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Edited Transcript of DFT earnings conference call or presentation 23-Feb-17 3:00pm GMT

Thomson Reuters StreetEvents

Q4 2016 DuPont Fabros Technology Inc Earnings Call

WASHINGTON Sep 15, 2017 (Thomson StreetEvents) -- Edited Transcript of DuPont Fabros Technology Inc earnings conference call or presentation Thursday, February 23, 2017 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Steven Rubis

DuPont Fabros Technology Inc. - VP or IR

* Chris Eldredge

DuPont Fabros Technology Inc. - President and CEO

* Jeff Foster

DuPont Fabros Technology Inc. - CFO

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Conference Call Participants

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* Dan Ochinero

Barclays Capital - Analyst

* Matthew Heinz

Stifel Nicolaus - Analyst

* Colby Synesael

Cowen and Company - Analyst

* Michael Rollins

Citigroup - Analyst

* Frank Louthan

Raymond James - Analyst

* Jonathan Atkin

RBC Capital Markets - Analyst

* Jonathan Schildkraut

Guggenheim Securities - Analyst

* Jordan Sadler

KeyBanc Capital Markets - Analyst

* Rob Stevenson

Janney Capital Markets - Analyst

* Paul Puryear

Raymond James & Associates, Inc. - Analyst

* Jon Peterson

Jefferies & Co. - Analyst

* Unidentified Participant

- Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen. Welcome to the DuPont Fabros Technology, Inc Q4 2016 earnings conference call.

(Operator Instructions)

I would now like to introduce your host for today's conference, Mr. Steve Rubis, Vice President of Investor Relations for the Company. Mr. Rubis, you may begin. You may begin.

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Steven Rubis, DuPont Fabros Technology Inc. - VP or IR [2]

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Thank you. Good morning, everyone. And thank you for joining us today for the DuPont Fabros Technology's fourth-quarter 2016 earnings conference call. Our speakers today are Chris Eldredge, the Company's President and Chief Executive Officer; and Jeff Foster, the Company's Chief Financial Officer.

Certain matters discussed during this conference call may constitute forward-looking statements within the meaning of federal securities laws. These forward-looking statements are subject to certain risks and uncertainties. The Company assumes no obligation to update or supplement these statements that become untrue because of subsequent events.

Additionally, this call contains non-GAAP financial information of which explanations and reconciliations to net income and operating income as applicable are contained in the Company's earnings released issued this morning. The release is available in PDF format under the Investor Relations section of the corporate website at www.DFT.com.

To manage the call in a timely manner, we will limit the questions to only two per caller. Should you have any additional questions you may return to the queue. I will now turn the call over to Chris.

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Chris Eldredge, DuPont Fabros Technology Inc. - President and CEO [3]

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Good morning. Thank you for joining the call. Today I will provide comments on our leasing performance, a review of 2016 achievements, goals for 2017, and Cloud trends driving our leasing performance.

DFT set a record 2016, leasing nearly 51-megawatts compared to an annual historical average of 30-megawatts. The new leasing record is 4 megawatts above the record set in 2015.

In 2016, 14 new leases were signed with a weighted average lease term of 12.2 years. During 2016, eight leases totalling 7.97 megawatts were extended by a weighted average of 2.3 years.

One pre-lease of 2.88-megawatts was signed in the fourth quarter with a lease term of 5 years. This pre-lease adds a new logo to the roster with a strategic Cloud customer and is a full service lease. Additionally, one lease totalling 1.3-megawatts was extended in the quarter by two years.

So far in 2017 we signed one lease for 4.2-megawatts. This lease represents our last 4.2-megawatts in [ATC7], now 100% leased.

DFT experienced strong renewal pricing in 2016. Upon the expiration of the original lease terms, cash based rents will be an average 3.6% higher and GAAP based rents will immediately be an average of 3.1% higher.

Two customers with leases set to expire in the second half of 2017 have informed us that they do not intend to renew their leases. The first lease, which expires on July 31, 2017, is for 1.14-megawatts in ATC4. The second lease, which expires on August 31, 2017, is for 0.54-megawatts in ACC6.

These leases represent less than 1% of our annualized base rent. And we are marketing these computer rooms for release. Neither name is a top 15 customer of DFT.

Looking back on 2016, the Company executed on several key initiatives. Land was acquired in our new markets, Toronto and Portland. The land in Toronto included the Shell Building that used for our TOR1 data center.

In Toronto, we have begun development and expect to bring on 6-megawatts of capacity in the fourth quarter of 2017. With another 12-megawatts available for future delivery in Phase I.

Portland is in pre-development and we expect to commence development later this year. We continue to forecast delivery in the second half of 2018. We will utilize our 4.0 design at both TOR1 and OR1 and continue to use our 3.0 design in our existing markets.

In Ashburn and Chicago, we expect future developments will utilize N plus 1 redundancy for electrical and mechanical infrastructure. DFT added its first full service lease in the second quarter of 2016 and just added a second in the fourth quarter of 2016. The full service lease represents a strategic tool to win new customers and we expect to see continued demand for both our full service and triple net leases.

Fourth quarter 2016 financial results were outstanding. As we achieved 20% plus growth rates across revenues, normalized FFO per share and AFFO per share. Jeff will provide the details for you later in the call.

Let's now discuss focal points for 2017. Continued execution on our 5 year strategic plan, building on leasing momentum, maintaining industry leading occupancy rates, successfully extending leases with T customers and opportunistically replenishing our land bank. DFT will make a significant CapEx investment in 2017 to move our 5 year strategic plan forward, as each of our markets will have projects and development.

We are now a full year ahead of the development plan we rolled out 15 months ago at our investor day. The goal remains to deliver 12% unlevered ROI and bring development projects forward according to market demand. Our goal is well supported by our industry leading occupancy rate, 99% as of February 23rd.

Renewal discussions are an important 2017 focus. As our first lease expiration with Facebook occurs in mid 2018. The plan is to engage in discussions that lead to a successful renewal.

Improving our land bank is also key. Today, we announced we entered into a contract to purchase 56-acres in the Phoenix market. We currently plan to hold this land in our land bank, and will require a pre-lease to develop this land near term. We continue to look at land in Ashburn, Chicago and Santa Clara.

We have five projects currently under development totalling 64.4-megawatts, 50.8-megawatts are expected to be delivered in 2017. 18.9 megawatts are already leased. An excellent position in the current competitive environment.

So, let's talk about the current competitive environment. We are not the only ones to see positive long term demand trends. Competitors are actively supplying the best data center markets with new products with plans for more.

In response, large hyper scale uses are lining up to take on the largest megawatt leases we have ever seen. The combined affect of these two elements, the introduction of new supply and purchasing power of hyper scale users is putting pressure on pricing. The impact on DFT, even though we are likely to see pricing pressure, we believe that the pressure will be positively offset by two factors.

First, the elimination of risk from our development pipeline as large leases with high credit names becomes the norm. And second, our ability to achieve targeted development yields through the design flexibility of our premium data centers.

The key is continued demand for data centers and the demand is there. Cisco's global Cloud index forecasts traffic within hyper scale data centers will grow 5 times by 2020. The fourth quarter Cloud provider performance illustrates the strong demand for wholesale data centers.

AWS revenues grew 47% year-over-year reaching an annualized run rate of more than $14 billion. In 2016 they migrated 18,000 databases, and added more than 1,000 new services.

Microsoft Du Jour grew 95% year-over-year, reaching an annualized run rate greater than $14 billion. Du Jour compute usage doubled and now three of four Du Jour customers are using premium services.

In January, Oracle CEO Mark Hurd updated his 2020 Cloud predictions. Mr. Hurd suggested 80% of production apps will be in the Cloud. 100% of test and development will be in the Cloud. And CIOs will spend 80% of the IT budgets on innovation rather than maintenance.

Snaps' recent IPO filing disclosed a contractual commitment to spend $2 billion on Google cloud platform in the next 5 years. Facebook announced plans to l spend more than $7 billion on CapEx in 2017. Lastly, Apple's Services Business generated $25.5 billion in revenues in 2016 and is expected to double in 4 years.

These data points illustrate why wholesale data center providers are well positioned for growth. We believe that DFT is particularly well suited to take advantage of this opportunity given our focus on wholesale. We are enthused about what we see in the pipeline of potential leasing opportunities in 2017.

The strong demand from Cloud providers has resulted in strong ROIs from our recently completed facilities. Today we announced that ACC7 is 100% leased. ACC74 delivered an unlevered ROI of almost 14.5%, well above our target return.

DFT remains committed to enabling the Cloud via our wholesale data center product. The Company continues to benefit from a robust pipeline inclusive of several Cloud service providers. We believe that DFT is well positioned to continue to compete for and win business from Cloud providers on terms favorable to our business.

Before turning the call over to Jeff, I would like to announce that Brian Durico, our Chief Revenue officer will shortly be leaving the Company. Since joining DFT in late 2015 Brian has played a key roll leading DFT's leasing efforts to a record volume in 2016. He has worked closely with current and perspective customers and show them the value of DFT's offerings.

Brian has decided to pursue other opportunities and he leaves with our best wishes. We have retained a search firm and are actively recruiting for Brian's replacement.

I will now turn the call over to Jeff.

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Jeff Foster, DuPont Fabros Technology Inc. - CFO [4]

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Thank you, Chris. I will cover four topics today; fourth-quarter and whole-year 2016 results, development updates, capital markets, and our 2017 guidance.

Earnings per share in the fourth quarter of 2016 totaled $0.44, versus a $1.23 loss a year ago. $1.23 loss in the fourth quarter of 2015 included an impairment charge of $1.52 per share for the NJ1 data center. Excluding the impairment charge, earnings increased $0.15 per share in 2016, attributable to two drivers.

First new leases commencing in the fourth quarter of 2015 and the full year of 2016. Second, lower preferred stock dividends, as we reduced our preferred shares outstanding by $150 million through the redemption of series A and B and issuing series C which carries the lower dividend rate. This was partially offset by dilution associated with the issuance of common shares in the first quarter of 2016.

Normalized FFO totaled $0.75 for the quarter versus $0.61 per share a year ago, an increase of 23%, or $0.14 per share. Normalized FFO benefited from increased operating income, excluding depreciation, as well as lower preferred stock dividends. These benefits helped overcome headwinds of $0.08 per share, resulting from the dilution associated with the common equity offering in the first quarter of 2016 and $0.01 of increased interest expense.

For 2016, normalized FFO totaled $2.80 per share, versus $2.46 per share a year ago, an increase of 14% or $0.34 per share. The 14% increase compared favorably to our 2015 investor day projection of 10%. The strong leasing for the year offset all of the dilution resulting from our common stock offering which was not forecasted in our investor day projection.

Fourth quarter 2016 AFFO totaled $0.78 per share, versus $0.60 per share a year ago, an increase of 30% or $0.18 per share. In addition to the increase in normalized FFO, we generated an additional $0.04 per share of growth from an increase in the add back of both straight line revenues and stock based compensation. For 2015 AFFO totaled $2.82 per share, versus $2.64 per share a year ago, an increase of 7% or $0.18 per share.

Full year AFFO growth was $0.15 per share less than normalized FFO growth, primarily due to a lower add back of straight line representatives associated with the collections of net data centers in 2015 that were not applied to revenue, as well as lower cash from our new ATC2 lease. AFFO growth for 2016 was lower than the 9% forecasted on investor day due to the straight line add back. As I will discuss in guidance, this trend is predicted to reverse in 2017.

One additional item on AFFO, this is last time we will present AFFO per share. We have considered the guidance offered by the SEC regarding disclosure of non-GAAP measures and we are following the trends of peers and other REITS in their elimination of the disclosure of AFFO per share. This metric is fading away. We will continue to present AFFO in dollars and the number fully diluted shares in units, so you will be able to do the math. Included in our 2017 guidance are all the components that are needed to derive AFFO per share.

Revenues in the fourth quarter totaled $141.7 million, representing a 22% increase from the year ago quarter. The fourth quarter of 2016 included several large ala carte projects, totaling $4.5 million in revenue.

For the full year of 2016, revenues totaled $528.7 million, representing a 17% increase from 2015. New leads commencements were the primary driver of the strong revenue growth. The 2016 revenue increase of 17% compared favorably to our 10% to 12% growth forecast at investor day.

Cash generated from operations in 2016 totaled approximately $290 million, an increase of $35 million or 14% year-over-year. After the payment of common and preferred dividends, we generated $101 million in cash in 2016 which was used to partially fund our 2016 development CapEx.

Same-store, cash net operating income totaled $84.4 million in the fourth quarter of 2016, versus $71.8 million a year ago, an increase of 18%. Same store, same capital cash NOI in the fourth quarter of 2016 totaled $64.4 million, versus $60.8 million a year ago, an increase of 5.9%. Filling the [HC2] vacancy in the fourth quarter of 2015 helped drive the out performance contributing 5% growth in the quarter.

Let's turn our focus to our growth engine, development. As of today, our operating portfolio of 287.1-megawatts is 99% leased, leaving about 2-megawatts in our operating portfolio available for leasing. This means our future growth is coming from development.

We currently have five projects under development totaling 64-megawatts, which are 29% pre-leased, leaving 46-megawatts available for pre-lease. Of the 46-megawatts, 32-megawatts are scheduled to be delivered in 2017, and 14-megawatts in 2018.

We are currently developing projects across three established DFT markets, as well as Toronto which is our first market since 2011. For 2017 total CapEx spend is forecasted to be between $600 million and $650 million, which will be a record for DFT. The estimated cost per megawatt to build in Ashburn is $8.9 million for ACC9.

We have increased the total megawatts of stage 3 from 25.6-megawatts to 27.2-megawatts by lowering the redundancy of the building from N plus 2 to N plus 1 as Chris discussed earlier. This lowers the estimated cost to construct CH3 to $10.25 million per megawatt, comparable to CH2.

The development costs as SC1 phase III is projected to be $10.2 million per megawatt, which compares favorably to the $12 million per megawatt we had for the first two phases of this data center. The decrease is due to phase III being constructed at a higher density and some design changes. Recently, we commenced development of the Shell portion of ACC10, to enable faster delivery to market as demand warrants.

As mentioned previously, our Toronto facility, TOR1, is being constructed using our new 4.0 design. This flexible design approach allows customers to select both their power density and redundancy. Maximum critical load for TOR1 is 46-megawatts, however the final megawatts for critical load in this building will be dependant upon customer selections. Currently 12 rooms are planned for phase I and 1 rooms for phase II.

Using our midpoint power density of 1.5-megawatts a room, phase I would yield 18 megawatts of critical load, with a maximum of 24-megawatts at 2-megawatts per room. We are delivering four rooms at opening, which are being constructed at 1.5-megawatts per room and N plus 1 redundancy. The remaining eight rooms are being held for customization by customers. The cost of phase I at 18-megawatts per critical load is forecasted to be approximately $10 [million] per megawatt in US dollars.

Our pricing matrix takes our 4.0 design into consideration and targets a 13% unlevered ROI. Toronto's target is higher than our normal 12%, as we anticipate tax leakage which will decrease after tax ROI by 1 percentage point. We believe that current market pricing supports our 13% target.

Turning to capital markets, our current plan is to fund our 2017 CapEx with $100 million to $125 million of cash generated from operation after paying dividends and the remainder will be funded with borrowings on our line of credit. We are borrowing in Canadian dollars to fund TOR1 and anticipate putting a mortgage on this property upon completion of phase IA. We anticipate a bond issuance to firm out the financing for the US dollar borrowings in late 2017.

On January 17, we pay our quarterly dividend of $0.50 per share, a 6.4% increase from the prior quarter. DFT's anticipated 2017 annualized dividend is $2 per share, representing an estimated AFFO payout ratio of 62%.

Last, let me discuss the guidance we issued this morning. The full year 2017 normalized FFO guidance range is $3 per share to $3.20 per share, representing an increase of $0.30 per share or 11% at the midpoint. The key assumptions are the following. First, the low end of the range assumes $0.01 per share of revenue from spec leases commencing in 2017 and the high end assumes $0.19 of revenue from spec leases commencing in 2017. Second, guidance forecasts placing 50-megawatts of service in 2017, the details of this are in the earnings release.

The drivers for the increase in normalized FFO at the guidance midpoint are increased NOI of $0.42 per share of which $0.31 per share is from leases that have already been executed. We also have lower preferred stock dividends of $0.08 per share from the retirement of the series A and B issuances of 2016, this is partially offset by $0.08 per share delusion from the 2016 common stock offering. $0.09 per share of higher interest expense due to higher rate and more borrowing to fund our development. And a $0.03 per share increase in G&A as we continue to add personnel to fully implement our strategic plan.

Full year revenues are expected to between $565 million and $585 million representing 9% year-over-year growth at the midpoint. EBITDA margins are expected to between 60% and 62%, versus 2016's 60.5%.

The first quarter normalized FFO guidance range is $0.76 per share to $0.78 per share, with the midpoint being $0.02 per share higher than the Q4 2016's normalized FFO per share. The increase is due to lower interest expense due to higher capitalization. One thing to note in our add backs normalized FFO to derive AFFO is that straight line revenues are predicted to be a positive add back for 2017, with a $0.01 per share add back in Q1 and $0.06 per share for full year 2017.

I would like to take a few moments to frame the possible scenarios around our renewal discussions with Facebook. Our first lease currently expires on June 30th, 2018. Renewal discussions typically begin one year out from the lease expiration.

Our goal is to begin renewal discussions as early as possible. Currently, we have leases with Facebook in four of our Ashburn facilities, ACC4, ACC5, ACC6 and ACC7.

Our leases with Facebook at ACC4 an ACC5 are well above current market rates. If Facebook were to renew the older leases at ACC4, ACC5 and ACC6 at what we believe is a competitive rate, then FFO per share would decline $0.04 per share per annum. If this renewal were to be executed on July 1, 2017, we would adjust GAAP rents immediately, and this would lower FFO per share by $0.02 in 2017. There is no change to AFFO until the rents adjust at the currently scheduled end of the lease.

To help you model that, here are the percentages of annualized base rent that expire in each year for Facebook, for their leases at ACC4, 5 and 6. It is 2.2% for 2018,4.1% for 2019, 5.8% for 2020, and 4.8% for 2021. Our 2017 guidance ranges include the different possibilities associated with the Facebook renewal scenarios.

Operator, we will now take questions.

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Questions and Answers

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Jeff Foster, DuPont Fabros Technology Inc. - CFO [1]

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(Operator Instructions)

Dan Ochinero, Barclays.

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Dan Ochinero, Barclays Capital - Analyst [2]

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Chris, as Jeff alluded to in his comments, it seems like much of our 2017 FFO growth is predicated on new development leasing. Can you elaborate on future leasing prospects from both existing tenants and new customers? What is the potential to sign larger deals on your Virginia and Toronto developments? And in light of your pricing pressure comments, do you expect pricing to decline from 2016 levels?

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Chris Eldredge, DuPont Fabros Technology Inc. - President and CEO [3]

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Sure. There are a few parts to that question, Dan. I will address each one.

First, we will talk about the pipeline. The pipeline hasn't changed. It is really strong. The 2X that I talked about on the last earnings call is still there. We expect to close some of those larger deals this year. And those deals will be in Virginia, Chicago, and in Toronto. So, we are anticipating pretty strong leasing.

The second comment is, you asked about pricing pressure. When you look at the sheer deal size of these opportunities, we have never seen deals this size before in the history of the Company. With that, there is definitely some pricing pressure. There are a few things we have to consider, right? We want to make sure we achieve our target yields, and that is not going to change. We are also taking development risk off the table with some of these large deals with some of these opportunities. We talked about the 29% pre-leasing that we have. That will help with the pre-leasing numbers. Also, we want to take care of our strategic customers. From our perspective, we think it is very positive and we are excited about our pipeline.

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Dan Ochinero, Barclays Capital - Analyst [4]

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Thanks. Do you think more of it is from existing tenants, or new logos or --?

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Chris Eldredge, DuPont Fabros Technology Inc. - President and CEO [5]

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I would say it is a combination of both. We have great customers. At lot of our existing customers are active in the market looking for more capacity. But there are also new potential customers in the pipeline as well. So it is a mix.

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Operator [6]

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Thank you. Matthew Heinz, Stifel Nicolaus.

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Matthew Heinz, Stifel Nicolaus - Analyst [7]

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Thank you. Good morning.

I wanted to frame up the FFO guidance range in terms of megawatts of leasing. Does the high end of the range essentially is from a full lease up of the 46 megawatts available in your development pipeline? And should we think about the $0.10 of midpoint spec leasing as roughly half that number?

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Jeff Foster, DuPont Fabros Technology Inc. - CFO [8]

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I would like to frame it a little different, Matt. This is Jeff.

So, of the 46 megawatts that you referred to, 32 megawatts are scheduled to be delivered this year. So, those are the megawatts that, if we lease, that we will get revenue from this year. It is really 32 instead of 46. It is really when those leases come in that derives the $0.19. If you look at our delivery of these megawatts, they are weighted into the back end of this year. The first half of this year, we will deliver ACC9 Phase 1, which is 14.4 megawatts, 2.88 is already leased. So that leaves us around 10 or 11 megawatts we can lease there. The other 22 megawatts that are available for lease are going to be delivered in the second half of the year. So, it really does depend on the timing, and how quickly we get these developments opened as to whether we are at the $0.01 or the $0.19.

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Matthew Heinz, Stifel Nicolaus - Analyst [9]

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Okay. That is helpful. Thank you.

One follow up, also on the guidance. You mentioned that you are assuming $0.06 of add-back on the straight line, which I assume would also be dependent on the magnitude of renewals that you mentioned. And large lease commencements throughout the year. Can you help us understand, does that $0.06 assume any Facebook renewal activity this year? And I guess, the moving parts with respect to the timing you talked about on any commencements?

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Jeff Foster, DuPont Fabros Technology Inc. - CFO [10]

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Yes. The $0.06 contemplates one of the scenarios for Facebook renewing this year. And if you look at our operating property table, we forecast there over the next 12 months the cash and GAAP-based rent for leases that have already signed. And the $0.06 is less than that. So it assumes for new leases signed that there would be a little bit of straight line drag.

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Matthew Heinz, Stifel Nicolaus - Analyst [11]

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Okay. Thank you very much.

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Operator [12]

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Colby Synesael, Cowen and Company.

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Colby Synesael, Cowen and Company - Analyst [13]

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I want to go back to the Facebook commentary. So, Jeff, you stated that the guidance includes, I think you said a scenario where Facebook would renew during the quarter or during the year. Can you be a little more specific in terms of what scenario you are assuming? And what are some of the other scenarios that could happen? And maybe some timing in terms of when that is expected to occur? And then, as it relates to the CapEx [status] of $600 million to $650 million, certainly well above at least our estimate. I was hoping to bucket where the bigger projects in terms of where that money is being spent? And how much of that includes projects that have yet to be disclosed. Thanks.

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Jeff Foster, DuPont Fabros Technology Inc. - CFO [14]

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Sure. On the Facebook, the way I modeled it in my guidance was the way I described it: as a mid-year renewal of ACC4, 5, and 6. We could have a scenario where they don't do a mass renewal. So I actually have some favorability to my guidance of about $0.02. Or we could have a scenario where they renew at a lower rate then I am contemplating, where I have some lack of favorability. And of course, it all depends on timing. It they were to strike a renewal April 1, there would be 9 months [in tax], if it were October 1, there would be three months of in tax, but I went middle of the road for the guidance.

On CapEx, you are seeing the bulk of the dollars in Ashburn at ACC9 Phases I and 2, and for the first phase of Chicago that we started right after the holidays. That is where the bulk of the dollars are. All the dollars that we had predicted in the $600 million to $650 million have been approved with the exception of Portland. We have not gone to the Board yet for approval of that data center. That would happen later this year.

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Colby Synesael, Cowen and Company - Analyst [15]

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And so, I am sorry, so is Portland not then included in the $600 million to $650 million? If the Board was to --?

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Jeff Foster, DuPont Fabros Technology Inc. - CFO [16]

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Portland is in the $600 million to $650 million. It is just the only one in the $600 million to $650 million we don't have the approval yet from the Board to move forward with because we have not asked for it.

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Colby Synesael, Cowen and Company - Analyst [17]

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And besides Portland, does the guidance provide room for additional potential expansions which you guys might announce or pull forward into 2017?

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Jeff Foster, DuPont Fabros Technology Inc. - CFO [18]

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Let me say one other thing about Portland. Portland is in pre-development right now. That is why we haven't gone to the Board. It was a raw piece of land which I think I described to some of you as a wheat farm.

We do not have in guidance the pull-forward of ACC10, other than just building the shell this year; or the pull-forward of CH3, Phase 2. If we were to have a leasing success with some of the large deals that are out there in the pipeline, we would have to update guidance appropriately.

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Colby Synesael, Cowen and Company - Analyst [19]

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Great. Thank you.

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Operator [20]

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Michael Rollins, Citi.

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Michael Rollins, Citigroup - Analyst [21]

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You mentioned changing your build strategy in some of your facilities to different levels of redundancy. I am curious if there is an analog or back of the envelope you can share with us in terms of how your cost per megawatt to build a facility changes when you go up and down the redundancy stack? Are there ways in which you can envision significantly improving your cost per build over the next few years? Thanks.

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Jeff Foster, DuPont Fabros Technology Inc. - CFO [22]

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Sure. This is Jeff.

On the cost change, for the change to an N plus 1 from an N plus 2, we are still building the same number of line-ups in the building, but now 1 is a spare versus 2 being spare. So we can sell an extra line-up. It increases our denominator and it saves costs that way. At Chicago's third building Phase I, that was about a 5% cost savings that we saw.

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Michael Rollins, Citigroup - Analyst [23]

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And when you think about the investment cost on a build-forward basis, are there any things that you can do to significantly improve that cost further? Or do you see the reliability requirements for the customers you are going after changing, and that might be an input into the process? Thank you.

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Chris Eldredge, DuPont Fabros Technology Inc. - President and CEO [24]

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Hey, Michael. It is Chris.

We rolled this out at our Investor Day. We talked about N plus 1 and 2N and N plus 2. That 4.0 design that we have is going to give the customers the flexibility to choose. A lot of the applications that are running in our facilities are real-time. That means they are some of the most critical and sensitive data. I call it production environments. People want their information in a secure facility. What we are seeing is N plus 1 is the most common design out there right now. And a lot of that data is being replicated across multiple data centers. We think there is an opportunity for potential customers to buy more from us across multiple locations.

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Michael Rollins, Citigroup - Analyst [25]

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Thanks very much.

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Chris Eldredge, DuPont Fabros Technology Inc. - President and CEO [26]

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You are welcome.

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Operator [27]

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Frank Louthan, Raymond James.

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Frank Louthan, Raymond James - Analyst [28]

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If you look out in the competitive market, we continue to see, like you mentioned, a lot of leasing and a lot of pre-leasing. Are you seeing within that, do you feel like any of your competitors are acting irrationally? And can you walk us through the design elements that you are talking about that are maybe helping you attract some share? How are you differentiating yourself in the market? Thanks.

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Chris Eldredge, DuPont Fabros Technology Inc. - President and CEO [29]

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I will talk about the markets in general. None of my publicly traded peers have done anything irrational in the space. I think we have all been pretty good with bringing supply onto market. There have been some [PE] backed companies that have done some irrational things in Chicago. We have seen that. I will not call out the name of the company. The facility is not the high quality of our facilities, or even my publicly traded peers. So, you see things like that out in the marketplace. But when you look at the design and the overall market in general, I already talked about it.

N plus 1 is the most common design that we are seeing out there. You look at the competitive landscape. When you're successful, competition will come. One of the things that we do as a Company is we like to compete and we compete to win. If you look at our facilities, we believe we build the highest quality facilities out in the space right now. There is a reason why our customers come and continue to buy from us time and time again. It is the sheer quality of our facilities. It is the people that we have operating the facilities; it is the relationships we have with our customer, both new and existing customers. People buy from people. And they come to us for all those reasons, and that is why we have been successful the last two years. If you look at our leasing, we have had a record year in 2015, a record year in 2016, and we are pretty excited about 2017.

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Frank Louthan, Raymond James - Analyst [30]

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All right. Great. Thank you.

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Operator [31]

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Jonathan Atkin, RBC Capital Markets.

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Jonathan Atkin, RBC Capital Markets - Analyst [32]

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So, I was interested in whether you are seeing existing customers that grow with you, existing logos. To what extent are they taking full service versus triple net? Then on the Phoenix land situation, maybe talk a little bit about the competitive [advantage on ] that market? I know you looked at it has always been a top 5 for you. Any updates on how you view the opportunities there? Thanks.

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Chris Eldredge, DuPont Fabros Technology Inc. - President and CEO [33]

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I will take the question first on the full service versus triple net lease. We did two full service leases last year. First was with a customer that hadn't done a deal with us since the IPO. The second was with a brand new customer. If you look at our existing customers, they love the triple net lease model because they see a lot of benefits to being on a triple net lease. And I think that's going to continue. I think you will see a healthy mix of both. Our existing customers really like the triple net lease and they are going to stay with it.

The next is about Phoenix. As I said in my prepared remarks, we will not do any development in that market without a pre-lease. The 56 acres is for a land bank, but there is a lot of activity going on in the Phoenix market right now. Intel just announced they will spend $7 billion in the market and hire 3,000 employees. The land we bought is in Mesa. Intel is going to spend that money in Chandler. It is going to be harder and harder to develop data centers in Chandler. And we think that Mesa land is something that is good for us to have. And we think it is a market that could be potentially be strong. But we are not going into the market without a pre-lease.

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Jonathan Atkin, RBC Capital Markets - Analyst [34]

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Okay. A follow-up.

Your number four customer, Rackspace, given the change in their business model, and presumably their future needs are a little different than when they initially signed with you. What are your thoughts about [reaching them] as a customer or perhaps subleasing space?

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Chris Eldredge, DuPont Fabros Technology Inc. - President and CEO [35]

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I think most of you know I talk to our customers all the time. The discussions I have had with Rackspace have been about growth in our facility. So, Apollo is in. They have a private equity firm in there working with them right now. They are layering on their financial support on top of the AWS platform and the [azure] platform. And their managed hosting business is doing pretty well. From our perspective, it is business as usual. Nothing has really changed.

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Jonathan Atkin, RBC Capital Markets - Analyst [36]

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And finally on the Chief Revenue Officer position that you are filling, are you looking to go inside or outside the industry? Any kind of parameters around that search?

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Chris Eldredge, DuPont Fabros Technology Inc. - President and CEO [37]

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We are just looking for a great person. When you look at our Company in general, we have been fortunate enough that we have had a lot of people here for a long time that have made contributions. And we have had a lot of people here for short terms that make great contributions. Personal goals change all the time. We support Brian in his decision. And we are really excited about bringing on someone new to help us land more new logos. Whether they're a data center person or a technologist, it really doesn't matter. We are looking for the best person for the job that can help us land some more of those new logos I talked about.

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Jonathan Atkin, RBC Capital Markets - Analyst [38]

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Great. Thank you very much.

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Operator [39]

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Jonathan Schildkraut, Guggenheim.

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Chris Eldredge, DuPont Fabros Technology Inc. - President and CEO [40]

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I don't know that name (laughter).

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Jeff Foster, DuPont Fabros Technology Inc. - CFO [41]

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I don't either.

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Jonathan Schildkraut, Guggenheim Securities - Analyst [42]

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First, Jeff, in your prepared remarks you talked about some of the set-up fees in the quarter. They were a little surprise to us. I was wondering if you might give us a little more detail as to what that is? And how it flows through the P&L from a margin perspective? And if it is something we could expect to be recurring? Is there a change in business model?

Then the second question is for Chris. You talked a lot about derisking capital deployment and pre-leasing activity. And working with some of your larger clients to really become part of their planning process for incremental capacity needs going forward. Given the scale of some of these deals and the fact that there is a big capital requirement and you are looking to get pre-leases before deploying that capital, is it changing the nature of the competitive landscape? That is, is it tilting the landscape in favor of some of the incumbents like yourself relative to the potential new entrants? Thanks.

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Jeff Foster, DuPont Fabros Technology Inc. - CFO [43]

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Hey, Jonathan. It's Jeff.

So, on the a la carte project, I mentioned that we did have $4.5 million of large ones close this quarter, which is a very high number. We account for those today at the time the project completed. So there is no percentage of completion method to smooth that out. Those were all with one of our larger customers who needed some work done on their computer rooms. So they come in a haphazard manner. We get most of them, most larger projects are to help a customer set up their room at the beginning if they pick us versus going with a third party to do it. So it is a large one time event, I would call it. I would not look for that to be recurring.

Then the margins related to something like that are generally quite low. I would say on average our margins in that business are about 10%. So I know a couple people called out the change in our EBITDA margins for Q4. That would be the reason for that. I am not modeling that on a go-forward basis to have that type of run rate.

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Chris Eldredge, DuPont Fabros Technology Inc. - President and CEO [44]

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So, Jonathan, to answer your question. We think the pre-leasing activity is definitely going to increase. One of the things I think has benefited us, is not necessarily the capital structure, it is the relationships we have with some of our existing customers. We have some of the top Cloud providers globally. When you spend a lot of time with them, there is an opportunity for us to talk to them about things that they are doing in their business. We are part of their forecasting process, which has helped us. It helped us against our peers to land some of these leases. And we expect to close some of these big deals that I am talking about in my prepared remarks this year. We are excited about the prospects, we have great customers, and now it is about execution. We got the team to execute on this.

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Jonathan Schildkraut, Guggenheim Securities - Analyst [45]

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Thank you for taking the questions.

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Operator [46]

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Jordan Sadler, KeyBanc Capital.

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Jordan Sadler, KeyBanc Capital Markets - Analyst [47]

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Thank you and good morning. Following up on your last comment there, Chris.

The big deals that are in your pipeline, are they bigger than what you currently have available? Vis-a-vis either the 32 or the 46 megawatts in your under-construction pipeline?

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Chris Eldredge, DuPont Fabros Technology Inc. - President and CEO [48]

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Well, I can't give you the exact size of the deal, but I can tell you they are big. We had some big leasing last year, with some opportunities, and they are bigger than what we did last year. That is what I could tell you.

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Jordan Sadler, KeyBanc Capital Markets - Analyst [49]

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So, what is the nature of it? I mean, it seems like, if I add up, if I look at the $600 million to $650 million to spend, you can get there pretty quickly. And your availability is somewhat limited. So, are these just multi year requirements? Meaning, they would be taken down beyond 2017? Is that the right way to think about it?

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Chris Eldredge, DuPont Fabros Technology Inc. - President and CEO [50]

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I think that is right way to think about it, Jordan. Some of these requirements we are seeing are multi-year. Some have a build-to-suit nature to them. So, not all the $600 million of $650 million of CapEx that we already have announced would go toward those requirements. It may take additional CapEx.

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Jordan Sadler, KeyBanc Capital Markets - Analyst [51]

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Okay. I have a follow-up.

Are there multiple tenants with these large requirements? Is there a potential that there are a couple of tenants in the market with large requirements that are shopping multiple vendors, if you will? And causing a surge in supply and a decrease in pricing?

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Jeff Foster, DuPont Fabros Technology Inc. - CFO [52]

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You know, I can't get into the specifics about the number of opportunities. But I can tell you that these deals are very competitive. So, when you are in a competitive situation, and you have the buying power of some of these hyper-scale Cloud providers, it leads to lower pricing. But as I mentioned before we are still going to get those yields.

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Chris Eldredge, DuPont Fabros Technology Inc. - President and CEO [53]

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I want to tell you that deals like this are causing any kind of surge in supply. I mean, they are deals that, when you win, you would have to do some building for. Like we said in the first answer, they are not just starting in this year. They are starting in future years.

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Jordan Sadler, KeyBanc Capital Markets - Analyst [54]

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Okay. So just coming back to the pricing pressure, then. On ACC7 you guys achieved 14.5%. If there is pricing pressure, and you are able to reduce your cost by a little bit, you know, 5% I think was the Chicago example. Number one, are 14.5% yields still achievable anywhere? Or are we just giving up on the potential upside relative to that 14.5%? And it is just getting harder to do the 12%?

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Chris Eldredge, DuPont Fabros Technology Inc. - President and CEO [55]

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I think the equilibrium for the market has always been 12%. We've had a couple periods where we have gone above 12%, this being one of them. But I think the equilibrium will go back to 12%.

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Jordan Sadler, KeyBanc Capital Markets - Analyst [56]

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Okay. Then just a follow-up on the tenants who are leaving mid-year. Any insight as to where they are going? Or why they are leaving?

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Chris Eldredge, DuPont Fabros Technology Inc. - President and CEO [57]

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You know, one is business downturn. It's MySpace, that's the 1.14 megawatts. The other is a gaming company that had a test and development infrastructure in our facility that they just didn't need anymore. It is more business downturn than anything else.

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Jordan Sadler, KeyBanc Capital Markets - Analyst [58]

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Thank you.

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Operator [59]

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(Operator Instructions)

Rob Stevenson, Janney Capital Markets.

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Rob Stevenson, Janney Capital Markets - Analyst [60]

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Jeff, did you buy back stock during the quarter? It looked like sequentially the shares in [unicount] went down?

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Jeff Foster, DuPont Fabros Technology Inc. - CFO [61]

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No, we didn't buy back any stock.

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Rob Stevenson, Janney Capital Markets - Analyst [62]

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It was 90 million last quarter and it was only 89 million and change on the AFFO count this quarter?

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Jeff Foster, DuPont Fabros Technology Inc. - CFO [63]

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No. 89.977 million. When we have --.

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Rob Stevenson, Janney Capital Markets - Analyst [64]

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(Multiple Speakers) last quarter.

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Jeff Foster, DuPont Fabros Technology Inc. - CFO [65]

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I know when we have some stock vesting, some of the employees turn in shares to pay for their taxes. It is also the effect of how we calculate our diluted securities under GAAP. But the number of shares outstanding haven't really moved materially other than when people turn back shares to pay for taxes. That is a very small amount.

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Rob Stevenson, Janney Capital Markets - Analyst [66]

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Okay. With the stock price now above $50, how are you guys thinking about attacking funding over the next couple of years? There is obviously no equity issuance in your guidance at this point. But given the amount of development that you have and the amount of development if you have demand that you could start over the next few years, given the land banks, et cetera, how should we be thinking about you guys using free cash flow? And what that gets to over the next couple of years on a run rate basis versus what you would need to fund through preferred or common if the pipeline increases?

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Jeff Foster, DuPont Fabros Technology Inc. - CFO [67]

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Yes. Well, I'm not sure what to call a normal pace of development anymore, since we are in a historic CapEx year, but if we keep at a measured pace of development in the next several years of, say, 30 to 40-megawatts a year, we are fine financing with all debt and we will stay under our 5 times net debt to EBITDA ratio. Be you if we do another acceleration like we saw last year and accelerate maybe the second Phase of CH3 or we accelerate ACC10, we would require an equity rate to stay in our debt ranges.

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Rob Stevenson, Janney Capital Markets - Analyst [68]

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Okay. Thank you, guys.

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Operator [69]

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Paul Puryear, Raymond James.

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Paul Puryear, Raymond James & Associates, Inc. - Analyst [70]

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For the PE money that is competing with you out there, how do you think they are underwriting it on an IRR basis, versus that 12% yield you are targeting?

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Jeff Foster, DuPont Fabros Technology Inc. - CFO [71]

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I will let Chris add to this. He is very close on the PE side. What I have been hearing is 15% to 20% IRRs. I think 20% was the norm for most people. But I have heard some people going down as low as 15%.

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Chris Eldredge, DuPont Fabros Technology Inc. - President and CEO [72]

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Just to add, what the PE guys are doing, there are some PE firms coming into the business and there is others that are exiting. There has been a lot of M&A activity in our space over the last quarter, quarter and a half. I think you will see PE guys exiting and I think you will see some of the PE guys entering the market, as well.

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Jeff Foster, DuPont Fabros Technology Inc. - CFO [73]

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Our 12% that we quote all the time is not an IRR. It is an unlevered return on investment capital. So our IRR would be slightly less than that due to the lease-up period.

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Paul Puryear, Raymond James & Associates, Inc. - Analyst [74]

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And how do they get to terminal value?

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Chris Eldredge, DuPont Fabros Technology Inc. - President and CEO [75]

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That I am not sure of. I know right now the private companies that are selling in the marketplace are selling at such high multiples, that would help them get the terminal value. But I am not sure in the current model what is they are assuming.

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Paul Puryear, Raymond James & Associates, Inc. - Analyst [76]

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What are those multiples. Can you share that with us?

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Jeff Foster, DuPont Fabros Technology Inc. - CFO [77]

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I can give you the EBITDA rate; it's anywhere between14% to 18% some of these transactions are trading at. One was, the Verizon deal was at 13% on the low end, so pretty high multiples.

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Chris Eldredge, DuPont Fabros Technology Inc. - President and CEO [78]

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We thought the 13% was pretty high for the asset.

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Jeff Foster, DuPont Fabros Technology Inc. - CFO [79]

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I thought it was very high.

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Paul Puryear, Raymond James & Associates, Inc. - Analyst [80]

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Great. Thank you.

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Operator [81]

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Jon Petersen, Jefferies & Co.

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Jon Peterson, Jefferies & Co. - Analyst [82]

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One clean-up item for Jeff.

You said your guidance assumes you will issue bonds in the second half of the year. Did you say how much? How much that would be?

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Jeff Foster, DuPont Fabros Technology Inc. - CFO [83]

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No, I didn't say how much. Two things I talked about. One, for TOR1 that we are funding in Canadian dollars. We would try to put a mortgage on that in the second half of the year once the first Phase 1A opens. And then, what the US dollar borrowings we would do bonds. But no, I did not really give a magnitude of that.

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Jon Peterson, Jefferies & Co. - Analyst [84]

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Do you care to give one?

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Jeff Foster, DuPont Fabros Technology Inc. - CFO [85]

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I will try to frame it out here, in the midpoint of my development spend at $625 million. I think I could get $100 million to $125 million funded through cash that I'm going to generate internally. Let's use the $125 million to make the math easy on me. That is $500 million that I would be borrowing this year. I would be looking for some of the mortgage in Toronto. $100 million, something like that. Maybe $150 million. And then the rest would be on the bond.

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Jon Peterson, Jefferies & Co. - Analyst [86]

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Okay. Thank you.

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Operator [87]

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Lukas Hartwich of Green Street Advisors.

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Unidentified Participant, - Analyst [88]

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Hey, guys. That is David on for Lukas. Two quick questions.

First, on the US bond issuance you are expecting later this year, I was wondering if you could talk about what type of debt you are looking at? And the terms you might be expecting?

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Jeff Foster, DuPont Fabros Technology Inc. - CFO [89]

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The last time we issued a bond, we went out looking for 10-year debt. We issued during the week where there was something really bad happening in Greece and we got 8 years. So I think we are comfortable with both 8 and 10 years on the tenor.

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Unidentified Participant, - Analyst [90]

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Okay. And then, unsecured, I am guessing is what you guys are looking at, as well?

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Jeff Foster, DuPont Fabros Technology Inc. - CFO [91]

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The same thing as we have done in the past. Really the same type of terms. Where if it is an 8-year you have a [non-call 3]. A 10-year, a non-call 5, and unsecured.

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Unidentified Participant, - Analyst [92]

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Excellent. The second question on the fee business side. I know there was a jump in revenue this quarter, which I assume was probably one-time in nature. But how should we think about that as we look forward to 2017?

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Jeff Foster, DuPont Fabros Technology Inc. - CFO [93]

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We had $4.5 million of very large a la carte projects close this quarter. For the year, my other revenue got up to around $14 million. I am modeling about half of that for next year. I don't expect the one-time projects to be as robust in 2017. If they do it, would be a pleasant surprise. Also, as I noted before, the margins are around 10%. So it's not a big impact to the bottom line.

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Unidentified Participant, - Analyst [94]

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Great. That is it for me.

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Operator [95]

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This concludes today's Q&A session. I would now like to turn the call back over to Chris Eldredge for closing remarks.

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Chris Eldredge, DuPont Fabros Technology Inc. - President and CEO [96]

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I want to thank everybody for attending the call today and we will see everyone soon.

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Operator [97]

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Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone have a great day.