Digital Realty Trust Inc (DLR) 2018 Q1 法說會逐字稿

Good day, and welcome to the Digital Realty First Quarter 2018 Earnings Conference Call. (Operator Instructions) Please note, this event is being recorded. At this time, I would like to turn the conference over to John Stewart, Senior Vice President of Investor Relations. Please go ahead, sir.

Thank you, Denise. The speakers on today's call will be CEO, Bill Stein; and CFO, Andy Power. Chief Investment Officer, Scott Peterson; Chief Technology Officer, Chris Sharp; 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, 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 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.

Before I turn the call over to our CEO, Bill Stein, I'd like to hit the tops of the waves on our first quarter results.

First of all, we set a new high watermark with quarterly bookings north of $60 million. Second, we beat consensus by nearly 4% driven by consistent operational outperformance, and we raised guidance by $0.05 at the low end. Third, the beat and raise flows through to cash flow, and we remain on track to deliver double-digit AFFO per share growth in 2018. Last but not least, we expect to achieve this growth while maintaining our target leverage and self-funding our 2018 capital plan through internally generated cash flow from operations and proceeds from asset sales.

And with that, I'd like to turn the call over to Bill.

Thanks, John. Good afternoon, and thank you all for joining us. With our Annual Shareholders' Meeting coming up in a little less than 2 weeks, I'd like to begin today with a discussion on governance, here on Page 2 of our presentation.

At our Investor Day in December, we shared with you our plan for providing shareholders the ability to amend our bylaws.

I'm pleased to report that in early March, our board approved a resolution giving any 3% shareholder, or any group of up to 10 shareholders comprising a 3% stake for 3 years the right to propose binding amendments to the company's bylaws. We believe that with this step, we are joining a small group of other high-quality REITs in leading the industry with sound corporate governance practices.

In keeping with our commitment to ongoing board refreshment, we also disclosed in our proxy that longtime Director, Bob Zerbst, will not be standing for reelection at the annual meeting. In addition to his role on the board, Bob served as Chairman of the compensation committee from 2012 to 2017 and as a board representative on our internal investment committee for the past 4 years. He was also Chairman of the investment committee at CBRE Investors when the initial investment in GI Partners, our private equity predecessor, was first approved. On behalf of the entire board, I'd like to extend our thanks to Bob for his years of service to the company.

The governance principle behind our board refreshment philosophy is balancing fresh thinking and new perspectives with experience and continuity. Following Bob's departure, 8 of our 10 directors will have joined the board within the past 6 years, whereas our Chairman and former Chairman have both served on the board since our IPO.

I would also like to remind you that we maintain a destaggered board. The majority of our directors' compensation is paid in stock. Each of our directors maintains a sizable investment in the company. The board and senior management are required to meet minimum stock ownership requirements; and finally, since 2014, the substantial majority of management's long-term incentive compensation plan has been tied to relative total shareholder return. We believe in eating our own cooking and we manage the business to maximize sustainable long-term value creation for all stakeholders.

Moving on to investment activity. We have already closed on the sale of 7 noncore assets year-to-date, generating proceeds of approximately $185 million and realizing gains of a little over $50 million. As Andy will address in his prepared remarks, this consistent execution on our capital recycling program has prompted us to raise the high end of our range for dispositions guidance by an additional $100 million, further bolstering our ability to self-fund our 2018 capital plan.

Let's turn to market fundamentals on Page 3. In North America, data center construction crews remain active across the primary data center metros, particularly in Northern Virginia, which is, by far, the largest and most active metro in the world. It is also Digital Realty's largest concentration, and we are blessed to have 345 megawatts of state-of-the-art capacity on our 2 existing campuses in addition to 180 acres of strategic landholdings that will support the buildout of another 290 megawatts of future capacity.

The market dynamic in Ashburn is highly competitive, and customers have plenty of options to choose from, both established players as well as new market entrants. By the same token, however, demand is both sufficiently robust and diverse to lift a lot of provider boats. New supply is coming online, but is being just as rapidly absorbed. On balance, the North American data center landscape is roughly at equilibrium, as you might expect, with a national vacancy rate at 10% on the dot.

In Europe, hyperscale users continue to dominate the data center [link] tables, representing over 70% of first quarter leasing volume. We estimate that approximately 40 megawatts were leased across the region in the first quarter, largely driven by hyperscale customers expanding in existing locations. London and Amsterdam were the standout metros this quarter, followed by Frankfurt.

Digital Realty did not have a particularly active first quarter in terms of signed deals, but we did restock the shelves and now have a full complement of inventory in each of the major metros in Europe.

We are also off to a strong start in the second quarter having landed a 4-megawatt deployment in Amsterdam in April, our first global deployment with a top legacy DuPont Fabros customer. We expect to see further momentum in Europe over the next several quarters.

In terms of current buying behavior, customers are looking for long-term commitment tied to flexibility and the ability to land and expand within the same location, which lines up perfectly with our connected campus strategy.

Across the Asia-Pac region, demand remains very healthy, and it's even showing early signs of further acceleration, driven by hyperscale users, both within the region as well as Western destinations.

While supply has remained largely in check, several sizable requirements are prompting potential new entrants to explore new markets. The marketplace remains highly fragmented, which creates barriers to entry, especially new geographies for unproven teams. That said, healthy demand dynamic is not yet translating to rental rate growth, given the prospect of potential new supply coming to market. Net-net, we believe our customers view our global platform and comprehensive space, power and interconnection product offering as a key differentiator in their selection of data center provider of choice.

Let's turn to the intersection of supply and demand on Page 4. Much ado has been made of the pricing and profitability on the recent state of hyperscale activity, and I'd like to take a moment to share our philosophy on pricing and returns.

First and foremost, I would like to remind you that we've always targeted superior risk-adjusted returns. Along the X axis here on Page 4, we've outlined the primary risk attributes we underwrite on new builds. It stands to reason that we would be willing to accept a somewhat lower return on a project that is fully pre-leased to a high-credit tenant on a long-term lease as opposed to a speculative new build. In addition, it should be intuitive that we were able to achieve the lowest unit cost by building at scale, or hyperscale, as the case may be.

Finally, evolving customer preferences for higher power density and lower redundancy have enabled us to drive down build costs, shrinking the denominator in the return equation. As a result, we are still able to achieve risk-adjusted returns that we consider quite acceptable on hyperscale builds.

The returns on our current pipeline represent a respectable spread above our cost of capital and also represent a very meaningful spread above current cap rates. Unrealized development profit margins are somewhat theoretical since we have no intention of flipping our core holdings. But we are confident that the returns we are able to achieve on our development pipeline are creating significant value for shareholders.

Let's turn to the macro environment on Page 5. The global economic backdrop remains quite supportive, and the long-term secular trends driving data center demand seem to be gaining momentum. The Cisco Global Cloud Index forecasts that the number of hyperscale data centers will nearly double by 2021. Hyperscale data centers will account for more than half of all installed data center servers by 2021, and traffic within hyperscale data centers will quadruple by 2021.

Digital Realty has the heritage and design expertise to efficiently meet this demand. Cisco also projects that 69% of the compute and 65% of the data will be housed in hyperscale facilities, which will become the foundation for the evolution of future ecosystems.

Software-as-a-service is expected to be the most popular cloud service model over the next 5 years, and Digital Realty Service Exchange facilitates secure private access to critical SaaS applications. We continue to see a healthy and growing partnership with our large multinational clients resulting in tailored data center solutions for the world's largest and most demanding customers. It is these custom solutions that continue to position Digital Realty and the Connected Campus as the standard for global growth.

Multi-region deployments are growing across all sales verticals, signaling a platform effect from our largest cloud, network and enterprise buyers and further validating the Connected Campus, our full product offering and our role as an international supplier of choice for their critical infrastructure.

Earlier this week, we launched support for Google Cloud's Partner Interconnect, a new service from Google Cloud that allows customers to connect to a Google Cloud Platform from anywhere. Partner Interconnect provides customers with the ability to extend private, on-premises networks from Digital Realty data centers to the Google Cloud Platform, reaching a broad set of public and private cloud-based service offerings. The new offering will enable our Service Exchange customers to reach Google Cloud platform services in 9 global metros, with additional markets to be brought online later this year.

The Google announcement was just 1 highlight of a great start to the year, and we look forward to building on this momentum going forward. We believe we are particularly well positioned to capitalize on the favorable demand setup and deliver sustainable growth for all of our stakeholders given our global platform, our comprehensive suite of power and connectivity solutions along with our operational and financial stability.

With that, 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 7. We signed total bookings for the first quarter of $61 million, including a $7 million contribution from interconnection. This marks the fourth quarter out of the past 5 we delivered bookings north of $50 million. We signed new leases for space and power totaling $54 million during the first quarter, including a $6 million colocation contribution. The weighted average lease term on space and power leases signed during the first quarter was approximately 8 years. We saw robust and balanced performance of lease signs across every month in the first quarter. We are seeing strong demand from current as well as new customers, and we signed 32 new logos during the quarter.

Demand across cloud customers remains strong, with many of the leading global cloud service providers expanding with us. A leading Chinese cloud and technology service provider expanded with us in Ashburn just a couple of quarters after first landing with us in that market.

We are pleased within our progress in the enterprise segment, landing broad and diverse customer engagements.

For example, one of the world's largest media entertainment, technology and content companies needed immediate access to enterprise quality data center capacity in the red-hot Northern Virginia market to support a new complex cloud-connected application. The customer cited 3 reasons for selecting Digital Realty: our track record of operational and financial resiliency; the quality of our product and speed of delivery; capacity when and where they needed us; and ease of contracting.

A national cancer research institution selected Digital Realty based on our proven track record of operational excellence as well as our interconnection solutions. Their critical business applications will be migrating from another provider and will reside within our secure campus environment in Phoenix.

A leading-edge personal finance company that is focused on helping everyone make financial progress has selected Digital Realty to consolidate their backend systems and storage into higher-density racks to help future-proof their rapid growth.

One of the world's oldest stock exchanges acquired a company in the U.S., and as a result of this acquisition, required data center expansion. Digital Realty was awarded 1 of 2 North America data center deployments.

MOBITV delivers live and on-demand video to any screen, connecting media reliably and securely anytime, anywhere on any device. The customers' connected media solution solved the complexity of delivering video across networks, operating systems and devices while managing associated rights. MOBITV chose our 250 Williams Street location in Atlanta to utilize the extremely highly connected 56 Marietta ecosystem as an activation point for their TV channel content to directly connect to end users.

We see continued strength in our network segment. Our first quarter network wins indicate continued strong demand for scale infrastructure in the infrastructure as a service subsector in addition to multisite colocation and interconnection demand in the content delivery network, Internet service provider and global carrier subsectors, including a major backbone expansion with one of the largest telecommunication providers in the U.S.

Our strategic alliances and channel referral partner programs continue to help us drive growth and provide a source of new customers. We are gaining traction with partners who want to include our capabilities into the solutions they offer their customers.

For example, partnering with [Insight,] one of our alliance partners, helped a customer migrate from a dated architecture as part of an overall technology refresh. We were a perfect fit to offer our colocation interconnection solutions paired with [Insight's] IT product and service capabilities, so the customer got 1 comprehensive solution.

With IBM, one of our first strategic alliances, we have been able to embed our capabilities across their Direct Link products that allow their customers to connect directly to their cloud infrastructure and cloud services. Through this partnership, we drove solutions for customer throughout our domestic campuses and internationally during the first quarter, strengthening our ecosystem and enhancing our ability to penetrate the enterprise vertical.

As we've discussed on previous calls, we see substantial opportunity for our partners in alliance program to create meaningful upside for our customers and our business over time through our referral, sell-to and sell-with partnership programs. We are pleased with the result to-date, and we expect continued growth in 2018.

In terms of integration, our efforts related to the DuPont Fabros merger are winding down. A number of functional areas have completed their project plans, and we've made solid progress towards achieving our synergy targets, but we remain focused on closing out all remaining tasks. The outstanding items are primarily related to operations and IT activities, with some IT organizational alignment intentionality delayed so as to avoid disrupting the customer experience. We have successfully completed the migration of all accounting, finance and HR-related applications, and we will continue to work on the customer portal consolidation and network migration through year-end. We remain on track to meet or exceed our $18 million expense synergy target, and we continue to expect the bulk of our integration activities will be wrapped up during the second quarter with loose ends completely tied up by the end of the year.

Turning to our backlog on Page 8. The current backlog of leases signed but not yet commenced reached an all-time high of $126 million. The weighted average lag between first quarter signings and commencements was 6 months, reflecting large lease signed for space currently under construction and scheduled for delivery later this year.

Moving on to renewal leasing activity on Page 9. We signed $57 million of renewals during the first quarter, in addition to new leases signed. The weighted average lease term on renewals was over 4 years and cash rents on renewal leases rolled up 4% with positive cash re-leasing spreads across all product types. We do still have a few above-market leases across the portfolio, most notably within the former DuPont Fabros properties. As a result, the mix of renewal leases signed in any given quarter could push our cash mark-to-market into the red. This is reflected in our guidance for slightly negative cash releasing spreads for the full year in 2018.

In terms of our first quarter operating performance. As we indicated last quarter, overall portfolio occupancy dipped 100 basis points sequentially to 89.2% due to a combination of development projects placed in service along with a churn event in Boston where an enterprise customer is consolidating their data center footprint. Similar to other opportunities within our portfolio, like the space we took back in Chicago a little over a year ago, a portion of this space will be repositioned to expand our Boston colocation product offering. We also expect portfolio occupancy to rebound beginning in the second quarter and to finish the year essentially flat at 90 and change.

Turning to our economic risk mitigation on Page 10. The U.S. dollar continued to soften during the first quarter and FX represented a slight tailwind to the year-over-year growth in our first quarter results. Interest rates on the other hand, continued to rise during the first quarter as shown on the bottom of the page. By way of reminder, we target variable rate debt at less than 20% of total debt outstanding, and we were at 18% as of the end of the first quarter. Given our strategy of matching the duration of our long-lived assets with long-term fixed-rate debt, a 100 basis point move in LIBOR would have just a 1% impact on our 2018 FFO per share. We believe our near-term funding and refinancing risk is very well managed.

Turning to earnings growth on Page 11. Core FFO per share was up 7% year-over-year and came in $0.06 above consensus. The upside relative to our internal forecast was primarily driven by operational outperformance and favorable FX.

As you may have seen from the press release, we are raising the low end of the range of our 2018 core FFO per share guidance by $0.05. Most of the drivers are unchanged, except for a 100 basis point increase in the low end of the range for the same-store guidance and updated FX assumptions, partially offset by another $100 million of asset sales.

In terms of the quarterly run rate, we expect to dip down slightly in the second and third quarters due to the timing of G&A investments and loss of NOI from recent asset sales, as you can see from the bridge on Page 12, before rebounding sharply in the fourth quarter as several large leases commence. We do not typically give explicit AFFO per share guidance, but I would like to point out that as John mentioned, the beat on the FFO line flowed through to cash flow, and we remain on track to deliver double-digit AFFO per share growth in 2018.

The growth in cash flow had likewise flowed-through to our distribution to shareholders. In early March, the board approved a 9% increase in the per share dividend. This marked the 13th straight year we have grown our dividend, and we are pleased to be among a select group of REITs to have raised the dividend each and every year since our initial public offering in 2004.

Finally, let's turn to the balance sheet on Page 13. Net debt-to-EBITDA stood at 5.3x at the end of the first quarter, and fixed charge coverage ticked up slightly to 4.3x. Our cost and capital structure affords us the ability to self-fund over $1 billion of development spending in 2018, largely with cash flow from operations and an assist from the asset sales Bill mentioned earlier. As a result, we expect to maintain our target leverage and coverage levels throughout 2018 without the need for additional common equity, as proceeds from asset sales are used to pay down debt, the full run rate benefit of DFT synergies are realized and our cash flows continue to grow as leases signed commence throughout the year.

As you can see from the chart on Page 13, our weighted average debt maturity is approximately 5 years and the weighted average coupon is approximately 3.4%. Over 80% of our debt is fixed rate to guard against a rising rate environment, and nearly 100% of our debt is unsecured, providing the greatest flexibility for capital recycling. A little over 40% of our debt is non-U.S. dollar denominated, acting as natural FX hedge for investments outside the U.S. We will continue to actively manage the right side of our balance sheet with an eye towards longer duration financings across the currencies that support our assets.

Finally, as you can see from the left side of Page 13, we have a clear run rate with nominal near-term debt maturities and no bar too tall in the out years. Our balance sheet is poised to weather a storm, but also positioned to field growth opportunities for our customers around the globe, consistent with our long-term financing strategy.

This concludes our prepared remarks, and now we'll be pleased to take your questions. Denise, would you please begin the Q&A session?

(Operator Instructions) The first question will come from Jordan Sadler of KeyBanc Capital Markets.

First one, just regarding the pace of leasing. I think this looks like one of the best quarters I can remember. And it comes on top of, as you pointed out, 2 pretty strong quarters. It happens to say lumpy but healthy on Page 7. But this seems like leasing has gotten much more stable over the past few quarters, and so congrats on the execution. But I'm curious will we see increased volatility going forward? And if so, what is the bias? Would it be upward volatility? Or downward?

Thanks, Jordan. We don't give bookings guidance. And I sense from your question that you're trying to obtain bookings guidance. We're not going to change our policy. But as you might imagine, we're -- we are pleased with the trajectory over the past several quarters. You're correct, this is a record quarter. We've had great volume, also a very strong mix in products, logos and geographies. If you look back over the last 12 months, bookings have been trending up, and that's how we obviously would like to keep it. We're confident in the growth of the business, long-term growth of the business, so I would expect the quarterly volume will follow that because the current funnel is very healthy. And we are confident that we can build on our recent momentum.

Okay. And then just moving on to the development pipeline, which seems to be gaining some momentum as well. Maybe you could speak to construction costs. You're quite a sizable developer in the scheme of things and construction costs appear to be rising as a function of increased demand but also tariffs and [sealed] labor demands, et cetera. How do you expect these rising construction costs to manifest themselves in the data center sector in your portfolio over the next couple of years? Are rents going to come up a lot because customers can bear the increases? Or will returns come down? What do you think?

Yes, let me take it at -- break that question apart. So first of all, I think that because of our designs, we've been doing an excellent job of taking costs out of the product. But I will say, I think it's going to be difficult to take much more cost out without affecting the residual value of the real estate. We have put in place something called our VMI program, which stands for Vendor Managed Inventory. We have that in place for all of our major suppliers. And what that is, is a 3-year contract where we've been able to lock in pricing for major items like generators, switch gear, UPS module. And importantly, we put that in place before the tariffs were put in place. So our pricing at least for the next 3 years won't be affected by rising steel prices. And the other factor that's important for everyone to keep in mind on the call is that we're the only data center company with an investment-grade balance sheet. And I think it's not just the cost of our jet -- of our debt but the way Andy has managed the balance sheet that gives us a distinct competitive advantage in not only a rising rate environment, but a currently, environment that has an inverted yield curve. So most of our debt is fixed and has been turned out for quite a period of time. We've also been able to de-risk the labor inflation that I think we will certainly see by keeping our contractors very busy and on site. It's another one of the benefits of having a global sales funnel and buying in bulk. And in terms of what's going to affect data center rents, we think that's most effectively direct -- most directly affected by supply. And if you think about the barriers to entry, it's a restriction in land, which we see certainly today in Silicon Valley and we think we're going to see it in Loudoun County in a few years. In some markets, you see a NIMBY sentiment, not in my backyard. We think that higher debt cost and build cost will also represent barriers to entry. So while I don't think that, with the exception of Silicon Valley, we're necessarily going to see wide growth in the very near term, I think that you'll definitely see it over the intermediate term.

The next question will be from Jonathan Atkin of RBC.

So a question about the kind of the demand that you're seeing going forward, the scale demand. And is that coming -- is that basically upsized requirements by traditional scale customers? Or are you seeing a broadening of the types of customers, either by vertical or by region, that are interested in doing most of [the other IPOs] ? And then following onto the last kind of answer about the developments. The development pipeline, just given the volume of demand out there, do you feel that you're appropriately stocked? Or would you consider having a little bit more work in process to accommodate what seems to be kind of a rebounding demand back to sort of 2016 levels?

Jeff (sic) [Jon], I'm going to take the first part of that question. I'll ask Andy to take the second part of it. The requirements, and I've said this on several calls, but the requirements have definitely grown larger over the last several years. But on top of that, and you mentioned in your question, the demand is also broader. It's more than just a handful of CSPs. And we're seeing it out of social media. We're seeing it out of global cloud, not just U.S.-based CSPs. We're seeing it out of the SaaS players and we're seeing it out of multinational hardware and software companies. Maybe going back to Jordan's question though on the level bookings. We do need at least 1, what I would say, major anchor transaction every quarter to hit 50. If we have more than 1, it will definitely be upside. If we don't hit that 1, there will be downside. But I would say based on the volume that we see in our pipe, I'm confident that we'll get 1. But nevertheless, it's still a lumpy business. And you see that with the 4-megawatt deal that we announced that we signed in Amsterdam this month. But I can tell you that on balance, we're very encouraged by both the breadth and the depth of demand and we're looking forward to what the balance of this year has in store for us. Andy, why don't you take the second question of Jonathan's?

Sure. Thanks, Jonathan. So your question related to appropriately stocking the development pipeline. It's obviously a very fine line as we've seen from our competitors and we've experienced firsthand here at Digital in the history of our company. I would say we have a very robust capital planning function with a regular cadence, and we're doing our best to line up the supply and demand as the best we can. I think we do have some competitive advantages on many fronts. When you have a large installed customer base that is looking to grow those markets with a preference to grow in adjacency to their existing loads, I think that translates into incremental wins that it's harder for a new competitor or a smaller provider to really attack. If you look at our pipeline, in total, it's been 100 -- almost 130 megs of -- north of 40% pre-lease. That's obviously book ended by some speculative development capacity and also fully preleased activity. If you just look at Northern Virginia, which is north of 60 megawatts, and that's north of 60% preleased, I can tell you that remaining, call it, 23, 24 megawatts that isn't preleased, we're almost playing Tetris with the customers in terms of wanting their timelines to move in with our delivery schedules. So we're definitely tiptoeing that fine line, and I think we have the right balance for right now.

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

One, with the DuPont integration largely behind you, I was curious about your appetite for M&A, particularly with some news out there that there could be some assets that are out there for sale, including some in, I guess, Brazil. And then secondly, your -- what is it? Your retention ratio was 58%, I believe, in your disclosures. That's below what's typically -- it's typically been. I wonder if you can just provide some color as to what's behind it and what your expectations going forward would be.

Colby, Scott here. I'll take the first part of that question. Yes, we continue to look for other M&A opportunities. As you know, we're looking at everything that's out there or not even not out there on the market. As always, we're focused on opportunities that have some strategic value to us. But as always, we are going to be good stewards of our shareholder capital and be disciplined as we pursue those opportunities.

And Colby, just to add to that though. When you look at where the share prices are today in the multiples, they're obviously down from where they were a quarter or 2. And that on the margin may make M&A less likely. I think you'd couple that with where some of the recent trades occurred, which were fairly lofty valuations. And I think that might argue that there would be less M&A near term. Andy, you want to pick up the second part of that question?

Sure. So I think you were pointing to retention [assuming just on the scale] of TKF product. It's up 60%. That was largely related to some churn. I think we'd called out a call a quarter or 2 ago in the Boston market, an enterprise customer. They were looking to consolidate some capacity. Now, not all churn, I would say, is a bad thing. That provides an opportunity to take back space and reprioritize that larger footprint into a colocation offering and expand our capabilities in the Boston market in particular. By and large, other than the episodic customer that we have here and there we do have some positive churn events where a customer is just outgrowing a traditional colocation environment and wants to grow with us on a campus. So customers moving from 1 part of the portfolio to another can actually be a positive. And on the colo side, the other major product domain, we actually had not -- maybe not record but very high retention low churn this quarter, call it north of 90% retention on those capacities.

The next question will be from Simon Flannery of Morgan Stanley.

Okay, great. So you talked about the healthy pipeline a few times. Are you seeing any benefit from tax reform in terms of [IM] enterprise spending on expansion? Any more confidence there? Or is that something that you think might feather in later in the year? And on the hyperscale side of it, is there any change in the mix between what they're self-performing, doing themselves versus what they are using you or others for in terms of outsourcing the build?

Simon, it's Dan Papes. Thanks for the question. From the pipeline perspective, you're right. As we've termed it here in our discussion today, it's very healthy. We're really pleased with it. We're pleased with it in the second quarter. And as we take a look at the remainder of the year. We can't -- we really can't trace any of it directly back to tax reform. It may be a small factor in there, but there's nothing obvious about the demand we're seeing from enterprise or the CSPs related to tax reform. We like to think it's just a great job being done by our sales team. But really, there's just no trace back to that, that we see. I'll let Andy take the second question. Thanks, Simon.

Sure. In terms of do-it-yourself versus seeking a professional provider like Digital Realty, I think by and large, we've seen more of a trend from even very highly sophisticated, well capitalized technology customers to come to Digital, especially in the major markets where we have full product offering in terms of space and power and also on the connectivity side and where we have landholdings to allow for their business to grow for years to come. I can just look at the mix of our largest signers -- signings in -- across the portfolio that we had several signings this quarter that were in the 2 to 3 megawatt kind of size, several in the 4 to 6 megawatt. I think 6 was the highest in total or 6.5, and it was from a smattering of customers, different customers, U.S. multinational, top 5 cloud service providers, other large sophisticated enterprises that couldn't have had the ability to do -- to build their own data center, and they've come to us for the capabilities and the global platform we deliver to them.

The next question will be from Michael Rollins of Citi.

A couple things if I could. One is if you go back to, I think, it was Slide 4 in the deck, you shaded the core plus range of 9% to 12% per development yield. And I'm curious how that fits into the current year guidance for development yields of 10% to 12%. And what does it say about the future direction of the aggregate development yields for the digital portfolio?

Thanks, Michael. This is Andy. I think the genesis of this chart was really to try and provide an [illustrious] view as to incremental risk takes on incremental reward and not an effort to change our guidance table, which we reiterated on the 10% to 12% for unlevered cash returns on our $1 billion of development spend. I think we obviously tilt towards the 10% when projects are derisked. Derisk can happen from a significant amount of pre-leasing or activity, and we tilt towards the higher end of that range when there's more risk in the equation.

The next question will come from Vincent Chao of Deutsche Bank.

I just want to clarify, just a lot of questions on the bookings. But Bill, you mentioned feeling comfortable I think the $50 million range assuming you get at least 1 anchor tenant. It sounds like 6.5 is the biggest for this quarter. So I mean, is that what you mean when you're referring to an anchor tenant, something in that 5- or 6-megawatt deal size? And then second question is more on the disposition. I know they're noncore so maybe not a great read-through for the rest of the value of the portfolio. But just curious if you could give some commentary on the California data centers that were 100% leased and that traded at a pretty high cap rate.

I mean, the -- take a look on that deal that you mentioned, the $6 million deal, keep in mind that there was shell associated with that, which will likely leads to some additional improved data center space that will be leased over time. But yes, that's fair. So Andy, you want to handle the asset sale question?

Actually Scott can handle [the disclose.]

Yes, I can handle that. Those assets were out in, call it the Sacramento market, which is a noncore market so not as robust a demand from the potential investors or buyers out there. Also, one of those assets was a little challenged with some structural vacancy there, which kind of led towards that higher yield on that.

And then just on -- I think to -- in summary, that's a continuation of the capital recycling program that really under Bill and Scott's leadership started years back to kind of exit markets, exit noncore assets and redeploy that capital at better returns into the core portfolio.

The next question will come from Frank Louthan of Raymond James.

So just curious on Europe. Obviously, the industry's seeing some strong growth there. Any thoughts on why not setting some capital and try to be more aggressive in that market? How should we think about that going forward?

Okay. Thanks, Frank. I can take that one. So I think that we're doing a very good job at executing Europe, and timing is everything because for example, we mentioned in the call a very sizable customer landed in Amsterdam with us in our scale campus with the legacy DFT relationship where they were able to grow internationally. And we thought it was going to land during the quarter, and it popped over into the next month. And on the back side, I think, I know there's been a tremendous amount of activity in a few other markets outside of Amsterdam. In Frankfurt, where we delivered our first campus offering of 6 megawatts, we're moving well along in terms of landing an anchor customer with a top 5 global cloud service provider. And turning to London. I know the team is working on a, call it a 600 kilowatt or so deal on the enterprise vertical as well as some demand coming out of our Asia-Pacific sales team looking to land in the London market. So we -- the timing of our inventory coming online seemed to be quite fortuitous in terms of increasing demand backdrop. And we think we have the right capacity. And if this continues like we've seen in the very end of the first quarter and beginning of second quarter, I think that would point to continuing to put investment into Europe.

The next question will be from Richard Choe of J.P. Morgan.

Just wanted to follow up on the SG&A line. It really dropped dramatically quarter-to-quarter. How much of this is seasonal? Is this the new base level? And is it going to rebound through the year? Or is there something else going on there? And I have one follow-up.

Richard, thanks for that question. So it's -- the answer to your question is yes and yes. It did step down partly due to seasonal in terms of bonus accruals. As we know, our numbers and performance close to the end of the year, that number will ratchet up a little bit in the third and fourth quarter, and you can kind of look at that similar trend in the past third and fourth quarters. We also were carrying in the G&A some headcount and some non-comp expense associated with our DFT acquisition that has been winding down in terms -- on both of those fronts. And we do think it will step back up at some of our G&A investments, be it IT systems, our investment in the sales and marketing department, sales engineering and our overall IT department, as we work on finalizing our integrations and [invested team.] Similar comments we made at our Investor Day in the beginning of December really to spend, not massive dollars, but an amount in the budget to fuel growth in the business. So I do think it will pick up in the back half of the year.

And then looking at the supplemental, it seems like on the lease expirations, things were pushed out. It might be a subtle difference but just wanted to be able to ask about it. Have you been working to kind of expend out customers and it's maybe not something that you can just point out on a big level, but it seems like a lot of the '18 and '19 expirations have been pushed out. Is there something there that we should be aware of?

I would say we're always looking to push out customer contracts and having customers contracting with us for longer terms at fair and rising rates. So we did about 57 million of renewals. I don't think that was a record renewal quantity for us. The weighted average renewal term on the TKF, which is the larger dollar longer-term stuff was, call it, 5 years. And we obviously keep chopping through our renewals every year. I think we're taking a very much a holistic approach with our global customer base and using those installed embedded relationships and contracts to come to mutually beneficial outcomes and package more business together and use that installed customer base as a competitive advantage that helps our customers more than some of our competitors can.

The next question will be from Lukas Hartwich of Green Street Advisors.

I noticed the base building construction pipeline increased by a fair amount this quarter. Can you provide some color on that?

The base building, I know -- my gut, Lukas, is if that's on the development pipeline, that's really largely driven by some of the activity in Northern Virginia. And like I said, we've got, call it, 23 megawatts that are as of the quarter, were unleased and we are working fast and furiously in bringing our incremental shells because we'll be quickly through [building out] on that campus, at least the first phase of it. We also -- something I should mention, we also had, in the prior quarter, there was a shell that was not there that we brought online because the customer signed a lease for the entirety of a shell, I think 36 megawatts, including initial take of 6 megawatts within it as well on a long-term basis. So that kind of speaks to the activity in that market. In particular that customers are -- some large amounts moving to fully contracts where we're really looking at dirt and taking an [extra] design very quickly.

That's helpful. And then just a quick follow-up. The straight-line rent line item. It looks like it's up a little bit over the last couple of quarters. And is that just driven by free rent on recent lease signings? Or what's kind of driving that line item?

The -- I think there was something in the prior quarter that deflated that adjustment, was episodic maybe on the leasehold side. I do -- I would say [with signing] more longer-term deals with escalators, it's going to certainly continue to widen that gap between your gap rent and your cash rent, so that will be probably another attributor to the widening of that number. But relatively, I would say fairly small adjustment, because I would say that our -- the delta between our FFO and AFFO is relatively narrow speaking to the quality of our earnings.

The next question will be from Robert Gutman of Guggenheim.

So we haven't seen much power-based building for quite a while, and it's turned up again this quarter. I was wondering, especially based on the [currency rate] I think in answer to your last question. Does this indicate anything about the customer view? Why are they -- why has this suddenly come back into the picture? Is it a positive read on demand? And similarly, the -- in Asia Pacific, we had significant Turn-Key leasing. I was wondering if you could provide some greater color on location and the context for that.

Rob, thanks for the question. So I do think the data point you pointed out does point to a trend we're seeing in the business as these large either top-5 cloud service providers, other hyperscalers are seeing a long-term growth trend in their business, and they're looking to lock up capacity in large quantities, knowing that they'll grow into it over time. In that example, they took down the entire shell and rented that for us -- from us or -- upon delivery, they will rent it from us and then took 1 suite and then will grow into that suite or that full shell over time. I think that's something -- not necessarily identical structures, but I think that many of our large and growing customers are thinking long term about the growth in their business. And this is just one way to tackle it. Turning to Asia. I would say I just spent some time over there with our team over there, who's incredibly talented and had some great success with the local customer base. And it really -- it's been about a bit of an import/export business, and I don't know that -- don't say that in jest, but it's bringing those local customers into the data centers in Singapore where we had significant pickup in leasing with the new logo on a large-scale deal. And it's also setting that same demand to other parts of the Digital Realty portfolio, and I'm thinking particularly of some of the Chinese customers where they've sent that demand into North America on both coasts and also tracking deals, as I mentioned earlier, in the European market with that same profile of customer. So overall, great progress from the team in Asia Pacific in the last handful of quarters actually.

The next question will come from Nick Del Deo of MoffettNathanson.

First, I was hoping to drill down a bit further into rent changes that you're seeing at renewal? And more specifically, if we slice your Turn-Key portfolio different ways, like older facilities versus newer facilities or Internet Gateways versus corporate facilities or higher resiliency versus lower resiliency, are there differences in what you see at renewal? Or would you characterize them as fairly similar across the board? And then second, I was just hoping you could give us an update on some of these customer service initiatives you're undertaking? And if you're starting to see any benefit in the result.

Sure, Nick. I'll tackle the first one, and I'll toss it out to team to talk about it on the customer service side. We have a table on the back of our financial sup that's either Page 20 or 21 or 22 that really breaks out the product offerings. I would say the outcome of our expirations in terms of cash mark-to-market is driven by the product offering, is driven by the customer profile. And as you can see on that, the bulk of our Internet Gateway, as you've mentioned, fall within our colocation footprint. It's not exclusively but you see that we had 3.5% cash mark-to-markets all with 90% retention. And if you move to the Turn-Key Flex, which is typically a little bit larger scale, definitely approaching the multiple megawatts in terms of expirations and renewals, that was closer to 4%. It's those colocation product offerings, those Internet Gateways that are typically incredibly network customer-dense, limited capacity, maybe the most challenging type of capacity to move to a new provider. But both, by and large have had -- we've kind of cycled through some peak [vintage] leases and turned into positive in the last couple of quarters. The other thing I want to touch on real quickly is we're really trying to take a holistic customer approach agnostic to product and try to bring as many pieces of business, be it a network node in an Internet Gateway, a scale renewal in one of our campuses, business in North America or Asia or Europe, and bring that in a holistic fashion to the customer and bring more to the table than just a transactional experience, which we think is a win for the customer in terms of delivering more value and we think it's a win for Digital. And that often -- how we treat that customer at the renewal and those economic equations may flow through with a little bit softer positive cash mark-to-market but may also translate into more signings in the portfolio near term and the future. Maybe I'll turn it over to Dan to talk a little bit about the customer service initiatives.

Thanks, Andy. Thanks, Nick, for the question. We look at our performance over the last few quarters and our confidence in the pipeline right now. I think your question on customer service is quite valid to ask. Because I think it's making a significant -- we think it's making a significant difference in the demand pipeline that we're seeing from our customers. We have customer success managers deployed across our client base. We've invested in that role inside the company so that we stay close to our existing customers while the sales team is out building new pipeline. And we get very, very positive feedback from our customers in regard to that. We mentioned previously our Digital Delivers Program, which basically when a customer has feedback for us, they just click a hyperlink at the bottom of any of our e-mails and get a response in 24 hours. And very positive feedback on that. We've talked about the focus on cultural changes and customer centricity in the company. That's making a big difference for us as well. And then finally, I'll say again the executive sponsor program where all of us are getting out into the field and spending time with our clients, understanding what their strategic and tactical needs are, makes us, a really well informed leadership team and able to much more effectively make decisions that end up in, we believe, much happier customers and repeat customers. That's working well for us.

And the next question will come from Sami Badri of Crédit Suisse.

Could you give us more color on why interconnection grew around 7% 1Q '18? And just in the context of just your performance in the quarter, can you give us a little more color on that? And also the after that, the second part to that is can you give us more color on the work you're doing with Megaport considering you actually invested another $5 million in a follow-on equity offering? And I could go from there.

Thanks, Sami. Maybe I'll just touch on the interconnection revenue on the signings and the flow-through in the P&L and I'll toss it over to Chris Sharp, our CTO, to add on to that and also give some commentary on the Megaport question you had. So it was a little bit lower. On the signings front, obviously stepped up versus the prior quarter but still not at a level that we're completely satisfied with. I won't -- can't tell you and point it to something specific, episodic on the signings. I would -- I often look at it, the interconnection signings, kind of hand-in-hand with the colocation signings where the bulk of that connectivity is being serviced. And on a quarter-over-quarter basis, while not at peak number, we're down, call it, [just over] 10%. I attribute that largely to our pipeline and execution around some larger colocation deals, so [several] megawatt, but call it 200, 300, 400, 500 kilowatts. And the -- another dynamic going on there is some -- the lines are blurring a little bit between our products in terms of colocation and scale and some of those type deals have actually fallen outside of the colo product into a scale TKF suite. We actually saw it tick up close to 14% or about a half a megawatt for sub-600 kilowatt deals that landed outside of colo. The prime example of that was a large telecommunication company that landed with us I think in 9 locations and about half were in [productized] colo and half were outside productized colo. But net-net I think it's good news because our breadth of product allows us to capture that. And I think the pipeline for some of the larger colo deals, which should have additional connectivity in the ensuing quarters is looking pretty strong. But maybe I'll open it up to Chris to add on that and we'll have him touch on the Megaport question as well.

Thanks, Andy. And Sami, you're absolutely correct. We're very happy with the partnership that we have in place with Megaport today. It's a very unique partnership out in the market. One of the things that we always emphasize is it's a core component to our overall service exchange, which some of the key highlights around the service exchange is it's really changing the dialogue that we're having with customers today and allowing us to really remove a lot of complexity from their deployments and allowing them to stand up their hybrid cloud architectures. And one customer in point after the -- in the most recently win in this last quarter is Netgain. They're a cloud IT provider delivering cloud hosting and managed services for a health care and financial vertical. It's really -- the service exchange is allowing them to provide a much more dynamic environment for their customers in accessing the Microsoft Azure cloud. And then lastly, I mean, one of the reasons that Netgain came to Digital is the fact that they we're able to provide a more robust, very performance-aware deployment and being able to access a set of future cloud services, which allows them to really broaden their horizons and leverage a future set of cloud service across that exchange. And that's where -- one of the reasons why we picked Megaport to partner with is that not only their work but our conjoined work in going to market allows us to really solve a very differentiated part of the market and the fact that we've been able to accelerate the launch of the service exchange into, most recently Amsterdam, Frankfurt and London due to the customer demand, because of the fact that we have all the top-5 cloud providers on that platform. So that's including Microsoft Azure, Google Cloud, AWS, Oracle and IBM. So it's really allowing us to have a value-based dialogue with our customer base. So we're very happy with the partnership we have in place with Megaport, and we look to continue to expand the service exchange functionality across our portfolio.

And ladies and gentlemen, that will conclude our question-and-answer session. I would like to hand the conference back over to Bill Stein for his closing remarks.

Thanks, Denise. I'd like to wrap up our call today by recapping our highlights for the first quarter as outlined here on the last page of our presentation.

First, we continue to execute on the integration of DuPont Fabros, capitalizing on the value of the installed customer base to realize revenue synergies, reaching record high bookings and backlog. We also delivered very solid current financial results, beating consensus and raising guidance. [Three of] the sustainable growth in our earnings has flowed through to cash flow as well as our distributions to shareholders. And our board recently approved a 9% increase in the per share dividend, making this the 13th straight year that we've given shareholders a raise on the dividend. We achieved this growth in our distributions to shareholders while preserving our best-in-class balance sheet, which we believe is a critical differentiator, particularly in a rising rate environment. Last but not least, our board has approved a resolution giving shareholders the right to propose binding amendments to our bylaws.

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 to see many of you at NAREIT in June.

Thank you, sir. Ladies and gentlemen, the conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines.