DuPont Fabros Technology (DFT) Christopher P. Eldredge on Q1 2016 Results - Earnings Call Transcript

| About: DuPont Fabros (DFT)

DuPont Fabros Technology, Inc. (NYSE:DFT)

Q1 2016 Earnings Call

April 28, 2016 11:00 am ET

Executives

James Warren Armstrong - Chief Accounting Officer

Christopher P. Eldredge - President, Chief Executive Officer & Director

Jeffrey H. Foster - Chief Financial Officer & Executive Vice President

Analysts

Jordan Sadler - KeyBanc Capital Markets, Inc.

Omotayo Tejumade Okusanya - Jefferies LLC

Jonathan Atkin - RBC Capital Markets LLC

Jonathan Schildkraut - Evercore ISI

Robert Chapman Stevenson - Janney Montgomery Scott LLC

Matthew Heinz - Stifel, Nicolaus & Co., Inc.

Emmanuel Korchman - Citigroup Global Markets, Inc. (Broker)

Colby Synesael - Cowen and Company

Operator

Welcome to DuPont Fabros Technology's First Quarter 2016 Earnings Conference Call. Today's call is being recorded.

At this time, I would like to turn the conference over to Jim Armstrong, Chief Accounting Officer for the company. Mr. Armstrong, you may begin your conference.

James Warren Armstrong - Chief Accounting Officer

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

Certain matters discussed during this conference call may constitute forward-looking statements within the meanings 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, reconciliations to net income and operating income as applicable are contained in the company's earnings release issued this morning. The release is available in PDF format in the Investor Relations section of the company's corporate website at www.dft.com. To manage the call in a timely manner, we will limit questions to only two per caller. Should you have additional questions, you may return to the queue.

I will now turn the call over to Chris.

Christopher P. Eldredge - President, Chief Executive Officer & Director

Good morning, thank you for joining the call. There are four main topics I would like to cover today. DFT's record leasing in the first quarter, the continuous growth of the cloud and its impact on leasing, our healthy pre-lease development pipeline, and an update on NJ1 sales process.

First, leasing, on the last call, I highlighted that we had record leasing in Q4 2015, up 32.4 megawatts. As they say records are made to be broken and this one did not last long. We signed seven new leases in the first quarter totaling 33.1 megawatts, that's 65.5 megawatts of leases in the last two quarters. Over the trailing 12-months that amounts to 77.7 megawatts of new leases. Big numbers by any measure.

Let's walk through the details. After locking in a 16 megawatt agreement, SC1 Phase III is now 100% pre-leased. We expect to bring SC1 Phase III online in the third quarter of 2017. The estimated unlevered GAAP return on investment is 11.5%, that's 225 basis points higher than the 9.25% achieved in the first two phases of SC1. The increase in ROI is due to lower development costs from design related savings and higher GAAP rent.

You may recall that as previously stated, we required a pre-lease of at least 10 megawatts and a double-digit return to develop SC1 Phase III. I'm very pleased that we surpassed both requirements.

CH2 Phase II opened 77% leased and commenced on April 1. During the quarter, we signed 2.8 megawatts of pre-leases and expanded critical load of an existing pre-lease.

CH2 Phase III had two pre-leases signed in the quarter totaling 10.1 megawatts. These leases are expected to commence in the third quarter of 2016 once Phase III is placed into service.

For ACC7 Phase III, we secured a pre-lease of 3 megawatts. This lease is expected to commence in the second quarter of 2016 when Phase III is placed into service.

We also had an existing customer expand, the critical load leased in one of their computer rooms in Phase 1 of CH2. Our version 3.0 data design provides customers with the opportunity to adjust the power density in their computer room. In this case the expansion totaled 0.6 megawatts.

A good portion of our leasing in Q1 can be attributed to the exponential growth of our cloud customers. As a leading enabler of cloud, we are encouraged by the continuing evidence of demand for cloud-based services, notably a recent JPMorgan survey of CIOs found that only 16.2% of enterprise workloads are on the public cloud today. The same CIOs expect this to triple over the next 5 years to 50% of enterprise workloads. Here are a few examples from the hyperscale universe that support those expectations.

Microsoft announced Azure contracts with BMW and Toyota, to assist in making their cars smarter and more connected. This is in addition to contracts Microsoft has with Volvo and Nissan. BMW is using Azure to power its open mobility cloud for their new BMW connected app.

Toyota will use Azure to run Toyota Connected to support in-car services, telematics, Internet of Things, home connectivity and smart city integration. It's no wonder Microsoft's data center spend is up 65% year-over-year.

Amazon had previously announced a deal with GM to use the AWS cloud products for its smart cars. In his 2015 letter to shareholders Jeff Bezos stated that Amazon became the quickest company to reach $100 billion in revenue and that AWS is expected to top $10 billion of revenue into 2016. At 10 years in, AWS is bigger than Amazon was at 10 years, has 1 million customers and is growing at a faster rate.

One example of growth Bezos cited is Major League Baseball selection of AWS for its stacked cast tracking technology. Stacked cast generates 7 terabytes of data per game and up to 17 petabytes of data for a season. All of this data will have analytics performed on it by AWS's EC2 platform.

We see cloud adoption expanding at an increasing rate in almost every way. Be it protestant development, storage or compute, the move to the cloud appears inevitable. So back to DFT's activity, our lease extensions are also worth noting. Since the start of the year we've extended the term of two leases totaling 0.82 megawatts by a weighted average of 3.6 years.

The GAAP-based rent increased 15% upon the renewal signing and cash-based rent is 6% higher than current rates. Results on our extensions are better than what we forecasted at our Investor Day.

We've averaged GAAP-based rent of $104 per kW per month for new leases signed to-date in 2016. This is a 3% increase over 2015 and continues the positive trend of increasing rates we've experienced since 2013. The average GAAP-based rent for the two extensions was $150 per kW per month.

Our substantial leasing results and positive rental rate momentum are encouraging and bode well for our development pipeline. Currently, we have five separate development projects underway. They are expected to be delivered in the second quarter, third quarter, and fourth quarters of 2016 and the third quarter of 2017. These sites will add 62 megawatts to our portfolio of which 29 megawatts, or 47% is pre-leased. We targeted a 12% un-levered ROI on these developments, which if achieved would result in $73 million of additional EBITDA per year once the space is fully leased.

Let's look at the details of the pipeline. In Ashburn, we anticipate delivering ACC7 Phase III in the second quarter of this year. This will bring 11.9 megawatts of new capacity to our portfolio, 25% of which is pre-leased.

Demand in Northern Virginia continues its impressive upward trend. To maintain our market leadership position in Northern Virginia, we are developing Phase IV of ACC7 for an additional 7.8 megawatts of capacity. This will complete ACC7 at total capacity of 41.6 megawatts.

Also in the first quarter, we closed on 44 acres of land that is now part of our Ashburn campus. This land has capacity for approximately 70 megawatts of data centers. ACC9 and ACC10 will be multi-tenant turnkey data centers and ACC11 is slated for a power based shell or a build-to-suit. We started developing Phase I of ACC9 which will have 14.4 megawatts of critical load. This phase is expected to be delivered in the third quarter of 2017.

In the Chicago market, development of CH2 Phase III is on time and scheduled to be placed into service early in the third quarter of 2016. This will bring an additional 11.3 megawatts online, of which 89% is pre-leased. This is the last phase in CH2. We are now planning the development of CH3.

We are in the process of relocating tenants from the warehouses that currently sit on the CH3 land. Our estimated timing for commencing the development of the first phase of CH3 is the second half of 2016 with the projected in service date in the first quarter of 2018.

In Santa Clara, we have commenced development of Phase III which is a 100% pre-leased. We expect to bring the 16 megawatts of critical load online in third quarter of 2017. That brings us to future growth in new markets.

We announced in March that we had entered into a purchase agreement for land in Hillsboro, Oregon, a suburb of Portland. This acquisition is for 46.7 acres that we expect to complete in the third quarter.

Our recent equity offering will allow us to begin development and pre-leasing this year with planned delivery in 2018. In Toronto, we are in active negotiations for a new development site. We continue to target Q1 2018 for delivery of our first phase in this underserved data center market.

Lastly, as you may recall, we are marketing our NJ1 data center. The level of interest in this property remains quite strong. We have now progressed through multiple rounds of bidding. It's not unrealistic to assume a third quarter 2016 closing.

With that, I will turn the call over to Jeff to discuss our financials.

Jeffrey H. Foster - Chief Financial Officer & Executive Vice President

Thank you, Chris. I want to cover five main topics today. Our first quarter 2016 results, the extension of the sales tax exemptions for our Ashburn campus, a capital market and development spend update, our dividend and our updated 2016 guidance.

During the first quarter, we achieved earnings of $0.36 per share, compared to $0.24 per share the prior year. This increase was due to new leases that commenced in 2015 and the first quarter of 2016. And also, a charge of $0.07 per share in Q1 2015 for severance and equity accelerations associated with the departure of our former CEO.

Our first quarter 2016 normalized FFO was $0.67 per share, the midpoint of our guidance. Our normalized FFO increased $0.06 per share, or 10%, compared to the first quarter 2015. AFFO for the quarter was $0.64 per share, compared to $0.65 per share for the same quarter of 2015, a decrease of $0.01 per share, or 2%. The decrease was primarily caused by a smaller add back of straight-line revenues due to Yahoo's ACC2 lease expiration and higher CapEx, primarily due to ACC2 enhancement.

Quarterly revenues were $124.1 million, an increase of $16.8 million, or 16%, from the previous year's quarter. The normalized FFO and revenue growth is in line with the target set out at our Investor Day. AFFO growth is projected to accelerate once more leases commence in Q2 and Q3 of 2016. A quick comment on same-store; this turned positive in Q1, as predicted on our February earnings call. Same-store, same-capital, is still forecasted to be positive in Q2.

Another positive event in the quarter was the extension of a sales tax exemption for our Ashburn campus, you may recall that DFT worked with a coalition in 2012 to obtain a sales tax exemption in Virginia for multi-tenanted data centers.

Since obtaining that exemption, leasing at Ashburn has been very strong. This exemption was scheduled to sunset in 2020. In March, the Governor signed a bill which extended the exemption through June of 2035. This will allow the Ashburn campus, including the newly purchased land that will contain ACC9, ACC10, and ACC11, to remain extremely competitive on a total cost of occupancy basis.

It should also yield positive results when discussing renewals with current customers. Our thanks to the Northern Virginia Technology Council for spearheading this effort. We also thank several of our largest customers for their participation in the work that achieved this positive result.

Let's move now to our capital markets update. In March, we had a very successful equity offering of $287 million. The number one question Chris and I have been asked in the last month is, why did you issue equity after stating at Investor Day the five-year plan could be achieved without issuing equity? The answer is quite simple. Our stock was trading above NAV in March, while it was well below NAV at Investor Day.

But more importantly, the constraint of not issuing equity was delaying the Portland market development start until 2017, with an estimated placed in service date of 2019. Given how strong demand for data center space is today, we wanted to move these dates forward so we could begin pre-leasing efforts as soon as possible. We now project starting development of Portland this year, with a placed in service date of 2018.

We had a target of raising $200 million of equity, but given how well the offering was received, we ended up raising $287 million. We are using the excess funds to redeem a portion of our Series A preferred stock. This will partially offset the earnings dilution from the equity offering, as I will discuss shortly.

As of today, we had no borrowings on our unsecured credit line, leaving the entire $700 million available. With cash on hand, cash generated after dividend payment, and our line of credit; we have the capacity to fund the entire five-year strategic plan.

Now let's discuss the dividend. On April 15, we paid our quarterly dividend of $0.47 per share, which was in line with the prior quarter. The anticipated 2016 annualized dividend is at $1.88 per share, which represents an estimated AFFO payout ratio of 67% at the midpoint of our guidance.

And I now would like to discuss our guidance. The full year 2016 normalized FFO guidance range is $2.71 to $2.81 per share. The midpoint of $2.76 per share is $0.01 higher than prior guidance, overcoming $0.20 of dilution from the equity offering. The original high end of the guidance range had $0.19 of speculative leasing, and the current range has $0.09 of speculative leasing, as year-to-date leasing has already produced $0.10 of normalized FFO per share.

Guidance reflects using the proceeds from the equity offering to pay down the line of credit which was $60 million, redeemed $85 million of the Series A preferred stock and using the remaining proceeds to fund development. Our second quarter 2016 normalized FFO guidance range is $0.63 to $0.65 per share. The midpoint of this range is $0.03 per share lower than Q1 2016. This is primarily due to the issuance of common equity, partially offset by the FFO produced by the new leases and the redemption of preferred stock.

Our full year 2016 AFFO guidance range was tightened to $2.75 per share to $2.85 per share from $2.70 to $2.90 per share. The midpoint of the range is unchanged at $2.80 per share.

Our second quarter AFFO guidance range is $0.64 to $0.66 per share. The midpoint is $0.01 per share higher than Q1 2016. This is primarily due to rent commencements occurring in Q2, including the new ACC2 lease, partially offset by the dilution from the common stock offering.

Before we go to questions, Chris will summarize our take on the quarter.

Christopher P. Eldredge - President, Chief Executive Officer & Director

Thanks, Jeff. To sum up, our record breaking 33.1 megawatts of leasing in Q1 2016 was outstanding. When you combine that with the 32.4 megawatts we leased in the fourth quarter of 2015, it's apparent that premium wholesale data center space is in high demand. We entered Q2 with an expanding portfolio, a strong sales funnel, a robust development pipeline. With the exponential growth of the cloud and the increasing demand for our data centers, we are confident DFT is well-positioned to remain a leading enabler of the cloud.

Now, let's go to your questions.

Question-and-Answer Session

Operator

Thank you. And our first question comes from Jordan Sadler from KeyBanc Capital Markets. Your line is open.

Jordan Sadler - KeyBanc Capital Markets, Inc.

Thank you, good morning.

Christopher P. Eldredge - President, Chief Executive Officer & Director

Good morning, Jordan.

Jordan Sadler - KeyBanc Capital Markets, Inc.

So, first question comes from right off of where you left off Chris, I think, in terms of the strength of demand. Can you talk about sort of what the pace looks like for the rest of the year in terms of maybe that demand funnel, obviously, two consecutive record quarters is what I'm looking at, we're all looking at here, and I'm just curious in terms of what the potential is to sustain this pace?

Christopher P. Eldredge - President, Chief Executive Officer & Director

I mean, when you look at our pipeline or our funnel, Jordan, it's really, really strong. I mean, it's probably the best it's been since I've been here. So we're seeing a tremendous amount of demand in Chicago and in the Northern Virginia market. That's one of the reasons why we started – or announced development of ACC7 Phase IV and we started ACC9 to support that level of demand.

A lot of it comes down to how much inventory we bring online and how quickly we can bring it online. So we have a lot of projects in development and we're trying to accelerate that, but as soon as we bring it on as you see by the history of our pre-leasing, which is about at 47% right now, the inventory, the 62 megawatts, there's a tremendous amount of demand for our product, and it's the hyperscale cloud providers, it's social media, it's media and content, we're in the very early stages of cloud right now, I'd say we're in the first inning, so I think demand is going to be healthy over the next coming years.

Jeffrey H. Foster - Chief Financial Officer & Executive Vice President

And, Jordan, just to add on there, Chris noted in this remarks, we've done 77.7 megawatts of leasing in the trailing 12-months. Our historical average is 30 megawatts a year, that will give you some context to how explosive demand is today.

Jordan Sadler - KeyBanc Capital Markets, Inc.

Right, and that's I guess, seems pretty obvious to me that there has been a huge acceleration, and I'm just kind of curious about your ability to sustain it as well as accommodate it is the other side of it, which you're obviously commencing leasing here. So, that's going to help you – sorry – commencing development so that's helping.

Can you maybe expand on the availability that you continue to sort of expand in Northern Virginia? So prior to – well, at this point given the additional commencements with ACC9 Phase I, you are now bringing your total potential availability in Northern Virginia to something like North of 30 megawatts. Whereas you've obviously got ACC7 Phase III coming online; only 25% leased ACC4 later this year, and not un-leased – maybe talk about the incremental start there.

Christopher P. Eldredge - President, Chief Executive Officer & Director

Yeah Jordan. Let me address that. So, for what we are bringing online this year at ACC7 Phases III and Phase IV is about 20 megawatts, 3 megawatts of which is pre-leased so that would be 17 megawatts available for leasing for capacity coming online this year. We also will be trying to pre-lease ACC9 Phase I which is another 14.5 megawatts. So over the next two years we have about 31.5 megawatts available to lease in Ashburn.

In Chicago, we are down to around 2 megawatts to 3 megawatts of leasing – or capacity available and some of that's in Phase II which is already up and running and the rest is in Phase III which will come online around July.

Jordan Sadler - KeyBanc Capital Markets, Inc.

Okay, that's helpful. Thanks for the color. I will hop back in the queue (24:32).

Operator

Thank you. And our next question comes from Tayo Okusanya from Jefferies. Your line is open.

Omotayo Tejumade Okusanya - Jefferies LLC

Yes, good morning. So again a big congratulations on all the leasing in the past two quarters. It's been amazing. Jeff, quick question. When I take a look at the same-store NOI growth, just again it's been negative for the past few quarters despite all those strong leasing. Could you just reconcile those two things of what I may be missing that's still kind of driving a negative same-store NOI?

Jeffrey H. Foster - Chief Financial Officer & Executive Vice President

Yes. Tayo, thanks for the question. That relates to the ACC2 lease. As you recall, our ACC2 with Yahoo! ended on September 30. So in the fourth quarter of last year, we didn't have any GAAP or cash revenue from that lease.

Omotayo Tejumade Okusanya - Jefferies LLC

Yes.

Jeffrey H. Foster - Chief Financial Officer & Executive Vice President

The new lease commenced for GAAP in the first quarter this year in January. So for the first quarter this year we did have GAAP revenue but the cash commenced April 1. So I would predict since that lease is fully commenced for GAAP and cash that you will see same-store, same-capital turn positive in Q2. You did see same-store turn positive in Q1.

Omotayo Tejumade Okusanya - Jefferies LLC

Got it. Okay, that's helpful. And then I know you've talked about generally the pipeline looks very strong, but could you just talk a little bit just about pricing in general and what you're seeing in some of your key markets?

Christopher P. Eldredge - President, Chief Executive Officer & Director

You saw our announcement, we've seen the pricing increase by 3%. It's hard to predict future pricing. But we're seeing positive pricing trends across all of our markets. As more of the supply gets taken up, we think it puts us in a pretty good position.

Jeffrey H. Foster - Chief Financial Officer & Executive Vice President

Yes I mean just to give color in Santa Clara, we were able to achieve 11.5% return on investment and that compares to the 9.25% we achieved last year on Phase II. So pricing is picking up in Santa Clara and we're seeing similar pickups in Chicago and Ashburn where while we didn't have any completed fully leased phases this time to announce, on the last call we announced 13% return on investments in those markets.

Omotayo Tejumade Okusanya - Jefferies LLC

Okay.

Christopher P. Eldredge - President, Chief Executive Officer & Director

Just to add on to Jeff's comments, too, we're also seeing longer terms.

Omotayo Tejumade Okusanya - Jefferies LLC

Got it.

Christopher P. Eldredge - President, Chief Executive Officer & Director

(27:02).

Omotayo Tejumade Okusanya - Jefferies LLC

Okay. And then apart from the cloud providers, any other tenant segments that are particularly strong demand wise?

Christopher P. Eldredge - President, Chief Executive Officer & Director

I would say the social media providers, media and content, anything somewhat related to the cloud is very, very strong and social media.

Omotayo Tejumade Okusanya - Jefferies LLC

Okay. Great. Congrats on a great quarter.

Christopher P. Eldredge - President, Chief Executive Officer & Director

Thank you very much.

Jeffrey H. Foster - Chief Financial Officer & Executive Vice President

Thanks, Tayo.

Operator

Thank you. And our next question comes from Jonathan Atkin from RBC Capital Markets. Your line is open.

Jonathan Atkin - RBC Capital Markets LLC

Yes, I was wondering if you could talk a little bit about the triple – I think all of your announced deals are still triple net, but you've obviously expanded your product flexibility to include full service. So I'm wondering what kind of progress that has made in your pipeline. And then secondly I wondered, if you would consider – what are your thoughts on M&A as a way of getting into some of the new geographies that you talked about at Investor Day and the criteria that you will consider for that? Thanks.

Jeffrey H. Foster - Chief Financial Officer & Executive Vice President

Hey, Jon. I'll address the first question about the triple net lease and the full-service lease. You're correct. All the leases were triple net. The leases were all with existing customers and our existing customers really see the value in a triple net lease. If you take a look at our pipeline there are a number of opportunities in our pipeline right now that are full-service leases. So we hope to have a full service lease completed by the next quarter. So we're seeing a tremendous amount of demand for that.

The second question you asked is M&A, and I think I stated at our Investor Day that our focus is on executing on our strategic plan. At this time that's our main focus, but if we were to look at M&A, there's certain characteristics, right. Obviously it has to be accretive, it has to get us into new markets like you mentioned, it has to help us with our tenant diversification with high creditworthy customers, and one of the important things for us is we're the only pure wholesale provider in the space right now. We own and operate all of our data centers. So we would want a company that potentially owned all their data centers. But at this time our focus is on executing on our strategic plan and expanding into those new markets.

Jonathan Atkin - RBC Capital Markets LLC

And then finally I wondered what are your views, Chris, on Chicago and how the demand drivers differ there in contrast with Santa Clara or Virginia? It's a market where there is a couple of new folks in competitive sets, so I just wanted to get your perspective on demand and how that maybe is different from the other geographies in which you operate? Thanks.

Christopher P. Eldredge - President, Chief Executive Officer & Director

Yes. I know there has been some recent announcements in Chicago with some of our competitors bringing more capacity online in the market, but when you take a look at the Chicago market, I still do believe it's an undersupplied market and there's a lot of opportunity there. That's why we have CH3, and we're trying to accelerate development of CH3 to support that demand, so I'm bullish on that market.

Santa Clara is another market that, again, I believe is undersupplied. It's very difficult to get land in that market. That's why we're buying land in Portland, to support some of that demand. We see some of that demand from Northern California going to markets like Portland, where power cost is cheaper; there is tons of connectivity, there's a lot of tax incentive for customers. So we see that as a very healthy market. Northern Virginia, again, we announced more expansion there. If you look at our pipeline and our sales funnel, it's a market where we think there is tremendous opportunity. We're in a really good place right now in this space, with the growth of the cloud and continuing outsourcing, we're very positive and bullish on our future.

Jonathan Atkin - RBC Capital Markets LLC

Thank you.

Operator

Thank you. And our next question comes from Jonathan Schildkraut from Evercore. Your line is open.

Jonathan Schildkraut - Evercore ISI

Great. Good morning, and thank you for taking the questions. I guess two maybe here. First, Jeff, is it possible to get an update on the expected rent roll down inside the base? I think the last time you guys talked about it, it was about 9%. I'm just wondering if there are any change on expectations there.

And then secondly, I noticed there was a handful of new disclosures this quarter, particularly around pricing, which I thought was really valuable. But one area where I think that it could be very helpful, considering all the pre-leasing that you're doing, is you get a better sense of backlog and commencement timing around that backlog. Is there any color that you could share with us or, over time, do you think that's something that you can incorporate into your disclosures – into your information pack? Thanks.

Jeffrey H. Foster - Chief Financial Officer & Executive Vice President

All right. Let me, Jonathan, talk about the rent roll down first. When we laid out the 9% expected rent roll down at Investor Day, there were two key underlying assumptions, and one was that demand would continue to accelerate, which it has, and that we would see rental rate increases of 2% to 3% a year. What we've seen so far this year is 3%, and we're only in the first quarter, so that's very positive compared to a 2% to 3% annual escalation prediction. And we've also had two leases renew, both of which were markups. So that was better than what we had in our model for those two leases.

Now those two leases represent less than one megawatt of our 273-megawatt portfolio. So I don't think that's caused the change to 9% at this time, so we're still sticking with our 9% estimate, but everything we see since Investor Day is positive for that.

And also under disclosures, I'm glad that you caught, I did disclose, not just base rent, but also more like a full service rent that includes the operating expenses. That's in preparation for our transition to full services and offering, and also I think it makes it more comparable to what our peers disclose. Even though a lot of them still disclose on square foot instead of megawatt. I would encourage megawatt disclosures also.

On the backlog, we traditionally haven't really made much of a disclosure on the backlog, but as we sign leases they commence. But we are doing a lot of pre-leasing, as you noted, so we will put something in the next release about the backlog. I think that's a very good suggestion.

Just to kind of summarize right now, we would expect the 89% of megawatts that is pre-leased at Phase III of Chicago 2 to commence in the third quarter, and we would expect the three megawatts of pre-leasing at ACC7 Phase III to commence in the second quarter when that opens. The big Santa Clara pre-lease would commence when Santa Clara opens. We're currently predicting third quarter of next year.

Jonathan Schildkraut - Evercore ISI

Great. And just...

Jeffrey H. Foster - Chief Financial Officer & Executive Vice President

Hope that helps.

Jonathan Schildkraut - Evercore ISI

It is helpful, but I think for us, from a modeling perspective, it's more important to see what the dollar commencements are than what the megawatt commencements are.

Jeffrey H. Foster - Chief Financial Officer & Executive Vice President

All right. I'll have to put some thought on that, because we definitely don't give away the pricing of individual leases, but let me think about that.

Jonathan Schildkraut - Evercore ISI

All right. Thanks, Jeff. Thanks, Chris.

Christopher P. Eldredge - President, Chief Executive Officer & Director

Thank you.

Operator

Thank you. Our next question comes from Rob Stevenson from Janney. Your line is open.

Robert Chapman Stevenson - Janney Montgomery Scott LLC

Good morning, guys. Can you talk a little bit about when you take a look at where you're going to be at the year-end, in terms of free cash flow or AFFO or however you want to think about it, retained cash? Going forward, what you think is a sustainable level of development that you can do without having to come back to the market to issue equity?

Jeffrey H. Foster - Chief Financial Officer & Executive Vice President

Yeah, Rob, this is Jeff. I'll handle that. We are currently fully funded on our five-year plan with no additional issuances of equity, between being able to borrow on our line and the $100 million of cash we generate after paying our dividends every year. So we are fully funded, and we will not go over our targeted of 5-to-1 net debt to EBITDA ratio.

Robert Chapman Stevenson - Janney Montgomery Scott LLC

What does that $100 million, though, go to at year-end, when things start to lease up, et cetera? And so, looking into 2016, what does that sort of give you as a basis, from a run rate standpoint?

Christopher P. Eldredge - President, Chief Executive Officer & Director

We've stayed right around $100 million, plus or minus $10 million to $15 million, for some time now, because the dividend also ends up going up. We target a AFFO payout ratio in the 60% and of course, we have to payout all our taxable income as a REIT. So it doesn't move that much over the five years, the $100 million.

Robert Chapman Stevenson - Janney Montgomery Scott LLC

Okay. And then could you just talk a little bit about, Chris, I guess that NJ1 could be sold here in the third quarter? Is pricing in line with expectations from the multiple rounds? Do the tenants want it unleased? What type of buyers are looking at this? People that are actually going to use it or people that want to operate it as a multi-tenant data center?

Christopher P. Eldredge - President, Chief Executive Officer & Director

Well, I can't talk about the pricing because we're in active negotiations right now, but here's what I tell you. The process is going great. There was a large number of interested parties. We have several strong bidders, and as we mentioned in the prepared remarks, don't be surprised by a third quarter close. When you take a look at the building, it is a tremendous asset. And the building is being sold as is. So we're not exactly sure what the purchaser plans to do with it, but we've seen a lot of diverse type of potential buyers. It's publicly traded data center providers, privately held data center providers, there was a document management company. We're very pleased with the progress and we're expecting a positive outcome.

Robert Chapman Stevenson - Janney Montgomery Scott LLC

Does the land for the next NJ facility go with it?

Christopher P. Eldredge - President, Chief Executive Officer & Director

Yes, correct, it does.

Robert Chapman Stevenson - Janney Montgomery Scott LLC

Okay.

Jeffrey H. Foster - Chief Financial Officer & Executive Vice President

Just to clarify. The Phase II is already a shell that's been built on the land. The remaining land that is there would not support a DFT-style data center.

Robert Chapman Stevenson - Janney Montgomery Scott LLC

Okay. Thank you, guys.

Operator

Thank you. And our next question comes from Matthew Heinz from Stifel. Your line is open.

Matthew Heinz - Stifel, Nicolaus & Co., Inc.

Hi. Good morning. Given the strong activity in the last two quarters and sort of pull forward of development, I was just wondering if you could give us an update on the five-year strategic plan and financial outlook relative to the one you gave at the Investor Day where I think you had implied about $4 per share of FFO based on roughly 10% annual growth for the five years?

Jeffrey H. Foster - Chief Financial Officer & Executive Vice President

Yes, Matt. This is Jeff. We're not going to give detailed update from that plan. But everything we set out to achieve in that plan, at this point in time, we've done better than what we put in that plan. So I feel very positive about the $4 and that was one reason we went ahead and issued the equity to accelerate developments and to try to get our plan accelerated also.

Matthew Heinz - Stifel, Nicolaus & Co., Inc.

Okay. That's helpful. And then just as a follow-up, I'm wondering what sort of visibility you have within the existing tenant base to expand along with you into Portland and Toronto or maybe any conversations you are having with new logos as you look for an anchor tenant in those new markets.

Jeffrey H. Foster - Chief Financial Officer & Executive Vice President

First thing I will say is that we don't have a pre-lease in those new markets, but there's been a tremendous amount of interest in those two markets from both our existing customers and potential new customers. I mean that's why we're very bullish on Toronto and Portland, and at this time we're putting Phoenix on hold, so we're not going out purchasing land in Phoenix, at this time. We're going to continue to monitor that market, but we do feel there is some level of risk to oversupply in that market. So we're moving full force ahead in Portland and Toronto. And our customers are driving the direction that we're going in.

Matthew Heinz - Stifel, Nicolaus & Co., Inc.

Okay. Thank you, guys.

Christopher P. Eldredge - President, Chief Executive Officer & Director

Thanks, Matt.

Operator

Thank you. And our next question comes from Manny Korchman from Citi. Your line is open.

Emmanuel Korchman - Citigroup Global Markets, Inc. (Broker)

Hey, guys. Just if we think about the demand for space that's already built out, so let's call it today's space versus spec space further out, is there a different demand for the two and is there a difference in pricing? So if you have the same customer that's urgently looking for space now, what kind of premium are they willing to pay versus the will sign a pre-lease with you for space whatever (40:31) six months or nine months or 10 months out?

Christopher P. Eldredge - President, Chief Executive Officer & Director

Manny, this is Chris. It's hard to predict the premium and pricing. It's hard to forecast the market, but as we talked about, we're seeing an increasing in pricing and we have a lot of large great customers that we have a tremendous relationship and they continue to buy from us. So we do see a slight increase in the pricing, but if you're looking for 10% or 15% increase, I don't think that's reasonable, but we're definitely seeing upward trends towards increased pricing.

Jeffrey H. Foster - Chief Financial Officer & Executive Vice President

And I think more importantly, Manny, given the strength for our pipeline, we're not offering discounts for pre-leasing.

Emmanuel Korchman - Citigroup Global Markets, Inc. (Broker)

All right. That was it for me. Thank you.

Jeffrey H. Foster - Chief Financial Officer & Executive Vice President

Okay.

Operator

Thank you. Our next question is a follow-up from Jonathan Schildkraut from Evercore. Your line is open.

Jonathan Schildkraut - Evercore ISI

Great. Thanks for hearing me out one more time. So Jeff, you actually hit on my next question a little bit which is that we've definitely seen spot rate prices stabilize. We get a little bit of improvement too. You guys have given us really good color on the renewal. And I guess the third sort of pricing that we track would be net effective rents, which is really the hardest one I think from the analyst/investor side to get a sense of. The difference between the spot rate pricing and net effective rents really being the free stuff that you have to give away, ramp periods or leasehold improvements. And so could you maybe elaborate a little bit on what you were just talking about, maybe tell us if there is a convergence, if you will, between the spot rate prices and the net effective rents in a way versus what we might've seen over 12 months or 24 months ago? Thanks.

Jeffrey H. Foster - Chief Financial Officer & Executive Vice President

All right. Thanks, Jonathan. The numbers we disclosed are GAAP, so it does take into account any tenant improvements that we pay for, any free rents that we give out or anything basically. It's all lumped together into the GAAP numbers. So we are on a total basis seeing rents increase.

On a cash basis, given the nature of our customers and how quickly they take down and use the space, the vast majority of our customers are not asking for the free rent. So that has become less and less of an ask. There is occasionally some help with their build out, but again our customers are bigger customers. They have plenty of money in the banks, so they don't focus on that as much. So, I think the cash and the GAAP have converged more in the last couple years than they were maybe in the first few years of our existence when we gave a lot of ramps to customers of free rent.

Jonathan Schildkraut - Evercore ISI

All right, awesome. Thanks for taking the extra question.

Jeffrey H. Foster - Chief Financial Officer & Executive Vice President

You're welcome. Thanks.

Operator

Thank you. And our next question is from Jordan Sadler from KeyBanc Capital Markets. Your line is open.

Jordan Sadler - KeyBanc Capital Markets, Inc.

Hey, guys. I'm just coming back to the five-year plan one more time, which was – I think you guys laid out $1.3 billion of development spend and about 175 megawatts placed into service over five years, and that's rough math $260 million of spend or 35 megawatts of development per year coming online. And I'm just trying to think about that in the context of 33 megawatts of leasing in a quarter, right. And so either, one, the plan feels like it's a bit frontend loaded; and/or are things coming together a bit better than you anticipated four months or five months ago?

Christopher P. Eldredge - President, Chief Executive Officer & Director

Hey, Jordan, it's Chris. The pipeline continues to get better and better each month. I know it sound like a broken record when we talk about it all the time, but we're seeing a lot of demand in the markets. And one of the challenges for us is bringing it on quick enough and that's one of the things that we're challenged with right now. We only have 113 employees, and we can only move so fast. But as you've seen by our pre-leasing, as soon as we bring it on, we lease it. And again that's why we're very bullish about the future. So, Jeff, any comments?

Jeffrey H. Foster - Chief Financial Officer & Executive Vice President

Yeah, hi, Jordan, I think right now we've had two I mean amazingly strong quarters. Those were preceded by quarters that were standard. And I think it's too early to totally change the trajectory of our development pipeline and how fast we develop and how much speculative development we will do just off of those two quarters. If it keeps up, we'll have to reconsider, but right now, I think we're doing the prudent thing and sticking to our plan.

Jordan Sadler - KeyBanc Capital Markets, Inc.

That's helpful. Any other plans to sort of beef-up the infrastructure, if you will, vis-à-vis Chris your answer there about 113 employees? Are you looking to add? I'm not sending in my resume just yet but...

Christopher P. Eldredge - President, Chief Executive Officer & Director

No, okay.

Jordan Sadler - KeyBanc Capital Markets, Inc.

Keeping in mind.

Christopher P. Eldredge - President, Chief Executive Officer & Director

(46:01) you saw in the plan that we outlined an increase in G&A. So we're sticking to the plan for now. And to Jeff's point, we're going to be prudent and we're going to do the right things. And we're going to mitigate any speculative build, so we're trying to be as smart as possible to capture that demand and we want to continue doing well, but 365.5 megawatts between the two quarters, it's challenged, I mean it's not easy to do that. And we're proud of our accomplishment. But we're sticking with our plan for now and we'll evaluate that in the coming months and quarters.

Jeffrey H. Foster - Chief Financial Officer & Executive Vice President

Yeah. This quarter Jordan we've added to our sales staff, our development staff and our legal staff and that's all the things we need to keep building and leasing at a fast pace.

Jordan Sadler - KeyBanc Capital Markets, Inc.

Okay. And then just a follow-up regarding the expiration at the end of the year, any insight in terms of what's going to happen there?

Christopher P. Eldredge - President, Chief Executive Officer & Director

Yeah. We've had conversations with that customer, and they are progressing, so that's about all I can say at this point, but as soon as we have something to announce, we will announce that.

Jordan Sadler - KeyBanc Capital Markets, Inc.

Okay. Thank you.

Operator

Thank you. And our next question comes from Colby Synesael from Cowen and Company. Your line is open.

Colby Synesael - Cowen and Company

Hi, thank you. Can you guys hear me?

Jeffrey H. Foster - Chief Financial Officer & Executive Vice President

Yeah.

Christopher P. Eldredge - President, Chief Executive Officer & Director

Yes, we can hear you, Colby.

Colby Synesael - Cowen and Company

Okay. Great. So two questions. One is, I think that there's a perception in the market that there is a handful of large, well-known companies that are driving the demand in the data center space right now, not just for you guys, but for a variety of your peers. And I guess, using that logic, is it fair to assume, or would you think that, as those guys put out their RFPs, they decide which of the providers, such as yourself, that they want to go with; once that demand has been absorbed for the next few months to quarters, that they're going to go away for a little bit?

And I guess this ties back to the question which has already been asked a few times which is, are you going to be able to sustain the levels of demand, maybe not the 30 plus megawatts, I'm not sure that that's realistic, but even something lower than that, considering that it's a handful of customers that are driving all this? Or do you really need to just continue to expand into new markets, perhaps where they don't have a big footprint just yet, to really be able to kind of continue that going forward?

And then I guess my next question is, I think that there had been a concern, maybe a few months – maybe quarters ago – that, based on your development pipeline, that we could see a slowdown in your FFO growth in 2017, just in terms of how things were going to come online. Do you think that with all the leasing that you've now done, and the facilities that you are planning on opening both this year and next year, that that's less likely, that we will see a slowdown in FFO, in terms of growth rate in 2017 versus 2016? Thanks.

Christopher P. Eldredge - President, Chief Executive Officer & Director

Hey, Colby, I'll take the first part of the question, and Jeff will take the second part of the question. I think you're accurate, with a handful of customers that are taking a lot of the space down right now. When you look at the cloud, social media, and media and content, some of the things that we talked about, we are at the very early stages in cloud. So I think you're going to see more outsourcing to the cloud, that hybrid model that a lot of us talk about, so I would say we're in the first inning, and two years or three years from now, we'll probably be in the third inning. So I think the pace of lease up is going to continue for the next five years. But we're also mitigating our risk by expanding into some of those new markets that we talked about, Toronto and Portland, and we're targeting different types of verticals that we think would fit well with us as customers.

We also unveiled, at development day, our new Data Center 4.0 design, which is going to enable us to support N, N+1, N+2 and 2N, to capture different types of customers. So we're planning for that, and we're working hard to try to diversify our customer base and add new customers if, in a certain case that does happen, but we don't believe that's going to happen in the future.

Jeffrey H. Foster - Chief Financial Officer & Executive Vice President

Yeah. Colby, just to add to that, before I do the FFO question, I'm going to read what Chris said in his script, that a recent JPMorgan survey of CIOs found that today, only 16.2% of enterprise workloads are on the public cloud. But the same group of CIOs expected to triple over the next five years, to 50%. So that's what we're seeing, that that demand will not slow down. On the FFO growth rate, 17% – go ahead.

Colby Synesael - Cowen and Company

Well, I was just going to say, in terms of the size of these leases that are being signed with these customers, I mean one would think that it's going to take them some reasonable amount of time to fully utilize that before they would be back in the market in these current markets for additional expansions, which again, just goes back to, where there could be potentially a lull at some point.

Jeffrey H. Foster - Chief Financial Officer & Executive Vice President

Colby, we're seeing in our data centers and build out that space quicker and consume power very, very quickly. So, I mean all the trends that we're seeing are very positive for us.

Christopher P. Eldredge - President, Chief Executive Officer & Director

Yeah. So let me address the FFO growth rate question. I think we did discuss this at Investor Day a little bit, Colby, that you're referencing. So 2016 is, we're predicting a very strong growth rate of 10%, and we indicated that we might have some supply concerns for 2017, on how much leasing we could do for that year.

But at this point, we've already preleased an entire 16 megawatts in Santa Clara that will give us, let's say, six months of rent in 2017. And we also have a lot of leasing in 2016 that, for 2017, will give us a full year. So we're not giving out guidance yet for 2017, but based on the preleasing we're doing, 2017 does look like it's going to be another good year for DFT.

Colby Synesael - Cowen and Company

Great. Thank you.

Christopher P. Eldredge - President, Chief Executive Officer & Director

Thanks, Colby.

Operator

Thank you. And our next question comes from Jonathan Atkin from RBC Capital Markets. Your line is open.

Jonathan Atkin - RBC Capital Markets LLC

Yeah. I was interested in your non-discretionary CapEx, the CapEx that's basically being deployed at six sites that have been in operation for many years. What are some of the bigger ticket items that you could sort of call out that's driving those CapEx elements, whether it's related to the Chilean (52:43) plants or electromechanical infrastructure, gensets or whatnot, it'd be interesting in getting a little bit of flavor for that? Thanks.

Jeffrey H. Foster - Chief Financial Officer & Executive Vice President

Thanks, Jonathan. So, yeah, this year, we're predicting $6 million of, what you call the non-discretionary CapEx, or the CapEx for our existing buildings. As you may recall in our triple-net leases we do recover this and we're anticipating again recovering a significant percentage of the $6 million. There will be some projects that were not recovering which are kind of driving the increase to $6 million. I highlighted that we did some enhancements at ACC2 at the request of the new customer and that's what drove the couple of million dollars we spent in Q1.

We also have some infrastructure improvements to buildings and infrastructure for the buildings that we won't pass through. But the bulk of the items that are beyond that are enhancements to the systems in the buildings themselves and it spread from IT systems to mechanical systems to electrical systems, there's no big one item in there. So I'd say the big item for the year was what we just did in Q1 to get ACC2 up to the new customer specifications.

Jonathan Atkin - RBC Capital Markets LLC

Got it. Thank you.

Operator

Thank you. And I'm showing no further questions. I would now like to turn the call back to Chris Eldredge for any further remarks.

Christopher P. Eldredge - President, Chief Executive Officer & Director

I just want to thank everybody for joining the call. And I look forward to seeing everybody next quarter at NAREIT New York. Thank you.

Operator

Ladies and gentlemen, thank you for participating in today's conference. That concludes today's program. You may all disconnect. Everyone have a great day.

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