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Edited Transcript of DLR earnings conference call or presentation 30-Jul-19 9:30pm GMT

Q2 2019 Digital Realty Trust Inc Earnings Call

Menlo Park, Aug 5, 2019 (Thomson StreetEvents) -- Edited Transcript of Digital Realty Trust Inc earnings conference call or presentation Tuesday, July 30, 2019 at 9:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Andrew P. Power

Digital Realty Trust, Inc. - CFO

* Arthur William Stein

Digital Realty Trust, Inc. - CEO & Director

* Gregory S. Wright

Digital Realty Trust, Inc. - CIO

* John J. Stewart

Digital Realty Trust, Inc. - SVP of IR

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Conference Call Participants

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* Colby Alexander Synesael

Cowen and Company, LLC, Research Division - MD and Senior Research Analyst

* Erik Peter Rasmussen

Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst

* Jonathan Atkin

RBC Capital Markets, LLC, Research Division - MD and Senior Analyst

* Jordan Sadler

KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst

* Michael Rollins

Citigroup Inc, Research Division - MD and U.S. Telecoms Analyst

* Michael J. Funk

BofA Merrill Lynch, Research Division - VP

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Presentation

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Operator [1]

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Good afternoon and welcome to the Digital Realty Second Quarter 2019 Earnings Conference Call. (Operator Instructions) Please note, today's event is being recorded.

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

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John J. Stewart, Digital Realty Trust, Inc. - SVP of IR [2]

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Thank you, Andrea. The speakers on today's call are CEO, Bill Stein; and CFO, Andy Power. Chief Investment Officer, Greg Wright and Chief Technology Officer, Chris Sharp, are also 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 the 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 second quarter results. First and foremost, consistent execution against our customer success initiatives drove all-time high new logos, our second-highest interconnection and renewal leasing and our third-highest total bookings.

Second, we leveraged our global platform to prudently allocate capital where we were able to achieve the most attractive risk-adjusted returns around the world, creating significant value for shareholders. Third, we extended our sustainability leadership with the publication of our inaugural ESG report and official recognition as an ENERGY STAR partner.

Last but not least, we capitalized on favorable market conditions to execute an opportunistic $900 million liability management trade, clearing our runway out to 2022 and extending our weighted average duration by nearly 0.5 years or ratcheting our weighted average coupon down by 10 basis points.

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

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Arthur William Stein, Digital Realty Trust, Inc. - CEO & Director [3]

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Thank you, John. Good afternoon, and thank you all for joining us.

The durability of Digital Realty's global platform was on full display in the second quarter of 2019, and our team was incredibly productive over the past 90 days. We delivered the third-highest bookings in the company's history, demonstrating the strength of our globally diversified portfolio. We also signed the second-highest volume of interconnection bookings as well as renewal leasing, and we expanded our colocation offering into the Asia Pacific region with a multimarket new transaction and customer expansion. We also landed an all-time high number of new logos this quarter, an encouraging indication our efforts to penetrate enterprise demand are bearing fruit and a promising sign for future interconnection revenue growth prospects.

Along those lines, I'm pleased to announce that we will be hosting MarketplaceLIVE at Spring Studios in New York on November 7, a daylong event connecting the community that builds the cloud network and Internet infrastructure. The event attracts a broad swath across the tech ecosystem, and we are expecting over 600 attendees from network engineers at start-ups to solution architects and cloud service providers to CIOs at Fortune 500 companies.

We further extended our global platform during the second quarter, and we took steps to secure our supply chain with several strategic land acquisitions shown here on Page 3 of our presentation. We closed on 3 smaller strategic land parcels in Northern Virginia to further physically connect our market-leading campus footprint. We also reentered Paris with new capacity based on significant verified customer demand. And earlier this afternoon, we announced that we are under contract to acquire a parcel in Frankfurt, building upon the success of our sales in the second quarter as well as the recent investment and our coverage of Western Europe. We closed on a land parcel in Tokyo through our MC Digital Realty Japan partnership. Finally, we also announced early this afternoon we are entering South Korea with plans to develop a carrier-neutral facility in the Sangam Digital Media City in Northwest Seoul.

We announced the grand openings of an expansion in Dublin in May, the second phase of our Osaka connected campus in June. And most recently, we announced that our Latin America platform, Ascenty, opened 4 fully leased facilities in São Paulo during the second quarter.

We continue to build upon our industry-leading commitment to sustainability with the publication of our inaugural ESG Report, and we were officially named an ENERGY STAR partner. We continue to invest in our human capital with several key hires. We achieved the Amazon Web Services Service Delivery designation for AWS Direct Connect. And last but not least, we further strengthened our balance sheet, locking in our lowest ever 10-year U.S. dollar bond coupon and opportunistically terming out our 2020 and 2021 maturities.

Let's turn to market fundamentals on Page 4. Following the record absorption in 2018, the primary data center metros in North America have been relatively quiet in 2019, especially given the tough year-over-year comparison in Northern Virginia, which is not only the largest data center market in the world, but is also the most competitive with the broadest selection of existing competitors and the deepest pool of new entrants trying to stake a claim. Loudoun County is ground zero and Ashburn is the most desirable submarket. Even for prime locations, however, the supply/demand pendulum has swung away from providers in favor of customers with various new entrants bringing speculative supply online, while the most voracious consumers remain in digestion mode.

We believe we have a set of significant competitive advantages in Northern Virginia, given the scale of our footprint, the head start from selling to an installed customer base with a strong desire to grow adjacent to their existing deployments and the longest runway to support their growth.

Ultimately, we believe it's a question of when, not if, hyperscale procurement cycles enter their next phase of growth, and the pendulum can swing back the other direction quickly. In the meantime, we do expect the current supply/demand dynamic will lead to dislocation in the market, which we believe will create investment opportunities for disciplined, well-capitalized competitors.

The New York metro area, in contrast, has seen the recent resurgence in demand. And the market has gradually tightened as excess inventory has been slowly absorbed while new deliveries have been sparse. In Dallas, there are a number of competitors with available supply, but we continue to enjoy good success in Dallas, particularly on our Richardson campus where existing customers consistently expand with us, despite the availability of competitive supply elsewhere in the Metroplex.

Recent developments in Chicago have been particularly encouraging. The State of Illinois recently passed legislation creating data center tax incentives that put Chicago back on par with other jurisdictions that have actively encouraged data center investment. Although we've not signed any major new leases in Chicago since Governor Pritzker signed the bill on June 28, we have seen an immediate uptick in customer interest. We are optimistic this bill will spur a rebound in demand. We commend Governor Pritzker and the Illinois State Legislature for their leadership in adopting this legislation as well as the Digital Realty's central region portfolio management team, which worked extensively behind the scenes along with the business and labor communities to advance this bipartisan legislation.

Supply remains scarce in Santa Clara, which is arguably the tightest market in the U.S. and generally commands a pricing premium relative to most other domestic metros. During the second quarter, we saw strong demand from cloud and from enterprise in Santa Clara.

Back across the pond, recent market leadership in Europe has shifted from London to Frankfurt, which has been the standout metro in 2019. Owing our success with an enterprise customer on our Frankfurt campus last quarter, we signed a major cloud service provider, brand new to our Sossenheim campus, with a large and growing deployment. Although requirements in Europe remain smaller than the U.S., partly due to data sovereignty considerations, they are getting bigger. The leading global cloud providers remain the primary consumers, and these cloud providers continue to exhibit a clear preference for expanding adjacent to their initial deployments. So landing the initial deployment is key. Our global Connected Campus strategy is uniquely positioned to capitalize on this consumption pattern.

You may have seen that Amsterdam recently placed a 12-month moratorium on data center construction. This is a developing situation, and the potential impact on future projects is not entirely clear. However, from our perspective, barriers to entry just got higher. And Amsterdam incumbents, such as ourselves, have a competitive advantage. We believe we are very well positioned, given the network density of our interconnection hub at Amsterdam Science Park, in-place permits on project currently under construction at our De President campus and visibility to incremental capacity adjacent to, but not subject to, either of the municipalities that have imposed the moratorium.

Across the Asia Pacific region, demand remains robust in our key markets, driven primarily by global cloud service provider requirements. We have seen notable strength in Osaka where we landed a major Japanese integrated communications service provider as a new logo, further validating our Connected Campus strategy for the Kansai region. Similar promising pipeline supports our ongoing campus development projects in Tokyo, Singapore and Sydney. On the supply side, market inventory remains mostly in check, and we remain bullish on our prospects in the region, given our first-mover advantage into Osaka, barriers to entry in Tokyo, government involvement in Singapore and rapidly growing cloud adoption in Sydney. While the IT infrastructure landscape across the Asia Pacific region continues to mature, we see a significant runway for growth for years to come.

Finally, we continue to see a strong pipeline of demand for our platform in Latin America, specifically focused across Brazil and now Chile from leading global cloud providers along with new potential customers. We are quite pleased with the performance to date and believe we are poised to continue to capture an outsized share of demand in this region characterized by significant upside from growing Internet adoption along with limited availability of institutional quality data center capacity. On balance, we believe customers view our global platform and comprehensive space, power and interconnection offerings as key differentiators in the selection of their data center provider.

Let's turn to capital allocation on Page 5. The data center sector is maturing as an asset class, and we have seen an uptick in fresh capital targeting the sector. This has had the natural effect of compressing returns, particularly in the U.S. This trend is somewhat of a double-edged sword. On the one hand, it has very positive implications for the value of our existing portfolio. On the other hand, it also makes it harder for us to achieve external growth through acquisitions.

We believe our global platform represents a competitive advantage in terms of capital allocation as well as access to capital. We have a unique ability to allocate capital where we see the most attractive risk-adjusted returns around the world while also tapping the broadest, lowest-cost pools of capital in the countries where we operate.

In addition, we are adapting to the growing demand within the data center investment sales market by seeking to harvest capital from mature assets in the U.S. and redeploy the proceeds into higher growth opportunities elsewhere. We believe we have a unique ability to allocate capital where we see the most favorable risk-adjusted returns on a global basis, and we believe our current investment activity is creating meaningful value for shareholders.

Let's turn to the macro environment on Page 6. The global economic expansion keeps plodding along. In the U.S., the recovery is now in its 11th year and earlier this month, became the longest expansion on record. Nonetheless, both fiscal and monetary policy remain supportive, and the U.S. remains a relative bright spot in terms of global economic growth.

As you've heard me say many times before, data center demand is not directly correlated to job growth. We are fortunate to be operating at a business levered to secular demand drivers, both growing faster than global GDP growth and somewhat insulated from economic volatility.

To put a finer point on the secular demand drivers underpinning our business, I'd like to draw your attention to Page 7. As you can see, McKinsey estimates that digital transformation will add $13 trillion to global GDP by 2030, driving demand for distributed digital infrastructures that we are uniquely positioned to address, thanks to our fit-for-purpose global footprint and interconnected scale.

During the second quarter, we saw early indicators of digital transformation demand on our platform. We captured a record number of new logos led by our enterprise vertical as these customers begin to deploy and connect components of their digital infrastructure globally. Given the resiliency of the demand drivers underpinning our business and the relevance of our portfolio to meeting these needs, we believe we are well positioned to continue to deliver sustainable growth for customers, shareholders and employees, whatever the macro environment may hold in store.

With that, I'd like to turn the call over to Andy to take you through our financial results.

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Andrew P. Power, Digital Realty Trust, Inc. - CFO [4]

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Thank you, Bill. Let's begin with our leasing activity here on Page 9. We signed total bookings of $62 million, including $6 million from our Latin America platform, Ascenty, at our pro rata share and a $9 million contribution from interconnection. We signed new leases for space and power totaling $53 million with a weighted average lease term of a little over 5 years, including an $8 million colocation contribution. As Bill mentioned, this was our third-best total bookings quarter and our second-best interconnection quarter.

I'd also like to clarify that Ascenty's second quarter bookings are in addition to the leases signed in the first quarter with a leading global cloud provider to anchor our entry into Chile. We also expanded our Digital Realty colocation offering into the Asia Pacific region with a multimarket new transaction and customer expansion, as you can see from the leasing activity table in our press release. Although this was a relatively small transaction, hopefully, it is a harbinger of bigger things to come as we move towards officially launching our first fully productized colocation offering in the region later this year.

In general, we are winning a greater share overall as well as larger and multimarket and multigeo-colocation deals, reflecting our growing traction within the enterprise segment and these customers' global hybrid cloud use cases. Some of these wins are landing in nonproductized colocation data centers even though these customers are consuming remote hand services and interconnection solutions commonly associated within colocation facilities.

As product lines continue to blur, we are contemplating changes to our disclosure to provide insight consistent with the way we run the business. We will keep you apprised as we contemplate future changes to our disclosure, with an eye towards maintaining transparent shareholder-friendly communication while balancing continuity against the evolution of our business.

During the second quarter, we delivered solid leasing volume, up 24% sequentially, with balanced performance across sectors, products and geographies. We are also seeing an acceleration of our channel business with healthy double-digit growth relative to the first half of 2018. We added an all-time high 57 new logos during the second quarter led by our strength in our enterprise segment, which accounted for 40 new logos. This was also a record quarter for new logos sourced through our channel partners, who contributed more new logos in the first half of this year than they contributed all of last year. We are gaining traction within the enterprise segment of customers deploying hybrid multicloud connected deployment globally through direct and partnership business, combining the best of our ecosystems.

Second quarter highlights include: HCL, an alliance partner, is one of the largest next-generation technology companies that help enterprises reimagine their businesses. HCL selected Digital Realty to host their Oracle Demantra infrastructure and SAP cloud environments. This deployment is on behalf of a top 10 U.S.-based food and beverage company with over $10 billion in revenue and a global distribution network. Digital Realty's global platform, paired with HCL's expertise in product management, market analytics and sales force management solutions enables HCL's customer to be highly responsive to the evolving pace of consumers worldwide.

We continue to benefit from our strategic partnerships, including IBM. A major global automobile manufacturer is relocating their corporate headquarters to be closer to their strategic alliance partners. As part of the relocation, the auto manufacturer is leveraging IBM Direct link dedicated hosting to enable their VMware environment to harness the power and flexibility of the IBM Cloud. This hybrid cloud deployment enables fast direct connectivity of its legacy finance application built on an IBM mainframe to their virtualized environment hosted on the IBM Cloud through a Digital Realty fiber cross-connect. The strategic partnership between Digital Realty and IBM enabled a seamless migration plan for the customer and secured the win for both companies.

A large global multi-conglomerate manufacturing and services company chose Digital Realty to deploy its edge networking node in our London data center. This company is working with our partner, IBM, to rightsize their data center footprint and manage their accelerating cloud sprawl and ballooning costs. The client chose Digital Realty as a key component of this complete digital refresh to utilize the speed, security and reliability of IBM Direct Link dedicated capabilities in our London location. By connecting to the multizone regional hub IBM has deployed in our data center, our client can move vast amounts of data quickly and securely between colocated and cloud-based resources, allowing them to deliver any application globally where and when it is needed.

We continue to see traction with our global interconnection platform. Mavenir, the only end-to-end cloud native network software provider for cloud service providers, is redefining network economics through automation products and solutions. By leveraging Digital Realty's Service Exchange, Mavenir is able to offer diverse pathing with multiple ways to connect data center environments and ensure 99.999% uptime across their strategic global locations, positioning them for continued expansion of their global service delivery.

Let's turn to the composition of our customer base on Page 12. Don't forget, the cloud lives in a data center. In fact, it probably lives in a Digital Realty data center, as you can see from the global accounts that make up over 1/3 of our customer base. The networks segment makes up over 25% of our customer base, and these pipes that connect customers to the cloud aren't going anywhere, regardless of which workloads they eventually migrate to the cloud.

Resellers account for 15% of our total revenue. We think our reseller concentration is a little bit unique, not least because we have only 9 years of remaining lease term with these customers, and these customers are typically deployed in multiple markets around the world with us as their global partner of choice.

Last but not least, enterprise represents a little less than 25% of our total pie. Here again, we think our concentration is a little bit unique. The financial services sector has long been our largest enterprise vertical. These customers are highly regulated, typically risk averse and symbiotic repeat buyers, as evidenced by the new business we did during the second quarter. 3 of our top 10 deals were with existing financial services customers.

We also see the growth in fintech being relevant to our platform as they evolve their architectures to achieve efficient data analytics out of their hybrid multicloud architectures. All of which is to say it's a hybrid multicloud world, and we believe our fit for purpose portfolio is uniquely well suited to solve for the full supply chain.

Turning to our backlog on Page 13. The current backlog of leases signed but not yet commenced stepped down from $144 million as of March 31 to $127 million at the end of the second quarter, primarily due to the deconsolidation of Ascenty. I'd like to point out that we've shown here the backlog for our consolidated portfolio, which ties to the top line of our P&L, and we have also reflected our pro rata share of the backlog from unconsolidated joint ventures, which runs through the equity and unconsolidated JV line item at the top of the bars on this chart. During the second quarter, the lag between signings and commencements was slightly above our long-term historical average at 8 months.

Moving on to renewal leasing activity on Page 14. We signed $125 million of renewals during the quarter, in addition to new leases signed. This was the second-highest quarterly renewal leasing volume in our history, following the all-time high of 138 million in 4Q '18. Incidentally, the 116 million in 1Q '19 is now the third highest, so our top 3 renewal quarters have all come within the last 9 months.

As you may recall, 2019 was our historical high-water mark in terms of lease expirations. Halfway through the year, we have reduced our expirations down from 23% of total revenue as of 3Q '18 to less than 10% remaining as of June 30, while also extending out contracts expiring beyond 2019. The weighted average lease term on renewals signed during the second quarter was nearly 5 years, while cash rents on renewals rolled down 5.8%. We have delivered positive cash and GAAP re-leasing spreads in each of the past 4 years. And although rents have been rolling down in 2019, our renewal leasing activity has been in line with our expectations, both in terms of volume as well as rate.

As I've previously mentioned, we believe we have a distinct advantage when we are competing for new business with a customer we are already supporting elsewhere within our global portfolio. And whenever we can, we try to provide a comprehensive financial package across multiple locations and offerings, including both new business as well as renewals.

In terms of second quarter operating performance, overall portfolio occupancy slipped 80 basis points to 87.8% due to the customer bankruptcy we mentioned last quarter as well as development deliveries placed in service in Frankfurt and Osaka, 2 of our tightest global metros. Same-capital cash NOI was down 5%. This includes a 90 basis point FX headwind. And you may also recall that we flagged last quarter that we faced a particularly tough comparison in the second quarter due to a sizable property tax refund we collected in the second quarter of last year.

We faced somewhat of a double whammy on the property tax line as we were hit with dramatically higher assessments in the central region this quarter, in addition to the refund in the year ago quarter. We intend to vigorously contest these unreasonable assessments, and we have an excellent track record of prevailing on appeal, as evidenced by the sizable refund collected in the second quarter of last year. In the meantime, however, we are required to accrue based on the higher assessed values, which unfortunately produces some volatility in the property tax line item.

The U.S. dollar remains elevated relative to prior year exchange rates, and FX represented roughly 100 basis point headwind to the year-over-year growth in our reported results from the top to the bottom line, as shown on Page 15.

Turning to our economic risk mitigation strategies on Page 16. We manage currency risk by issuing locally denominated debt to act as a natural hedge. So only our net assets within a given region are exposed to currency risks from an economic perspective. In addition to managing foreign currency exposure, we also mitigate interest rate risk by proactively terming out short-term variable rate debt with longer-term fixed rate financing.

Given our strategy of matching the duration of our long-lived assets with a long-term fixed rate debt, a 100 basis point move in LIBOR would have less than a 50 basis point impact to full year FFO per share. Our near-term funding and refinancing risk is very well managed, and our capital plan is fully funded.

In terms of earnings growth, core FFO per share was down 1.6% year-over-year or essentially flat on a constant currency basis, primarily due to a tough comp from the sizable property tax refund in the second quarter of last year. As you can see from the bridge chart on Page 17, we do expect the quarterly run rate to get back down in the second half of the year, primarily due to stiffer foreign currency headwinds as the dollar has continued to strengthen over the course of the year, along with a higher share count from settling the forward equity offering.

As you may have seen from the press release, we are reiterating 2019 core FFO per share guidance, although there are a few puts and takes in the drivers this quarter. As you may recall, we raised the range for net income by $0.25 last quarter to reflect the noncore activity running through the P&L, most notably the unrealized gain on the contribution of Ascenty to the joint venture with Brookfield. We are bringing the net income range back down by $0.15 this quarter to reflect the loss on early retirement of debt from the opportunistic refinancing of our 2020 and 2021 bond maturities at a 60 basis point savings as well as a noncash Topic D-42 charge from the redemption of our series H preferred stock, which will be replaced with our new series K preferred at 150 basis point tighter coupon. Both of these financing charges are added back to core FFO.

Moving up the guidance table from the net income line. Under the balance sheet section, we've updated our assumptions to reflect the actual outcomes on the refinancings I just mentioned. We've also raised our recurring CapEx guidance by $15 million. The higher recurring CapEx guide is not due to higher capital spending on the physical plant but is entirely due to capitalized leasing commissions on several strategic renewal transactions. And is directly associated with locking in long-term contractual cash flow streams.

Last but not least, our expectation for cash re-leasing spreads has improved from down high-single digits to down mid-single digits due to the evolving commercial terms on the mix of renewal transactions we currently expect to execute this year.

We are keenly aware of the highly competitive dynamic, particularly in select U.S. markets. But nonetheless, the cash rent roll-down on our 2019 vintage expirations does not appear to be as pronounced as previously believed.

In addition, although we are pleased with the trajectory of our quarter-over-quarter improvement in bookings, including a 24% increase this past quarter, most of this activity has been concentrated in facilities still under construction. Given the 8-month lag between signings and commencements, recent bookings won't really move the top line needle in calendar year 2019, although the composition of our recent activity does position our sales team with incremental move-in ready opportunities to be offering customers in the back half of this year.

Last but certainly not least, let's turn to the balance sheet on Page 18. Net debt to EBITDA stood at 6.1x as of the end of the second quarter, while fixed charge coverage remained healthy at 4.2x. Pro forma for our settlement of the forward equity offering, net debt to EBITDA remains in line with our targeted range at 5.5x, while fixed charge coverage is just under 4.5x.

In addition to proceeds from the forward equity offering, we expect to begin to realize the latent cash flow capacity from signed leases, including the 24-megawatt Ascenty just delivered, which are coming online in the third quarter, but which are not contributing to our last quarter annualized credit stats. Over time, we also expect to use the proceeds from our capital recycling program to maintain our target leverage profile.

In terms of second quarter capital markets activities, as previously mentioned, in early April, we completed a redemption of all $365 million of our 7.375% series H preferred stock, which we replaced with $210 million of permanent capital under our series K perpetual preferred at 5.85%. These savings are over 150 basis points.

In June, we capitalized on favorable market conditions to raise $900 million of 10-year U.S. dollar bonds at 3.6%, the lowest coupon we have ever received on a dollar-denominated 10-year paper. This was an opportunistic liability management exercise, and we used the proceeds to tender for our 3.4% notes due 2020 and our 5.25% senior notes due 2021. A little over 80% of the outstanding bonds were tendered during the second quarter, and we settled the redemption of the remaining 20% in mid-July. This successful execution against our financing strategy is a reflection of our best-in-class global platform, which provides access to the full menu of public as well as private capital, sets us apart from our peers and enables us to prudently fund our growth.

As you can see from the debt maturity schedule on Page 19, the recent financings have extended our weighted average debt maturity by nearly 0.5 years to 6.4 years and lowered our weighted average coupon by 10 basis points to 3.3%. A little over half of our debt is non-U. S. dollar denominated, acting as a natural FX hedge for our investments outside the U.S. Over 85% of our debt is fixed rate to guard against a rising rate environment, and 99% of our debt is unsecured, providing the greatest flexibility for capital recycling.

Finally, as you can see from the left side of our Page 19, we have a clear runway with virtually no 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 fuel growth opportunities for our customers around the globe, consistent with our long-term financing strategy.

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

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question comes from Jon Atkin of RBC.

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Jonathan Atkin, RBC Capital Markets, LLC, Research Division - MD and Senior Analyst [2]

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I have a couple of operational questions, I guess, first by region. In the major U.S. markets, I'm wondering where you see the leasing or demand pipeline the strongest or quarter-to-date bookings geographically, where that has been strongest. I think Bill mentioned a couple of examples in the scripts.

And then on Asia and specifically Korea, I wondered how you kind of view the puts and takes of deploying capital in that market, given the large role that [Puchabe] will play in accommodating the hyperscale demand so far in that market and what is arguably lower colocation pricing than in rest of Asia.

And then finally, on Europe, I just wondered, the new land parcel in Hattersheim and the expectations around how quickly one could potentially develop capacity there.

Finally, just want -- I don't think you mentioned that in your script, but any kind of updated views on the demand dynamics in the London market?

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Andrew P. Power, Digital Realty Trust, Inc. - CFO [3]

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Thanks, Jon. I'll try to weave the questions into a couple of coherent answers. And I think we're probably going to ping-pong around the team here.

So first off, U.S. markets, we -- I would say the second quarter was accentuated with some pockets of strength in some more unusual places as well as places where we've been pretty consistent, kind of working from East to West. The Northern New Jersey/New York metro market, that has continued to tighten. And we saw a few wins in the financial services and other related verticals in that market during the quarter.

Hop down to Dallas, our Richardson campus, we continue to expand with both existing and new customers landing on that campus and quite pleased with the progress on that market.

And then over to the West Coast, Santa Clara, obviously a very, very tight market. We had both enterprise-related and also top cloud service provider wins during 2Q.

Looking a little bit into a crystal ball more into back half of the year, I would say the Toronto market where we had some great wins earlier in the year continues to be very tight. I think we're very well positioned with our campus location in that market. A brand-new asset, and we've had a few customers landing and also looking to expand in that location. We are looking at the incremental opportunities in the New York metro area. And also, 2 markets, obviously, a little bit challenged, both Northern Virginia and Chicago. Bill related some of the good news on Chicago, so we're hoping for some green shoots there. And in Northern Virginia, we're also working on some capacity, some existing customers looking to expand with adjacency as well as some new customers looking to land on our market-leading campus.

I think you touched on London and Europe. Maybe I'll hit that and then hand off Korea to Bill or maybe Greg can chime in on the Frankfurt portion. So maybe on the front end, the Frankfurt market, as we mentioned, has been one of our hottest markets. We initially entered that market just a few years ago. I think our first anchor customer was a top 3 CSP. We subsequently grew with an enterprise customer. And if you can see the absorption on our leasing table and developments, that was certainly our star for the quarter, and we're rapidly running out of capacity in that market.

Maybe, Greg, you want to talk about some of the activity and other leases there in terms of expanding.

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Gregory S. Wright, Digital Realty Trust, Inc. - CIO [4]

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Yes. Well, first of all, I think the question was in terms of Frankfurt -- sorry, I didn't get my mic on. I think one of the first questions was in terms of Frankfurt and in terms of potential timing. Look, the contract is subject to conditions, including power zoning and planning, and that will probably take roughly 20 -- 24 to 30 months. But again, in terms of the layout, the site and the potential for the site, as we said, it's only 3 miles from the Frankfurt airport. We're very excited about that.

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Andrew P. Power, Digital Realty Trust, Inc. - CFO [5]

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Lastly, over in Europe, London, we're pretty excited about opening up our Cloud House and Docklands campus strategy, a highly interconnected series of buildings in the Docklands in London. And we've been working on some strategic colocation-oriented wins in that market. We also have had some increase on our Crawley campus and some other pockets within the London portfolio. So seeing some good opportunities in that market as well.

Bill, maybe want to kick back to Jon's question on Korea?

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Arthur William Stein, Digital Realty Trust, Inc. - CEO & Director [6]

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Yes. Jon, I think Korea could be -- we think Korea is going to be pretty similar to Japan in terms of how it plays out. We're not -- we haven't decided yet whether we're going to pursue that on our own or with a partner. But clearly, we went into Osaka several years ago, created a Connected Campus. And that's worked out extremely well for us. And likewise, we've been building up in Tokyo. So Seoul is really the next leg of that strategy.

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Operator [7]

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Our next question comes from Michael Funk of Bank of America Merrill Lynch.

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Michael J. Funk, BofA Merrill Lynch, Research Division - VP [8]

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I guess the first was kind of a follow-up. Bill, earlier this year, I think you made some comments that looking into the second half of the year trajectory for bookings or the funnel looked relatively strong. And I think there's been some mixed commentary out there across the industry. So maybe just an update on your earlier comments this year about the second half of 2019.

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Arthur William Stein, Digital Realty Trust, Inc. - CEO & Director [9]

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Sure, Michael. Well, I mean I think that our performance hopefully in the second quarter is consistent with what we said in March when we said we weren't going to write off the balance of the year. And I think clearly, that's not the case. I think if you look at the second quarter versus first, there's clear positive momentum and acceleration. It's our third-highest bookings quarter, as Andy said, with a record number of new logos standing at 57. And frankly, we expect continued improvement during the balance of the year.

And it's great to be able to leverage our global footprint, and that's how that's working out. So we expect that international is going to play a major role in the back half of the year. But we still would see a fair share of bookings coming out of North America.

To sum up, we remain highly confident in the long-term demand drivers for our business, those being big data, mobile and Internet of Things. And we really like our position, given the strength of our global diversified platform.

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Michael J. Funk, BofA Merrill Lynch, Research Division - VP [10]

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And then just a related question as well. Thinking about the new market entry and the expansion that you announced today, maybe just kind of walk through, I guess, the intelligence, the thought process. And even the mind of the customer relationships and what you know about their expansion and how that maybe directs some of that new market entry and I guess the visibility that gives you into entering the new markets, like South Korea and expand in Frankfurt.

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Arthur William Stein, Digital Realty Trust, Inc. - CEO & Director [11]

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This new market entry and the expansion into -- expansion in Frankfurt, the reentry into Paris, it's all based on conversations that we have with our customers. So it's -- we're not going into these markets on a purely speculative basis. This is more than one customer, too.

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Operator [12]

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Our next question comes from Jordan Sadler of KeyBanc Capital Markets.

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Jordan Sadler, KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst [13]

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So I just wanted to -- you touched on Northern Virginia a little bit in your prepared remarks as being oversupplied. And you also alluded to that potentially creating some opportunity. I'd be curious about those opportunities. If you could sort of talk about anything that you're seeing there.

And then separately, Andy, in contrast, as you were talking about some of the market strengths in the back half, and you mentioned Northern Virginia, which kind of surprised me a little bit as it sounds like that's got the potential to pick up a little bit. Are you -- have a good line of sight there in the second half? Or is that just you see customers kicking around some requirements and expecting to land somewhere and potentially with you guys?

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Andrew P. Power, Digital Realty Trust, Inc. - CFO [14]

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Thanks, Jordan. So in regards to my commentary, I was speaking to our dialogues with our customers, and so not on a speculative basis really of what we're seeing in terms of opportunities.

Listen, Northern Virginia, Ashburn, obviously, the largest market in the world. It's been the most robust and diverse. At the same time, it's become one of our most competitive markets. And we're certainly seeing some pricing pressure on new opportunities, while at the same time, some of our largest customers have been in "digestion" mode for the first half of this year.

We think that this market is going to work through this current supply/demand challenge, and we're optimistic on the market. We think these hyperscalers are going to resume their growth. And we are seeing some green shoots around some of these private outfits not just in that market but broadly speaking, some of the private outfits who have entered the markets in the last 12 to 18 months who have either not moved forward with speculative capacity or we're even seeing signs where some are selling land that they previously bought to build data center capacity.

In the meantime, we're just being -- picking our spots. So we're trying to find places where we compete beyond price where our unique global platform can add substantial value. That is customers who need a global partner and a full product suite. It's our installed and growing customer base on our Northern Virginia campuses that wants to grow with adjacency. And then lastly, it's customers that place value on the longest runway for growth for their deployments in that market, which they find in our campuses.

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Jordan Sadler, KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst [15]

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So on the opportunity side, it sounds like there may be some land parcels, for example, that may be -- you guys might be able to pick up.

And then separately, on the leasing front, it sounds like you've got capacity coming online. And you know that you have tenants who've been waiting for some of the capacity to deliver, which could line up well for you guys in the second half. Is that fair?

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Andrew P. Power, Digital Realty Trust, Inc. - CFO [16]

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Well, I would just put some finer details. I don't think we're -- I think we're feeling pretty good about our supply chain in Ashburn and in other markets. And it's much more tighter markets, be it at Paris or Frankfurt, South Korea, new market entry where they're focused on the land. So I don't see it, other than those small parcels that really physically connected the campuses and add an incremental ingress/egress to an existing campus parcel we owned, I don't see us picking up those land parcels. I do see as a good sign as potential competitor -- the tide of potential competitors subsiding a little bit here, which helps overall backdrop.

But going back to the demand that I was referencing, it hits all those highlights I was talking about. It was international customers looking for global partners across the full product spectrum. It's a customer that landed in a certain building already on our campus and wants to grow a megawatt or 2 megawatts right next door. It's the larger customers who we've already built the entire shell for and they're building out there capacity in, call it, 3, 6 megawatts chunks and have kind of anchored all their infrastructure on our campus. And lastly, it's specific customers that say, this not going to be my first time to layer my workload. I need to find a partner that's going to give me a really long runway for growth. And they find that with Digital Realty.

So all of those are kind of examples I can think in mind of opportunities we landed in recent quarters or opportunities we're working on right now in a still fairly competitive Ashburn market.

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Operator [17]

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Our next question comes from Erik Rasmussen of Stifel.

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Erik Peter Rasmussen, Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst [18]

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I'm just going to circle back with NoVA once again, meaning you talked about the supply/demand imbalance and then more supply coming online. And then still sort of the market in digestion mode. But just trying to balance that and understand your thoughts on maybe -- the confidence level of you seeing some pickup. Obviously, you're going to have some supply -- supplier capacity coming online. But what does that then do in terms of pricing? I mean are we really looking at a challenge to get to that low end of your pricing range in that market and development yield?

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Andrew P. Power, Digital Realty Trust, Inc. - CFO [19]

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That's a market where there is certain private smaller location operators that are solely competing on price that will likely ink deals just to fill capacity. And my guess is it will be a short-lived run in our business, quite honestly, given the competition.

We're picking our spots. We're trying to find customers who really value our product offering and not just going to the lowest common denominator on price. And we've been winning on that -- on those merits for some time. So obviously, that's a market where the pricing has been under pressure, given the relative supply/demand backdrop.

What I would -- Erik, what my comment really goes to is I don't think demand is as barren as some might suspect, and that's based on conversations we're having live with our customers. And we're going to pick our spots and be competitive and work through a potential temporary dislocation in this market. And in fact, when you look at this in a broader Digital Realty platform backdrop, I think it's just a small piece of our puzzle, as you saw from the quarter where we sequentially increased the signings 24-plus percent, put up a bronze medal or #3 in our records. And Ashburn really didn't play a demonstrative amount to those signings at all. So I think we're going to work through this and come out the other side of this just fine.

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Erik Peter Rasmussen, Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst [20]

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No. That's helpful. And maybe just on the same-cash NOI forecast. You reduced that to the mid-single digits versus high-single digits. How should we think about this and beyond this year? And then will the headwinds from the legacy DFT business be completed this year?

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Andrew P. Power, Digital Realty Trust, Inc. - CFO [21]

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Sure. So the -- what I would say on that front, so we are -- got a couple of things going against us in terms of the same-store pool. You obviously have the FX, which we highlighted in the script. We also had the customer bankruptcy that we reserved for last quarter. It's going to flow through this quarter. We also had a tough comp in terms of real estate property taxes. A quarter, a year ago, had some benefits. This quarter, we started accruing for one of our central regions.

If you net that out, it's not quite as bad on kind of a same-store basis. I think negative 5 is like closer to negative 2.5 when you kind of do the normalizations on both periods. And the negative is really due to we're in our largest expiration year. And despite quite strong retention, we've had some downtime when re-leasing capacity.

As we also highlighted in our script, quite pleased with the trajectory of the new signings, the 57 new logos, creating interconnection signings, multimarket, multigeo-colocation, APAC. But there was one point the sign commences close to 8 months. So the in-year 2019 contribution that might flow to that same-store pool is not as great as we'd like it to be.

And the flip side of that, that leaves inventory for our sales reps to be selling move-in ready space in some hot markets. And you can see in our [self], we have capacity now sitting available in a market like Amsterdam, which is obviously tightening on the backdrop of some of the municipality moratoriums; Osaka, which has been a hot power market; and even 3 megs sitting in Frankfurt, where quite honestly, there will probably be a food fight over that last capacity on that campus.

And then lastly, I would just say while the same-store pool is very valid and very instrumental, looking at our financials, our dialogues with our customers is a total commercial package. So we're often tying in multiple product lines, new signings and renewals and complex commercial solutions for our customers. So some often, like a little bit in this quarter and certainly in the prior quarter, we may give our customers some relief on existing contract. But we're winning an incremental share of their business at good returns. And it's a win-win for the customer benefiting from platform digital and a commercial win for the company.

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Operator [22]

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Our next question comes from Michael Rollins of Citi.

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Michael Rollins, Citigroup Inc, Research Division - MD and U.S. Telecoms Analyst [23]

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I think, first, if you could talk a little bit about just broadly the cloud impact that you're seeing on your business in terms of just the direction of bookings as well as what you're seeing on churn and the pace of migrations to the cloud from your customers.

And then secondly, if you could talk a little bit about what happened in terms of -- I think it was the renewal rate in the PBB business and just maybe what caused the dip there.

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Arthur William Stein, Digital Realty Trust, Inc. - CEO & Director [24]

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Mike, I'll take your first question. Andy will take your second. Relative to the cloud, it's been, as you might expect, a significant source of demand for us. And we haven't seen the pickup in churn that some of the others have mentioned, some of our peers have mentioned on the calls.

I mean we've mentioned this is the third-highest booking quarter we've had, huge number of international wins, 57 new logos, which was a record, second-highest volume in cross-connect bookings. And we really do see the world moving to a hybrid multicloud architecture, and Digital is focused on the enterprise. And we think our offerings, such as the Service Exchange, really enabled this shift to a hybrid multicloud.

Cloud ultimately resides in a data center, and they lead -- they sit in an awful lot of our data centers. They're signing many long-term deals with us. So we think we're really, really well positioned to benefit from the growth in cloud demand, but we're also very focused on attracting enterprise customers to sit both in our data center and connect to the cloud on our campuses.

Andy, you want to handle the second question?

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Andrew P. Power, Digital Realty Trust, Inc. - CFO [25]

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Michael, just so I make sure I address your second question, would you mind repeating that. You said the renewal rate on the PBB?

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Michael Rollins, Citigroup Inc, Research Division - MD and U.S. Telecoms Analyst [26]

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Yes. So if I look at the Page 22 -- sorry, 21, this quarter, I think the PBB retention ratio dropped to 62.6% from the LTM of 93.5%. And was curious if there's anything specific that caused the drop there.

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Andrew P. Power, Digital Realty Trust, Inc. - CFO [27]

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Yes. I think what you have is a little bit of a small sample set, as you can see, especially on the square footage, 39,000 versus almost 2 million of square feet in the prior quarter. So there's really only 4 renewal contracts that happened in this quarter. So 1, 1.5, depending on the square footage rating renewed.

I believe that was a customer in our Houston footprint, not a large market for Digital Realty or a major focus. And I think we only have a site or 2 in that market. But I would say it's pretty much an anomaly. And as you'll recall from last quarter, those power-based buildings are typically very high retention rates and usually the longest duration renewals, given the fact that the customer is often putting even more substantial capital commitment into that capacity. So I don't think there's a trend or anything in that renewal stat.

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Operator [28]

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Our next question comes from Colby Synesael of Cowen and Company.

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Colby Alexander Synesael, Cowen and Company, LLC, Research Division - MD and Senior Research Analyst [29]

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First off, on the price renewal change, the mid-single digits versus previously the high single digits, is that specifically because the legacy DuPont customer has not yet been renewed? And is there now an expectation that they will not renew in 2019?

And then secondly, there are some things that seem like they would drive your core FFO guidance up. So there was the one time you paid tax benefiting in the first quarter. It seems like the equity forward didn't come in as linearly as maybe it was anticipated. And then obviously, you just mentioned the reduction in the renewal spread. Are the offsets to why that might not have happened, if I have them correctly, the FX, the bankruptcy, the tough real estate property taxes and then the longer book-to-bill?

And then just lastly, a higher-level question. What does the capacity look like for the back half of this year in terms of available megawatts, if you will, in the markets where you're seeing the most demand? Do you have enough capacity effectively available, you think, in the markets where you're seeing the most demand to sustain the level of momentum you saw in the second quarter?

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Andrew P. Power, Digital Realty Trust, Inc. - CFO [30]

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Thanks, Colby. I think there's a bunch of numbers questions in here, so let me try to tackle all 3 in no specific order -- actually, maybe I'll work in reverse order because it might be easier.

So available capacity, I think we're set up pretty nicely in terms of available capacity in the back half of the year. And you can see that either in what's on our development cycle in terms of unleased capacity or you can see it in the pre-stabilized, just delivered. And the highlights in that -- in those markets are, as I mentioned, Frankfurt, Osaka, Amsterdam, London. There's markets in our Latin America platform as well. So I think we're set up pretty nicely in terms of available capacity that are coming in the back half of this year. But as you know, as we move into the back half of this year, we're also working on capacity that's even coming online in early 2020. So in many of these tighter markets, be it Tokyo and others, the customer is really stretching out the timelines, coming to us even earlier given there is such limited capacity.

Would I like more in some of those markets? Of course. Frankfurt is a market where we've just seen a rapid acceleration. And it's a tightening market. Hence, it's been tough to get -- land parcels, but pleased with the global investment team, just great work in tying that down on the heels of our success. But net-net, I think we're in a pretty good space for back half of '19 going into 2020. Markets coming online in -- with capacity in the backdrop of attractive demand.

Going to, I think, your guidance question, if you net out the outcome on the guidance, we obviously beat our internal numbers in the first quarter, largely due to some timings on the Ascenty close and our funding or bridging of our partners' equity and being compensated for that.

And as you move into second quarter, we kind of came in line with our numbers. And if you look at kind of the math, you pretty much need to kind of flatline-ish with the second quarter numbers into both Q3 and Q4 to kind of get roughly to the midpoint of our guidance.

I would say you've got a couple of things going on there. One, you got obviously NOI coming online for capacity that are signed but not commenced. So that's the positive. The headwinds, which may exist -- reaffirm our guidance to this current range are: you have FX continuing to be a headwind on a year-over-year basis; two, you have our equity forward, which we delayed to match our sources and uses to later in the year, so the share count from that equity forward getting drawdown is going to come into the share count; and then three, I mentioned the headwind with the property tax accrual. Again, we do look to try to modify those and appeal. But we're not going to win on any type of appeal in, call it, 3 months' time. So those are the offsetting headwinds.

And as I mentioned, the signings, great quality, many metrics across the board. It does have a longer sign to commence, time period of 8 months. So it's probably doing a little more -- the second quarter signings are probably paying a little more work to building us up for our 2020 numbers than actually in your 2019 contribution. But the positive, as I mentioned, will leave us with move-in ready capacity in several great markets for our sales reps to be selling into right now.

Last but not least, on the guidance table, we did improve the -- our expectations for our cash mark-to-market for the full year. We don't want to specify any specific confidential customer dealings. What I can tell you is among our large -- both legacy digital and legacy DFT customers, we're moving closer and closer to final resolution of a path forward on some of their capacity renewals. We've worked with this customer who we've been helping in growing their capacity over the 12 -- past 18 months across now, I think -- I believe all 3 of our connected Ashburn campuses, the triangle that surrounds Loudoun County.

We've been helping them with connectivity across these campuses. Their needs and requests over time have changed. And I think the shape and form of that renewal will be constructive for both the customer and for Digital and likely result in a little bit better outcome in terms of rate as we push out some of those contracts that do expire over several years to begin with, I hope, a couple of years from there into the future. So that was really the driver for the guidance table change. So we do expect to complete that renewal in short order.

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Operator [31]

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This concludes our question-and-answer session. I would like to turn the conference back over to CEO, Bill Stein, for any closing remarks.

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Arthur William Stein, Digital Realty Trust, Inc. - CEO & Director [32]

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Thank you, Andrea. I'd like to wrap up our call today by recapping our highlights for the second quarter as outlined here on the last page of our presentation:

We advanced our top priority of deepening connections with our customers, delivering all-time high new logos, our second-best renewal leasing and interconnection bookings and our third-highest total bookings in our history.

We extended our global footprint and took steps to secure our supply chain with several strategic land acquisitions. We reentered Paris. We secured our second campus in Frankfurt and announced our entry into South Korea.

We also underscored our commitment to delivering sustainable growth for all stakeholders with the publication of our inaugural ESG Report and our official recognition as an ENERGY STAR partner.

Last but not least, we further strengthened our balance sheet with redemption of high coupon debt and preferred equity and the opportunistic issuance of another $900 million of long-term capital.

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

Thank you all for joining us. I hope you enjoy the dog days of summer and hope to see many of you at MarketplaceLIVE in New York in November.

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Operator [33]

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The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.