QTS Realty Trust, Inc.
Q2 2018 Earnings Call Transcript

Published: 26 Jul 2018

[Operator:]

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

[Stephen Douglas:]

Thank you, Operator. Hello everyone and welcome to QTS' Second 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 are also 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 Web-site at www.qtsdatacenters.com on the Investors tab. We have also provided slides and made them available with the Webcast and on our Web-site, 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 actual results may vary materially. Forward-looking statements in the press release that we issued yesterday, 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, monthly recurring revenue, ROIC, adjusted EBITDA, and core adjusted EBITDA. As a reminder, in conjunction with our previously announced strategic growth plan, beginning last quarter we realigned various information included in our earnings materials to focus our guidance and key performance metrics around our core business which primarily consist of our Hyperscale and Hybrid Colocation businesses, along with the 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 within our earnings materials. We refer you to our press release that we issued yesterday 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 Web-site. And now, I will turn the call over to Chad.

[Chad Williams:]

Thanks, Steve. Hello and welcome everyone. QTS' strong performance during the second quarter reinforces that the strategic initiatives we implemented are successfully driving significant value and growth in our business. Turning to Slide 3, through our accelerated efforts around Hyperscale and Hybrid Colocation verticals and leaning in on the significant differentiation enabled by our software to find data center platform, our business model is uniquely positioned to capitalize on the two strongest drivers of demand in the sector. And I am pleased to say that our execution on our strategic growth plan has resulted in accelerated financial performance for two consecutive quarters to start 2018. During the second quarter, we reported year-over-year growth in core revenue and OFFO per share of 16% and 15% respectively. This is consistent with our expectation for an acceleration in top line growth approaching mid-teens by 2019. In addition, our strategic growth plans has enabled QTS to achieve the highest margin in the Company's history with a core adjusted EBITDA margin of approximately 52% during the second quarter, representing more than 500 basis points of improvement year-over-year. Our strong financial performance in the second quarter was supported by our continued positive leasing momentum. QTS delivered core net leasing of 13.1 million of incremental annualized revenue in the second quarter, in line with our prior four-quarter average. This performance was particularly strong, considering our higher-return Hybrid Colocation business accounted for most of the volume in the quarter. Our strategic growth plan has also positively contributed to the predictability of the performance in our business, including a significant reduction in customer churn. Our initial churn guidance for the core business this year was between 3% to 6%, which compares to the churn rate we have historically experienced in the consolidated business of between 5% to 8%. The 200 basis point reduction in the churn correlates directly to the increased revenue growth and provides further support to our expectation for acceleration in our business. During the second quarter, we reported core rental churn of 0.8%, bringing our year-to-date churn to only 1.8%, which is among the lowest in the industry and is currently on track to be approximately half the churn we have experienced in our consolidated business in 2017. I'm very pleased with our team's performance through the first half of the year. We have laid out an ambitious plan to drive accelerated growth in our business and our team has executed at a high level. In a very short period of time, we have taken significant strides in positioning QTS to capitalize on the strong underlying demand we are seeing in the market in both Hyperscale and Hybrid Colocation and driving enhanced value creation. And the results of our growth initiatives are showing up in our strong core financial and operating results year-to-date. Moving to Slide 4, one of the initiatives we were excited to announce last quarter was our strategic partnership with GDT. GDT is an international multi-vendor IT solutions provider, headquartered in Dallas, Texas. GDT is also a current QTS customer and partner, and consistent with our plan to narrow the scope of our Cloud and Managed Services that we directly deliver, we are in the process of transitioning certain non-core Cloud and Managed Services customer contracts and support to GDT. Through this partnership, we were able to maintain consistent customer support on solutions like managed hosting enabled through GDT's platform which is integrated with our Service Delivery Platform, while driving enhanced profitability and a new source of potential growth for QTS. As of today, we have migrated approximately 75% of the non-core systems and services to GDT and GDT is shadowing QTS' managed hosting monitoring toolset. The migration of customers to GDT's platform will follow during 2018 and be complete before the end of the year. The response from customers that are being transitioned to GDT's platform has been overwhelmingly positive. This is a strong testament to the level of engagement from both QTS and GDT teams in working with our customers. It also reflects the fact that through our integration with GDT, we are not asking our customers to take on significant additional risk in their infrastructure. Customers' equipment is still being hosted in the same QTS facilities on the same equipment, and in many instances they are still being supported by the same professionals as the GDT team will have hired more than 60 former QTS employees that supported our managed hosting business. So, from a customer standpoint, there is very little changing except the vacuum support for their services will now be managed by GDT instead of QTS. Last quarter we discussed our expectation to complete the migration of non-core customers and services to GDT's platform by the end of 2018 and we are currently running ahead of that schedule. As customers are transitioned over to GDT's platform, QTS will receive a reoccurring partner channel fee of 15%-plus for non-core Cloud and Managed Services revenue that is migrated. In addition, under the terms of this agreement, GDT will expand its colocation presence within QTS facilities to support customers as they are migrated to GDT's platform. As the migration of customers on to GDT's platform is still not expected to be complete until later in the year, the financial impact on our core business is expected to be limited in 2018. However, due to better-than-expected customer retention, we now expect the potential core revenue contribution in 2019 from the migration of non-core services and customers of approximately 8-plus million, which is up from approximately 5-plus million we discussed last quarter. Jon Greaves and his team have done an outstanding job coordinating our integration with GDT. While we still have much work ahead of us to complete the transition of customers, I am very pleased with our progress so far in this new partnership. Next onto operating performance on Slide 5, during the second quarter we signed new and modified leases totaling just over 13 million of core incremental annualized rent, which is in line with our prior four-quarter average. This follows the near-record core leasing quarter we reported in Q1. We ended the quarter with a backlog of signed but not commenced annualized core revenue of approximately 51 million, in line with last quarter, which continues to add to our visibility of future growth. Importantly, our second quarter leasing performance was driven by strong value in our Hybrid Colocation business which contributed the majority of the quarter's new leasing performance. There is understandably a lot of excitement in the industry among investors regarding the Hyperscale side of our industry due to the opportunity Hyperscale provides as a growth accelerant with strategic, high credit quality tenants. However, the engine of QTS has always been our Hybrid Colocation business which represents two-thirds of our revenue base and provides an enhanced return profile and customer diversification across our footprint. In early April, we officially completed the realignment of our sales force around the Hyperscale and Hybrid Colocation with the addition of Clint Heiden as our new Chief Revenue Officer. Leading our colocation sales and marketing team, I am pleased that he has hit the ground running, as evidenced by the team's strong performance in the second quarter with good momentum entering Q3. As I will discuss later in my prepared remarks, the momentum we're seeing in Hybrid Colocation is enabled by the industry's first software defined data center platform, which includes our CloudRamp solution. In fact, I can point to a host of deals in the second quarter where SDP, our Service Delivery Platform, was driving factor behind QTS' winning the contract. As we discussed last quarter, we are also seeing a growing pipeline of larger deals in enterprise vertical. During the second quarter alone, we signed four colocation deals in the 500 kW to 2 MW range versus only two deals signed in this range during all of 2017. Our Hybrid Colocation pipeline remains strong and we will continue to look to find the right balance in our business between the steady performance of the diversified higher-return Hybrid Colocation business and the growth accelerant opportunities through strategic Hyperscale transactions. While this quarter's leasing performance was heavily weighted towards our Hybrid Colocation business, we are in advanced conversations with a number of Hyperscale customers on potential deals across our footprint. We are seeing an industry backdrop for Hyperscale demand that suggests the leading cloud and technology companies are in continued data center infrastructure expansion mode as their own businesses accelerate, and this appears to be a multi-year demand cycle. Against this backdrop, QTS has never been better positioned with strategic mega data center scale infrastructure in key markets and active dialogs among the largest users of the data center resources. We are pleased with our Hyperscale pipeline and we anticipate announcing at least one additional larger Hyperscale transaction by the end of this year. As we have discussed in the past, Hyperscale deal flow can be lumpy, which is yet another reason why we've positioned our business so we are not completely reliant on the number of Hyperscale deals hitting in a specific quarter to meet our financial objectives. In order for us to meet our stated growth expectations, our longer-term guidance only factors in approximately one to three larger Hyperscale deals signed each year. Pricing in the business remains across our footprint with the pricing on renewed core leases up 5.6% during the quarter relative to pre-renewal rate. This represents a back to back quarter of 5%-plus renewal rates, demonstrating the strong value that our customers continue to see in our platform. Looking back to QTS' history, our renewal rates have consistently increased in the low to mid single-digit percentage range. We are proud of this stat as it is a direct reflection on the service culture at QTS, which continues to lead the industry and our net promoter score. Overall, we are pleased with the level of leasing activity we saw during the second quarter and we are encouraged that our technology-enabled mega-scale platform continues to differentiate QTS in the market. Next onto Slide 6, our Service Delivery Platform or SDP remains a key differentiator and further establishes QTS as a lead innovator within the hybrid colocation market. Mega-scale infrastructure will always represent the foundation of our business. We build world-class data centers, some of the largest in the world, and have demonstrated a long track record of leading infrastructure performance. However, we are also focused on providing more than just great space and power to customers. We are differentiating by enabling unprecedented visibility and control of our infrastructure to solve for our customers complex hybrid data center requirements. The adoption of cloud is changing with the buying and consumption patterns of data center and infrastructure services. SDP is the facilitator to take a very traditional consumed IT services, enable them to be cloud-like in nature and on par with industry-leading software and infrastructure as a service provider. Many of you are familiar with the software defined networking and how that technology is transforming connectivity strategies. Similar to SDN, through SDP we are overlaying technology and software on top of the physical data center infrastructure and making colocation accessible in a way that's never been offered to customers before. By integrating and automating customers' access to a broad range of world-class software and IT platforms, we are able to leverage their R&D budgets and unify the data center lifecycle experience. Through SDP we are providing programmatic access to leading partners on public cloud, private cloud, SDN, and DCM, to deliver a comprehensive hybrid colocation solution. In essence, SDP is the glue between the various partner platforms. In total, we have more than 15 partners currently integrated into SDP, with more to come, and we have made access to this platform seamless by enabling customers to manage their infrastructure remotely, even from their iPad or iPhone. We now have over 15,000 unique users on SDP, and growing. The platform collects more than 90 million data points each day on customer's infrastructure that can make them available for use by our customers and enable them to make faster and more informed decisions regarding their technology management and strategic planning. SDP also enables us to respond quickly to customer's demand for new functionality. With 375 new features introduced year-to-date, some of the features we've recently introduced included online ordering of crossConnects, enhanced real-time power analytics data, and an asset manager that function as a self-service app that enables customers to catalog, track, and manage equipment lifecycles allowing them to optimize utilization of their various apps that's located in QTS facilities. By enabling our integrated user interface, customers don't need to call up our service center or sales people every time they want to order a crossConnect or request power utilization of a specific rack or access to security logs for their cage or cabinet. We have made all of the data and capability directly accessible from any connected device or through the QTS API or application programming interface. The API allows customers' internal applications interact directly with our system, which enables us to integrate our customers directly with a variety of partners on our platform. We are also seeing operating benefits as we utilize SDP internally to drive efficiency and cost savings for our business. I've asked our CTO, Jon Greaves, to lead a multi-year initiative within QTS to digitize our platform end to end, and clearly SDP will play a critical role in that. Moving to Slide 7, our differentiated technology approach is being recognized and validated by world-class IT partners. Leading industry analysts, and most importantly customers, while we are early to the market with this platform, initial feedback from the customers have been overwhelmingly positive. From the utility of the data center that customers can leverage to the ease of functionality, we have received significant third-party validation that SDP gives QTS a significant competitive advantage and will support our success going forward. In addition, we believe the endorsement from two of the largest public cloud providers in the world, in AWS and IBM cloud through our CloudRamp relationships, represent further validation that our technology-enabled solutions are truly differentiated in the market and we look forward to the future potential of growth opportunities with additional partners over time. Now to Slide 8, I'd like to highlight a few key customer wins during the quarter. One key theme for each of these deals I'll mention is, our Service Delivery Platform played a key role in QTS winning the quarter. During the quarter we signed new 600 kW Hybrid Colocation customer in Piscataway, New Jersey for a 10-year lease. This customer, a global investment bank, conducted a broad RFP process that included a number of data center peers. They manage a portfolio of data centers globally themselves and as well as work with other QTS peers, and identified QTS' Service Delivery Platform and the ability to integrate their APIs in real time to QTS as a unique differentiator. Upon signing the lease, this customer told us the ability to innovate within our data center was a significant reason they chose QTS, and we are already in discussions on expanding their footprint both in Piscataway and other QTS locations. Piscataway continues to be a great success story for QTS. Since acquiring the facility from a data center peer in 2016, we have either expanded existing customers within the facility or brought in new customers in each subsequent quarter. We've increased the return on invested capital and net asset from approximately 5% at acquisition to over 12% currently, and we still only have 50% built out. Our success in Piscataway is directly tied to our ability to deliver a differentiated hybrid-enabled colocation solution beyond just space and power. Our pipeline of deals in Piscataway continues to build and we look forward to the opportunity continue to drive incremental value in our New Jersey footprint. Next, during the quarter we signed a multiyear renewal of 0.5 MW expansion in our Santa Clara facility with a leading silicon-based clean energy automotive manufacturing company, known for its track record of innovation. This expansion brings this customer's total deployment within QTS up to 1.5 megawatts and we are now generating over $4 million of annualized reoccurring revenue. This company has been a QTS customer since 2011 and over the past 24 months has grown significantly within our Santa Clara campus as their underlying business has accelerated. AI is a critical part of this company's go-forward strategy and the data that is being pushed real time to their car fleet is being directed through our facility. This customer is also an active user of the power analytics data we provide through the SDP platform. Our software defined platform aligns well with this customer's need for infrastructure visibility, speed, and agility, enabling them to more accurately forecast their future capacity requirements. In addition, our service and support track record is highly valued by this customer and we are currently discussing incremental expansion options to take their footprint up to the 2 MW range. We remain encouraged by the level of customer activity we're seeing across our footprint. With our sales transition complete and Clint leading the charge, our Hybrid Colocation sales team is hitting stride. Combined with our continued positive momentum we are seeing in the Hyperscale sales strategy, we expect to continue to build upon our positive Q2 performance. Turning to Slide 9, our market-leading position in Atlanta continues to drive value for QTS. Between our two facilities in Suwanee, Georgia and Downtown Atlanta, we have built out nearly 700,000 square feet of raised floor and capacity are currently generating an average return on invested capital of approximately 20%. Our Atlanta facilities together support over 540 customers and our Downtown Atlanta facility alone supports more than 2,000 crossConnects and represents one of the most strategic interconnected site in the entire Southeast. We have received questions from investors over the past several months on the incoming competition in Atlanta. We have enjoyed the strength of the Atlanta market since our entrance in 2005 and I think our competitors will have success in Atlanta as well. Atlanta continues to build momentum as a Tier 1 market, and rightfully so considering its low cost of power, low natural disaster risk, strong confluence of fiber connectivity, and a large concentration of corporate headquarters and local technology talent. The Atlanta market has recently received an incremental boost with the passage of House Bill 696, outlying tax incentive legislation for the data centers in Georgia. Passage of this tax bill represents a culmination of four years of work by the QTS team. In coordination with the Technology Association of Georgia, we are pleased to see Georgia join other key data center markets, like Virginia, Texas, and Oregon, in providing enhanced incentives for data centers. This tax bill further establishes George as a destination for data centers and will provide increased economic incentives to QTS, as well our existing and new customers. Demand in the Atlanta market remained strong. Of the 83 new logos year-to-date across to our platform, more than a quarter were signed in our Atlanta footprint. This includes one of the largest transportation companies in the U.S. which signed a 10-year 0.5 megawatt lease in the Atlanta Metro facility, which in an embedded customer base of 540-plus customers in Atlanta, we also see a natural growth from existing customers continuing to expand with us. As a reminder, approximately 50% of our incremental growth comes from existing customers. In addition, our incumbent position as a leading provider in that market with the ability to expand our footprint at a meaningful cost advantage gives us a significant competitive advantage. We directly own one of the largest preposition substations in the country in Atlanta at 120 MW of transformer capacity, which enables QTS to support additional data center capacity expansion on adjacent land and offers customers the lowest cost of power in the market at sub-$0.04 a kilowatt. This compares to the rest of the market, close to $0.05-plus a kilowatt or approximately 25% higher. Atlanta will remain a core growth opportunity for QTS and we look forward to leveraging our strong incumbent position to continue to drive incremental success in this market. With that, I'll turn it over to Jeff Berson, our Chief Financial Officer, to discuss our financial results, balance sheet, and outlook in more detail. Jeff?

[Jeff Berson:]

Thanks, Chad, and good morning. Turning to our financial results on Slide 11, as we discussed last quarter, our guidance and disclosure of key performance metrics will be focused around our core business units 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 include technology services that support these products. 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 revenue is likely to decline at a rate faster than non-core expenses due to the natural lag between revenue migration and cost removal. By the end of 2018, through the transition of this business, both non-core revenue and expense will be fully out of our financial results. For the second quarter of 2018, we delivered strong year-over-year core growth across key financial metrics. We reported core revenue of $102.5 million, up 16% over core revenue in the second quarter a year ago; core adjusted EBITDA of $53.6 million, up 28% year-over-year; and core operating FFO per share of $0.64, representing 15% increase year-over-year. Next on Slide 12, our core business has continued to benefit from increasing margins due to the operating leverage in our cost structure. During the second quarter we reported a core adjusted EBITDA margin of 52.3%, which represents an increase of more than 500 basis points over the prior year second quarter and approximately 200 basis points sequentially of a typically lower-margin first quarter. The key source of margin improvement has come from leverage on our G&A base. Core general and administrative expenses as a percentage of core revenue were 17.6% in the second quarter, representing more than a 200 basis point decline year-over-year. As we continue to scale the business and leverage the existing investments we've made in our operating capacity and mega-scale infrastructure, we expect to continue to realize incremental margin expansion over the next several years. As a reminder, we've guided to approximately 50 basis points of incremental margin expansion in both 2019 and 2020. Now, moving to Slide 13, I'll review our current balance sheet and liquidity position. As of June 30, 2018, we had a total of approximately $870 million in liquidity in the business, made up of availability under our credit facility and cash on hand. We ended the quarter with leverage of approximately 4.7x net debt to annualized consolidated adjusted EBITDA. During the second quarter, we executed a Series B perpetual convertible preferred stock offering, which resulted in gross proceeds of approximately $316 million. This offering was upsized from an original target of $225 million. The capital raise combined with a $107 million Series A perpetual preferred stock offering in March demonstrates our ability to fund the business in a shareholder-friendly manner while minimizing near-term equity dilution. Importantly, these two capital raises provide sufficient funding for our current growth development plan through the end of 2018. Between our debt and preferred securities, more than 80% of this capital base is now subject to a fixed rate, further insulating our capital stack from interest rate risk. We will continue to actively evaluate a range of additional financing options within our business, including structured financing, JV partnerships, and potential asset divestitures, to drive incremental efficiencies in our capital structure. Overall, we are pleased with the available liquidity in our business and the ability for our balance sheet to support our future growth. Now, onto our capital development plan on Slide 14, our guidance for cash capital expenditures in 2018 is unchanged at a range of $425 million to $475 million, excluding M&A. During the second quarter we completed a soft opening of our Ashburn facility with 14,000 square feet of raised floor brought in service to accommodate the installation of our anchor tenant. Over the balance of 2018, we expect to deliver approximately 67,000 square feet of new raised floor capacity in Ashburn, Dallas-Fort Worth, Atlanta, Chicago, and Piscataway. In addition, we are deploying capital this year related to the 24 MW Hyperscale lease that we signed in Manassas, Virginia which is scheduled to commence in early 2019. Finally, onto our financial guidance on Slide 15, as a reminder, our financial guidance is based on the results of our core business. We continue to expect 2018 core revenue to be between $408 million and $422 million. We also continue to expect 2018 core adjusted EBITDA to be between $218 million and $228 million. And despite the front-end loaded timing and upsizing of the Series B perpetual convertible preferred offering compared to our initial financing assumptions, we are reiterating our 2018 core operating FFO per share guidance range of $2.55 to $2.65 per share. Looking ahead to the third quarter, we expect Q3 adjusted EBITDA margin to decline sequentially, reflecting typical seasonality and the higher utility cost, partially offset by continued operating leverage in the business. In addition, we anticipate Q3 OFFO and OFFO per share to decrease sequentially as a result of a full quarter impact from dividend payments associated with the Series B preferred security offering which was completed near the end of the second quarter. Moving on to churn, the year-to-date outperformance on churn that Chad discussed supports strong momentum for the remainder of 2018 and into 2019. Visibility on future customer churn remained strong with approximately 75% of our Hyperscale rent coming from leases with maturities in 2022 and beyond. In fact, among our top 10 customers who represent approximately 40% of our revenue, we currently have no customers with a weighted average maturity date earlier than 2020, which further reduces our risk. As a result, we have reduced the top end of our annual rental churn guidance for 2018 to 3% to 5% from 3% to 6% previously. Not only are we targeting core churn this year approaching the lowest rate in our Company's history, but based on our recent renewal rate performance, we continue to renew our retained customers at consistently higher pricing, reflecting the value and pricing power in our differentiated model. Overall, we are pleased with our second quarter performance. The strategic growth plan initiatives that we have implemented have unlocked the underlying strength and momentum in our business and we are confident we are on track to meet our long-term financial objectives. I'll now turn the call back over to Chad.

[Chad Williams:]

Thanks Jeff. Finally, onto Slide 17, over the past several months we have taken deliberate steps to position our business for accelerated leasing, improved profitability, and enhanced predictability. By refocusing 100% of our resources on our Hyperscale and Hybrid Colocation businesses and leveraging our next-gen software defined data center platform, we are confident QTS has the right strategic plan in place to extend the Company's long track record of value creation for shareholders. Our year-to-date performance is supported by the underlying strength in our business. We continue to capitalize on the significant growth opportunities in our sector with 16% year-over-year core revenue growth and 15% year-over-year growth in core OFFO per share. Our financial results are supported by the highest leasing performance through the first half of the year since we went public in 2013 at over 34 million of incremental annualized core rent signed. As we continue to grow, we have also been able to successfully realize the operating leverage in our platform, with over 500 basis points of margin expansion year-over-year resulting in adjusted EBITDA margin of just over 52% in the second quarter, the highest in our Company's history. We have outperformed our churn year-to-date, our pricing metrics remain healthy, and the occupancy across our footprint is up nearly 300 basis points from the first quarter. And finally, we are pleased that we are ahead of schedule in our integration with GDT and tracking above our initial customer retention expectations, which provides enhanced confidence in our 2019 performance and beyond. The underlying strength in our business is a direct result of the strategic growth plan that we have implemented and we are confident that we can maintain the current pace of execution going forward. I'd like to take this opportunity to thank our QTS employees for their continued hard work, particularly in driving our growth plan forward while maintaining a world-class infrastructure service that is the hallmark of QTS. This includes those who have supported our managed hosting platform over the past several years with the same dedication to customer support and excellence. I'd also like to thank our customers and shareholders for their continued trust and confidence in the QTS team. With that, we'd be glad to take questions. Operator?

[Operator:]

[Operator Instructions] Our first question is from Jordan Sadler with KeyBanc Capital Markets. Please go ahead.

[Jordan Sadler:]

I wanted to follow-up on the Hyperscale side. Obviously you guys had a successful quarter on the Colo front, but in the slide deck you pointed to, at least one additional larger potential Hyperscale deal by year-end, and so I'm curious, one, what a large requirement, how you define 'large' in terms of that type of deal, Hyperscale deal, and then just what the pipeline looks like overall, if you can characterize that?

[Chad Williams:]

It's Chad. From a large, our Hyperscale really kind of starts at 5-plus megawatts, so that's kind of how we think about transactional size to kind of make it in the Hyperscale. Our pipeline continues to be something that continues to build momentum and we're seeing terrific demand. I think the one thing I'd call out is there's a lot of conversation around Hyperscale and the business and the momentum. We continue to see that business grow in demand, but I think one thing that really helps QTS is, we focus more intentionally on Hyperscale as the additional docks and locations and the size of our existing infrastructure and our mega-scale data centers around the country, whether that's Irving or Richmond or Atlanta, that has the ability and terrific cost advantage and power and those things, but it's also having the relationships, because it is very difficult to get into the relationships that are driving this type of demand because of the speed in execution and risk onboarding new vendor has in this business. And I'm just thankful that as we became more intentional, as seeing this in first quarter with our transaction in Virginia, we are at the table and we have existing relationships with a number of hyperscalers that allow us to be in the conversation, and I think that is something that we are capitalizing on. Many of those customers wanted us to do things in larger tranches previously. It's nice to be able to sit down with a more intentional focus and allocation to that and be able to capitalize on some of those existing relationships. And the ones that we don't have, you can be assured that we're making progress in a lot of areas because of our size, scale, location, and advantage in doing that.

[Jordan Sadler:]

Okay. And as it relates to the SDP platform and the transparency that's providing your customers, I'm curious if Hybrid Colo customers, what the trend is in terms of power, are they looking incrementally for metered power requirements or are [breaker amp] [ph] still – are you guys still selling [breaker amp] [ph] type deals, and what that split looks like today sort of on a pro forma for the non-core business?

[Chad Williams:]

Jordan, I'm going to let Jon Greaves kind of take the SDP platform and transparency, and then I'll maybe help back on the power?

[Jon Greaves:]

Thanks Chad. So what we're seeing on SDP is again very much continued interest in the transparency the platform brings, both in terms of power but also in terms of sensor giving visibility of things like the cooling situation inside the data center, and finally on top of that also the security, having the visibility of the security as a function inside that type of data center and then a full control of all the above. So absolutely that's really been a very key factor. I think what we also have seen customers really focusing on that instead of the power, looking like a [indiscernible] – looking much more real time that can better match the power with the workloads that are in that [indiscernible] data center.

[Jordan Sadler:]

Okay. And so, Chad, are you seeing more metered power versus [breakered amp] [ph] requirements, are people looking to really pay for what they use?

[Chad Williams:]

We kind of see a combination of both, but all-in, on Hybrid Colocation there's a number of customers that do want a metered solution, and in the course with our visibility and our toolset, that's something that we can easily serve up to them. But we also see customers that just want to focus on their business and not really drive a lot of that in a metered scenario because it does put some additional load on them for managing that. So, we kind of still see it both ways. I don't have the percentage right now in front of me, but glad to circle back with you on that, but I don't think we've seen any major trends or shifts differently than what we have seen in the business historically.

[Operator:]

Our next question comes from Robert Gutman with Guggenheim Partners. Please go ahead.

[Robert Gutman:]

Good leasing this quarter. So couple of questions actually. I was wondering if you could talk a little bit more about the 5%-plus growth in renewal pricing, what really drives that like-for-like basis, are people taking some incremental service or is there more in the package basically than what there was before, or is it driven by power density? And secondly, Chad, you said you were confident on the leasing momentum and it was 13.1 million in the quarter. Would you say that 12 million to 14 million is kind of the range going forward or would you not commit to a range at this point?

[Jeff Berson:]

This is Jeff. As it relates to renewal rates, it's a combination of a number of different things. I mean, the biggest driver of the increase in renewal rates I think is just the service for it and some of the product enhancements that QTS can offer customers. It puts us in a great position upon renewal and we've got a lot of happy customers and we can drive further support. SDP is just one example where customers that have signed on with us a couple of years ago are now getting far better visibility in their infrastructure and they are willing to just pay a little bit more and stick with us and maintain. And so that's really what you're seeing. I'll tell you the renewal rates that we are thrilled with at north of 5% over the last couple of quarters, we've seen each of those quarters a couple of customers that renewed at some nice increases. More normalized expectations going forward will be more of what you've seen with us consistently over the last four or five years, which is renewal rates sort of up in the 1% to 4% level, and we would expect to maintain that. As it relates to the leasing question, our average annual leasing by quarter last year was 10 million to 12 million. Based on the accelerating growth in the business and the momentum we're seeing, we are very pleased that we are above that. Obviously we need to be above that for the accelerated growth and what you are seeing over the first half of the year supports that. So, it puts us in a good position to continue to have visibility and confidence in the momentum of the business and achieving the expectations that we have and we know the market has.

[Chad Williams:]

And Rob, just to add to that, I think the confidence is we want to continue to build a successful business around our Hybrid Colocation business. It's always been the heartbeat. I always talk about it in that way. I think our Service Delivery Platform, our software defined data center is enhancing the next generation of services that's serving up the data center in a much different way in a market that's kind of served it at the same may for a long time, and we are excited about that and it can directly tie to the ability to retain and grow revenue with customers. But the ability for us to continue to have reliability and predictability in the leasing is really the combination of Hyperscale and Hybrid Colocation working together. Now Hyperscale business is lumpy and we talk about that in kind of one to three deals a year. It was great to get our first deal early in the year. But that's what gives us confidence. The reliability and stability of being able to be a consistent performer in leasing is foundationally on the Hybrid Colocation business and the complementary acceleration of intentional Hyperscale business when we see that it fits a customer and QTS well.

[Operator:]

Our next question comes from Ari Klein with BMO Capital Markets. Please go ahead.

[Ari Klein:]

Can you maybe address the EBITDA margin outlook going forward? It seems like it's going to imply the pretty strong sequential ramp in Q4 given that it will be down in Q3. So, how do you select to get to the guidance range?

[Jeff Berson:]

So, if you speak about the EBITDA margin, again we couldn't be more pleased in being able to demonstrate some of the efficiencies in the business that you've seen this quarter. You do have some seasonality. Given Q3 with the summer months and utility costs, you typically do see margin come down in Q3 and we'd expect that. And then you see margins come back, and you've seen this historically pretty healthy levels in Q4 based partially just on the shift in utilities being a quarter that it doesn't take as much to cool the facility. But then the second aspect is, things like payroll taxes and others that tend to – and accruals that tend to get expensed in the business over the first half or three quarters of the year tend to trickle off during Q4. And so, we usually have very high margins in Q4, I'd say higher than the average margins, just based on where that is during the course of the year. We continue to be confident what we've put out in our guidance, at our revenue guidance and our EBITDA guidance, and we have ranges in there to protect ourselves about continuing to be able to hit those numbers.

[Ari Klein:]

And then just maybe quickly on the CloudRamp with AWS, how is that tracking, what are your expectations there longer-term and how significant of a business could that become?

[Jon Greaves:]

So, absolutely – this is Jon Greaves speaking – so, we've been seeing continued progress in CloudRamp in all of the markets. I think really of interest is the technology we've built inside CloudRamp now. We have now expanded into other processes [indiscernible] as well enabling automation and continued progress on that front. As we spoke earlier, CloudRamp tends to be smaller deals. So, from a starting point, it was a pretty small business to grow from. What we are seeing though now is the CloudRamp technology starting to appear into kind of larger traditional Hybrid Colo deal which will have an automation and again improving that customer experience significantly.

[Operator:]

The next question comes from Richard Choe with JP Morgan. Please go ahead.

[Richard Choe:]

Just wanted to follow up on the Hyperscale deal pipeline, where are you seeing interest and where do you think you have a strategic advantage in terms of winning deals? And then on the enterprise side, what are you seeing in terms of the pipeline?

[Chad Williams:]

This is Chad. What's nice about the Hyperscale pipeline that's growing, we have got a number of existing sites that has just a basis or an advantage because of an infrastructure-rich acquisition that had a lot of cost advantage in the core. So, what's nice about the pipeline that I am seeing build in this business is we have a very balanced opportunity set of existing facilities, which is always our first and highest priority, to fill and take advantage of that cost advantage. And in many of those cases where there are existing infrastructure-rich facilities, we also have tax incentives, whether it's in Virginia or Georgia now, which we are proud to have helped with, and cost advantage from a utility and substation. And I don't want to under-emphasize. The cost advantage in the state of Georgia at sub-$0.04 a kilowatt is 20%-plus advantage to competitive market dynamics. So, we hear a lot about Atlanta, we're excited about Atlanta, we continue to have 25% of our new logos show up in Atlanta, and we love that market. We think a lot of people be successful, but when you say, why you think we'll be successful in the Hyperscale, it's that we have a tremendous scale of the existing infrastructure level with cost advantage and tax incentives that really help and we can move really fast. And so, what I like about the Hyperscale pipeline is the pipeline is developed about 50% on existing sites that we have great cost advantage and great timing advantage and operational efficiency, and then the sites that we have added, I've been thrilled to see that the sites that we have added in Hillsboro, Phoenix, Ashburn, and Manassas, have all been the right markets to see tremendous interest together. So, as we've talked about, we've been doing a lot of the predevelopment work to get those sites in a less than 12 month delivery range. Of course, we are building on the Manassas site because that's where our Hyperscale transaction early this year awarded to, but I just feel like we've got the right dot, we've got the right team focused on the initiative, and we've done it before, and so we're excited about that. I may have Clint talk to you just a little bit about the enterprise pipeline. That's really a result of the Hybrid Colocation business. But as you can see in this quarter, we continue to feel very good. But I'll let Clint kind of address that directly.

[Clint Heiden:]

Thanks Chad. The Hybrid pipeline, as we have already noted from the year, four deals in the 500 kW-plus have closed as relative to two last year, and we see that continuing to grow for us and drive our deals going forward.

[Operator:]

The next question comes from Erik Rasmussen with Stifel. Please go ahead.

[Erik Rasmussen:]

So first, it seems like you are getting a lot of momentum picking up in the Hyperscale side of the business with a solid pipeline you just mentioned. You have talked about one of three deals per year, but given that you are seeing a lot of interest, what would maybe make you change your expectation for doing deals in that space?

[Chad Williams:]

You mean in the amount of volume of the deal?

[Erik Rasmussen:]

Demand volume, correct.

[Chad Williams:]

Jeff and I and the team constantly have conversations around that, and the stem point is, we have always been focused on its about growth and we have always been focused on that and delivered in that. But it's not about growth at the cost of other things. And so, what I have to manage as a steward of public capital is that bridge between investors have different horizons on timing and we have just resisted historically not to deliver, whether you are a short-term, mid-term or long-term investor, we want you to be happy to be in QTS shares. And so, the balance of that is that growth is important. And I do believe there is a market dynamic that says that you need to win and win when you can to gain scale. I understand that. But I also believe that balancing that and making sure that our shareholders feel like we are capital efficient and that we are thoughtful about that growth over a period of time is important. I might kind of say that we continue to talk and have talked about the last six, seven months about trying to find creative ways that might accelerate Hyperscale growth in the form of JVs, and I know a lot of people have been talking about that, and I'm not going to get into a lot of details, but we continue as Jeff and the team evaluate opportunities to how can QTS potentially be able to take on some more Hyperscale but also balance that and the capital efficiency and thoughtfulness that we need to have to our shareholders at different time horizons. And I'd say, just stay tuned on that. We are continuing to work through with partners and opportunities, because I do think the Hyperscale team will put us in a position where some of those good choices might have to be made, but I just want people to know that we're trying to balance that aspect of that.

[Erik Rasmussen:]

Very good. And maybe just as my follow-up, on the GDT, it seems like you are tracking ahead of schedule, 75% have migrated, [those] [ph] systems are non-core. How do you see this transitioning or transition accelerating throughout the year and so the progress? I mean, obviously it has not been linear, and then you have up-sided your financials by over 3 million or around 3 million. Is there potential and other surprises in terms of what you are seeing right now where you could potentially get to even higher numbers from here?

[Chad Williams:]

Erik, I'm going to let Jon take that. Jon is really, he and the team of people around him have been doing extraordinary work with our new partner, and I want Jon to kind of address that directly.

[Jon Greaves:]

Thanks Chad. So Erik, we have been very, very pleased with the progress and GDT has been really a great partner throughout this process. Just to maybe step back a little bit, if you kind of think of what's happening with these customers, we're not asking them to move data centers. They are staying on the same hardware that's been running, so migration risk is very, very minimal. In many cases GDT have actually interviewed and then hired the employees from QTS that are transitioning out of the Company, so again really a lot of stability there. So what the customer really just sees on the back-end is GDT is delivering the service through that partnership with QTS and certainly using some of our platforms to do so. So, we are very pleased on that front. In terms of the financial side of that, I'm going to let Jeff maybe cover that and see if there's any other color he wants to provide.

[Jeff Berson:]

Sure. We feel really good about where we are in that transition. We have mentioned 75% of the systems have already moved over to GDT, and what will happen at GDT, they will be managing those systems in parallel with QTS to make sure that when we transition the customers, which is when it actually starts driving the channel revenues for us, that's still scheduled to happen before the end of the year, and we feel very confident in watching GDT manage through the systems in parallel with QTS that that transition will happen. As a result of that and as a result of just customer confidence around the conversations we're having and customer confidence in GDT and the support, it's why we were comfortable increasing our expectations of what we can get from this GDT partnership from 5 million to 8-plus, and I'd say we are going to stick with that and feel very good about it.

[Operator:]

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

[Frank Louthan:]

As you look at the new construction, what inflationary pressures have been here, you're seeing on both raw materials and labor, and do you think this will have any sort of impact on your development yields? And then, can you give us any color on the potential new changes that Clint might be making with account packages and so forth as he is stepping in here versus what you may have adjusted earlier in the year with the sales team? Thanks.

[Chad Williams:]

I'll take the construction. We are seeing it really – let me start with saying that we are consistent and have been consistent that our yields, we continue to feel comfortable with a 9% to 11% range on the yields for Hyperscale. That's been a consistent kind of thing. I think it really gets back to, even though there's a lot of conversation about Hyperscale deals, there is a handful of people that are actually in the deals. And so, we see a very well behaved, consistent, reliable market and feel good about the 9% to 11% range. We are seeing construction cost move. It kind of depends on which market. And Texas has always been a hot market. You've always had to kind of learn how to figure out how to build in a reasonable fashion. It affects speed, it affects costs, it affects the parts and pieces that go in. It's always been consistent with QTS because we have always said, and I've said on many calls, a few years ago there was a big trend on every quarter that numbers were going down on cost to build and we were always kind of saying, the consistency is, is that yes, we are innovating and designing and delivering but we have a certain standard to data center we won't build below, and we have always said, the pieces, parts and components are always going to go up. And seeing that, so are we seeing instead of 3% price increases on equipment, 5-plus, we are seeing that a consistent thing across the board that increasing in pricing is going up, and I think that's why I highlighted on my earlier comments that about half of our pipeline is in existing facilities. That means those are powered shells. That means that QTS has an ability to have the next 30, 40, 50 megawatts worth of builds not have to buy concrete, steel, utility infrastructure to get that powered shell up. We have got that built already. We have over 1 million square feet of powered shell. That's going to be a very neutralizing affect on construction cost increases for QTS that is very differentiated. And why I am excited to talk about that is that we have always had a great ability to expand in our powered shells. It's just hard to get investors the value of that. I think we have a great opportunity now with the demand in Hyperscale and the construction cost going up for people really to start looking at the embedded value in our powered shell inventory that's around the country and value that has a differentiation on QTS. And I think those things are what we are focused on and we are going to continue to capitalize on that and manage that expense as we move forward. As far as the question about Clint, I'll tell you, from working with him since he joined the team in April, which we couldn't be more excited about, he is a man with a purpose and an energy that has been unbelievably impactful in a short period of time. I love the sense of purpose and execution he has and maybe I'll give him just a quick second to kind of talk about maybe some of the more blocking and tackling things that he has been up to in the internal sales force for Hybrid Colocation.

[Clint Heiden:]

Thank you, Chad. So the first thing is, I came into an exceptional sales team. Not one person on my direct staff has turned over. It's a group that was very well tenured and doing very well in the marketplace. The things we have started to do or started to focus on more are really the unique differentiators we have around the service delivery platform, our power cost, and the advantages we bring to the market. So I haven't had to fundamentally change any of the ways that we are approaching the market with the reps or the shell leaders that we have, but simply have started to push more aggressively on our unique differentiators that we feel position us in the marketplace.

[Operator:]

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

[Eric Luebchow:]

Thanks for squeezing me in. Just real quick, you talked a little bit about the potential JV opportunities. Maybe a little more detail on what your criteria would be for a partnership and would that be to help fund kind of a new Hyperscale development or are you also potentially looking at partners for one of your stabilized properties as well?

[Jeff Berson:]

I think the answer is, we are open to a lot of different ways that we can look and fund the business. I think we have demonstrated that in the last couple of quarters. And what we like about some of the potential partnerships and JV opportunities that could be available in the market is it just provides another financing to us, and that could be a financing source in recycling capital from existing stabilized facilities. It could also be in financing sources that drive new builds for Hyperscale tenants and contracts that get signed. So, there's a lot of different ways it can play out. These deals can be very complex. Each deal could be a little bit different. And so, we don't want to get ahead of ourselves in terms of exactly what something might look like or when something could happen. We feel very good with the funding we have planned and we have put in place for the business in the first six months and we have got our funding set for the year. And so, it doesn't mean that we are not looking to always think about new ways to fund the business, but we don't have an urgency around that and we're just continuing to figure out the right partners and the right way to deal with it.

[Operator:]

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

[Nick Del Deo:]

First, it looks like Virginia Beach is developing into a real hub for subsea landing. I think [indiscernible] just announced another cable the other day. Are you seeing any heightened interest in Richmond as a result or do you anticipate any longer term benefits in Richmond from that trend?

[Chad Williams:]

This is Chad. I'm going to take the first part and then I'll let Jon talk a little bit more about the technology. I think it was an unbelievable opportunity. We were probably the happiest people in the data center business when Virginia Beach got on the board and actually kind of started working towards a new direction. It was exciting to see that another big hyperscaler has now joined on and they are adding another cable into that landing station. We think that it is the future opportunity for us. And I'm happy to say that that comes right through the Richmond data center. And I'll maybe have Jon talk a little bit about some of that recent development for us but it's an unbelievable opportunity. Jon?

[Jon Greaves:]

Absolutely, Chad. And Nick, as Chad said, it's [indiscernible] exciting to see the activity in the market there. In as long that the cable is coming in, we've actually spent a fair amount of time looking at feeding appearing market in that vicinity as well. So we've got a lot of work with different partnerships to make the Richmond data center really become kind of a nucleus to start breaking out a lot of those cables and then allowing customers to connect to those cables. So we are very excited to see that continued growth and expect to see more cables come in the future.

[Chad Williams:]

And the one other thing I might bring up is that there is some real speed advantages that can get you eventually a lot of different places that you are going to have in Richmond versus Northern Virginia. I don't think it's by accident that there is a couple of billion dollar data center project on our adjoining land or adjacent to us in Richmond now, and the amount of capital and interest in that market has been something we feel like over the next five years it's going to be an exciting opportunity and connectivity is going to be a center-piece of that.

[Nick Del Deo:]

Okay, that's great to hear. I'll keep it to one question given the time. Thanks.

[Operator:]

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

[Simon Flannery:]

On the Hyperscale versus Hybrid, how do you think about the evolution of that split over the next few years, do you think it will still be in that sort of 35-65 split or could that go more 50-50 as you get some of these larger deals onboard? And then just keeping on with that sort of notion of finding these Tier 1 markets like [indiscernible] maybe Richmond getting more connectivity, does that mean that some of these smaller second-tier markets you might decide to exit or put them in some of these joint ventures, so you might sort of shrink down to sort of some of these larger core facilities? Thanks.

[Chad Williams:]

Simon, I'll take the first. The Hyperscale business will have a tendency to recalibrate some of the percentage. We have always been consistent. We don't wake up every day trying to hit some percentage. We rather drive to our return on invested capital and our profitability and our OFFO per share and that type of stuff. So that's where we are focused. But yes, I mean when you're bringing or doing large 5-plus megawatt transactions in Hyperscale, you are going to see a consistency where the Hybrid Colocation business as a percentage of revenue will probably shift, although Clint feels very confident about the Hybrid business. So maybe he can keep up with the Hyperscale business. It would be a great opportunity for us. But we are going to probably see that. We don't have a numerical number we wake up and try to get every day, but we focus on the metrics that drive our business. As far as the JV and other markets, the thing about QTS, we are always looking, as Jeff said, to optimize our balance sheet and put our position and our assets in the best possible position. And so, everything we look at is trying to optimize that. What's kind of fun about it is we really don't have much left in what you would call small and regional sites. I mean, our mega data centers now will drive the majority of our business for the foreseeable future. Where we do have some smaller sites, let's take Miami, it's such a dense colocation and connectivity market. We have one business in Miami through the Miami relationships that have gone to Atlanta. So, sometimes those smaller regional sites are onboarding to the large mega scale deals. I can think of probably one of the most productive sites historically, and some of the reasons we have some of the largest hyperscalers in the world in Atlanta was because of our regional location in Santa Clara and being in the hotbed of hyperscale community. So, the assets themselves you look at and say, well, they are not real big, but they are leased, they are profitable, and they drive consistency of having people in the market that can drive business to our core centers. So there's a little bit of that that we always have to manage through, but the mega data center infrastructure will drive the future of this business unquestioned.

[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:]

Just want to thank everybody for their time and focus on the quarter. We appreciate the excellence and continued trust and confidence in QTS, and I want to thank our QTSers that continue to lead the industry in innovation and drive our customer satisfaction. Thank you for what you do and thank you to our shareholders. Have a great day. Bye-bye.

[Operator:]

This conference is now concluded. Thank you for attending today's presentation. You may now disconnect.