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DuPont Fabros Technology, Inc. (NYSE:DFT)

Q2 2009 Earnings Call

August 5, 2009 10:00 a.m. ET

Executives

Victoria Baker – Investor Relations

Hossein Fateh – President and Chief Executive Officer

Mark Wetzel – Executive Vice President, Chief Financial Officer and Treasurer

Analysts

Jordan Sadler – KeyBanc Capital Markets

Michael Bilerman – Citigroup

Christopher Lucas – Robert W. Baird

Brendan Maiorana – Wells Fargo Securities

David Harris – Royal Capital

Operator

Good day and welcome to the DuPont Fabros Technology Second Quarter 2009 Earnings Conference Call. Today’s conference is being recorded. At this time, I would like to turn the conference over to your host, Ms. Vicki Baker of the Financial Relations Board. Please go ahead, ma’am.

Vicki Baker

Thank you. Good morning everyone, and thank you for joining us for DuPont Fabros Technology’s second quarter 2009 results conference call. Our speakers today are Hossein Fateh, the company’s President and Chief Executive Officer, and Mark Wetzel, the company’s Chief Financial Officer and Treasurer.

This release is available in PDF format in the Investor Relations section of the company’s corporate website at www.dft.com. 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 are contained in the company’s earnings release issued earlier. To manage the call in a timely manner, questions will be limited to two per caller. If you have additional questions, please feel free to return to the queue.

Now I will turn the call over to Hossein.

Hossein Fateh

Thank you Vicky, and good morning everyone. Thank you for joining us on our second quarter earnings call. As noted in last night’s press release, I’m pleased to report that DuPont Fabros delivered another solid quarter in 2009. These results were in line with the high end of our quarterly expectations. Now past the midpoint of year, we remain confident in our 2009 plan. We have tightened our 2009 FFO guidance range by $0.09 per share, and expect to be closer to the high end of the original range provided last February. We also increased our expected dividends range by $0.03 per share. I want to thank our entire team for their efforts and contributions.

Last quarter we talked about staying the course and focusing on several specific areas. These were first, leasing; second, our customers; third, the opening of our latest development, ACC5 Phase I; and fourth, liquidity. Mark will speak to our liquidity later in the call; I will update you on the rest.

I’m happy to report that we have executed two new leases so far in the third quarter. Chicago is now 48% leased as of today. This is a increase of 31% from our last earnings call. ACC5 Phase II is now 38% pre-leased. Both leases are with existing customers. One customer is an Internet company and the other is enterprise-focused. And each of these tenants evaluated their future capacity, they looked to us because of their satisfaction with the design of our facility, and our operational excellence. One lease is in our Chicago facility and one lease is in Phase II of ACC5. The total contract value of these leases is approximately $275 million. The weighted average lease term is 10.6 years and each lease is triple-net.

To summarize our leasing activity to-date, we have now signed eight new leases totaling 27.4 megawatts of critical load, 145,000 square feet – raised square feet of space, and approximately $612 million of contract value. The weighted average lease term is 10.8 years and each lease in triple-net. This is more than three times our projected 2009 revenues.

As of the end of the second quarter, our top two tenants, Microsoft and Yahoo!, continue to represent 63% of our base rent. This is down from 86% at the IPO in October 2007. We expect this percentage to drop to 59% by the end of the third quarter due to the commencement of the new leases in the third quarter. As a reminder, the lease expiration table on page 10 of our press release detailed out the executed lease terms and takes into account all customer – all – takes into account all customer termination rights.

With Microsoft and Yahoo! in the new – with Microsoft and Yahoo in the news lately, we want to remind everyone that they do not have – they do not have any termination rights. The average combined lease – remaining lease term with both of these companies is 6.7 years. The average remaining lease term for our entire portfolio at June 30 is 7 years.

Let me now walk you through each of our buildings. Chicago is approximately 48% leased as of today. This continues to be a great asset located in a good long-term market. Our overall sales pipeline continues to grow. The enterprise sales cycle continues to be long and somewhat unpredictable, in – although this is beginning to stabilize. We remain comfortable with a 24-month lease-up from Chicago’s opening last August. At 48% leased, we’re now halfway there. We continue to expect a 12% unlevered return at stabilization on Chicago.

Turning to Ashburn, ACC5 Phase I remained at 57% leased. In ACC1 Phase II is now 38% pre-leased. We are actively leasing the remainder of the Phase I space. The term of the new Phase II lease begins January 1 of 2011, with potentially early access in the fourth quarter of 2010. We as landlord have the right to move the tenant to Phase I to meet the customer’s needs if Phase II is not developed and completed. And if this right were to be exercised of today, Phase I would be 95% leased.

Phase I of ACC5 in Ashburn, Virginia has been commissioned, and earlier this week we obtained a certificate of occupancy from Loudoun County, Virginia. Congratulations to our construction team and everyone involved in this opening. For accounting purposes, Phase I will be placed in service on September 1 and all the leases executed will commence on that date. We expect a 15% unlevered return at stable utilization on both phases of ACC5.

I would like to add one final point on the current leasing environment. Since last summer when the economic downturn began, lease approvals and signings are simply taking longer to execute. Our customers must obtain Board approval because of the total capital commitments involved. Despite the challenging economic environment, we’re seeing increased traffic. The number of RFIs and RFPs that we’re being asked to respond has increased dramatically. But the two leases we just executed were not really part of the formal RFI and RFP that was – that we’re responding to. Time will tell whether this increase in activity will lead to a corresponding increase in executed leases. That being said, our pipeline of prospective tenants is very good. We like what we are seeing and hearing.

As for immediate development pipeline and its funding and timing, our decision process looks like this. We need $80 million of new funds and 8 to 10 months finish ACC5 Phase II in Ashburn, Virginia. Once funded, we plan to use $35 million of the pre-purchased equipment originally slated for Santa Clara to build out Phase II. The shell and the underground work are completed on Phase II. The underground work is a big part of the construction of a data center. As noted, it is currently 38% pre-leased. Once fully leased and stabilized, this $80 million is expected to generate $25 million of net operating income, a 31% return on the new capital. Northern Virginia is our backyard and this remains our top market.

Turning to New Jersey, we need $75 million of new funds and six to eight months to finish New Jersey Phase I. Once fully leased and stabilized, this should also generate $25 million of net income, a 33% to return on the new money. We continue to believe that Northern New Jersey is a top market as well. Perspective tenants are continuing to show interest. We need to raise these funds and identify a completion date. We are actively seeking new debt proceeds to restart our development pipeline. The focus has shifted somewhat as we look to New Jersey and ACC5 Phase II in Northern Virginia as the logical next two developments to complete.

Once we redeploy the equipment to ACC5 Phase II, our development in Santa Clara will need approximately $220 million and 12 months to finish. The West Coast location is now number three in our line for restarting, and remains a key component of our strategic US data center plan. We intend to build this data center. However, we need to be absolutely certain that we’re rewarded when we build it. The development restarts that I have outlined are not included in our 2009 annual guidance range at this point. We remain committed to each development; however, we plan to manage this growth carefully.

Now, I will turn the call over to Mark, who will take us through our financial results.

Mark Wetzel

Thank you, Hossein. Good morning everyone, and thank you for joining us. I want to cover four key topics today: our second quarter results, our Q3 and full-year ‘09 guidance, a liquidity update, and an update on our 2009 dividend.

For the second quarter of ‘09, the company’s FFO was $0.28 per share compared to $0.35 per share in the second quarter of ‘08. Q2 revenues were $49 million, a 16% quarter-over-quarter increase. Specific to our second quarter results, as compared to Q2 ‘08, the FFO decrease of $0.07 per share is primarily due to greater interest expense from higher overall debt outstanding, as well as less capitalized interest.

Total interest cost expense to the P&L in Q2 ‘09 amounted to 74% of overall interest incurred. This compares to 25% in Q2 ‘08, an $0.08 per share or $5.2 million difference. Sequentially to Q1 ‘09, the $0.03 per share increase is primarily the $0.02 for the one-time loan payoff charge in Q1 ‘09, and a $0.01 per share of additional one-time projects completed in Q2.

As Hossein stated, FFO for the second quarter of ‘09 was at the high end of our guidance range. AFFO was $0.21 per share for the second quarter, the same as a year ago. Year-to-date AFFO was $0.40 per share compared to $0.41 per share a year ago. Cash rents increased quarter-over-quarter, offsetting the increased interest expense charge of the P&L.

Our Q3 FFO guidance range is projected at 27 to $0.30 per share. We are increasing the lower end of our previously provided annual 2009 FFO guidance range by $0.09 per share, from $0.96 to $1.12 per share, to $1.05 to $1.12 per share. This update is detailed on page 15 of this quarter’s press release.

With respect to our liquidity, I want to reiterate that we have no debt maturities until August of 2011, assuming these satisfy our quarterly financial covenants and expansion conditions, and I remain comfortable that we will. The leasing of our available space in Chicago and Ashburn remains our number-one priority, and this continues to help us delever the company.

Our overall 2009 sources and uses of cash continue to be as described in February. We have no issues with receivables collections. We plan to pay off all outstanding accrued construction commitments by the end of the calendar year. As of today, we have $15 million of cash, $20 million of line availability, and $10 million of restricted cash. We should end the year with a cash position and line availability of between $25 and $30 million before dividends, assuming no new proceeds.

We have no definitive update at this point as to the source we are timing at new funds. We are in active discussions on new debt proceeds. For us, the logical choice is a secured loan on our new ACC5 asset, which currently has a $25 million first mortgage on it. Phase I at stabilization is expected to generate $25 million of NOI. We expect the same from Phase II. With the leases in hand we are on track to achieve this.

Obviously, leasing remains a top focus and resolves a lot of concerns. We are seeing a greater level of interest on the part of secured lenders. I would not say it is overwhelming, but we are seeing interest. We are cautiously optimistic, but it is too early to comment on when, how much, term or rate. We cannot re-start any development until the new funding is obtained, whatever the source.

As to an equity issuance to raise funds, let’s be clear. Lammot and Hossein, our Chairman and CEO, the two largest shareholders through the OP units they hold, are strongly aligned with the long-term interest of the shareholders. Looking ahead, if it makes sense to raise equity, we will not hesitate to do that. At this time, however, we do not believe we have an immediate need to do so.

Finally, I would like to update you on our dividend policy. As noted in our press release issued last night, we will not declare a third quarter dividend, and we will revisit the timing of our dividend in the fourth quarter. We will meet the required redistribution test for the year. We did, however raise the estimated range by $0.03 per share, and expect a $0.23-per-share midpoint payout. This midpoint represents a $15.5 million payout. We can fund this payment in cash if we so elect. The board will review all necessary factors regarding the dividend policy in Q4, and will act appropriately.

With that, let me turn it back over to Hossein.

Hossein Fateh

Thanks, Mark. Before I open up the questions, I wanted to emphasize that our focus remains leasing and taking care of our customers. We are proud of the design of our buildings and we are proud of our operating team. We believe we are the best-in-class operator. Looking ahead, we plan to raise new funds to continue our growth strategy. We will optimize the cost of the funds raised to make sure we use the less costly money for our shareholders.

The DFT story remains focused on four strategic locations – Northern Virginia, Chicago, New Jersey, and Santa Clara – and a development pipeline of internal growth already on our balance sheet. We continue to achieve unlevered NOI returns on investment of 12 to 15% for our new developments. With the visibility that we have into the wholesale market, we believe that supply and demand are hugely in our favor. Looking ahead, we are excited at our leasing prospects for the remainder of 2009 and 2010. We have great confidence in what the future holds for the company.

With that, we will be happy to open the call up for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) And we will take our first question from Jordan Sadler with KeyBanc Capital Markets.

Jordan Sadler – KeyBanc Capital Markets

Thanks, good morning guys.

Hossein Fateh

Hi, Jordan.

Jordan Sadler – KeyBanc Capital Markets

I wanted a follow up on the leasing activity that was executed post-quarter end. You said those two leases were not part of the formal process, or the process, and the pipeline is very good, so it’s pretty interesting. So that suggests to me that demand is accelerating, and I know some of your brethren – not necessarily in the wholesale side of the business, but some of your brethren in the wholesale – the, in the data center business – have said they expect increased capital spend and increased demand in the second half of the year. Is that, would you say that’s consistent?

Hossein Fateh

Bob, let me – I mean, I think we are a little bit of a different business than the colo (colocation) guys, but what we’re seeing is – what I meant, what we meant by saying they were not part of the formal process, is that the two leases we executed were relationship deals that we have relationships with. What we have seen is the requests for proposals has gone up dramatically, not only in the number but also in the number of megawatts that tenants need.

However, we are cautious not to say we expect bigger leasing activity. This quarter has been a tremendous leasing, and we can’t expect to have 12 megawatts of leasing every quarter. So what we’re saying is, we’re optimistic, but we want to – we are cautiously optimistic as what the prospect holds, but we don’t know if all these requests, when they will turn into solid leases.

Jordan Sadler – KeyBanc Capital Markets

Will you – on ACC5, and going for the secured debt on that, will you go on the entire property or just Phase I?

Mark Wetzel

No, the collateral package – Jordan, this is Mark – the collateral package will be the whole, Phase I and Phase II.

Jordan Sadler – KeyBanc Capital Markets

Okay, okay. And so you wouldn’t need to sign any additional leases per se, even though that development as a whole is probably, I don’t know, 50% leased?

Mark Wetzel

We’re talking a variety of ways to do it, whether there’s an accordion feature or whether we kind of condo this, structure the deal, so it’s nothing set in stone at this point. But we’ll try to match up with the – with maybe a corporate guarantee, with – based on the cash flows. But leasing is, the prospective tenant list is still good for us, and we just see the momentum going.

Jordan Sadler – KeyBanc Capital Markets

Okay. And then, just on the – I think you have an upcoming move-out in Northern Virginia. You have an expiration about 27,000 square feet of raised, at some point this year. Can you give us the timing and what the...

Hossein Fateh

Yeah, I think it’s the – January, it’s really only about 1% of our total revenues, and the cash rents will actually be increased dramatically. So we’re not really worried about it. It’s very marketable space, and we’re working on leasing it up as well.

Mark Wetzel

So it’s technically 12/31, Jordan.

Jordan Sadler – KeyBanc Capital Markets

12/31 move-out. And no prospects for that space yet?

Hossein Fateh

We’re talking to people actively and we have some prospects. We haven’t signed anything.

Jordan Sadler – KeyBanc Capital Markets

And then lastly, the – what was the – what is the timing of the commencements that – so, leases that are not yet started? I know, I think you said that in ACC5, September 1, when that comes on-line, Phase II you talked about in the release. But what about everything out in Chicago, and anything else on ACC4?

Mark Wetzel

Well, just to go through it, the Phase I of ACC5, all 57% kicks in September 1. The Phase II is January 1 of ‘11, with an early access on October 1 of ‘10. Chicago, that lease commences November 1 of ‘09.

Jordan Sadler – KeyBanc Capital Markets

That’s the new lease, or all the leases?

Hossein Fateh

No, the new lease.

Mark Wetzel

Just the new lease. The other leases are – have commenced, in Chicago.

Jordan Sadler – KeyBanc Capital Markets

November 1. All the other leases are commenced. And is everything commenced in ACC4 at this point?

Mark Wetzel

Yes.

Jordan Sadler – KeyBanc Capital Markets

All right, I’ll hop back in the queue. Thanks guys.

Mark Wetzel

Okay.

Operator

And we will take our next question from Michael Bilerman with Citi.

Michael Bilerman – Citigroup

Good morning. Mark Intentin’s here with me as well. Hossein, can you just go over, I guess from ACC Phase II and this lease that you’ve signed? It sounds like you have the ability to move that at your right to ACC5 Phase I. At what point would you need to start full construction to deliver Phase II for this tenant, for I guess an October ‘10 early right, or at least a Jan. ‘11.

Hossein Fateh

Well, I mean depending on if the tenant wants it in October or January, we need about nine months to build the space. So some time in the first quarter we need to start construction.

Michael Bilerman – Citigroup

And so I guess, how are you thinking about – I guess you’re sort of thinking, you’ve got four or five months now, because I guess you don’t want to put yourself up to a nine-month full deadline, you want to give yourself a little bit of lead time in case things go awry...

Unidentified Company Representative

(Inaudible)

Michael Bilerman – Citigroup

But, you need money, right? I mean, you’re not...

Hossein Fateh

Well absolutely, and I think the way you have to think about it is that we’ve just built this building like, three times, right? We know exactly what it costs, we know exactly how to build it, we’re cutting and pasting the same building. So we’re very comfortable with our nine-month schedule. Now – and we have the same team that has done it in the first phase of ACC4, second phase of ACC4, and the first phase of ACC5. So at this time, between now and sometime in the first quarter, we are going to look at all the options we have, from least expensive, straight debt, to high-yield, to converts, to even equity and decide how we’re going to raise the money to build it.

Michael Bilerman – Citigroup

And just walk through in terms of the cost. ACC5 Phase I, you have 155 to 165 of costs, and I think you mentioned that the incremental for Phase II would be $80 million, plus the $35 million of...

Hossein Fateh

Sure, $35 million of equipment.

Michael Bilerman – Citigroup

For equipment, correct.

Hossein Fateh

Yes. So, with the new money we only need $80 million to put Phase II in service.

Mark Wetzel

Yeah. Let me add a couple comments to that. The $80 million number that we talked about is new money. The equipment, we’ve basically pre-purchased that, that’s already on our balance sheet. We have a little bit to fund on that between now and the end of the year, but that will be fully funded. The cost – the overall cost to build Phase II is in the 145 to 155 range. So we’re going to build Phase I in the 155 range, so it’s – it will come in a little less, but it’s in that ballpark.

Michael Bilerman – Citigroup

Okay.

Mark Wetzel

New money is the $80 million that Hossein referenced.

Michael Bilerman – Citigroup

And are your costs that you – when you talk about these yields, is that fully loaded for cap interest, for timing, for TI’s, or is it just literally your hard construction cost?

Mark Wetzel

No, it’s all hard and soft cost, the issue of leasing commissions, as you know, we don’t budget 100% leasing commissions, because we do a lot of deals directly, but we have – it’s included.

Michael Bilerman – Citigroup

And last thing Mark, can you walk through – you talked about where you are today, $50 million in cash, $20 million available on the line, and $10 million of restricted which goes towards ACC Phase I, and thinking that you’ll end the year between $20 and $30 million. Can you walk through today versus that point, take into account what, the sort of inflows and outflows, and then thinking about the dividend commitment somewhere in the $15 million range, how that factors in to those discussions?

Mark Wetzel

Okay. Well, cash at 20 – as of June 30, cash at $20 million, restricted cash of 15, cash flows for Q3 and Q4 in the $20 million range, On the uses side we have roughly $25 million in construction commitments to cover, we have some remaining monies to spend on ACC5, less the restricted cash, and then we have to pay down a little bit of the line in Q3 here. So that’s not touching the line, right? The line’s availability is $20 million, so free cash is in the $10 to $20 million range.

Michael Bilerman – Citigroup

And then your divid – you are not taking into account the payment of the dividend then, now?

Mark Wetzel

If – exactly. So if we pay the dividend on December 31, free cash plus the line availability will be covered.

Michael Bilerman – Citigroup

Do you think, if – the $20 to $30 million that you have at the end of the year?

Mark Wetzel

That’s before the dividend,

Michael Bilerman – Citigroup

It is before the dividend.

Mark Wetzel

That is correct.

Michael Bilerman – Citigroup

So if you pay the dividend you are down to having $5 to $10 million of total availability.

Mark Wetzel

If we wrote the check on December 31 that is correct.

Michael Bilerman – Citigroup

And is there future commitments as we start heading in to 2010 that have already been committed?

Mark Wetzel

No. There is not.

Michael Bilerman – Citigroup

So, then everything from that point becomes having to raise new capital. There is nothing, there is no...

Mark Wetzel

Well, free cash flow in 2010 – we’re not going to get into our ‘10 guidance yet. But it considerably steps up from 2009. So we have no construction commitments carried into ‘10 at this point, until we decide to restart a development.

Michael Bilerman – Citigroup

Okay. All right, thank you.

Mark Wetzel

Okay.

Operator

And we will go ahead and take our next question from Chris Lucas with Robert W. Baird.

Christopher Lucas – Robert W. Baird.

Hi, good morning guys.

Mark Wetzel

Hi, Chris.

Christopher Lucas – Robert W. Baird.

Just a point of clarification. In the press release, from rack space as related to your Chicago lease, there is a quote I want to read, and I want to get some clarification. It says, “Because the lease provides for rack space to grow into the space over time, the company is better able to match its expenses to revenues, as driven by customer demand.” And so I guess my question on that is, is that – is the lease commencement for the full amount beginning in November, or does it expand over time based on their usage, or there is an option for them to take on more space in Chicago?

Mark Wetzel

The – it’s kind of tiered, Chris. The base rent is staged over time, based on usage over the first three years. The OpEx is over the first year and – as well as the management fee.

Hossein Fateh

And Chris, as you know, all our leases have a couple of years of takedown. So this is just talking about the initial takedown process.

Christopher Lucas – Robert W. Baird.

Okay. And then I guess...

Hossein Fateh

The lease commences on November 1.

Christopher Lucas – Robert W. Baird.

Right.

Hossein Fateh

Because of straight-lining, we bring all the income back.

Christopher Lucas – Robert W. Baird.

Okay. So from a straight-line perspective, all of it is showing up on some average basis over the life of the lease, but for purposes of cash it is much more stepped.

Mark Wetzel

Yeah, stepped in year one.

Christopher Lucas – Robert W. Baird.

Yes.

Mark Wetzel

Year two as well, but OpEx is covered basically in year one.

Christopher Lucas – Robert W. Baird.

From a cash perspective?

Mark Wetzel

Correct.

Christopher Lucas – Robert W. Baird.

Okay, so it’s – okay. And then second, just on the general lease question, or leasing activity question, on the demand side in Northern Virginia, can you provide some context in terms of the sources of the demand? Between the various parties.

Hossein Fateh

Both, actually both Virginia and Chicago, we’re seeing increased activity from enterprise-type companies, from Internet-type companies, we are well – I want to be cautious and not get too excited about it, but literally our requests for proposals have gone up two to threefold, and the sizes of the tenants have gone up threefold. But I want to be cautious, because I really – we don’t know if that’s going to translate into leases or not, or how soon. So the leasing we’ve done this quarter has been tremendous, and we’ve always said leasing is lumpy; this one was a big lump. So we can’t expect this, 12 megawatts every quarter.

Christopher Lucas – Robert W. Baird.

Yes. So as a follow-up, is there any way to understand what are discrete individual requirements versus some underlying requirement where there are multiple bidders for the same requirement, and therefore you’re seeing sort of an expansion of that demand that may not be fully realizable?

Hossein Fateh

I’m not sure that I understand the question correctly.

Christopher Lucas – Robert W. Baird.

Well, if you have a service provider that is – that – well, multiple service providers that are bidding for a third-party contract...

Hossein Fateh

No, no, this is – what we are seeing is direct user demand.

Christopher Lucas – Robert W. Baird.

Okay.

Hossein Fateh

It’s not from service providers.

Christopher Lucas – Robert W. Baird.

Okay

Hossein Fateh

Very little of our space is leased to resellers or service providers.

Christopher Lucas – Robert W. Baird.

Very good. Thank you very much, guys.

Hossein Fateh

Thanks.

Mark Wetzel

Okay, thanks Chris.

Operator

And we will take our next question from Brendan Maiorana with Wells Fargo Securities.

Brendan Maiorana – Wells Fargo Securities

Thanks, good morning.

Hossein Fateh

Hi, Brendan.

Brendan Maiorana – Wells Fargo Securities

Hossein, I wanted to follow up on your initial comments about Microsoft and Yahoo! You know obviously the announcements over the past week or so are fairly recent. But have you had a chance to discuss with them the potential impact that could be in terms of your portfolio, and in terms of the demand that they may...

Hossein Fateh

Well, I mean...

Brendan Maiorana – Wells Fargo Securities

Ultimately see?

Hossein Fateh

We don’t expect much expansion from neither Microsoft and Yahoo! in our space. However, we don’t really see any impact because there are, as I stated, no outs in any of the leases on Microsoft, and Yahoo! So for us it’s a, keep collecting rent – keep collecting our rents. So the buildings that both of them occupy are – all of the space they both occupy are very full, and both of them are using a significant amount of space. So we don’t really see any impact to us from their announcements.

Brendan Maiorana – Wells Fargo Securities

Ah, maybe I’m reading between the lines here a little bit, but it sounds like you are saying – I recognize that there is not an immediate impact in terms of your collecting the rents, but would there be an expectation that upon the expiration of those leases that there may be some contraction going forward, and you would thus need to backfill with additional tenants?

Hossein Fateh

It’s really too early to tell what happens, Mark, and like as our – I mean, I believe our average leases with those guys have still approximately seven years of term on it.

Mark Wetzel

Yeah, 6.7 years.

Hossein Fateh

So 6.7 years is really too early to tell what decisions are made by those two in six and a half years.

Mark Wetzel

Brendan, what we do track is the power usage of each of our tenants, and as Hossein alluded to, they are continuing to be one of the better tenants about managing and using the available power that they have with the space that they occupy. So they are – it’s not like they are not using the space and they just let the lease expire. They would have to shift that traffic or that usage somewhere else.

Brendan Maiorana – Wells Fargo Securities

Right, I guess that’s something that we ought to be paying attention to over the next few months, right? As this is sort of a more recent development.

Hossein Fateh

No, no we have always tracked it, and they’ve always used mostly all of their power, so – we’ve always tracked that.

Brendan Maiorana – Wells Fargo Securities

Right. No, fair enough. Also wanted to follow up on the decision to do AC – or to think about ACC5 Phase II relative to Santa Clara. It sounds like the amount of additional capital spend would be about the same at Phase II as it would be at Santa Clara

Hossein Fateh

No, that’s not the case. In Santa Clara, we would need approximately $180 million of new capital; ACC5 Phase II, we need approximately $80 million of new capital. So the additional capital needed is $100 million less on ACC5 Phase II, because of really three factors. One is, all the underground work and of the data center is done, and the fact that we’re using – and secondly really the cost of labor in Virginia is significantly less; the shell in its entirety is already constructed, really amounts to the cost savings.

And frankly the other decision is, it’s already 38% or so pre-leased. So why not use the – why not go the safer route rather than take leasing risk. So we know that from now to approximately next year when we deliver the building, we can lease the balance of Phase I up, so we have inventory.

Brendan Maiorana – Wells Fargo Securities

Okay, no, that’s helpful. I think I must have mis-heard one of the numbers you quoted earlier in the text. Mark, can you give us an update in terms of your lenders, what some – as you are looking to do the mortgage on ACC5, replacing that on ACC5, what terms you are looking at in terms of loan-to-value, in terms of rate, and in terms of amortization and things like that?

Mark Wetzel

This is probably not the place to get into that, but we are looking at four to five year money, we are looking at rates – we haven’t really gotten the rates, but I’m guessing they’re in the, similar rates that some other players have issued out there. If we go down a high-yield route those rates are little higher, but there is discussions, it is active, but at this point it’s kind of early to say.

Brendan Maiorana – Wells Fargo Securities

And can you give us any sense of where loan-to-values may be, or cap rates or things like that lenders are looking at?

Mark Wetzel

Well, we – they tend to look at the loan to the EBITDA ratio, so the issue of loan-to-value, if we just look at our ACC4 building, which is right across the street, that was $250 million of loans – of a loan on a $680 million value, so it’s – we would look at similar dollars. We would look at a similar rate structure, but that was – that’s a good comparison for us.

Hossein Fateh

And it’s producing, ACC4 was producing approximately – is producing approximately $53 million of net income, so on $53 million we raised 250.

Brendan Maiorana – Wells Fargo Securities

Right.

Hossein Fateh

So we would have similar ratios going forward.

Brendan Maiorana – Wells Fargo Securities

Right. So just sort of simplistically, if we threw a 10 cap – which I’m not saying is the right or wrong number – but if we threw a 10 cap on it, you would get roughly 50% loan-to-value.

Mark Wetzel

That’s a good way to look at it.

Hossein Fateh

But we don’t want a 10 cap on the value.

Brendan Maiorana – Wells Fargo Securities

And just a point of clarification, if I look at your – the yields that you are quoting, 15% at ACC5, 12% at Chicago, those are in-place, day-one yields? Or is it that that’s the cap yield over the term?

Mark Wetzel

Yeah, that’s stabilized, in-place.

Brendan Maiorana – Wells Fargo Securities

Okay. So if I look at your – if I look at your cash NOI in Q1, which was $90 million, add in $25 million roughly for Phase I of ACC5, $25 million of Phase I for Chicago, that gets me a pro forma NOI number of around $140 million. Is that how we should be thinking about it?

Mark Wetzel

I think I agree with your numbers. Yes.

Brendan Maiorana – Wells Fargo Securities

Okay. All right, thank you.

Operator

(Operator Instructions). And we will take a follow up from Jordan Sadler with KeyBanc Capital Markets.

Jordan Sadler – Key Banc Capital Markets.

Hi. Just on the dividend payment, I’m not sure if Lammot’s in the room, but definitely – you are obviously, Hossein. I’m curious as to your thoughts on a stock versus cash dividend?

Hossein Fateh

Well, I mean the – I mean everyone’s preference is to have a cash dividend. So we’re going to look at where we are at the end of year and make that decision. I think the Board and management, including Lammot and I, would prefer to do a cash dividend, but we need to weigh that option at the end of the year.

Jordan Sadler – Key Banc Capital Markets.

Okay. And then just Mark, to clarify, it sounds like you expect cash flow to step up headed into the first quarter. What would be sort of the 1Q run rate on cash?

Mark Wetzel

At this point I don’t want to get too far into 2010. We will talk about that at probably Q3 or at the end of the year but it...

Jordan Sadler

But it predominantly relates to the ACC5 lease coming up.

Mark Wetzel

ACC...

Jordan Sadler – Key Banc Capital Markets.

Or is ACC5 also stepped in terms of cash? Because the take-down...

Mark Wetzel

Well, the burn-off at ACC4 is very real going into next year. The Chicago leases step up, and obviously ACC5 Phase I. So those are the three big components

Jordan Sadler – Key Banc Capital Markets.

ACC5 Phase I, what is the – is it a similar sort of lease structure as Chicago?

Mark Wetzel

Ah, no.

Jordan Sadler – Key Banc Capital Markets.

A couple of years – a couple of years to take-down, or...

Mark Wetzel

It’s – a year to take-down is, on the base rent is – I think it’s 50% in year one.

Jordan Sadler – Key Banc Capital Markets.

50% of base rent received in year one?

Mark Wetzel

For the base rent. The OpEx and management fees start at day one, but the leases are tiered over time, over the first year.

Hossein Fateh

And that’s just like how we’ve done it on ACC4.

Jordan Sadler – Key Banc Capital Markets.

The base rents will kick in, basically, come at March 31 or something like that, or March 1?

Mark Wetzel

That’s...

Jordan Sadler – Key Banc Capital Markets.

Is that right?

Mark Wetzel

Yeah, some of it’s 50%, some of it’s tiered, but it does step up over time.

Jordan Sadler – Key Banc Capital Markets.

Okay. That makes sense. The other question I had for you is just, in terms of what you are seeing in the market on the investment front, any assets coming for sale, distressed sellers?

Hossein Fateh

I mean – I think we are a little bit different than some of our competitors, because for us the best investment we can make is our own development projects. Like I said, the new money that would be going into ACC5 Phase II and New Jersey, with the yield unlevered when leased in excess of 30%. There is no way there is an opportunity to buy anything in the market at a 30% cap rate.

Jordan Sadler – Key Banc Capital Markets.

So you are not looking at anything?

Hossein Fateh

I mean we would look at everything, but I think our focus is our own projects, because I don’t think – and you will agree – that there are no opportunities at 30% cap rates elsewhere in the market.

Mark Wetzel

But Jordan, to be clear, we have received and looked at a variety of packages, so it’s just, the radar screen for us right now is to strengthen our own balance sheet, focus on what’s on the balance sheet and put that to use.

Jordan Sadler – Key Banc Capital Markets.

Mark, where do you expect to be 90 days from now in terms of your capital raise? Just to give us a milestone.

Hossein Fateh

We will tell you in 90 days.

Mark Wetzel

We will tell you in 90 days, but that’s a good timeline.

Jordan Sadler – Key Banc Capital Markets.

Okay. Do you expect to have better color, or something in hand, or...?

Mark Wetzel

We will have better color. That’s probably the best way to say it.

Jordan Sadler – Key Banc Capital Markets.

Thank you.

Hossein Fateh

I mean, the thought process is that from now, we need to – we need to start the development sometime in the first quarter. From now to ‘10 we’ll look at all the options to optimize the lowest cost of funds to build our development pipeline.

Jordan Sadler – Key Banc Capital Markets.

Perfect. Thank you.

Mark Wetzel

Thanks, Jordan.

Operator

And we will take our next question from David Harris with Arroyo Capital.

David Harris

Hey, good morning fellows, how are you?

Mark Wetzel

Hi. How are you?

David Harris

Good. Forgive me if you’ve touched upon this. I was intrigued by the reference to the LEED Gold certification for ACC5. This pertains to the building as opposed to the user, am – I am assuming?

Mark Wetzel

Yes, that’s to the building.

David Harris

Okay. Does it imply that you’re building to any different standard on ACC5, than previous...?

Hossein Fateh

I mean, LEED – no we just, we have not seeked LEED certification. Now let’s face it, from a – LEED, how it works is you put a bike rack and ddd you put a few things, you put a white roof, you put a flushless urinal, and when you get to the mid – and each of those things gives you a couple of points. When you get to 30 points or 35 points you get something like that, you get a LEED certificate, and we are aiming for that. But frankly a LEED is very good from a marketing standpoint and like – some tenants like to see it, but our data center efficiencies, we’ve – we design our data centers for much more efficient mechanical and electrical equipment that we do not get points, that we do not get points for.

David Harris

So henceforth we can assume that you’d be applying for LEED certification on all your developments, simply because it enhances your marketing...?

Hossein Fateh

Yes I think that’s fair.

David Harris

Okay, and there is no real additional costs involved?

Hossein Fateh

It’s – there are some costs, but it’s not in – I’m mean it’s certainly – it’s a couple of hundred thousand dollars or something.

David Harris

And more generally on this point of energy usage in data centers, it seems to me that the heat that was being generated by the environmentalists over energy usage has sort of abated somewhat. Is that fair to say, or do you got a sense the tenants are pushing more aggressively to diminish their power usage?

Hossein Fateh

Well I think the way you need to look at it is, our data centers we believe are some of the most efficient in the country. On the heat generation, our chilled-water plant, for every dollar of electricity we spent $0.28 cooling it. That is extremely efficient. Our crack units have – on the new data centers have variable speed drives, which drives efficiency. Our UPS units on the dynamic UPS, they only burn us approximately 65 kilowatts for 1.3 megawatts, which is 5%, while many battery-operated UPS’s burn almost 9% of the electricity.

On the non-essential parts of the data center we have motion sensors on all the lights. We put a white roof in. But these things that we’re doing drive our data centers to be on the power side, the most efficient in design, but we have in mind our tenants – they – we do that to minimize our tenants’ operating expenses. And many of this things I mentioned that we are doing, we don’t get any LEED points for it. So the efficiency is really driving our desire, to make our cost of occupancy more competitive.

David Harris

Okay. I mean – and this is a big-picture question related to this, is you don’t get any sense that we’re on the brink of a big breakthrough in terms of a diminished energy usage by the users?

Hossein Fateh

No.

David Harris

I mean, the gains are somewhat still incremental?

Hossein Fateh

No. I mean there really is not – you can’t – a dollar of electricity going into, you need to cool it, spend $0.28 cooling it. When and if someone produces a chip that doesn’t produce heat, at that point we’ll get some savings, but we’re not really seeing that. Or when and if you can have servers that don’t use electricity, that’s when we get to efficiencies, but we don’t see a time when servers don’t use electricity.

David Harris

So would it be fair to say this, I mean this is a sort of conclusion I drew a couple of years ago when I was working with you around the time of the IPO was that the engineers are still focusing their energies on expanding capacity rather than reducing the cost of running these, the servers?

Hossein Fateh

I mean, I think the way you need to look at it is, billi – the manufacturers of servers look at billions of calculations per second that the server produces, over how many watts. They are trying to make that more and more efficient, but the demand that us as a society are putting on the servers is growing faster than that ratio.

David Harris

Okay. Yeah, so the relationship still holds, is how...

Hossein Fateh

Absolutely.

David Harris

Focus on capacity rather than reducing cost.

Hossein Fateh

Yeah. I mean, everyone tries to be more efficient, but the demand is increasing because of new business models that we see developing every year.

David Harris

Okay, great. Thanks for answering those questions.

Operator

(Operator Instructions) And we will take a follow-up from Michael Bilerman with Citi.

Michael Bilerman – Citigroup

Yeah. Mark, just on the guidance change, it looks like most of that was just from, I guess you were giving me where rates are today, because the uptick at least in your guidance, where most of the street had already been there. Is that fair to assume?

Mark Wetzel

That’s fair to assume. We had some speculative revenue obviously in the guidance as well, and we’ve secured those leases. We – the interest rates, because we do have a sizable floating piece of debt that is, a lot of is rate driven. But also we had some additional one-time projects in the Other Revenue line that’s a couple of cents.

Michael Bilerman – Citigroup

And then on the Other Revenues, do to the Other Expenses move up proportionately, or is that all the increase going from 6 to 8 to 11 to 13, in terms of Other Revenues, does that all drop to the bottom line?

Mark Wetzel

No. Other Expenses would go up correspondingly. So, we do various projects for – one-time projects for various tenants that range from 10 to 20% markup.

Michael Bilerman – Citigroup

So, the net for the year is, you have about $1.5 million of net Other Income. I guess your expectation is that that’s about $3 million for the year, or...?

Mark Wetzel

Yeah, that’s – I think I range, moved – we moved the range up six to eight, it went up to 11 to 13, so on that margin net incremental will be a couple of cents.

Michael Bilerman – Citigroup

And then just in terms of the take up of the leases, can you just be very specific in terms of the leases that are starting in Chicago and in ACC5 Phase I, in terms of the cash and the GAAP? In fact, I take it that if you have a stage take-out that’s effectively free rent into your GAAP. Effectively, is it a lower cash yield over the life of the lease?

Mark Wetzel

Well, if the straight-line revenue that we provided guidance on was $20 to $25 million for the year, if you look at the first six months on the FFO reconciliation page, I think it was only about $7.4 million, so opening the doors at ACC5 will drive a lot of that additional amount in the last half of the year to get inside our range.

Michael Bilerman – Citigroup

But there is much longer take-up, it sounds like, at Chicago in terms of cash.

Mark Wetzel

Well, specific to 2009, that’s what I’m – I mean, as we go into ‘10 or ‘11 we’ll talk about that at year-end, but in terms of what’s going on for 2009, the straight-line revenue line that I provide in the other guidance assumptions is holding up, that we will fall inside those goal post of $20 to $25 million. We’re only at 7.5, so to speak, on – as of 6/30. So you’ll see the incremental jump in Qs 3 and 4 because of the openings of ACC5 and Chicago.

Michael Bilerman – Citigroup

The Chicago, with being 50%, 48% leased today, those leases commence but the cash doesn’t come in for a period of time.

Mark Wetzel

Well, the lease that we just executed in Chicago starts in November 1, so for 2009 it’s incrementally small for November or December.

Michael Bilerman – Citigroup

But does cash and GAAP being the same, or is that it starts November and then they will have a two year sort of take-down in terms of when they actually have to pay cash rents?

Mark Wetzel

Every lease we do, they’re long-term, 10 plus years typically, has a cash-GAAP difference. That’s why we give the straight-line number.

Hossein Fateh

And two years is typically what it takes to stabilize a data center.

Mark Wetzel

But, I mean we’re expecting a sizable jump between ‘09 and ‘10 for our Chicago asset as well as our ACC5 asset on the leases executed today. But I don’t really want to get in to the ‘10 numbers just yet. But for 2009 it’s – step one is get the leases signed, step two is – that’s my job, to manage the cash, but we will ensure that as we end the year and as we go into next year that these leases, from a cash flow perspective they do jump.

Michael Bilerman – Citigroup

Where are you in terms of discussions on the line renewal?

Mark Wetzel

It’s almost too early to chat. We’ve had discussions with several of the players inside that line. So basically, it was talk about it later this year or first part of the next – of 2010.

Michael Bilerman – Citigroup

And from a covenant perspective you feel comfortable that you are going to meet those, given the increased cash flow that’s going to coming. But is there any other conditions that could throw a wrench into those plans?

Mark Wetzel

Sitting here today, no.

Michael Bilerman – Citigroup

What would be the other conditions that you need to meet, right? I mean what are – other than the financial covenants, what other things need to be in place? So at least we can monitor them.

Mark Wetzel

There is – it is just maintaining the covenants, and pay a fee to do the extension.

Michael Bilerman – Citigroup

Okay. Thank you

Mark Wetzel

Okay.

Operator

And we’ll take our next question from Chris Lucas with Robert W Baird.

Chris Lucas – Robert W Baird.

Hey. Just a quick one Mark, just on the underwriting that the lenders that you’re talking to are doing. Do they look at things on a cash basis, or on a contracted sort of basis?

Mark Wetzel

They are looking at both, Chris. Obviously cash drives it; everybody looks at the cash side first, but lease execution is critical, and then we map up out the cash over the next couple of years, and so they – it’s both.

Hossein Fateh

Term, credit of tenants.

Mark Wetzel

Credit of tenant, all that.

Chris Lucas – Robert W Baird

Okay, super. Thanks guys.

Operator

And it appears we have no further questions at this time. I would like to turn the conference back over to Hossein Fateh for any closing or additional remarks.

Mark Wetzel

Just thank you.

Hossein Fateh

Yes, thank you everyone for listening to our call. Speak to you next time.

Operator

This does conclude today’s conference call. Thank you for joining. You may now disconnect.

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