Slide 13 of the deck where this year, we have about $11 million commencing in '18 and the same period a year ago, it was, I believe $31 million.

I think that's really just a product of the signings that have not commenced on the book.

Last year, I can think of, at that time, we had signings for some fairly large deals and like Osaka, Japan, where we'd literally signed the deal before we'd broken ground on the site.

So these were much larger amounts of signing with a forward commencement period.

So I think it's really a timing of inventory coming on relative to signings that are in the backlog that's driving that.

And then just lastly, I wanted to circle back because John Stewart just reminded me, he didn't think I appropriately addressed Jonathan Adkin's question, to make sure I was clear, the reason Softerra and CenturyLink disappeared from the #2 tenant and Softerra appears, because CenturyLink sold its data center business and Softerra is the new customer for those 20 assets that are on our top list, just to be clear on that point.

And the next question will be from Matthew Heinz of Stifel.

I think Bill made a comment on the prepared remarks regarding some large requirements or RFPs floating around the marketplace.

Could you expand on that?

So just with respect to the large requirements referred to in the prepared remarks, I was hoping you could just expand on that a bit with respect to customer verticals or application types, a little color around that and then also, whether you think you have the right inventory in the right markets to be competitive on those deals?

(inaudible) versus the vertical segment, Dan, do you want to talk to it?

And then I'll jump in the application.

Sure.

(inaudible)

Okay.

Just from the application side, I think, Matt, one of the things we're seeing is the growth of performance sensitive applications that our network, the latency dependent and throughput dependent and that one is scale in the campuses.

And if you look through that lens, we continue to see the cloud compute deploy.

We've seen -- those are in smaller deployment sizes at this point.

But we're excited -- enterprise private cloud and storage solutions to support that, there was a major wave in the last quarter and frankly, over the last few weeks, of all these new announcements to support enterprises, both part of the Azure platform or Oracle's platform or VMware, for example.

The big drivers right now, we're starting to see in the deployment are higher power density solutions for application, artificial intelligence and machine learning, that plays off of the cloud, in hybrid cloud.

And then definitely, mobility, we're seeing early days at the Internet Gateways of growth on the mobile applications as well.

So those are kind of the drivers, and then, Dan, if you want to talk to the vertical sectors.

Yes.

So thank you, [Matthew].

We, as I have previously stated, have organized our go-to-market teams by what we call buyer types and verticals, and we call them sectors.

First is the global solutions sector.

That's our cloud service providers and hyperscalers.

And I think I mentioned that we see continued strong demand in that area and we're going to continue to serve that and the contemplated merger with DuPont Fabros is going to serve us well there.

From an enterprise perspective, we, I think, took our eyes off that in the previous couple of years.

We now have our eyes staring straight at that market and within the enterprise space, the conversations we're having with clients all the time is about hybrid cloud and what direction they should take or what direction some of them plan to take and how we can serve them with the portfolio of solutions that we have, both with the ability to go from a single cabinet to multimegawatt deployment but also with our Connected Campus and Service Exchange capabilities.

But we're a quarter and a half into focusing on the enterprise in a different way, and we're seeing that as a good thing for us to have done.

And then in the network space, we're seeing -- we don't report our number separately but from a sector perspective, our sales into the network space and our pipeline into network space is one that we're very excited about and will continue to contribute possibly in the future.

That's helpful color.

And just as a follow-up, it looks like there was a nice sequential improvement in retention ratio on -- primarily on the PBB side, but I was wondering if you could just comment on the TKF retention, which seems to be kind of tracking well below historical trend through the first half.

Sure, Matt.

So we agree, we had fairly high retention, both on PBB and colocation.

PBB in the second quarter at 89% and colocation at 90%.

And the other thing I'd highlight is, at the lease term, a lot of these transactions are fairly long, it's 7.7 years for TKF, 8.6 for PBB, for a weighted average across all the products of just over 8 years.

With regard to TKF, the retention dipped a little bit below the last 12 months and obviously, a little below historical average.

It was a slightly lighter renewal on quantum.

That's about 20% of the last 12 months average in terms of expirings for our [feats], so the sample set was a little smaller.

In particular, there was a megawatt or 2 expiration where the customer had decided to not retain with us on that specific lease, but actually consolidated their applications and their load into other spaces that they had taken with us on that same campus, in a building where they had more room to grow.

So a bit of moving the puzzle pieces together, but obviously, a technical non-retention and that is on one of our campuses in one of the top 4 North America markets we're seeing strong demand and we had strong new signings in that market.

So I know we've re-leased a portion of that but I think we'll be able to quickly re-lease the remainder of it.

The next question will come from Jon Petersen of Jefferies.

Just a question on guidance.

In the last quarter, you talked about how the first and the fourth quarter were going to be the highest and it sounds like the second quarter will be a down quarter.

Clearly, we're up this quarter.

I'm just kind of curious, where did we come in?

Where did you guys come in above your own expectations this quarter versus what you had expected last quarter?

And I'm trying to figure out how that doesn't flow through to the rest of guidance.

I appreciate you have some financings coming, but it seemed to me that revenue and EBITDA is trending ahead of your expectations.

Sure, Jon.

So we beat our internal reforecast by a handful of pennies, I would say, 50% of that was operational and the other 50% was financing and another items in the P&L.

On the operational piece, there were some good wins but not all of it flows through, a onetime item or 2. And on the financing, some of that is a product of delaying our sterling bond offering, which we had anticipated doing earlier in the quarter but obviously, were caught offsides in being able to access the public markets while we were in M&A discussions and ultimately, lined up the transaction.

So that -- we didn't end up moving forward of that until -- in July.

So we are a little ahead for the quarter.

When you look at the back half of the year, for Digital Realty stand-alone, it's a bit of a delay actually in terms of what we said last quarter, what we thought was going to be a strong first half and a little bit step down in the back half just got pushed a quarter.

The things that we have working against us and also in some of our revenue gains are some operational seasonality things on our colocation where we're having exposure to the power cost, obviously, harder in the summers.

And then there's also, our dispositions we have not closed on any of those dispositions yet, although our team's working hard and making great progress.

But obviously, when you sell assets that are income producing, you lose assets already out of the gates and I think that the timing of those disposed will be back end-loaded.

And then just lastly, on -- holistically on guidance, we do have some -- a handful of pennies of negative carry.

We upsized the sterling bond offering and now, a portion of that sterling bond offering will go to ultimately refinance the DFT transaction.

And then we have the moving parts of the remaining U.S. dollar long-term financings and the ultimate timing of closing the DFT transaction.

So we felt it more prudent to leave our current co-FFO guidance as it is for now and then come back and update you postclosing of those transactions.

Okay, great.

That's very helpful.

And then just one follow-up.

On DFT, one thing I heard you guys talk about is that customers like doing business with DFT or at least, the customers they had like doing business with them.

Just kind of curious what you can do to, I guess, keep those relationships strong and kind of what it is about what they like doing business with DFT now that you've had a little more time to kind of research the process there?

Is it the design of the buildings?

Is there certain key people that need to be kept?

Is it lease structures?

Just maybe a little more details on what you guys think you need to keep that culture.

Thanks, Jon.

This is Dan Papes.

A few things that we observed.

One is that DFT, they have very close, I would call it business relationships at very senior levels with our customers and interact with them frequently.

They have a smaller number of customers.

So to some degree, they're able to do that.

But it's also cultural and there are some people there that will add to our culture from a customer centricity perspective that we think will be helpful.

They also have some customer support processes that we haven't been able to dive into deep detail with.

But the way they interact with their customers on a regular basis from an operations perspective has been shared with us from our shared client base.

And we feel like that out of our operations group, we'll gain benefits from that from the processes and the philosophies with which they use to manage their customer relationships day to day.

So those are some of the things that we've observed and that we're going to try to leverage should the merger close.

And I'm sure there'll be other things that we'll uncover as we go that tell us why those customers enjoy doing business with them and will enjoy doing business with us together.

The next question will come -- I'm sorry, go ahead.

Sorry to interrupt you.

The only thing I'd add is, I think the key element is not being "single-corded" on your relationships and having the team at the executive level, at the site, in design and structure and in sales and operations are all supporting the customer day in, day out.

They certainly had some early wins with some large customers and they're able to support those growth and so in that great support and success was translated incremental wins over time.

I can think of large customers that landed and expanded with them in the Ashburn campus and continue to want to do so.

And that's very similar to here at Digital, we had some great wins with the likes of a ridesharing company and another social company and we were early with them and we had a great experience with them.

So I think we've come together with 2 similar cultures and I think it's going to be a great combination together.

And the next question will come from Vincent Chao of Deutsche Bank.

Just a follow-up and last question, just in terms of the close business relationships that you mentioned, do you have visibility on how successfully you'll be able to keep those folks that have those relationships?

This is Andy again.

I can tell you, we made that a high priority here at Digital.

Bill, out of the gates, spent a significant amount of time right meeting this team in the field throughout the entire organization.

Just in the last handful of weeks, I spent a fair amount of time with Scott Davis, from their team, going through all the 3 North American campuses, sitting down with the operational team in the field.

The guys, the ladies and gentlemen that are day in, day out supporting those customers and their mission critical infrastructure and we tried to give assurances that our goal is to have them as long timers here at Digital going forward.

Vincent, this is Dan Papes.

I'll just add to that.

Bill has made very clear to us and with the approach here that we agree with, which is, we didn't just buy some very high-quality assets.

If we -- when the merger closes, there are also some best practices and some cultural elements and some of those that I just mentioned in my previous comments that are of value here that we want to retain and leverage and so forth.

That includes people.

So what we see here is we're probably acquiring -- we are acquiring some industry best practices that, in some cases, might be better than the way we do things today and we want to go ahead and leverage those.

And some strong people with not only -- who have strong relationships with customers but also some strong people from a delivery and design perspective as well.

So our idea here is to capitalize on the multipronged portions of DuPont Fabros that goes beyond the assets, includes the people, the processes and elements of the culture.

On a totally different topic, you mentioned, Bill, you talked about the G&A margin, the leading G&A margin of the combined entity.

And I was just curious, is there an opportunity, you've been in sort of a $7 million to $8 million bookings level here on the interconnection side for a while, curious if you were to step up the investment on the G&A side, is there an opportunity to really bolster that bookings number?

Or do you think that, that's not really the way to get that number higher?

I mean, Vin, I think we do need some additional sales resources.

Dan's looking.

I don't think he's fully staffed quite yet.

So it's not going to hit G&A in a material way.

But with the right sales sources in a couple of those sectors, we can certainly move that number.

Vincent, a few comments from me.

As the leader of the sales organization, we -- I would say, as Bill mentioned, a marginal amount of additional sales resources, we think, would be helpful here.

We're also very focused on the quality of our resources.

We have made some significant, I would say, upgrades in the quality of our sales people and some of them may cost a little bit more but if we take on less of them and they're more productive, that's very helpful to us.

The equation comes out the same from a cost perspective.

And so that's the approach we're taking.

I don't see a need and I don't go ask Bill and Andy for meaningful or impactful, from a financial perspective, additional sales headcount at this time.

I think we drive based on the headcount that we have today and make sure it's quality headcount.

The next question will come from Richard Choe of JPMorgan.

Wanted to ask about kind of bigger picture.

Given the DuPont acquisition and other company -- data center companies focusing on cloud providers, how should we think about the hyperscale cloud business?

It's lumpy but it seems like it could last for a while.

Do you see this as a multiyear type of business that is worth going after?

Or is it something that is just kind of the here and now?

I wanted to get your sense on that.

Rich, it's Bill.

You hit it right.

It's lumpy.

Unquestionably lumpy.

It's getting lumpier, I think.

I think the potential orders are getting bigger.

And I think it's here for the foreseeable future.

At least we have -- we don't have any indications yet that it's waning.

Dan, do you want to add to that?

Yes, Richard.

Just to add to that, I think Bill uses the right term foreseeable future.

When we talk to our large customers, cloud service providers and those who aren't CSPs but are hyperscalers, they don't talk about a trough in 2018 or anything like that.

Their plans seem to be to continue to grow.

It's just not to get too basic about it, but the fact of the matter is the amount of data is exploding and the amount of processing is exploding.

The need for storage is exploding.

And it's hardly, just kind of look at what's happened in the IT industry today and the demands of customers for more and more data, just -- you look out as far as you can see and you just can't see why it would diminish any time within our line of sight.

So we think -- we just think it's going to continue and we're going to keep going after it.

And then to follow up a little bit on the acquisition.

In terms of -- and I appreciate it if you don't want to talk about a specific customer, but Facebook is a significant customer of yours.

It's 1.6 years average lease term.

DuPont's got some renewals up and coming.

How is that going to be handled in terms of renewals for both the companies in terms of dealing with large customers that are coming up?

Sure, Richard.

And obviously, just want to reiterate, up until the transaction closes, we are operating as 2 independent companies.

So the DFT team is handling renewals as well as new leasing with their customer base and we're doing the same with our customer base on our side of the table.

I can tell you, for the larger customer, the larger hyperscalers, cloud service providers or names that you've referenced, we're in active discussion on renewals and in locations where we have them with near-term expirations, they're -- what they've expressed to us is a desire to stay and renew on a long-term basis.

And these are customers that, in other locations, they've recently grown with us.

So the leases have just recently commenced or will be commencing soon.

I would anticipate the DFT side is having similar types of conversations with their customer base and many of these are the same customers.

I think, also, you can look at -- DuPont's addressed this issue, particularly with Facebook, in their Q4 2016 prepared remarks and then again, in Q1 of 2017, and that'll give you a little color but there's probably not a lot to add to that.

And the next question will come from Frank Louthan of Raymond James.

A little bit of upside in some of the tenant reimbursements that we're looking for.

Just curious, is there anything going on there, anything onetime?

And then you mentioned, you're acquiring more green power and I keep hearing this from others in the industry as the growing demand.

It's becoming a little bit more of a focus for some of the customers.

What do you think that you're doing there that maybe others are not that's enabling you to source more green power?

And how do you plan to meet that need going forward?

Sure, Richard.

There's nothing that materially comes to mind as episodic on the reimbursements, either on a consolidated basis or on a same capital basis but happy to follow up with you offline if there's something we see there.

On the green initiative, and I'll open this up obviously to Jarrett and team here, I think a few things.

I think our scale and our credit worthiness as a counterparty has been the differentiating factor.

I know that is something that, when we entered into our wind farm purchase agreement several quarters ago, which essentially provides sustainable green power to North America colocation footprint, that they were seeking an investment-grade credit rated party, which was kind of linked to the ultimate financings to get that project up and running.

And being the only investment-grade data center REIT, we were one -- only one out there that can really offer that.

Jarrett, anything else do you want to add on the green front?

The vision was really -- predates me.

Bill really set up a dedicated team to set up the sustainability vision, had a dedicated team.

And then we've engaged from our product and with sales, it voices a kind of -- we've interviewed the customers and they're really seeing value on it.

So we started with the wind power deal but we covered our colocation product with this.

We've since augmented with solar initiatives and there's a whole team now working, a power working group, that is working on that focus and you can see the results as we were really announcing this quarter.

You're seeing that being recognized now in the industry as a leadership role and we're committed to that globally.

And you are correct, Frank, it's important to our customers.

The next question will come from Robert Gutman of Guggenheim Securities.

So in looking at your customer list, it looks like you had some really nice gains quarter-over-quarter with some of your top customers, like Uber, Oracle and Navisite particularly stood out.

But it also looks like Rackspace returned 14,000 square feet and reduced its annualized rent.

I was wondering if the reduction from Rackspace is what is reflected in the 65% retention ratio in the turnkey category?

And secondly, since they're a 9% customer of DuPont Fabros, and I believe that last we saw them, they were somewhat underutilized on their commitment of space, although that's a while before they went private, what do you see?

Is there a possibility of more return of space from them going forward?

Sure, Rob.

Obviously, due to confidentiality reasons, we don't like to speak to specific customer's ins and outs.

But if a customer's location is decreasing, that would obviously fall in the non-retained bucket of an expiration.

There's certain customers, and I'd bucket in the name -- like the name you mentioned, that has taken space down with us over time and multiple suites in a campus, and sometimes, they want to consolidate their infrastructure to be a more centralized or take up an entire building versus having multiple buildings across the campus.

So there's sometimes where moving parts and consolidation comes to play.

So a non-retained space is not initially an awful thing because incremental deliveries, they may have already leased with us, maybe commencing coming online.

So not necessarily specific to the name you mentioned but that's a trend we've seen and really part of our value proposition where a customer can land with us and know that their business model's going to be future proofed based on these series of buildings, we have our campuses in the hundreds of acres that we have adjacent to it.

And if I could just do one follow-up.

In light of the DuPont acquisition, could you just restate your viewpoint on sort of very large hyperscale single tenant assets?

On the construction of them going forward or participating in those opportunities.

We are certainly seeking to participate in those opportunities with the -- just to refresh everyone's memory, the DFT team filed their second quarter earnings release this morning.

They have an active pipeline of projects that are in construction and some of which I toured in the last several weeks with the team and they're, call it almost 80 megawatts of active development across their core markets.

And those are roughly half pre-leased, with great customers commencing leases and about leaving space that will be coming online and be readily available to lease for a large footprint or smaller footprint scale customers.

So we remain committed to the full product spectrum from the (inaudible) up to the hyperscale.

And the next question will come from Andrew DeGasperi of Macquarie.

I wanted to ask first on the acquisition with DuPont.

Are you seeing any change in the competitive environment now that most of your customers know you're obviously going to merge?

And are you seeing potentially any delays on your agreements because of that?

Or any potential opportunities on the flipside, for that matter?

Given the fact that we must be fiduciaries to our independent shareholders and act -- operate independently, I have not seen any change in terms of competitive nature or delays to business to date.

Great.

Just one follow-up.

As far as your synergy number for the acquisition, I know you're still probably tight-lipped about it, but since you've been doing the due diligence for a while, is there potential for expanding that number at this point?

I would just -- at this point, which we're now, call it just over almost 2 months since the acquisition and based on the fact that we did extensive diligence of this business and this team and prior to the transaction, I think, we're right now, currently would reiterate the, call it $18 million-ish of overhead, which is, I'd say, 70-ish percent of their G&A.

And the next question will come from Matthew Heinz of Stifel.

Just regarding the topic of green energy and your initiatives there over the last several months, what do you think that brings to the conversation regarding some key renewals in DuPont's portfolio and just with respect to kind of your capabilities and your rankings in those -- in the green power area relative to DuPont and your capabilities there?

Matt, I would say, where the puck is going on green, it's going to become more of a table stakes requirement for any of these large investigative customers and consumers of power.

And I think we have a competitive advantage today given how long we've been making sustainability a priority to Digital, the financial benefits I mentioned as a counterparty to secure green power.

So I think we're very much aligned with what our customers want in the sustainability and green front and I think we're only going to, as a combined company with DFT, be able to offer that offering to our customers in a likely lower cost and more comprehensive way.

And ladies and gentlemen this will conclude our question-and-answer session.

I would like to hand the conference back over to Bill Stein for his closing remarks.

Thank you, Denise.

I'd like to wrap up our call today by recapping our highlights for the second quarter as outlined here on the last page.

We set the stage for continued future value creation with an agreement to merge with DuPont Fabros, a high-quality, highly complementary portfolio concentrated in top-tier U.S. metros in an accretive transaction that strengthens our balance sheet and expands our relationship with a blue-chip customer base.

We also continue to support the growth of a diverse mix of customers who are driving the digital economy with a healthy level of new business and record renewal activity.

We delivered solid current period financial results, beating consensus estimates by $0.05.

Finally, we further strengthened our balance sheet by settling the remainder of our forward equity offering using the proceeds to redeem high coupon preferred and opportunistically raising an ample mix of attractively priced debt capital.

We finished the quarter with a debt-to-EBITDA in approximately 5x and fixed charge coverage over 4x.

As I do every quarter, I'd like to conclude today by saying thank you to the entire Digital Realty team whose hard work and dedication is directly responsible for this consistent execution.

Thank you all for joining us, and we hope you enjoy the dog days of summer.

Thank you, Mr. Stein.

Ladies and gentlemen, the conference has concluded.

Thank you for attending today's presentation.

You may now disconnect your lines.