QTS Realty Trust, Inc.
Q3 2018 Earnings Call Transcript

Published: 30 Oct 2018

[Operator:]

Good morning and welcome to the QTS Realty Trust Inc. Third 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' Third 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 website 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 actual future 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. 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 website. And now, I will turn the call over to Chad.

[Chad Williams:]

Thanks, Stephen. Good morning and welcome, everyone. QTS’ financial results during the third quarter demonstrate the strong performance of our team and differentiated platform and this performance is supported by an industry demand backdrop that is as robust as we've seen as a company. Earlier this year, we laid out multiple strategic initiatives that we had high confidence would drive an acceleration in our business performance. And as you can see in our third quarter results, QTS has delivered on those initiatives with strong execution. We have put up the strongest performance in the first three quarters of 2018 that we have had as a public company. Our strength and momentum has been a direct result of the changes we implemented at the beginning of the year. We have now firmly put the restructuring behind us and our success is poised to carry us into equally strong 2019. During the third quarter, we generated one of the strongest quarters of leasing volume in QTS’ history with a broad based strength across our balanced Hyperscale Hybrid co-location verticals and our Hyperscale sales pipeline is the strongest we've ever had. Hyperscale contributed about third of the leasing volume in the quarter. With the momentum carrying over into Q4, this caps off a record 52 million of year-to-date bookings for QTS. Next, we significantly outperformed our initial expectations and have fully completed the transition of customers to GDT's platform, both ahead of schedule and with significantly higher customer retention, which now positions our business for an acceleration in 2019. In addition, our core profitability has expanded by over 500 basis points year-to-date. Churn has reached a record low for our core business and our revenue and profitability growth is accelerating. QTS’ successful execution of our strategic initiatives has positioned our business for a new level of performance, setting the stage for continued strong growth, heading into 2019. Turning to slide 3, our third quarter results reflect QTS’ solid execution across our Hyperscale and Hybrid co-location platforms. QTS delivered a very strong Q3 leasing performance, building on the sales momentum that we exhibited during the first two quarters of 2018. QTS’s signed leases representing 18.1 million of incremental annualized core revenue in the third quarter, well above our prior four quarter average and representative of expanding pipeline of opportunity. Moreover, this leasing reflects a very healthy mix of customers and locations across our footprint and the strength in the Hyperscale vertical that we've discussed in recent quarters. Year-to-date, we've signed leases, representing more than 52 million of incremental annualized core revenue, which is the highest in our company's history through the first three quarters of a year. Accelerating leasing performance continues to support the growth in our financial metrics. During the third quarter, we reported year-over-year growth in core revenue and adjusted EBITDA of 14% and 20% respectively. On a year-to-date basis, through the third quarter, core revenue and adjusted EBITDA are up 15% and 24% respectively. This remains consistent with our expectation for an acceleration in our top line revenue growth for ’19 and beyond. We have also been able to generate a meaningful improvement in our overall profitability through a streamlined go to market strategy and efficiency gain by leveraging our software defined datacenter platform. During the third quarter, QTS reported a core adjusted EBITDA margin of approximately 51%, which represents a 250 basis point improvement year-over-year. In addition, we've been able to enhance the predictability of our business by realizing customer churn rates well below our historical average through execution on a more simplified product mix. During the third quarter, we reported core rental churn of just 1.1%, bringing year-to-date churn to only 3%, which remains among the lowest in the industry. As a reminder, our full year churn guidance is 3% to 5%, which was revised downward last quarter from an initial expectation of 3% to 6% and compares to historical churn rate we've experienced in our consolidated business of between 5% to 8%. That 200 basis point reduction in churn correlates directly to the increased revenue growth and provides further support to our expectation for an acceleration in our business. QTS’ strong performance since the beginning of 2018 reinforces that the strategic growth acceleration initiatives were implemented are driving significant value. I am pleased with our team's performance in successfully executing our business plan and laying the foundation for continued future growth and differentiation. Through our world class people and technology enabled solutions, we have established QTS as a leading innovator in the datacenter sector, positioning our business to capitalize on the strong underlying demand we're seeing in the market in both Hyperscale and Hybrid Co-location. Now, moving on to our operating performance on slide 4. During the third quarter, we signed new and modified leases, totaling 18.1 million of core incremental annualized rent, which was more than 20% above our already strong prior four quarter average of 15 million. We ended the quarter with a backlog of signed, but not yet commenced annualized core revenue of approximately 59 million, representing a 15% increase, relative to Q2, which continues to derisk our future growth plan. Pricing remains firm across our footprint as customers continue to see value in our software defined datacenter solutions and service culture, which has led the industry in net promoter scores. Pricing on renewed core leases were up 2.1% during the quarter, relative to pre-renewal rates, which is consistent with our overall expectation of renewal rate increases in a low to mid-single digit percentage range. Our sales results this quarter were driven by a broad strength across our platform with our hybrid co-location business contributing approximately two-thirds of total leasing volume. We are thrilled with the level of activity for our Hybrid Co-location vertical this year. We are seeing a broad-based uptick in performance driven by an increase in deal size, continued differentiation from our software defined datacenter platform and overall positive enterprise demand backdrop and solid execution by our sales team, led by our Chief Revenue Officer, Clint Heiden. Our Hybrid Co-location vertical remains a critical element of our growth strategy, as it enhances customer diversification, drives higher return on invested capital and helps to offset the inherent lumpiness of Hyperscale deal flow. Hybrid Co-location sales volume was broadly distributed across our footprint, with particular strength in Atlanta, Piscataway and Richmond. Notable leases signed during the quarter included a 750 KW expansion in Chicago, with an existing consumer electronics customer, a 300 KW lease in Piscataway with a global communications vendor and a 150 KW lease in Richmond, with a industrial manufacturing company. Our Hybrid Co-location pipeline remains strong, enabled by the industry’s first software defined datacenter platform and we will look to close out the year with good momentum building in 2019. Turning to slide 5, I'd like to take a few moments to discuss our Richmond location, which has grown into a major contributor for our business and it’s positioned for significant contribution for the years to come. The Richmond data center market was effectively created by QTS when we acquired and repositioned a major semiconductor plant in 2010. Of the 34 new logos signed during the third quarter, more than 25% were signed in our Richmond footprint. QTS’ mega data center in Richmond sits on 220-acre campus and supports upwards of 1.7 million square feet of raised floor capacity, with over 500,000 currently in deployment. This is one of the largest data center platforms globally. Combined with a materially advantage cost basis, our value creation opportunity in Richmond is immense and the spotlight on Richmond has grown in recent quarters. Several months ago, one of the largest social media companies in the world announced their intention to build $1 billion data center campus, located immediately adjacent to our property in Richmond. This is in addition to another corporate data center that neighbors our property and is owned by and operated by one of the largest global banks in the world. These major investments provide significant critical mass to the Richmond market and have already attracted meaningful increase in activity and interest from network providers who seek to gain access to the market via fiber deployments into the campus. The most notable connectivity development enrichment is the completion of the MAREA and BRUSA subsea cables, two of the highest capacity and lowest latency subsea cable systems ever built. These cables, which are operated by Telxius provided low latency connectivity to Europe and South America and terminate in the US directly into the new Virginia Beach landing station. Last week, we were pleased to announce that Telxius has selected QTS’ Richmond data center as a key point of presence, which positions our facility as the closest mega scale data center to the cable landing station in Virginia Beach. This is significant in that it enables QTS to offer customers in Virginia, including Aspen with large scale capacity and the lowest latency connectivity to Europe and South America available in the market. We expect the Richmond market to continue to gain traction as an attractive alternative to Northern Virginia and grow in to key destination for both enterprise and hyperscale customers. Those who have followed the data center industry for years know how significant the cable landings from Latin America have been for the Miami market, which exists almost entirely due to the telecom infrastructure terminating in Miami, as a US gateway. Next, on slide 6, Atlanta is another market that we've continued to see consistently strong performance. Atlanta has been a core engine for economic growth for QTS. Between our two facilities in Suwanee and Downtown Atlanta, we have continued to capture a significant market share. Our incumbent position as a leading provider in the market with over 700,000 square feet of raised floor capacity and embedded customer base of 540 plus customers and a structural power cost advantage enabled by our 120-megawatt in grid substation positions QTS for continued future growth in Atlanta. Additionally, the recent passage of the new legislation provides a incremental tax incentive for data center providers and customers and further establishes Georgia as a key destination for data centers. Earlier this month, we were pleased to announce that we closed on the acquisition of a 55-acre land parcel, immediately adjacent to our existing mega datacenter facility in downtown, Atlanta. Since acquiring our Atlanta metro site in 2006, we have acquired four separate parcels of land, adjacent to our property and this 55-acre parcel represents the final centerpiece. This strategic site provides QTS the opportunity to extend our leadership position in Atlanta and drive incremental operating leverage by expanding our downtown campus by an incremental 150 megawatts. Importantly, the neighborhoods immediately surrounding our datacenter campus have dramatically gentrified since our first purchase many years ago. As a practical matter, it would be difficult, if not impossible to locate a mega data center footprint in Metro Atlanta economically at this stage. We expect to begin preliminary site work over the next couple of months to preposition the site for future development. The Atlanta market remains a clear growth opportunity for QTS and we look forward to leveraging our strong income position to continue to drive incremental success in this market. Now moving on to Hyperscale on slide 7, which contributed approximately one-third of our leasing volume in the quarter. We continue to view Hyperscale as an expanding opportunity to strategically accelerate growth with some of the largest and fastest growing technology companies in the world. We have discussed in recent quarters the traction we are gaining within Hyperscale and during the quarter, we are pleased to sign new leases with two core Hyperscale customers, aggregating to approximately 7 megawatts in existing QTS facilities, supported by strong capital efficient growth. Earlier this year, we announced the signing of a Hyperscale lease with a leading software-as-a-service company in Manassas, Virginia. As part of the lease agreement, the customer is expected to ramp up for an initial committed deployment of 5 megawatts into the full 24-megawatt facility over approximately two-year period. During the third quarter, we are pleased to announce that this customer took down its second tranche of turnkey capacity, which is included in our Q3 leasing results. This second tranche represents an incremental 4 megawatts, which we would expect to deliver in mid-2019. We will continue to recognize the additional leasing performance in our go-forward quarterly result, as this customer signs additional commitments and ramps into the full 24-megawatts of turnkey power capacity, providing additional visibility and pipeline for future growth. We remain encouraged by our ongoing conversations with additional Hyperscale customers, regarding opportunities across our footprint. These conversations continue to suggest that we are in the midst of a multi-year datacenter expansion phase for the leading cloud and technology companies, as their own businesses accelerate. And with over 1 million square feet of cost advantage powered shell capacity in the top US data center markets and over 600 acres of fully entitled land available for development, we are well positioned to win our fair share in Hyperscale. Since realigning our sales focus to be more intentional targeting larger Hyperscale opportunities toward the end of last year, we have made significant progress in deepening our relationships with key customer accounts. We have several larger potential opportunities in our pipeline that we are actively pursuing with both new and existing customers and we will look to provide additional detail in the coming months around these opportunities. We continue to anticipate signing one additional larger Hyperscale transaction by the end of this year and our expanding Hyperscale deal pipeline provides incremental support to our future top line growth expectations. Overall, we are very pleased with our leasing performance year-to-date and during the third quarter. We remain confident that our software defined platform, megascale footprint and world class customer support provide a strong foundation for continued growth and leasing, heading into 2019. Next, on slide 8, as part of a more intentional focus to drive Hyperscale leasing growth, in late 2017, we announced multiple land acquisitions in key Hyperscale markets, including Ashburn, Phoenix and Hillsborough. Subsequently during 2018, we acquired additional land in Manassas, Virginia, which is rapidly emerging as an attractive alternate to the more concentrated Ashburn market. These expansions rounded out our footprint and provide scalable capacity in the markets where the majority of Hyperscale deal activity is taking place. Looking at overall Hyperscale deal activity in the industry over the past several years, more than 50% has occurred in the Virginia market and that is consistent with the opportunities that we're seeing in our pipeline. To capitalize on these opportunities, in less than a year, we have transformed our growth opportunity into the top US data center market. We now have the capability to deliver a total of more than 650 gross megawatts and 3.2 million square feet of raised floor across our 395 total acres within our current Ashburn, Manassas and Richmond footprints. In fact, we see our Virginia footprint as the best positioned in the market for multi-location opportunities with significant capacity in three core locations. Demand within the Virginia market, particularly among Hyperscale customers continues to grow and we are excited to have positioned our platform to drive long term success in the largest and fastest growing datacenter market in the country. Turning to slide 9, I'd like to now discuss our corporate governance modifications that we announced several weeks ago. QTS board is comprised of an experienced and engaged independent representatives who are committed to enhancing shareholder value by aligning with our corporate governance’ best practices. QTS was pleased to announce the appointment of Mazen Rawashdeh to our Board of Directors as a new, independent director. Mazen brings more than 25 years of experience in the technology industry, specifically in large scale data center infrastructure management and strategy, for some of the largest technology companies in the world. He currently serves as the Chief Infrastructure and Architect Officer of eBay. His addition brings valuable technology infrastructure experience and knowledge to our board and takes our board composition to 9 total directors, 8 of whom are independent. In addition to expanding our board of directors, QTS announced a number of additional corporate governance modifications, including the rotation of board committee chairs, the decision to opt out of Muda, the hiring of a new consultant for the board and executive compensation and the reduction in the company's related party transactions. These modifications represent the latest example of the QTS’ board’s commitment to best in class governance policies and positions QTS to continue to deliver value for our shareholders. With that, I'll turn it over to Jeff Berson, our Chief Financial Officer to discuss our overall financial performance and outlook in more detail. Jeff?

[Jeff Berson:]

Thanks, Chad and good morning. Moving to slide 11, as you're aware, over the past several months, we've been working to transition certain non-core managed hosting customer contracts and support to our strategic partner GDT. Through this partnership, we're 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 the end of the third quarter, we're pleased to announce we've completed the migration of non-core services and customer contracts to GDT with strong success and ahead of schedule. When we began this process at the beginning of the second quarter, there were approximately 180 customers that we identified whose services and support we would look to migrate to GDT’s platform. We were successful in migrating more than 85% of those customers. While we laid out conservative initial expectations, we’re not surprised by our level of success in this initiative. GDT was carefully chosen as our strategic partner, based on their high level capabilities as an IT solutions provider and the fact that they were already a QTS customer and partner, integrated into our software defined datacenter platform. Through integration with SDP, we were able to offer customers a smooth and transparent migration. In addition, the GDT team ended up taking on more than 60 former QTS employees that further supported our managed hosting business and smooth customer transition. The timing for completing this initiative is ahead of our initial expectations of full migration by year-end. In addition, while the financial impact to our core business this year is limited, due to better than expected customer retention, we now expect a potential core revenue contribution in 2019 from the migration of non-core services and customers of approximately 10 plus million dollars, which represents an increase from our expectation last quarter of 8 plus million and our original stated assumption of 5 plus million and further de-risks our growth expectations for 2019. This initiative involves a significant effort across multiple groups within QTS and positions our platform to accelerate into a growing opportunity within Hyperscale and Hybrid Co-location. We’d also like to thank the GDT team for their partnership and engagement over the course of the last several months to successfully complete the migration and maintain the high quality support that our customers have come to expect from QTS. By the end of 2018, through the transition of the non-core managed hosting business, both non-core revenue and expense will be fully out of our financial results. Execution on cost reduction has tracked in line with expectations and we expect to complete the elimination of all non-core costs by the end of 2018. In addition, we anticipate any remaining restructuring related costs will be recognized in Q4. Now, turning to slide 12, I'll review our current balance sheet and liquidity position. As of September 30, 2018, we had a total of approximately 750 million in liquidity in the business, made up of availability under our revolving credit facility and cash on hand. We ended the quarter with leverage of approximately 5.3 times net debt to annualized consolidated adjusted EBITDA. Based on increased visibility to de-levering through an expanding backlog of signed, but not yet commenced revenue, we're comfortable maintaining leverage in the mid to high five times range in the near term to support our ongoing capital development plan. Supported by the Series A and Series B perpetual preferred stock offerings we completed earlier this year, our current capital plan development is fully funded through the end of 2018. We remain pleased with the available liquidity in our business and the ability for our balance sheet to support our future growth. Between our debt and preferred securities, more than 75% of this capital base is currently subject to a fixed rate, which insulates our capital stack from outsized interest rate risk. In addition, we have no significant debt maturities before 2022. As a normal course of business, we continue to actively evaluate a range of additional financing options to support our future growth. These options include, but are not limited to, structured financing products, asset divestitures and JV partnerships, which provide the potential to drive incremental efficiencies in our capital structure over time. We'll continue to monitor market conditions for opportunities to enhance the health of our balance sheet further and improve our overall cost of capital. Now, on to our financial outlook on slide 13. As a reminder, our financial guidance is based on the results of our core business. We're maintaining our core revenue guidance range for 2018 of between 408 million and 422 million, but expect to come in at the higher end of this range, due primarily to higher than anticipated utility recovery revenue, which passes through directly to higher operating costs. We're also reiterating our guidance for 2018 core adjusted EBITDA of 218 million to 228 million and core OFFO per share of $2.55 to $2.65. Moving on to churn guidance, our visibility and confidence in lease expirations through the end of this year remains strong. As a result, we're maintaining our rental churn guidance for 2018 of between 3% and 5%, which reflects the reduction last quarter from 3% to 6% previously. Finally, we’re reiterating our CapEx guidance range for 2018 of between 425 million and 475 million, excluding M&A. Overall, we're pleased with our operating results in the quarter and our execution on key strategic initiatives year to date. We are very encouraged by the increasing demand opportunity we see in our business and we’ll continue to look to allocate capital in a disciplined manner to balance both our growth and returns across our platform. And now, I'll turn the call back over to Chad.

[Chad Williams:]

Thanks, Jeff. Turning to slide 15, earlier this year, we implemented a plan to position QTS for accelerated leasing, improve profitability and enhance predictability. And I am pleased that our successful execution on our strategic initiatives is driving strong momentum that is clearly visible in our operating and financial metrics. Year-to-date, through the third quarter of 2018, we've been able to generate our highest leasing volume on record, which represents a 60 plus percent increase, relative to our average quarterly leasing over the prior three year period. We have recognized a more than 500 basis point increase in our overall profitability and a 30 plus percent reduction in customer churn, relative to our average performance over the past three years. We have also completed the migration of non-core customers and services to GDT ahead of schedule with a stronger expected contribution to growth in 2019, driven by better customer retention and the strength in our result is broad based across our Hyperscale and Hybrid Co-location verticals with our Hyperscale pipeline continuing to expand. The QTS team has accomplished a lot so far in 2018 and is excited to lean in to what we believe is an expanding growth opportunity for our industry and QTS. Through our industry's first software defined datacenter platform, megascale infrastructure and premier service delivery track record, we are differentiated in the marketplace and customers are taking notice. Our confidence level in both Hyperscale and Hybrid Co-location leasing performance remains high and we look forward to finishing out the year with strong momentum headed into 2019. I'd like to take this opportunity to thank our QTS employees across the country for their hard work and commitment to service to each other, our customers and our communities. As always, I’d like to thank our customers and shareholders for their continued trust and confidence in QTS. With that, we'd be glad to take your questions. Operator?

[Operator:]

[Operator Instructions] Our first question comes from Erik Rasmussen with Stifel.

[Erik Rasmussen:]

Yeah. Thanks. Nice leasing and great job on the GDT transition. Wanted to just circle back, it seems like you've seen a lot of strong momentum in the business Hyperscale and then obviously the GDT is tracking ahead of schedule. How would you categorize your opportunities going into 2019, especially as it relates to maybe growth for next year and then I have a follow-up?

[Chad Williams:]

Eric, thanks. This is Chad. We are excited at where we are. The opportunity for us to really laser focus on ’19, it just helps to get things like GDT done early. It gives us the ability to kind of continue to laser focus on kind of Hyperscale and Hybrid Co-location, our enterprise customer base and we continue to feel the momentum is building. Obviously, we start ’19 with a few less things to do, with things like the narrowing of the service, taking complexity out of the business and I think I couldn't be more encouraged about where our people and where our products with our service delivery platform and software defined datacenter is taking us. I think ’19 is going to be an exciting year of products, customer opportunity and really the focus in Hyperscale and Hybrid Colo. I think the book but not build backlog reaching back up almost $60 million is another very encouraging sign that we just got great visibility going into ’19 and momentum to build for the years to come. So we're very excited about the opportunity.

[Erik Rasmussen:]

Thanks, Chad. It sounds good. And then maybe just to Jeff on the CapEx, you saw a meaningful step up this year, given the growth plans, should we kind of expect a similar range in ’19 or was it ’18 kind of a high spend year and maybe moderate sometime next year?

[Jeff Berson:]

Yeah. Thanks, Eric. So, obviously, we’re going to give out our formal guidance at the end of Q4, but when you look at the growth opportunities we've got in the business, you’ve seen it accelerate in ’18 and to Chad’s point, with the backlog that we've got and the continued confidence we've got at the growth levels moving into ’19 and the visibility for that, you've got to put some capital in to support that growth. That being said, we're thrilled that we raised $400 million earlier this year. Our business plan is funded through the year. We're continuing to put money out at returns that are far in excess of our cost of capital and we think that there's a lot of opportunity to drive value in to ’19 and beyond.

[Operator:]

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

[Jordan Sadler:]

Wanted to just see if we could flesh out what's going on in the Hyperscale side in the pipeline. It looks like for you guys, in terms of inventory, Ashburn seems to be have a little bit of room. Manassas seems to be committed to this one customer who is going to ramp into it, where are you looking to site this one potential Hyperscale customer that you envisioned signing before the end of the year.

[Chad Williams:]

I think, Jordan -- this is Chad -- great question and what's great about it is there's multiple sites. As most of you all know, with over 1 million square feet of powered shell in the ground, we can point hyperscalers a lot of different directions for speed cost ability and great return metrics for us, because of that powered shell inventory, whether you're talking about the new building that did a soft opening this month in Ashburn, whether it's Richmond with this powered shell, whether it's Chicago or whether it is Dallas, Fort Worth, there is many places and I would -- I think what's most encouraging about hyperscale for us, it's an exciting part of our business. We've been much more intentional about it the next year, the conversations are very broad and very diversified in locations and that's what's probably most encouraging to me is that there's a lot of opportunities in a lot of different markets and our speed advantage, and ability to offer kind of that product with speed, cost and delivery is a great combination at a great time. And, we do have some things like enrichment going with the Trans-Atlantic fiber coming through the building now that offers some new, unique features for our hyperscale customers that we look forward to capitalizing on, but overall, the pipeline continues to build momentum and if I think about where we were last year, when we really started that initiative to more intentionally focus on hyperscale at the end of last year and where we are today, we couldn’t be more encouraged about where we're heading into fourth quarter with the opportunities and we do look forward to that.

[Jordan Sadler:]

Chad, just as a follow-up, I think we've talked about a larger hyperscale customer being a 5 plus megawatt type customer, I'm just curious what kind of lead time does this hyper customer require it in terms of having a facility open, ready and available or what kind of –

[Chad Williams:]

Well, what we typically see on hyperscale in those conversations, it's kind of like what we've done in Hillsboro, in Phoenix, which were big acquisitions of very strategic infrastructure rich land. Our purpose on those was to preposition those sites to be 12 months or less delivery. We're just about to achieve that with the preliminary planning and permeating and dirt work that we've done in both those new markets and we pretty much, for the most part, can accelerate and be part of just about any RFP with that kind of timeline, if you can be 12 months or less. Here's the really strategic part. For the million square feet of powered shell that I have combined in the footprint across the US, we can offer six months or less in those markets and that's kind of from start to finish, for anywhere from 2 to 5 megawatts and potentially more. So, that's a very interesting dynamic that can help lead us to defer results because of our speed, but having that combination, less than 12 months, I mean, if you look at what we did in Ashburn, that full build was well less than 12 months from start to occupying the first client that we pre-leased in that space. Our speed, our standardization, our development with what Mr. Robey and that team is doing is continuing to advance that and giving hyperscalers a very unique insight.

[Operator:]

Our next question comes from Eric Luebchow with Wells Fargo.

[Eric Luebchow:]

So your guidance implies a pretty substantial ramp in EBITDA in the fourth quarter. Could you just remind us what costs will be coming out and as we think about beyond this year, how much additional cost cutting and operating leverage runway do you have beyond the 53% to 54% margins you expect this year?

[Jeff Berson:]

Sure, Eric. This is Jeff. So, we laid out a plan in terms of pulling costs out of the business and driving margins up in the year versus where we were last year and I think the good news is correlated to the GDP transition and everything that we've done in our business, the vast majority of the cost takeout and the improvement in EBITDA and the improvement in margin, we've already accomplished. We've achieved every aspect of the cost that we laid out. We love the fact that our margins, if you look at the first nine months of this year on the core business versus last year, are up over 500 basis points and we think we're driving a lot of operating leverage. On a go forward basis, the expectation is we will continue to see operating leverage, but on a more normalized basis, I think, maybe 50 basis points a year of increased margin improvement. As you think about Q4, a part of that ramp in profitability in Q4. Q4 always tend to be an unusually higher margin, more profitable business. Part of that is you've got some accruals like employment and sales tax and other aspects that accrue through the first nine months of the year and just don't hit in the fourth quarter. You also have a period just based on the winter where the cost of cooling is lower. So you tend to see unusually higher margins in Q4 on top of the fact that we're maintaining stable cost as revenue is growing. So, all of that will factor in.

[Eric Luebchow:]

And just a quick follow-up, could you maybe talk about what growth rate or percentage of revenue you're seeing in your interconnection business and has the addition of the Microsoft Azure Express route in the AWS direct tech nodes had any impact on that business’s trajectory?

[Jeff Berson:]

Sure. From a financial standpoint, the interconnection business is growing close to 8%, sorry, really north of 15% and represents 8% of our revenue at this point. That's up from 7% and 6% over about a year ago. So, you are seeing the growth in revenue coming from that accelerate above our overall revenue. We like that business, it’s higher margin, but the other aspect and I’ll ask Jon to jump in is we're also transitioning a little bit in terms of the way we can offer that interconnection and it's driving the digitization and the technology differentiation that I think QTS is known for leaning in on. Jon, maybe you want to jump in a little bit.

[Jon Greaves:]

Great. Thanks, Jeff. And Eric, what Jeff is alluding to is the automation and the platform would put in place over the last several years, particularly the platform we use for cloud ramp and other services are now fully embedded in the platform. So, customers can order a lot of these services now online and then frankly even just month over month, we just see incredible increase in customers preferring to buy online versus buying in person.

[Operator:]

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

[Ari Klein:]

Chad, you mentioned some of the positive activity going on in the Richmond market. Has that resulted in any change in pricing in that market? And then Jeff, just going back to the comments on the strength in the pipeline and the growth into next year, how do you think that impacts your capital plans and you mentioned some potential options there, how you rank those preferences?

[Chad Williams:]

Ari, I’ll take the first part. This is Chad. Thank you for the question. What's been fun about, as we talked about in the script, a large number of customers, actually hybrid enterprise customers see growth in Richmond and as we know, the one reason that we love a balanced business in this quarter probably represents one of the best balances we've ever had between hyperscale and hybrid colo is that we do have a lot better pricing dynamics around hybrid co-location. So I would say that I wouldn't say it's any materially different, but it's just strong and consistent enterprise pricing for those hybrid co-location deals that we've seen tremendous pick up in Richmond. So we are very encouraged about that. I do think the opportunity to do hyperscale is available in Richmond and I think over the next few years, you'll see even more that play out, but I wouldn't characterize it as anything really above the norm or irregular. It's kind of right in the sweet spot of, we talk about that in 9% to 11% returns for hyperscale and I think, Richmond will be consistent with that. Our cost basis there does help us quite a bit, because of what we have in the dirt there and what cost advantage we have and so much infrastructure, but we see consistency and opportunity is really what we see. Jeff, do you want to take the next part?

[Jeff Berson:]

Sure, Ari. So, we talked a little bit, our CapEx guidance this year of 425 to 475, we’ve maintain that guidance. But that CapEx has driven, we think, market leading growth in the business this year and we do expect that that growth will continue next year and will need the CapEx to put in to continue to fund that. At the same time, to Chad’s point, the powered shell that we've got and the visibility we've got to bring space on line and meet customer’s needs at a more capital advantaged level and the fact that our product mix has given us higher returns, we think does drive capital efficiency in the business, so we're excited about that. From a rank and options, I can tell you without question that I and everyone in this room think that our equity does not appropriately reflect the underlying value of the business. It's not something that we're excited about at this time. We do have a lot of options in terms of raising capital. Again, we're very happy that we did the 400 million in the preferred and the convert earlier this year, which gives us capital support. We've got to put back backlog that gives us visibility to natural de-leveraging if the business ramps and as we go forward, having additional options that could include JVs, working with other financial partners, monetizing assets and other factors are things that we're all in conversation with and we’re open to multiple different sources there.

[Operator:]

Our next question comes from Robert Gutman with Guggenheim Securities.

[Robert Gutman:]

I was wondering if you could provide us a little more color on the progress of the CloudRamp product, how that’s selling through AWS. And if you're intending to provide some metrics on that at some point?

[Chad Williams:]

Yeah, Rob. This is Chad. We continue to kind of find the foundation with CloudRamp and I'm going to let Jon kind of talk about it in more detail, but one thing I want to kind of call out is the underpinning of what drove that opportunity is really the digitization and what we call the first industry software defined datacenter. That is embedded now across our entire platform. And I'm going to have Jon talk a little bit about that, how he sees CloudRamp playing out.

[Jon Greaves:]

Absolutely. Thanks, Chad. And Rob, good to speak to you again. So, on the CloudRamp front, the technology that was the core of CloudRamp, as I mentioned has now been embedded throughout the platform. So we have the ability to automate and take kind of e-commerce like transactions now across a wide variety of services, ranging from everything from small hands and kind of physical activities in the data center all the way through to physical cross connects and virtual cross connects. So, we’re excited to see that move forward. CloudRamp specifically, as we mentioned on the last call, we’ve expanded the relationship now to include other cloud providers and we’re also taking that same technology and expanding it to other carrier related services as well. So we’re very excited to see the continued growth there in each of the markets you launched an.

[Chad Williams:]

And again those customers are smaller and the opportunities are more of a enterprise level hybrid, but I think it's also why in a market where people are trying to differentiate yourself, it's one reason I think that we put up one of the strongest quarters in our hybrid history is because our products and the differentiation around those hybrid co-location products are differentiating ourselves. CloudRamp is a piece of that and but really the technology and the focus around the software defined datacenter is really giving Clint and his team a differentiation, as Jon and the product team really roll that stuff out. So we couldn’t be more excited and we’ll continue to grow multiple cloud providers and hopefully continue to see good momentum, even if it is small customers that come through in that cycle, it adds up over time and we’re excited about that.

[Operator:]

Our next question comes from Sami Badri with Credit Suisse.

[Sami Badri:]

I wanted to talk about the SaaS 24 megawatt lease that you referred to on the slide deck and how your customers actually leased more capacity? I think maybe potentially earlier than you planned. Could you maybe talk to us about how you thought or how you think that is going and is this actually being absorbed faster than you expected and my broader question is really tying to more Hyperscale CapEx and hyperscalers are performing and how they’re deploying CapEx and just wanted to get a sense of the overall sector and the way you guys see it since you're becoming more indexed to Hyperscale CapEx over time?

[Chad Williams:]

Yeah. Thank you, Sami. Specifically, about the current customer, I would say that we talked about the 24 megawatt customer being a couple of year deployment and I would say that, you're saying that a two year deployment, are they a little bit early, maybe a month or two, but they're not dramatically early or late, so they're kind of hitting what we actually kind of like, which is they're doing what they said or thought they would do. So we haven't seen any irregular and it's always great to pull something in a little sooner and that's what you're seeing play out there. Hyperscale is lumpy and the reason we've built this business with the foundation to be able to have an access to the dozen or so hyperscalers that really matter and the thousands of enterprise customers that still exist every day is because of that lumpiness. And so I know there's been a lot of chatter in the market lately. I can tell you from Tag Greason and the hyperscale team that they continue to see strong deal flow and even though it is lumpy and still is lumpy, we have not seen any changes materially to demand profiles or opportunities in our funnel. And so I think like everything, there's always a little noise once in a while and when things settle down, everybody kind of realized that it's moving right along and that's what we're seeing in hyperscale.

[Sami Badri:]

And then my next question is just has more to do with Arizona and when you think that's going to become almost a more comparable market to Ashburn, just given that the amount of construction that's actually occurring in specifically that state has recently stepped up pretty significantly in the first half of 2018. When would QTS potentially consider really deploying capital and scaling up the business there? Are you waiting on a specific inflection, certain customers, et cetera, maybe you could just give us some more color on that side?

[Chad Williams:]

Yes. It's a great question. Arizona has been a great market and some of our competitors have really done well there. We certainly noticed that. I will tell you our patients I think ended up with the best property left in Arizona with the 85-acre purchase last year in the center of Phoenix with unbelievable power, water and infrastructure communications access. It's just an unbelievable site. It is why we were encouraged to take it all the way through the rezoning, the re-platting and have it now data center eligible and ready to go and we're very close to being able to be in that, if not now in a 12-month or less window. So we are in kind of an active conversation with opportunities there and I really want the deal flow that comes from that to really drive significant thing. We have to watch where our capital goes, we have to be thoughtful about investing not in too many locations, at the same time, so we're going to let deal flow and pipeline strength kind of drive us there, but when you think about our site and being in the middle of Phoenix is a very unique opportunity that with some of the suburbs, kind of be in full and having to stretch out to newer suburbs, this is right in the heart beat of Phoenix and I think it'll be a site over time that will bring tremendous value and opportunity for QTS and we'll just see how the pipeline develops and let that kind of drive really the interest in what we view there.

[Operator:]

Our next question comes from Michael Funk with Bank of America.

[Michael Funk:]

The first, it's a clarification. There has been a lot of noise this quarter around pricing and demand. So just to clarify, you’re saying that you’re still targeting or underwriting the same returns for both hyperscale and colocation, correct?

[Chad Williams:]

Yes. Yeah. I mean, we continue to see the opportunity in Hyperscale in the same 9% to 11% range and our hybrid business continues to be a returns leader for us and we continue to see co-location especially with our differentiation, what's been fun is what Jon and the team's doing around the software defined datacenter. It's amazing how much you can change the conversation from price to solution and when you can change that price to solution, it's not that people aren’t always looking for a good deal. They are and there's enough competition out there that's willing to price stuff, but when you can get yourself out of that pricing conversation sooner and be talking about how you're embedded in their solution and how you can connect to their systems and how you can drive the automation in the data that customers really want in this level of data and technology that we have, it is a great conversation. I know Clint and the team are leading the way in that conversation, but returns are -- we haven't seen any material change.

[Michael Funk:]

And then maybe a comment on your visibility and what you're seeing on deployments of next generation technology such as AI, machine learning, big data and where we are in that life cycle with regard to future demand driven by those newer technologies and even the importance of the proximity that your data centers offer for that type of new technology demand?

[Chad Williams:]

Yeah. Michael, I'm going to let Jon take that, but it's all about why we are convinced that the data center industry hasn't changed much in the last couple of decades and it's why a few years ago, when we really focused on that and said we want to change the way we deliver services, it's one of the reasons why I’m most encouraged and Jon can talk to you a little bit about the specifics of how that's developing.

[Jon Greaves:]

Absolutely. And Michael, one of the big trends I think we’ve seen over the last probably two quarters now is the more emergence of kind of those AI workloads really making it into the datacenters for production use. So often those come in now with a much more high density solution that requires kind of GPUs and other kind of exotic hardware into the mix that allow them to achieve the results they’re looking for. The other trend we’ve seen a lot of is a lot of the source data, particularly if it's coming from an IoT solution tends to be originating now from the clouds with customers electing to do the data processing and data warehousing that data outside of the cloud. So the proximity play absolutely comes in to factor and it's really two-fold. One fold is latency, which matters. The second is actually cost and as you probably aware, getting data into the clouds tends to be pretty straightforward and pretty economical, but pulling data back out to some other activities becomes kind of a lot more expensive. So some of the activities we’ve been building around our software defined networking strategy that sits within the software defined datacenter has really enabled customers some really unique grants to kind of managing the data strategy.

[Michael Funk:]

And then one final one for Jeff here, just a bookkeeping question. Have you evaluated the impact of the new lease accounting standard? What it meant for FFO in 2018 and potentially what that means in 2019?

[Jeff Berson:]

Yes. Thanks, Michael. So the answer is from the new lease standards and accounting standards, we do not expect any material change in our numbers in ’19. Some of the big aspects that drove changes, one, we own the vast majority of all of our infrastructure, 90 plus percent and so we don't have any issue around the leasing standards and we love that we own our real estate. And the second is we've been fairly conservative in terms of the way we capitalize salaries for our sales people and so that's been another big area where you’re seeing some change and given that we've been conservative all along, we don't see any significant change or adjustment in our numbers.

[Operator:]

Our next question comes from Frank Louthan with Raymond James.

[Frank Louthan:]

I apologize if I missed this, but where are you currently with your salesforce and what percentage are you getting from channel sales and how should we see that shifting over the next 12 months?

[Chad Williams:]

Frank, I'm going to let Clint take that, but Clint joined the team as you all know April 2 and his pace is hard to keep up with, but I’m going to let Clint speak a little bit directly about kind of where he's seen and what he's done in channel and the sales force since getting here.

[Clint Heiden:]

Yeah. Thank you, Frank. So, we've put a big effort in to the channel group. We think it's a great way to funnel leads into our sellers and partnering with that go to market approach. We've also combined some other tools that help us bolster the leads into our core selling organization. So going into 2019, we feel that the channel and the broker community are very strong avenues for us as are our internal lead generating programs and the emphasis on core marketing efforts that we've put to -- we put in place.

[Chad Williams:]

And just to brag a little bit on Clint, the new inside sales function that he created from scratch since he got here has shown material change in what it's producing since we didn't have really that function like Clint set it up. It's just been an amazing thing to see his imprint and change in that organization and the opportunity to take the strengths that we had and really build on that. So the inside sales function is a great new dynamic that Clint's built and developed in a short period of time.

[Frank Louthan:]

So Clint, for perspective, sort of where was channel as a percentage of sales when you got there and what do you ultimately think your target is and then as another follow-up, from a sales productivity standpoint, where are you with the change you’ve implemented in the sales force relative to where you think it should just sort of top out?

[Clint Heiden:]

Yeah. Sure, great. So we roughly had 30% coming from the channel, call it, 2017. 2018, we’re seeing it trend through the first two quarters, upwards of 50%. And then going into 2019, I'd like to see that kind of go into the 60%, 65%. Then leads being generated from this inside sales team coming from zero to now producing relatively -- in the hundreds of inbound leads now are outbound generated leads. The productivity per rep, if you go back to January, I think was about, $5000 of MRR per rep, generating on a monthly basis. We've now seen that jump up to roughly 8,700 MRR per rep and we've also seen a lower cost go to market with the number of reps. So we've seen bookings per month in hybrid go up, cost in sales go down and leading to more efficient overall sales organization and leading to a more efficient overall sales organization.

[Operator:]

Our next question comes from Richard Choe with JP Morgan.

[Richard Choe:]

Hi. I just wanted to get a little bit more color, with the GDT transition, the higher book, but not billed, but with rental revenue coming down, how should we think about how revenue growth should be going forward and then I have one follow-up. Like, when should we see it start ramping?

[Chad Williams:]

So I think if you look at rental revenue and you look at overall revenue in terms of where we are Q3 over Q2, you’ve already seen extremely strong growth, so the book not billed backlog, the increase in leasing volume, the reduction in churn and downgrades in the business and the greater visibility we have from what we're seeing is all already reflected in the revenue growth that you're seeing quarter over quarter and year over year. We've seen mid-teens plus year-over-year revenue growth on our core business in Q1, in Q2 and in Q3 this year and we anticipate and continue to be confident with our expectation and guidance that you’ll continue to see that mid-teens market leading revenue growth going forward.

[Richard Choe:]

And then in terms of, it seems like, given the book not billed and given the commentary that you've had, it seems like the CapEx numbers are going to be pretty flat, if not higher going forward. I know you don't want to give ’19 guidance, but how do you think about your leverage target and you had commentary about the equity side. How should we think about your comfortable kind of range with leverage going forward?

[Chad Williams:]

Sure, Richard. So we’ve always maintained and continue to be comfortable with leveraging in the mid to high 5 turns. Over a longer term basis, I think you'll see leverage in and around the mid-5s, but given the book not billed backlog and the visibility we have and our perspective in terms of the underlying value of the business relative to our stock price, similar to what we said earlier in the year, we are comfortable with that leverage going up more to the high 5s. We don't anticipate any need to bring leverage beyond that and we have full expectation to be able to continue to drive and grow our business and again, we're happy that that plan is fully funded through the rest of the year and have good visibility into next.

[Operator:]

Our next question comes from Nick Del Deo with MoffettNathanson.

[Sydney Marks:]

This is Sydney Marks calling in for Nick. Thanks for taking the question. Given some of the volatility we've seen, as of late, can you talk about the relationship between capital market conditions and your willingness to invest at the current rate? I mean, how challenging of an environment will we need to see before it influences your investment plan?

[Jeff Berson:]

Hey, Sydney. This is Jeff. So the good news from QTS standpoint is because of the product mix, because of the higher returns in hybrid colo that we're seeing blended with the strong returns from Hyperscale, when we're putting capital out, we are continuing and as you can see in this quarter, it's sort of a high double or mid-double digit type return. It’s far in excess of any aspect of our cost of capital. We can continue to put money out with a very large spread between that cost and the returns and continue to drive value for shareholders and drive value in the business. So our expectation is as long as we continue to see opportunities to put our capital and strong returns to drive value, which we have and we don't anticipate changing, we’ll continue to grow the business.

[Sydney Marks:]

One quick follow-up, I know we’re over, just regarding the new property in Atlanta, is the $80 million price tag reported in the press accurate and is this building one that can be repurposed or is it a tear down?

[Chad Williams:]

Yes. The property is the – this is Chad. The property is the final piece in the puzzle for our expansion. We couldn't be more excited about the opportunity to have 150-megawatt roadmap now in Atlanta. It's taken us about five years to make that assemblage in probably one of the hottest areas in all of Atlanta, called West Midtown. So it was not a given that we could make that acquisition and we do feel it's very strategic, partly because we will feed all of that property from our cost advantage owned in grid substation in Georgia Power. So that's a great opportunity for us and probably the most encouraging part is now, we have a very comprehensive story to sit down and talk to our over 300 customers at Metro about expansion and opportunity for continuing to be able to grow with QTS, which was a huge part of that initiative.

[Operator:]

[Operator Instructions] Our next question comes from Jonathan Atkin with RBC.

[Jonathan Atkin:]

So there's some pretty interesting disclosure about the Virginia market. Richmond obviously, but also Northern Virginia and can you drill down a little bit more perhaps how you see medium to longer term the dynamics of the Manassas market evolving over time, not just for you, but for the industry, because there's a lot of other folks that have sort of validated that opportunity. Manassas over Ashburn, is it – they’re going to be parallel paths or will it be different types of requirements that you see landing in that markets in Manassas. And then briefly, if there was anything to kind of call out on cross connect trends by geography or through partners versus kind of cloud connect versus enterprise. I'm interested in just a little bit more granularity on what you're seeing on the cross connect side?

[Chad Williams:]

Jonathan, I’m going to let Tag Greason, our Chief Hyperscale Officer to talk to you about Virginia and then Jon can follow up with the cross connect.

[Tag Greason:]

Hey, Jonathan. How are you doing? This is Tag. Thanks for the question about Virginia. It's a fascinating market, if you look at the state wide aspect of the marketplace. What you're hearing from our customers and our prospects is diversification across different locations. Ashburn can't be the only place in Virginia for people to set up shop. As you know, Ashburn land prices continue to increase and get more scarce. We've got a great runway in Ashburn, but next Ashburn needed to reveal itself and that is clearly becoming Manassas. We've got a great runway in Manassas as well. But when you look at the overall marketplace, hyperscalers don't want to be too concentrated in one location, so that Manassas alternative is becoming a very, very viable alternative. More importantly, though, Richmond, which is an asset that we've been focused on for years becomes even more viable as you get the trans-Atlantic cable coming through and so really the bottom line for Virginia is having options for the hyper scalars and the hybrid co-location customers to deploy in other than just the very, very dense Ashburn area. I'll turn it over to Jon for the second part.

[Jon Greaves:]

And Jonathan, just on the cross connect side of things, what we see from a volume and demand is the most kind of requested type of cross connect is really from our locations to one of the software defined networks and then using that as an on ramp to reach other targets or other clouds. The second highest in demand is actually just the straight data center to cloud provider cross connect with the probably the more traditional carrier cross connects somewhat slowing down a little bit. Those are the two that are really the drivers for all of the activities we’re seeing. And then on top of that, we're also seeing increased demand now for the virtual cross connects, allowing customers to kind of essentially multiplex multiple single cross connects over a single physical cross connect.

[Operator:]

Our next question comes from Nate Crossett with Berenberg.

[Nate Crossett:]

I just wanted to ask a quick question on Atlanta. We've seen some new players entering the market recently and I just wanted to know, are you the only one with the power cost advantage? I believe you said around 20% in the past. Is it possible that other players could get a similar power advantage?

[Chad Williams:]

This is Chad. We think of ourselves because of the scale having a unique opportunity, some of that power cost advantage has just been because we've been there a decade. We own our substation, the substation is in grid and we have access to a program that allows us to use the scale of our purchasing to do that. Can it be replicated? I don't know of it being done or able to, but you certainly wouldn't be able to do anything unless you could own your own substation, have it in grid and have the ability to get on a program that really was started over a decade ago that has the size and capacity that powers one of the largest data centers in the world, taking that pricing and volume. So obviously, there's a lot of hurdles there, you never say nothing can be done, because I don't know that to be factual, but I do know a lot of the facts and the facts would lead me to say that we have a very strategic advantage that drops significant savings to our Hyperscale customers and I think it's one of the reasons why they have been probably most keen on us demonstrating a roadmap and why it is so strategic that we were able to make that final strategic acquisition of that site to give us contiguous 150 megawatt roadmap at a very cost advantage power basis. So we're excited about it.

[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 on behalf of all the QTSers out there that make this possible. We appreciate your hard work. Thank you to our customers and most important, thank you to our shareholders. We appreciate the trust and confidence you placed in us. We couldn't be more excited. Sorry, we ran over on time. We had a lot of good things to talk about, look forward to continuing to keep investors updated and we appreciate the partnership and the opportunities in the community. Thank you and we'll talk to you next time.

[Operator:]

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