QTS Realty Trust, Inc.
Q1 2018 Earnings Call Transcript

Published: 26 Apr 2018

[Operator:]

Good morning, and welcome to the QTS First Quarter 2018 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation there will be an opportunity to ask questions. Please note that this event is being recorded. I would now like to turn the conference over to Stephen Douglas, Head of Investor Relations. Please go ahead.

[Stephen Douglas:]

Thank you, operator. Hello, everyone, and welcome to QTS’ first quarter 2018 earnings conference call. I’m Stephen Douglas, Head of Investor Relations at QTS, and I’m joined here today by Chad Williams, our Chairman and Chief Executive Officer; and Jeff Berson, our Chief Financial Officer. We also are joined by additional members of our executive team, who will participate in Q&A. Our earnings release and supplemental financial information are posted in the Investor Relations section of our website at www.qtsdatacenters.com on the Investors tab. We also have provided slides and made them available with the webcast and on our website, which we hope will make it easier to follow our presentation today. Before we start, let me remind you that some information provided during this call may include forward-looking statements that are based on certain assumptions and are subject to a number of risks and uncertainties, as described in our SEC filings, and future results may vary materially. Forward-looking statements in the press release that we issued this morning along with our remarks today are made as of today, and we undertake no duty to update them as actual events unfold. Today’s remarks also include certain non-GAAP measures, including core revenue, FFO, core operating FFO, adjusted operating FFO, MRR, ROIC, adjusted EBITDA and core adjusted EBITDA. In conjunction with our previously announced strategic growth plan, QTS is realigning its product offerings around Hyperscale and Hybrid Colocation, while exiting certain of its non-core C3-Cloud and Managed Services offerings, as well as colocation revenue attached to certain customers in the Cloud and Managed Services business that we expect will not remain with QTS post transition. QTS has realigned various information included in our earnings materials to focus our guidance and key performance metrics around our core business, which primarily consists of our Hyperscale and Hybrid Colocation businesses, along with technology and services from our Cloud and Managed Services business that support Hyperscale and Hybrid Colocation customers, which together will be the Company’s primary business following the completion of the strategic growth plan. For informational purposes, QTS has excluded its estimated Non-Core business from certain financial and operating statistics with. We refer you to our press release that we issued this morning and our periodic reports furnished or filed with the SEC for further information regarding our use of these non-GAAP financial measures and a reconciliation of them to our GAAP results. These documents are available on the Investor Relations page of our website. And now, I will turn the call over to Chad.

[Chad Williams:]

Thanks, Steve. Hello and welcome everyone. As you’ve seen, we have brought forward our first quarter 2018 earnings releasing conference call to coincide with the announcement of our strategic partnership arrangement with GDT, which I’ll discuss in more detail in my prepared remarks. QTS has delivered a very strong performance in the first quarter supported by our continued positive momentum in both our hyperscale and hybrid colocation business. Core net leasing of $21 million represented the second highest total in QTS history and importantly was accomplished predominantly within our existing markets. Our core financial results during the quarter were consistent with our strong expectations for the business and reflect continued positive momentum and underlying demand in the datacenter sector. Turning to Slide 3, I am pleased with our team’s performance executing on the strategic growth plan that we laid out last quarter. These initiatives are enabling us to unlock significant value in QTS by positioning our business for an accelerated growth and profitability. Importantly, we are already seeing the positive flow through performance. During the first quarter, we reported a core adjusted EBITDA margin of 50%, which represents a 300 basis point increase year-over-year. Core revenue grew 16% year-over-year and excluding a $5 million one-time payment from a customer in Q4 core revenue growth of 5% sequentially. Core adjusted EBITDA in Q1 reflected a 23% growth year-over-year. As you can see in our earnings material, we have provided additional disclosures this quarter breaking out core and non-core to enable an enhanced visibility into the fundamental performance in our go forward core business. As a reminder our core business consists of hyperscale and hybrid colocation businesses, which includes technology and cloud and managed services that support these businesses. Next on Slide 4 as we discussed last quarter, there are three main elements of our strategic growth plan. First, we have aligned – realigned our organization around the two primary drivers of demand in our business

[Jeff Berson:]

Thanks Chad and good morning. Turning to our financial results on Slide 10. For the first quarter 2018, we delivered healthy year-over-year core growth across key financial metrics consistent with our expectations. We reported core revenue of $100.4 million, up 16% over core revenue in the first quarter a year ago. Core adjusted EBITDA of $50.2 million, up 23% year-over-year and core operating FFO per share of $0.64 representing a 15% increase year-over-year. We’ve expanded our disclosures this quarter to reflect our strategic growth plan initiatives. As we discussed in February, our guidance and disclosure of key performance metrics will be focused around our core business unit over the course of 2018 to isolate trends in the go-forward business and provide better visibility into how we’re managing the organization. Our core business comprises our Hyperscale and Hybrid Colocation businesses, which includes technology and cloud and managed services that support these products. The core business excludes certain cloud and managed services product that will be transitioned to GDT, for example managed hosting as well as the portion of estimated colo revenue loss attached to specific C3 deals, which in aggregate, we have categorized as non-core. We’ve also separated our performance in the non-core business to provide full visibility. As Chad discussed, we expect to complete the transition of customers currently taking non-core products and services over to our partner GDT by the end of 2018. As such go-forward models beyond 2018 should be based exclusively on our core business. During 2018, you will continue to see non-core revenue and expense within our GAAP results. These will decline over the course of the year on a timeline subject to the pace of migrating customers over to GDT’s platform. Non-core revenues likely to decline at a rate faster than non-core expenses due to the natural lag between revenue migration and loss and cost removal. By the end of 2018 through the transition of this business both non-core revenue and expense would be fully out of our financial results. Now moving to Slide 11, I’ll review our current balance sheet and liquidity position. As of March 31, 2018, we had a total of nearly $700 million liquidity in the business, made up of availability under our credit facility and cash on hand. We ended the quarter with leverage of approximately 5.7 times net debt to annualized consolidated adjusted EBITDA. Due to subsequent backlog assigned but not yet commenced business, we provide enhanced ability to future cash flow growth. We’re comfortable with our current leverage level. To provide additional funding for growth capital development plan this year we launch a perpetual preferred stock offering with 7/8 [ph] dividend in March, which resulted in net proceeds of approximately $103 million. The perpetual preferred market provides us an additional efficient means of raising capital and demonstrates our ability to fund the business through options other than common equity. Over the course of the year we will continue to evaluate a range of financing options within our business, including structured financings, JV partnerships and potential asset divestitures. We are pleased with the available liquidity in our business and overall health of our balance sheet. That said, we’ll continue to monitor market opportunity to drive incremental efficiencies in our capital structure and capital allocation. Effective capital allocation has been and always will be a key focus for QTS. Since our IPO we’ve deployed nearly $1 billion of cumulative development CapEx across numerous projects that are generating an above market return on capital. We’ve consistently employed from a subsequent approach to capital allocation with success ranging from low basis infrastructure rich development projects like Irving, Texas in Chicago. To opportunistic enterprise sale leaseback opportunities like in Fort Worth, Texas, where we acquired existing data center infrastructure at a fraction of what was already invested in facilities. We’ve taken our competitors data center faculty and successfully wrapped our integrated services platform around them to drive significant incremental value like in Suwanee, Georgia and Piscataway, New Jersey. And more recently we’ve demonstrated an ability to de-risk expansion into new markets through Greenfield developments with large acre tenants. We are confident that our approach and successful track record of capital deployment and differentiated business model will continue to drive solid value creation within our assets. Turning to Slide 12, we believe the initiative associated with our strategic growth plan materially strengthen our overall credit profile in terms of weighted average remaining lease term, backlog visibility ensure and churn profile. The average remaining contract length for our core customer base is approximately 32 months as of the first quarter 2018, up from approximately 26 months reported last quarter, which reflected both core and non-core. Focusing on our top 10 core customers, which represent approximately 41% of total recurring revenue, the average remaining contract length currently sits at approximately 48 months including lease extension signed during the first quarter. This compares to approximately 38 months for our top 10 customers reported last couple of quarter, which included both core and non-core. Visibility to future growth is also enhanced. As a percent of annualized core recurring revenue our backlog assigned but not yet commenced core revenue currently sits at approximately 16%, which represents a material increase relative to 12% as of last quarter on a consolidated basis. Our strategic growth plan also increases the predictability in our business. Annual churn guidance from our core business in 2018 is currently 3% to 6%. And based on our Q1 core churn of 1% we are on pace to meet that guidance. Our core guidance for 2018 represents a 200 basis point reduction relative to our historical range for the consolidated business of 5% to 8%. Finally, moving to Slide 13, we are reaffirming our guidance for 2018. As a reminder, our financial guidance is based exclusively on the results of our core business. We continue to expect 2018 core revenue to be between $408 million and $422 million. We expect 2018 core adjusted EBITDA will be between $218 million and $228 million, which reflects a significant improvement in our adjusted EBITDA margin resulting from our cost reduction initiatives. Our 2018 core operating FFO per share guidance is also unchanged at a range of $2.55 to $2.65 per share. Our guidance assumes annual rental churn for the core business of between 3% and 6%. We continue to expect to spend between $425 million and $475 million in cash capital expenditures in 2018 to support our future growth by delivering new capacity in Dallas, Atlanta, Chicago and Piscataway, as well as opening our newest mega data center in Ashburn, Virginia this summer. In addition, we will deploy development capital this year related to the 24 megawatt hyperscale lease that we signed in Manassas, Virginia, which is scheduled to commence in early 2019. As Chad discussed, a capital efficient structure this hyperscale lease combined with the fact that our record bookings occurred on our existing footprint, allowed us to reiterate our previously disclosed CapEx guidance range. We remain focused on executing our strategic growth plan initiatives across multiple levels and are on track to meet our financial objectives in 2018 and beyond. And now I’ll turn the call back over to Chad.

[Chad Williams:]

Thanks, Jeff. Before moving on, I’d like to briefly address our upcoming annual shareholders meeting on May 3. We’ve been speaking and will continue to reach out directly to many of our QTS shareholders to discuss our strategic growth plan and execution. We appreciate and value the input and feedback that we have received. I’d like to call your attention to a presentation that we have posted on our website and filed with the SEC that provides additional detail and support regarding certain misrepresentations about QTS. Our board comprises experienced and engaged individuals who are committed to enhancing shareholder value and who are actively overseeing the execution of our strategic initiatives. We are confident that QTS has the right team and strategic plan in place to continue the company’s track record of profitable growth and value creation. Finally on Slide 15, I want to take the opportunity to reiterate how pleased I am with our team’s execution on our strategic growth plan. Our strong performance during the first quarter is evidence of the momentum we’re seeing in our business. That momentum resulted in the second highest leasing performance in QTS history at $21 million of core annualized rent signed. Strong leasing in the quarter contributed to our $54 million book but not build backlog of core annualized rent, which provides increased visibility into future growth. With the addition of Clint Heiden a proven sales leader in the data center industry as our new Chief Revenue Officer, we’re excited to further extend our leasing performance. Our momentum in leasing drove 16% core revenue growth year-over-year in the first quarter, while we demonstrated a 300 basis point improvement in our core adjusted EBITDA margin as compared to the first quarter a year ago. To support our continued growth, we also demonstrated the ability to open up additional shareholder friendly funding sources through our perpetual preferred offering during the quarter. And most recently yesterday afternoon, we announced our partnership agreement with GDT enabling QTS to successfully implement our strategic growth plan initiatives. In the short time, since announcing our strategic growth plan, we have already made significant progress and we are confident that we can maintain the current pace of execution going forward. We have much work ahead of us, but we’re off to a strong start in 2018 through the hard work and dedication of our QTS across the country. With that, we’ll be glad to take your questions. Operator?

[Operator:]

Thank you. We will now begin the question-and-answer session. [Operator Instructions] And our first question comes from Jordan Sadler of KeyBanc Capital Markets. Please go ahead.

[Jordan Sadler:]

Thanks. Good morning. I wanted to address the pipeline I think Chad in your commentary, you spoke to the hybrid colo and the enterprise pipeline increasing pretty significantly. I think you said dozens of 500 megawatt – sorry 500 kilowatt to 2 megawatt deals in the pipe. I’m curious how that compares to what the pipeline look like maybe last quarter even a year ago for those deals. I know you said you only closed a couple of deals, but I’m curious to what the pipeline as how that’s changed?

[Chad Williams:]

Hey, Jordan, thanks. This is Chad. I think the realignment on the sales organization that that, that Dan started a few months ago and Clint has picked up and run with has really changed the dynamic of the deals that were seen, because historically we had a team that had a kind of artificial cap of 500kW. So last year, we’re evaluating the sales performance and how do we dramatically change that. We just needed get more of that. And the more of that was we just unleashed the sales organization and when we refocused the hyperscale team led by Tag Greason to focus on just the top 30 accounts. It opened up the largest group of sellers that I have in our commercial account teams to focus on larger deals. And also the simplification of the services business is allowing us just a laser focus on what we call our hybrid colocation. So we’ve just seen a pretty dramatic increase in the ability to have a lot more of that. And we put a 500kW deal with the federal team in the books in the first quarter. And we have literally multiple deals in the pipeline that are addressing our ability just to get more opportunities in that business. So we’re excited about it. We think the realignment that builds organization is being very effective in that.

[Jordan Sadler:]

And then what about hyperscale I know part of this strategic plan is aimed at the hyperscale and you signed nice lease in the first quarter. What is that pipeline look like today and how should we think about the flow of those types of deals throughout this year?

[Chad Williams:]

Yes. I think hyperscale is always a lumpy business as we all know. We were excited to get a significant win in the first quarter in a very friendly structured type arrangement with one of our current customers as far as capital efficient. We don’t feel like we have to go when numbers of those deals each year, but we’re going to – we’re certainly going to win our fair share this year and we are encouraged. I mean we’ve talked about the pipeline in the past being kind of 4x. That team reports to me directly now and Mr. Greason, our Chief Hyperscale Officer is leading that. And we couldn’t be more confident about our ability and our value prop in the speed, the location, the experience, the operational partnership that we demonstrate to customers that allow us to put wins in the column. So I couldn’t be more excited about the opportunity, but I think we will be a measured player in that space and we will win where we have existing space in economics advantage and we’re excited about its continues to build momentum.

[Jordan Sadler:]

Okay. And then just one for Jeff. On the balance sheet, I think you said, you comfortable with the leverage level and you’ve got plenty of liquidity here. But as we sort of make our way throughout the year is there an upper range of leverage in terms of the expectation of what you to hit…

[Jeff Berson:]

Yes. Sure, Jordan. As we mentioned in last quarter, although our long-term focus on leverages maintain sort of in and around the 5.5 turns, given the visibility we have the book not bill backlog, which as a percentage of our revenue has never been higher and the fact that we do see natural deleveraging in the business plan over the course of the year. We are comfortable with that leverage getting closer to around that 6 turns over a call at the next quarter so and then coming back down. We’re also comfortable since you bring it up to there has been a lot of focus on the capital needs for the business. We were excited to demonstrate that we do have to fund the business to perpetual, preferred and other options outside of just relying on the equity markets. But having some comparable with slightly higher leverage given the visibility in our business at this point is something that, that we’ve mentioned and something we’re comfortable with.

[Jordan Sadler:]

Okay, thank you.

[Operator:]

Our next question comes from Robert Gutman of Guggenheim Securities. Please go ahead.

[Robert Gutman:]

Hi, thanks for taking the question. So I was wondering if you could provide – I don’t see base rent recoveries from tenants just the compositions of revenue that you typically provide. And in addition, it would be helpful to have gross leasing broken out by hybrid and hyperscale for the quarter not just the overall. And lastly, the EBITDA margin was up 300 basis points year-over-year, but it declined 30 basis points quarter-over-quarter. I was wondering if that was due to seasonality of the timing of the migration of revenue.

[Chad Williams:]

Hey, Robert. This is Chad. I’ll take the basis of the revenue or the bookings, which I was excited. Again we had a great hyperscale win in the quarter, but the mixture of that is still kind of the engine of our business is our hybrid colocation. So that mixture of business was a 50-50 mix in our bookings, which is what was so encouraging about the momentum we’re seeing on both sides of our business. So with that I’ll have Jeff talked a little bit about the other questions.

[Jeff Berson:]

Yes. Hi, Rob. I’d say if you’re thinking about the P&L towards the core level in terms of rental recoveries and cloud and managed. What you’ve see in the core businesses that cloud and managed services business, obviously is coming down as we transition revenue over to our partner. And so a lot of that’s been pulled out of core. From a recovery standpoint, most of recovery that we’ve been getting has been more on the traditional space in power business. So you’re not going to see a big shift in terms of recoveries or power recoveries from this transition to core. And then your last question in terms of margin, that’s exactly right. What we’ve seen historically is seasonality, where you do see margin drop from Q4 to Q1, a big impact to that is just the payroll tax, which typically tapers outwards Q4. So you tend to get much higher margin in Q4, and then it’s steps down in Q1. But you can see some of the impact of the cost savings we put in place in the business, if you look at Q1 last year to Q1 this year of 300 plus basis point margin improvement and over the course of this year continuing to see margin improvement as we go quarter-over-quarter, as revenue continues to ramp. So we do feel like we’re well underway we’ve identified all of the costs that we are be pulling out of the business. It’s just a question of transitioning the customers now going through that which will be completed by the end of the year and continuing to drive significant margin growth.

[Robert Gutman:]

Okay, thanks. Just to clarify so 50% of the gross number would be core hybrid.

[Jeff Berson:]

Yes.

[Robert Gutman:]

In terms of leasing.

[Jeff Berson:]

Yes.

[Robert Gutman:]

Okay. And the tax benefit keeps coming back up, what would you estimate the tax benefit for the year.

[Jeff Berson:]

Yes. I think we’re happy that the tax benefit is coming down quite a bit, because that has created some noise in the past. It was about $700,000 in Q1. It’s going to be even lower than that going forward. So we’re not anticipating over the course of this year in the core side of the business a material impact from that tax benefit.

[Robert Gutman:]

Thank you.

[Chad Williams:]

Thank you.

[Operator:]

Our next question comes from Richard Cho of JPMorgan. Please go ahead.

[Richard Cho:]

Thank you. Just wanted to get a sense of what your customer feedback has been in terms of this transition. What are you hearing from your customers? And then also you mentioned, following up on the earlier question about the 500 kilowatt to 2 megawatt deals. How long do you think, it will take for them to close and one could actually see revenue starting from them.

[Chad Williams:]

Yes, thanks Richard. I’ll take the first part of that. This is Chad. I think the sales cycle is longer on the larger deals, just because of the complexity around that in the hybrid colocation, so 500 KW to 2 megawatt deal. I would characterize that as a quarter-by-quarter of three to four month process that typically plays out. So we expect to see that materializes the year goes on. Certainly a much shorter cycle than a hyperscale cycle, which you could see six to nine months of a cycle on a typical hyperscale deal. Jon Greaves is here and is leading our hybrid colocation business in transition, I might have him add some comments around the customer feedback to date.

[Jon Greaves:]

Thanks, Chad. And Richard, the feedback has been very positive today. We’ve had a lot of interactions you can imagine with the customers since we announced the change. Certainly understanding what’s going on. The customers we’ve spoke to following the latest announcement with GDT have been very excited with GDT. Particularly the scope of capabilities they have, which really ranges from security services, all the way through to some of the high end managed services. So I assume that we have really a great fit there and I’m looking forward to engaging with GDT kind of more formally.

[Richard Cho:]

Great, thank you.

[Operator:]

Our next question comes from Eric Luebchow of Wells Fargo. Please go ahead.

[Eric Luebchow:]

All right. Thanks for taking the question. Could you maybe talk a little more about the 24 megawatt customer lease in Manassas? What your return expectations are for deals of that size? And whether there’s been any recent pressure on hyperscale returns given all the capital change in the space? And then additionally, in Manassas are you also planning to support a hybrid colo solution as well. So you can get some more yield out of that property or what primarily be used for the larger hyperscale builds.

[Chad Williams:]

Hey, Eric, this is Chad. Great question. We’ve talked about the yields on hyperscale be in 9% to 11% yield. We talked about this transaction beyond on the lower side of that, and that’s consistent with how we’ve been discussing it. We really haven’t seen a ton of change in that and don’t expect to see that at least in the near-term. It’s still comes down to even with a lot of capital chasing hyperscale. It’s still comes down to a pretty short list, when you put in location, speed, economics and the things that the hyperscalers are focused on, which they do care about operational, historical point of view have you operated infrastructure scale, what other value can you bring to them. And I think the handful of people that are relevant in hyperscale, have a good historical point and a good relationship, because you can’t you show up with capital and expect to get into that business. You have to have the right locations and a team that’s capable of executing it. I think that shows time and time again with the people, the handful of people that have been successful in this. They have good relationships and those hyperscale is reliant on them, because speed and execution is a huge part of it to not just price. So I think we’ve seen that play out and we’ll continue to be encouraged and I think that’s the way the yields will play out with our stuff. Where you could see us be a little more competitive is to Jeff’s point earlier, we do have some infrastructure rich assets that can give us tremendous cost advantage, whether you want to look at Richmond or Irving or Chicago or Atlanta. So, where we might have a better cost advantage on building that you could see those yields be on the higher end of that. So we’ll look forward to that. The Manassas property is a 66 acre property, so we are just building the building that we have under contract right now. It is not going to be a shared building. We are building and designing it where it could handle hybrid co-location at any point in the future because we always build our infrastructure to support our full business. But the property does have 300 megawatts substation that’s being built on the adjacent property actually we have some property on that on our property that we’re going to be giving to the power company. So we have tremendous access to power and fiber there in Manassas, a 65 acre site. So the thought that we could have a hybrid co-location building to drive that campus higher returns is very, very possible in the future but not right now.

[Eric Luebchow:]

Great. Thanks. And just a quick follow-up in your supplemental it looks like your core returns on invested capital were more like in the 12% range. I’m just curious if your expectation for the kind of 16% stabilized returns has changed at all based on some of the restructuring efforts that you’re going through?

[Jeff Berson:]

Sure. This is Jeff. So the nice thing about check point at even on hyper scale builds that were designed for multi-tenant purpose that we can back fill with hybrid-colo and drive hybrid-colo over time. Those are still deals that are getting mid-teens returns, it still gives us the opportunity for upside on that. And then the other factor that you see in the returns profile in the business certainly from the quarter is that we have a number of facilities that are still early in their development and as a lower utilization. And so as you continue to drive higher utilization in those facilities and build out that hybrid-colo you can get to significantly higher returns. That being said, the overall returns will certainly be dependent on the product mix and I don’t want to imply that this hyper scale deals are mid-teens but it becomes a great way to build higher utilization early in a facility and then drive hybrid-colo as we go.

[Eric Luebchow:]

Okay. Great. Thanks.

[Jeff Berson:]

Thank you.

[Operator:]

Our next question comes from Frank Louthan of Raymond James. Please go ahead.

[Alex Brown:]

Yes. Hi, this is Alex Brown on for Frank. I wanted to dig into the new lease expirations schedule in the supplement. Can you just walk us through the activity in the quarter? It seems like you were successful extending some customer leases and the pricing was up. But is that a part of a broader company program to extend customer leases or just some lumpiness in the quarter? Thanks.

[Jeff Berson:]

Yes. I would say it’s just part of normal course of business. We had two large hyper scalars whose leases were coming up and their strategic customers were a vendor for them and that was a natural partnership an expansion that we executed. It was nice to see our pricing go up and continue to kind of just be a reliable great partner. The size of those two deals totaling 19 megawatts was a big expansion, we were excited to get that done early and to continue to deliver service and product to those customers that we had a long term relationship with.

[Chad Williams:]

Alex, I just jump in. It’s another way to demonstrate that or to see how we’re unlocking inherent value in the business through some of the migration process that we’re going through with GDT on the C3 side. What we’re left with in terms of business that weighted towards support and services that enhance the colo whether it’s hyper scale or hybrid you end up with a customer mix where we’ve gone 60% of our revenue from leases expiring over the next couple of years that’s drop down to 43%. So you’ve seen an enormous drop in terms of the customers with leases coming up in the next couple years. We’ve got much longer visibility in terms of those top 10 customers going from a weighted average length of 38 months to 48 months. So you’ve seen a great extension of that which just builds and supports the credit profile and the visibility of the business.

[Alex Brown:]

And then one other question here. This is a new phenomenon for QTS, can you just remind us why such a large percentage of the backlog is going to install for over 18 months? And then with a little bit more color on the pacing of the commencement this year. Where can we be – maybe 12 months from now? Thanks.

[Chad Williams:]

Sure, Alex. So I think given the size of our backlog that a number of a lot of that is come from some of the larger deals that we’ve signed recently obviously the 24 megawatt at Manassas is a big driver of that. That’s a facility that won’t be up and starting to ramp until the beginning of 2019. And then a number of other large customers that just have ramps over a period of time. That’s not unusual just again if you look at book-to-bill backlog as a percentage of our overall revenue it provides tremendous visibility for us. But to your point it’s not all in the next year it ramps over the next couple. I think the relative split in terms of how that book-to-bill backlog rolls off over the next couple years is not materially different than what you’ve seen in the past. Because it so we then waited just given that the length between booking and billing for wholesale or hyper scale deals that’s been pretty consistent.

[Alex Brown:]

Okay. Thank you.

[Operator:]

Our next question comes from Simon Flannery of Morgan Stanley. Please go ahead.

[Simon Flannery:]

Great. Good morning. Coming back to the GDT deal, can you just provide us a little bit more color on how that’s going to progress over the year? And in particular what percent of the non-core business just that sort of 200 customers account for? And what are your plans for the other non-core customers? Are you pursuing similar deals with other companies? How should we think about that over the balance of the year? And then on the EBITDA guidance, I think you’d said before that it would be second half loaded. Your guide implies a significant ramp in EBITDA through the rest of the year. Perhaps you just give us a little bit more color on the exact pacing of that Q2 second half and what is driving that? Thanks.

[Chad Williams:]

Yes. Thanks Simon. I think, the first thing were extremely excited to have GDT, they’ve been a partner of ours for a couple of years. We’ve been getting to know each other. They sit on our partner advisory committee. So it was exciting to see that through the process they rose to the top and kind of one that. I think they’re substantial business and capability and their integrated services business and their advancements going to be very good for our customers, which was a very, very important element of this decision. How do we take care of some of the best QTS’s customers that we have? And I think GDT is going to do on a phenomenal job of picking up that and carrying it forward. And I think their broad set of services will be very helpful in our ability to migrate successfully and grow relationships. I might have Jon, talk a little bit about – a little bit more about the details on some of your other questions. And then maybe have Jeff take on the margin and profile.

[Jon Greaves:]

Yes, absolutely, Thanks, Chad. And Simon, the book of business we’re talking about here is these are full impacted customer list. So there’s no additional customers, we’re expecting to be migrating GDT beyond the imagined scope. And this is the narrowing of the C3 business. So this is the complete list.

[Chad Williams:]

And Simon just on the second side, this is the complete list of customers and this is all going to GDT. So we are thrilled with SDP platform and the ability to bring other partners on to that to support customers in various ways. But for this transition services that we talked about last quarter, a 100% of that can be covered and intends to be covered by GDT. So we do not need to find another partner to execute on that transition.

[Simon Flannery:]

So non-core revenue will kind of decline to zero exceeding 2018. Is that the way to think about it?

[Chad Williams:]

That’s correct. We remain on track, if not ahead of schedule in terms of our expectation of that full transition by the end of the year. I think your question was a little bit about my comment on natural deleveraging as a business ramps over the course of this year. And that based on sort of two factors. The first is the CapEx guidance that we give a new front end loaded. A good portion of that CapEx is bringing on our Ashburn, Virginia facility, which is coming online by the first half of the year. So we’re excited within the next couple of months of bringing that online. And so that’s we’re seeing some of that capital like which is why it’s more front end loaded. And then EBITDA ramp is just over the course of the year as the business continues to grow and when other things that we love about the ability to shine a bright light on the course side of the business is provides for investors and analysts and others to see the strong underlying growth that we have been experiencing at core business and really unlocking that and being able to drive that business and continue that growth going forward.

[Simon Flannery:]

And maybe just right to have some of these rents, renewals or did they come towards the end of the quarter or so that they’ll really benefit Q2 versus Q1 over a study through the quarter?

[Jeff Berson:]

They were throughout the quarter. Okay. Thank you.

[Operator:]

Our next question comes from Nick Del Deo of MoffettNathanson. Please go ahead.

[Nick Del Deo:]

Hi, thanks for taking my question. First, I just wanted kind of following up on Simon’s question. Can you give us some insights into where you stand from a cost cutting perspective specifically is not directly tied to the C3 business like what share of the run rate costs are recognized or cost cuts were recognized in the quarter and what your total plan reductions were executed.

[Jeff Berson:]

Sure, hey, Nick. So on the cost plan, the first thing that I want to point out again is that all of the costs that we intend to take out of the business have already been identified. So there’s no sort of soft targets that we still have to go to achieve. A good portion of those costs, if you think about the breakdown number of those costs or people in severance, we’ve made some real tough decisions within QTS, decisions that we didn’t love making, but it’s important in terms of managing the business and sizing the business correctly for the simplified infrastructure and services that we’re providing. Additional cost savings are coming from software licenses, R&M repair and maintenance on hardware support some of that infrastructure and then just general ongoing maintenance costs. If you think about how those costs come out of the business. They will come out consistently over the course of the year. But you do see some cost come out early on that were easy to sort of pull out while we’re still transitioning the customers. What you should expect to see over the course of the year is the remainder of those cost are really going to be in the business until we fully transition out from those customers. You will see over the next couple of quarters from the non-core side of the business revenue starting to come down as we transition customers over time. But a lot of the costs that we have to continue to support those customers will stay in the business until closer towards the end of the year, fully out before the end of the year and fully transitioned at that point.

[Nick Del Deo:]

Okay. That’s great color. Thanks Jeff. And then a few clarifications on GDT if you can, how big a customer’s GDT today and how large will they become post-transition or the underlying lease is going to be transferred as is or do they get reset somehow? And give any sort of preferred status with GDT that’s interested to do more business your way, going forward?

[Chad Williams:]

Yes, I would think of a GDT as a partner for QTS today and as they grow that partnership the opportunity for their business to direct business to our business is just growing. Keep in mind, one of the key elements of this partnership was we wanted to find somebody that wasn’t competitive either in hyperscale or hybrid co-location. So providing the physical space and power that is not part of their business, they need partners like us and that’s how they thought about it. They need places to put their customers to grow their business and I think that’s what makes it such a natural fit. Jon, do you have anything to add to that.

[Jon Greaves:]

Yes, Chad. I think you summed it up very well. It’s a very natural fit, no overlapping in services and again, I think that would be ability to deliver all of the services that we’re talking about transition. So we’re expecting a very smooth hand over of customer.

[Chad Williams:]

And they have committed to keep these customers in QTS data centers, which was another key element of the partnership pickup in the expansion of our partnership. And I think just because we’ve been a partner with them couple years, it was a great way for us to have experience already and to have those commitments be something that we were all excited to do and move forward with.

[Nick Del Deo:]

Okay. And can you comment at all on how large GDT is and will become?

[Chad Williams:]

There are private entity but over 700 employees and approaching $1 billion in revenue…

[Jeff Berson:]

Rather than the contribution to your business, rather than GDT side itself. I’m sorry.

[Chad Williams:]

Sure. So we talked about in the script that as we transition revenues to the customers, if there is a channel payment that we have contracted with GDT that channel payment depending on the details of the customer range from 15% to 20%. So we think, that provide some nice profit for us and frankly one of the way, you can look at it is that channel, which is extremely high margin. It also provides a higher return for QTS and just the overall margin we had when we were operating the business ourselves to provide some nice upside from that. In terms of how the absolute dollars will get impacted from that channel payment, you’re not going to see a lot in 2018 because we really going to be transition in these customers over the course of the year you’ll see the big impact 2019, hard to site exactly what that impact is, because it’s going to be dependent on what revenue transitions over to that customer, but we do think it provides a nice upside in the business.

[Nick Del Deo:]

Okay. Thanks everyone.

[Operator:]

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

[Michael Funk:]

Hey, good morning guys, thank you for taking the questions. First want to see the commentary about the sales force realignment in the pipeline you have now with the 500 kW to 2 megawatt type customer. Maybe just help me think about drawing a line between that commentary and the annualized rent assigned. I mean I think we estimates probably for say $10 million to $12 million per quarter based on the past couple years a results. And a kind of back of the envelope being that pipeline into transitioning to sign deals implies that could be 10%, 15%, 20% higher going forward. Help me think about that one first.

[Chad Williams:]

Sure. Hey Michael. As you think about the net leasing statistic. We’re thrilled that $21 million that is a high number we don’t think people should anticipate nor do we need to continue to do that on a quarter-to-quarter basis part of that was driven by hyperscale that will be lumpy, but that hyperscale creating nice acceleration on top of very strong and continue diversified core growth. You’re exactly right over the last couple of quarters, we’ve averaged sort of $10 million to $12 million per quarter based on the momentum in the business and the accelerated growth that we talked about unleashing last quarter. We do expect that average leasing number will grow from there, it will be higher than $12 million, but don’t have to be anywhere close to that $20 million level they continue to support mid-teens growth.

[Michael Funk:]

Sure and of course. And one more quick one to, on the renewal rates I mean you mentioned higher stand and then the previous maybe the commentary about the rates versus the market rates in general where you resign those I believe Atlanta obviously was a larger ones.

[Chad Williams:]

Yes, yes. That’s exactly right. So we always try to make very clear that when we’re reviewing customers and they don’t change their square footage what’s happening to our core pricing. And you see consistently really over the last four years that our average renewal rate has been increased anywhere from sort of 1% to 4%. So as we’re renewing customers on an apples-to-apples basis we’re largely able to increase pricing modestly which demonstrates I think the support that we’re giving customers the enthusiasm they have for what we can do. And the diversification they keep us out of sort of commoditize lowering price on your renewed conversation and enables us to drive higher pricing because we’re at a higher value. You saw that number higher in the quarter north of 5% which is unusually high and you’re exactly right. We’ve seen our core business still in the 1% to 4% renewal rate across the diversified base, but that shot up a little bit in the quarter because of the two larger hyperscale deals that we did renew in Atlanta and that we knew that increasing prices and just because the size of those two deals the fact to bring that number up. We love the fact that we renewed those customers, we have always been confident and the strength of our business in the Atlanta market. We think we’ve got most critical assets in that market with some of the cheapest power in the market it puts us in a great position to continue to grow our business to attract the right customers. And the fact that we did renew those two large customers at increased pricing for multiple years. I think just demonstrates that it puts a final stamp on our strength in the Atlanta market.

[Michael Funk:]

And there is a bit more focus here, if you could Jeff was some fear that maybe there was some risk to those renewals in Atlanta given some the new capacity coming on some more competition. In any commentary about the process around this renewal how competitive that was and what differentiated QTS?

[Jeff Berson:]

Yes, Michael. I think separating kind of the outside noise from the internal reality. There was no competition – that the environment in Atlanta is such that you know we do have some new competitors coming to town, but those facilities are going to be open till some time in 2019. So I don’t know where that momentum came on customers leaving especially significant cloud service providers. We just try to work through it and confirm and tell people what we knew to be the truth which is we have terrific customers that value a long standing partnership and to disrupt that is not something that you just show up and take a customer. And the other point I’d like to make is that our Hybrid Colocation business has hundreds of customers in Atlanta. The other disconnect for me is, it’s not about trying to take one customer here or there. It’s to hear Atlanta for us is to take dozens of customers out of our facilities and try to move them 30, 35 miles outside of town. And you’re taking away the ability for us to Jeff’s point we have some of the cheapest power in the entire country, at sub forced into kilowatt we have scale and infrastructure that some paralleled. And we’re in the center of the connectivity universe on the assets we have been Atlanta. So Atlanta is strong and vibrant and continues to grow and will be a market that we continue to mine tremendous value out of. And we’re excited to be there, we’re also excited that competition is coming because we think that the deal flows will pick up and give us more shops and more opportunities because more people will be looking at other places the column in the southeast is becoming gaining momentum which we feel is only going to be good for us and other competitors in Atlanta because the deal flows just going to pick up because of obvious reasons that Atlanta market is growing in strength. We’re just glad we’re there, we’re glad we’re there early, and we’re glad we’re there with such a scale.

[Michael Funk:]

Okay. Thank you for the time.

[Operator:]

Our next question comes from Sami Badri of Credit Suisse. Please go ahead.

[Sami Badri:]

Hi, thank you. So in the core business reported 1% churn at in full year guidance reported 36% and if we took the midpoint of that that implies the term for the rest of the year in the core business will be little bit higher ex-M&A and excluding consolidation what is causing some of the core businesses churn? Sure, Sami. So 3% to 6% guidance for the year. 1% in the first quarter we think put us where we in the middle of the guidance we have. I don’t think there’s any implication to take that except that we’ve got phenomenal churn statistics. This churn rates have come down materially from where it was last year again based on the narrowing of our business and just continue to demonstrate strength, visibility and predictability in our business. So thanks for calling that I would thrilled with it. And I’m not sure if you with the second question there. How it relates to guidance is, if you can bring your churn down by, call it 2% historic we’ve been at a 5% to 8% target, and now we’re talking about a 3% to 6% target just put that in context for every 1% or 2% reduced churn at the incremental 1% to 2% growth in the business inherent, so we think it could continue to provide strength and support in the acceleration of growth in the business.

[Sami Badri:]

Got it. Thank you. And then a follow-up is regarding the lease with the SAS customer in Virginia, so I just kind of want to get a better idea on the return on invested capital your profile in year one, and then potentially what it looks like in year two and year three, just so I can understand the dynamics of the specific deal overtime, hope you can something give us some color on that.

[Jeff Berson:]

Sure that Manassas deal if you remember there’s two pieces to it, there is the lease on the power churn and then there’s the lease on the turnkey raised floor. The overall lease is behind that drive return on capital as Chad said of about 9% rented, the return on the turnkey slightly higher than that, the return on the power shows slightly below that, but not materially different. What we love about that structure which is fairly unique, easy drive capital efficiency, which we continue to look at the way we put our capital and drive that efficiency. So we didn’t trap capital in a powered shell that we’re not getting a return with typically would happen in those types of structures, we are going to return there. But on top of that we didn’t build out 24 megawatts and then have that scale over the next couple years, we were able to just put significant capital to the first five. It also provides the visibility that will ramp over the next couple of years, as a customer tend to increasing take additional megawatts every couple of quarters. The ramp to that return is actually pretty rapid, again we’re not talking about a 9% return over a 24 megawatt turnkey deal we’re talking about 9% return over the first five megawatts, and so they could ramp that very quickly, so it’s not one of those situations where it going to take three, four years to get full 24 megawatts since our return, you’re going to see that very quickly.

[Sami Badri:]

Got it. Thank you for the color on that. And then is this customer – is this an existing customer to happens to be churning out of another part of your portfolio that’s going to move all their equipment to specifically Manassas or is this going to be a net new deployment for them irrespective of any other deployments to have in your portfolio?

[Chad Williams:]

Sami, thanks for the question there’s been a lot of confusion on this in the marketplace. So we love to keep answer in this. This is 24 megawatts of net new capacity to QTS. Yes, it’s an existing QTS customer, but yes, this is 24 megawatts of powered shell in five megawatts of incremental new power in space for QTS, and I hope that this question answers once and for all this question within the industry. So we’re excited to answer that.

[Sami Badri:]

Thank you. That’s all I have for you guys today.

[Operator:]

Our next question comes from Vincent Chao of Deutsche Bank. Please go ahead.

[Vincent Chao:]

Hey, good morning everyone. Just wanted to understand a little bit the economics for GDT, I know for this year no real revenue coming off for that, but going for the 15% to 20% I think you guys outlined about $37.5 million or so of Q3 revenues that would come out of the business as part of the restructuring, is that the right base to use on that 15% to 20% and then as far as the growth component, yeah, I guess, can you maybe provide some color on sort of GDTs top-line growth historically and maybe what the opportunity is within those 200 contracts or what they need to lease more space from you in order to grow that business?

[Chad Williams:]

Sure, Vince, so in terms of the actual financials around it, you’re right, in terms of the general non-core revenue bucket, but what’s unclear behind that and we will continue to refine and make clear to investors as we transition customers, what revenue actually transitions over to GDT. What we’re assuming is that you don’t see one 100% transition there, so you’ll see some revenue move over to GDT and you’ll see us with that 15% to 20% channel fee coming from that. You’re also going to see some offset which I know we talked about last quarter of an expectation over the potential to see some loss on the colo side of our business from customers that were transitioning, because you always build into these sort of situations, the reality that not everything happens as planned, and want to make sure we’re building in a conservatism into our numbers. When you net all of that out, again it’s going to be unclear what the upside is relative to any of the revenue that doesn’t transition. We expect that it should be for 2019 it leads $5 million of incremental revenue coming from that channel payment, and I’d add to that that’s extremely high margin, because it’s not revenue that we have a lot of cost to support customers behind. There could be upside from that, but again until we really continue to transition customers it’s hard to get more granular.

[Vincent Chao:]

Okay, thanks. And then just maybe there was a question about just sort of some additional deals flowing to you from GDT, I just curious there, is there any exclusivity that you provided to GDT in terms of bringing on other managed services and within the things really.

[Chad Williams:]

Vince, this is Chad, no we’ve had a great channel partner relationship with GDT for over two years, they’ve been a great partner in our channel, but we’re not exclusive in providing any certain amount of services, but we are very encouraged with their competitive landscape, and they’re people that are on the street selling QTS products and colo and we want to continue to encourage that behavior as we move forward. I think the service delivery platform and the announcement that GDT is coming on cloud ramp is another example that their customers, which are many need places to find their power in space in their hybrid colo. So we feel like it’s just another great channel opportunity, it solve a couple topics for us, it gives our customers a great place to land, it gives us an ability to peel back, a high margin revenue stream on a reoccurring basis. They are committed to using QTS infrastructure that part of it is exclusive with the customers that migrate. And so we’ll see growth out of that overtime, and we’ll also see the opportunity, but the general business does not have any restrictions or anything unusual around the partnership or the channel just like our other channel relationships.

[Vincent Chao:]

Okay, thanks. and just one last one on the balance sheet I mean Jeff, you talked about the five and a half times debt-to-EBITDA target over time trending a little higher right now. but obviously to support a big backlog and curious now that you have the preferred in there, how do you think about the debt plus preferred to EBITDA target, which I think is a little bit over six times if you look into that way.

[Jeff Berson:]

Sure, Vin. I mean the preferred is there, we love that as another source of capital, it’s a way to continue to fund the business without equity dilution. We understand that it fits somewhere in-between equity and debt. the fact that there’s no maturity on it that it is perpetual, and so it is permanent capital, gives us great comfort beyond traditional debt. but it’s in the balance sheet; it also provides a source for additional funding as we continue to grow. the other aspect is although we have been clear that we’re confident with leverage has been a little bit higher. there are multiple ways that we can continue to fund the business beyond just preferred and I’d add that if you just look last year, remember the business itself generated approximately $100 million of free cash flow after dividend that can also go back into the business. So we’ve got multiple funding sources and as people do their math, I just want to remind them, we’re generating a lot of cash ourselves that are going back into the business on top of the ability to grow it.

[Vincent Chao:]

Okay. Thank you.

[Chad Williams:]

Thank you.

[Operator:]

Our next question comes from Jon Peterson of Jefferies. Please go ahead.

[Jon Peterson:]

Great, thanks. So maybe, just one question on GDT, in terms of the channel fee, 15% to 20%, now I found out that only on the customers that you guys are going to transition over to GDT. So I’m just trying to think and he said that $5 billion of revenue in 2019 is maybe a good guess at this point. but as I’m thinking longer-term, over time GDT is going to sign new customers, it sounds like you’re not going to get channel fees on those. they might have some churn come out. So this revenue stream at best probably isn’t growing very much and maybe at worst kind of declines over time and maybe goes away. So assuming the promise there is correct. I guess my question is why structure of this way versus just sell the whole business and we’ll get one large fixed acquisition price and just be done with it?

[Chad Williams:]

Jon, this is Chad. I’ll take the first part of that. thank you for asking this question, because if they came off the way that you said it, we certainly want to clarify. this is an ongoing channel fee. We expect our business once GDT is integrated to SDP to be available to our hybrid colocation sales folks to keep selling this type of product, just not have to deliver it. this is an income stream that moves forward on existing business and new business. So this is part of the partnership and the key element. this is something that will be a reoccurring business for us going forward and a continued access to our sales force. We’re just not going to have to deliver the end services to be able to drive that business. So Jeff, do you want to add anything or Jon?

[Jeff Berson:]

I guess just one other point Jon that’s in addition to the channel fee that is there as long as these customers are there, it will grow with these customers and to Chad’s point, it will be there for new and future customers, because our sales team is continuing to sell to our customers the integrated solution, that’s that hybrid colo enterprise customer, they are looking for this integrated solution is what we have and we’ll continue to differentiate our business. And so we anticipate continuing to send future business to GDT at that 15% to 20% based on the channel fee. But on top of all of that, remember we’ve also got GDT that are committing to support these customers, and we expect will continue to grow on hosting these customers in QTS facilities. so you’ve also got GDT as a direct growing colo customer for QTS, so multiple pairs of growth with GDT.

[Jon Peterson:]

But I guess is that fair to conclude that the growth – thank you for that color by the way, but I guess is that fair to conclude that the growth there will be slower than your kind of core – what you guys call your core business now today. I mean that’s why you’re going through this anyway, right?

[Jeff Berson:]

I mean it could. To your point, our core C3 business historically has not grown as quickly – sorry our C3 business has not grown as quickly as our core underlying business and that’s part of why we’re doing this. but you’ve got to also remember that GDT is a business that is built at a much larger scale with a much larger sales force geared towards a much broader customer base to drive these kind of services. A part of the reason that GDT as a good partner here is because this is a business that they’re going to put significant resources behind continuing to grow and expand, and leveraging in their overall channel as a system integrator to move up the stack in these services. So we think they will be very successful with this. We will be very enthusiastic if we are – if they are and regardless of whether it grows at the same rate of our core business or slightly higher or slightly lower, it’s all upside with the incredibly high margin at QTS.

[Jon Peterson:]

Got it. Okay, thank you. Appreciate it.

[Jeff Berson:]

thank you.

[Operator:]

This concludes our question-and-answer session. I would like to turn the conference back over to Chad Williams for any closing remarks.

[Chad Williams:]

Well, thank you for short notice and being on the call this morning. we appreciate the interest. I do appreciate all of our shareholders, their input and their impact on our business. We continue to work hard at QTS to execute our strategic growth, acceleration plan. We’re encouraged and excited about the year in 2018, the result in first quarter speak to that. but thank you again for your trust and confidence in QTS we look forward to meeting and discussing any of our businesses with our shareholders and the analyst, and thank you for your support. The conference has now concluded. Thank you for attending today’s presentation. you may now disconnect.