QTS Realty Trust, Inc.
Q1 2017 Earnings Call Transcript

Published: 2 May 2017

[Operator:]

Good morning and welcome to the QTS First Quarter 2017 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Stephen Douglas, Head of Investor Relations. Please go ahead sir.

[Stephen Douglas:]

Thank you, operator. Hello, everyone and welcome to QTS's first quarter 2017 earnings conference call. I am Stephen Douglas, Head of Investor Relations at QTS and I am joined here today by Chad Williams, our Chairman and Chief Executive Officer; Jeff Berson our Chief Financial Officer and Dan Bennewitz, our Chief Operating Officer, Sales Products and Marketing. We're also joined by and additional members of our executive team who will participate in Q&A. Our earnings release and supplemental financial information are posted in the Investor Relations section of our website at www.qtsdatacenters.com on the Investors tab. We also have provided slides and made them available with the webcast and on our website, which we hope will make it easier to follow our presentation today. Before we start, let me remind you that some information provided during this call may include forward-looking statements that are based on certain assumptions and are subject to a certain 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 FFO, operating FFO, adjusted operating FFO, MRR ROIC, EBITDA and 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. Hello and welcome to QTS's first quarter 2017 earnings call. Our growth continues to be driven by our QTS core strategy of providing fully integrated datacenter solutions across the broad footprint of mega scale infrastructure. On Slide 3, from QTS’s inception, our fully integrated and flexible model was built from the understanding that not every IT requirement fits into a single standardized infrastructure bucket. Our ability to grow and evolve with customers as their IT infrastructure changes, allows QTS to continue to support the future needs of their IT stack. We continue to see evidence that demand for hybrid IT datacenter services is not only accelerating, but rather becoming the standard IT infrastructure model for enterprise customers. According to Rightscale 2017 State of the Cloud Report, leveraging hybrid cloud is the top priority for enterprise central IT and based on IBM’s 2016 Applied Insight Survey, 70% of hybrid IT implementers report they will always have a blend of traditional IT and cloud. QTS has invested in the technology and the service capability to deliver a truly integrated hybrid solution that customers can manage from a single user interface as opposed to alternatives in the market, which require coordinating multiple disconnected partner relationships and products. As an example, we were pleased to recently announce that QTS is now one of the few select companies to achieve AWS Advanced Consulting Partner status. Achieving this partner level requires compliance with a rigorous set of certification and requirements which now opens up additional revenue opportunities for QTS. In addition to our ability to provide customers to access to AWS public cloud to our direct connect solution, our enhanced partner status gives QTS the unique ability to provide expert management of customers AWS public cloud solutions. Through QTS’s integrated platforms customers continuously provision dynamic workloads on AWS which will then manage as part of the QTS delivered fully integrated hybrid cloud solution. Our enhanced partnership status is further evidence that the public cloud providers continue to look to a partner with datacenter companies like QTS that can provide the hybrid datacenter solutions that enterprise customers need. Look for additional announcements from QTS over the coming weeks on ways we are innovating and digitizing the datacenter customer experience and further enabling our customers’ diverse hybrid datacenter strategies. In addition, we have the premium support staff in place and securing compliant solutions to differentiate ourselves in the market, develop lasting relationships with our customers and deliver increasing value and support over time. The market opportunity from growing hybrid IT demand is significant for datacenter providers and we have a unique ability to capitalize on. Turning to the quarterly leasing performance on Slide 4, for the quarter we signed new and modified leases totaling approximately $4.3 million of net incremental annualized rent. This was below our four quarter average and was not in line with our internal leasing targets. Our leasing performance was partially impacted by several potential C1 opportunities which we had expected to close in the first quarter, but ultimately were pushed beyond Q1 in addition to a somewhat lighter C2 leasing quarter. As we discussed in previous quarters, wholesale deals can be uneven as customers do not buy in quarterly windows but when they hit, they offer the opportunity to accelerate growth. This can create volatility in reported quarterly leasing results as we’ve experienced in certain quarters in the past and we will continue to see in certain quarters in the future. While we are not satisfied with our leasing performance for this quarter, we do not believe Q1 as an accurate reflection of the strong demand trends we are broadly seeing in the market. When looking at leasing performance over our trailing four quarter period, we are coming off near record leasing results and our pipeline remains strong with visibility into a number of significant opportunities over the coming months. In fact, so far through just the second quarter to-date, we already have visibility on net leasing volumes that is tracking at a level comparable to the entire Q1. While we are active in dialogue with a number of C1 hyperscale customers including both new logos as well as existing customers looking to incrementally expand their deployments with QTS as we experienced over the past year, while the largest single multi-megawatt deal that we signed in 2016 was four megawatts with a leading hyperscale cloud provider, that customer ended up doubling its footprint in Q1 to Q2 last year and in total now aggregates to 8 megawatts. We have also continued to see a number of our largest customers incrementally expand with us ultimately reaching hyperscale size and footprint. As another example during the first quarter we talked about a 1.2 megawatt footprint expansion with a global software as a service provider in our Atlanta footprint. While no one would typically consider 1.2 megawatt deal a hyperscale, this is a customer that now aggregates over 10 megawatts with us across multiple datacenters within our footprint. We will continue to evaluate larger C1 hyperscale opportunities as we do with all deals across our footprint striving to balance near and long-term financial performance and capital allocation. In addition to continued visibility on C1 growth, our C3 cloud and managed service business is ramping well. Consistent with the inflection in demand for hybrid datacenter solutions that we are seeing in the market, this quarter, we experienced the strongest annualized revenue growth in C3 over the past three years. Strong C3 performance also has contributed to significantly improved pricing in our C2 and C3 and overall new and modified leasing results. During the first quarter, pricing for C2 and C3 new and modified leases were up 30% compared to our prior four quarter average and overall pricing for new and modified leasing was 39% higher driven primarily by growth in C3 leasing. Our C2, C3 pricing historically approximated 1300 per square foot with growth in our C3 business, C2, C3 blended pricing on new leases as averaged over 1700 per square foot over the past two quarters. The strength we are seeing in C3 continued to support our thesis around hybrid IT with 60% of our revenue generated from customers using more than one of our C products. C3 also represents another lever we have in our business to drive incremental value on top of space and power for our customers at incrementally higher returns on capital. For renewals on a like-for-like basis, where customers renewed contracts without a change in square feet, we experienced renewal rate increases in the first quarter of 2.6% versus the pre-renewal rates. This was consistent with our expectation of a low to mid-single-digit renewal pricing increases. Overall, the pricing environment across our footprint remains steady and is consistent with the positive market trends we are seeing. There are a number of additional key performance metrics with our business that remains positive. Our backlog of signed but not yet commenced annualized revenue remains strong on $42 million and continued to provide enhanced visibility into future cash flow growth and returns in our business. Churn during the quarter came in at 3.3% excluding a one-time churn related to a previously disclosed customer move out in the lease facility in Northern Virginia. Our normalized churn for the quarter was approximately 0.7%. This is consistent with our full year churn expectation of 5% to 8% regarding the specific customer churn in Northern Virginia that I just mentioned and that we’ve been discussing on previous calls, we continue to evaluate multiple options for the 2 megawatts of vacant capacity. We will continue to analyze our alternatives and expect to announce our plans for this vacated space before the year end. Now this quarter, I’ve asked our Chief Operating Officer Dan Bennewitz to lead our sales, product and marketing organization to provide additional comments on some of the demand trends we are seeing in the market and why we are so excited about the opportunity in front of us with our product set. Dan?

[Dan Bennewitz:]

Thanks, Chad. Our first quarter leasing performance was below our prior four quarter average and while we have experienced similar performance levels in prior quarters over the course of our history, it is not consistent with how we expect our business to perform nor the robust opportunities for significant growth that we are seeing across our footprint. Turning to Slide 5, the underlying demand trends across our sales channels remains strong. Our overall sales opportunity funnel is up nearly 30% versus a year ago and we added 40 new customers in first quarter 2017 which was an increase of almost 50% relative to first quarter 2016. To capitalize on the expanding growth opportunity we are currently seeing, we are increasing our internal direct sales capacity over the course of 2017. We are doing this through a combination of additional direct quota-bearing sales reps as well as accelerating the ramp to full productivity of sales personnel hired over the past 12 months. In addition, we are expanding our channel partner program to go after more of the market opportunity and expect that it will contribute approximately 30% of booking by end of this year, versus 22% this has contributed last year. Our sales funnel is primarily driven by two sources of the demand today. Hyperscale and large version 1000 enterprises which are driving C1 and core enterprise outsourcing which is driving C2 and C3 blended hybrid solutions. Our total C1 pipeline today is up almost 35% versus a year ago. Although these larger opportunities tend to carry lower rents per square foot, they also offer the opportunity to strategically accelerate growth with some of the largest and fastest growing datacenter customers in the world. The other side of the demand that we are consistently seeing in our funnel is more traditional enterprise outsourcing. As Chad mentioned, this is where we are seeing strong activity and interest in our hybrid IT datacenter solutions. Our C2, C3 pipeline today is up approximately 25% versus a year ago, with new logos accounting for approximately 60% of the funnel. Industries where we are seeing strong hybrid datacenter demand include, software as a service, cloud and technology, financial services, healthcare and government in that order. We are seeing this activity across our footprint, but most prominently in Dallas, Virginia and Chicago followed closely by Atlanta and New York, New Jersey. We are also seeing stable pricing in the market. Pricing may change based on product mix, but for comparable products across our markets, we continue to see strong market dynamics to support the pricing in core QTS markets. As Chad discussed, the ability to support our customers’ future IT infrastructure roadmap is a powerful differentiator for us in the market and something we will continue to leverage. With that, I will turn it back to you Chad.

[Chad Williams:]

Thanks, Dan. Moving on to Slide 6, I’d like to highlight some of the key customer wins during the quarter. Following our official Chicago mega datacenter opening in the third quarter, we have been pleased with the initial ramp in demand in addition to announcing a larger 3 megawatt anchor tenant lease with a hyperscale cloud-based software provider in Q3, we have driven increasing performance from our local C2 sales team. During the quarter, we announced the signing of new C2, C3 combined leases with Columbia College, one of Chicago’s top creative academic institutions, QTS is assisting Columbia College in consolidating its IT infrastructure as part of a five year strategic plan to modernize the college’s technology infrastructure and move to an outsourced IT model. As part of this agreement, QTS will host Columbia College’s primary environment out of our Chicago mega datacenter and also provide a cloud-based disaster recovery solution through our facility in Suwanee, Georgia. QTS’s ability to provide a broad set of fully integrated solutions and connectivity on ramp to the cloud services provides a long-term roadmap that customers are increasingly looking for as they move from a primarily in-sourced to outsourced IT model. Also in Chicago during the first quarter, we signed a C2 lease with a new logo. This customer, a leading global in-flight Wi-Fi communications provider shows QTS on the strategic location of our site adjacent to downtown Chicago access to a multitude of connectivity options and the overall quality of our facility and on-site personnel. In our conversations with this customer, it is important that their datacenter was located less than a ten minute drive from their downtown Chicago headquarters. In addition to space and power, this customer lease agreement includes 12 cross connects to various carriers in a future path to an AWS direct connect, which was the key differentiator from them and they are evaluating alternate options in the market. This customer is seeing significant growth in its business and we look forward to potentially expanding our relationship across QTS’s broader footprint in the future. More broadly, these two deals in Chicago demonstrates the unique value that our highly connected, metro Chicago location provides, specifically for higher return local C2 and C3 customers. Our pipeline in Chicago remains strong and we look forward to taking advantage of the additional growth opportunities there are in the future. Shifting to Piscataway. For the third quarter in a row now, we are pleased to report a new lease signed in our Piscataway New Jersey site. During the quarter, we signed a deal with a web-based financial services company headquartered in lower Manhattan. This customer is taking a combination of C2 space and power with additional C3 services and connectivity. As part of this agreement, this customer will be migrating its primary production datacenter from downtown Manhattan to our site in Piscataway, largely as a result of risk mitigation following the impacts of Hurricane Sandy. While the overall size of this deal is relatively small, it represents the beginning of what we continue to believe is a significant opportunity to drive higher returns out of the Piscataway site through the execution across the higher touch, integrated technology services model. We have a pipeline of C2 and C3 deals that continues to build and we look forward to the opportunity to continue to drive higher return and efficiencies in New Jersey. With that, as I transition the call to Jeff Berson, I want to take a minute to thank Bill Schafer for his many years of service as our Former Chief Financial Officer as well as his continued support and involvement with QTS as our new Executive VP of Finance and Accounting. As you all know, Jeff assumed the Chief Financial role effective April 3rd. As expected, Bill has provided a seamless hand off of the financial leadership position to Jeff. I am excited about the role that Jeff and Bill partnership in leading our financial organization will play in supporting QTS’s next phase of growth. I’ll now turn the call over to Jeff Berson to discuss our financial results, development pipeline and outlook in more detail. Jeff?

[Jeff Berson:]

Thanks, Chad. I’d like to echo your comments. Bill has been an exceptional partner to me since I joined QTS and particularly from the time I took over the CFO role. I’ll continue to rely on his experience and guidance and appreciate the opportunity to expand our partnership in my new role to further QTS’s growth and strategic aspiration. Now, moving on to the financial results on Slide 8. For the first quarter of 2017, we reported total revenue of $106 million up 12% over the first quarter a year ago. Adjusted EBITDA of $48.3 million, up 12% year-over-year, and operating FFO, up 7% year-over-year. Operating FFO for the first quarter includes a non-cash tax benefit of approximately $1.5 million. As disclosed previously, our year-over-year operating results were impacted this quarter by an approximate $10 million annual churn event that occurred at the end of January in one of our leased sites in Northern Virginia, which Chad discussed previously. As this customer move out occurred at the end of January, there will be an additional month of incremental impact in the second quarter that will result in moderated quarter-over-quarter growth in Q2. For the first quarter, we achieved an annualized unlevered return on invested capital of 13.8%. As we’ve discussed on previous calls, due to the early stage of investments in new lower utilized facilities like Piscataway, Chicago and now Fort Worth, we expect our ROIC to remain below 15% fully stabilized target over the course of 2017 and ramp over time as these newer mega datacenters lease up. Next, on development on Slide 9, during the quarter, we spent approximately $66 million in capital expenditures, the largest majority of which was related to ongoing developments to our existing site. We brought an aggregate of 31,000 square feet of raised floor online in Chicago, Dallas and our Vault Campus in Northern Virginia during the first quarter. As of the end of the quarter, our total built out raised floor was nearly 1.4 million square feet, which represents just over half of the total powered shell raised floor capacity of 2.5 million square feet in our existing facilities, not including land that we own adjacent to our mega datacenter. Over the balance of 2017, we anticipate bringing online an additional 131,000 square feet of raised floor, which includes 14,000 square feet of raised floor in Chicago as part of our continued ramp in that market and over 67,000 square feet in Dallas between our Irving and Fort Worth facilities to support continued strong momentum we have experienced. We also anticipate bringing online additional capacity in Atlanta, Piscataway, Santa Clara and Northern Virginia. Turning to Slide 10, I will review our resulting balance sheet and liquidity position. As of March 31, 2017, we had a total of approximately $512 million in liquidity in the business made up of availability under our credit facility and cash on hand. On March 20, we announced that we had established a $300 million at the market equity shelf registration. The ACM provides us an additional efficient means of raising capital in a moderated and disciplined process as part of our overall balanced capital allocation strategy. In addition, as part of our conservative approach to balance sheet management, in early April, we entered into four interest rate swap agreements with regard to $400 million of our credit facility term loan. Entering into these swaps, effectively fix the interest rate on $400 million of term loan borrowings at approximately $3.5%. The swap agreement commenced on January 2, 2018, and runs through the respective maturity date of our two term loans which are December 17, 2021, and April 27, 2022. $200 million of swaps was allocated to each term loan. We evaluated multiple options to manage our floating rate debt exposure. Ultimately, we decided on these swap agreements as they were the most cost effective option, they allow us to lock in long-term rate visibility, and they allow us to take advantage of lower variable rates through the end of this year. As a result of executing these interest rate swap agreements, we have effectively reduced our floating rate interest rate exposure pro forma as of March 31, 2017 from approximately 65% of our outstanding debt to approximately 29%. We are pleased with the available liquidity in our business and overall health of our balance sheet, but as always, we will continue to monitor market opportunities to drive incremental efficiencies in our capital structure. Finally, on Slide 11, we are reaffirming our guidance for 2017. We continue to expect 2017 adjusted EBITDA to be between $203 million and $211 million. Our 2017 operating FFO guidance is unchanged at $151 million to $157 million or between $2.54 and $2.76 per share fully diluted. As we discussed last quarter, we anticipate year-over-year and sequential growth for revenue, adjusted EBITDA and OFFO to be slower in the first half of the year as a result of the previously disclosed customer move out at the end of January in Northern Virginia. We then expect growth across our key financial metrics to reaccelerate meaningfully, as we move back into the second half of the year. Our churn expectations for 2017 remains at our historic target of 5% to 8%. However, given the previously disclosed churn, we expect to end up at the higher end of the range this year which is consistent with our commentary last quarter. Lastly, our 2017 guidance for capital expenditures is also unchanged at between $325 million and $375 million. Overall, we remain pleased with the underlying trends in our business and are excited about the significant runway we see for incremental profitable growth opportunities in existing and potential new markets. With that, I’ll turn it back over to you Chad.

[Chad Williams:]

Thanks, Jeff. We are off to a strong start in the second quarter and look forward to extending our steady execution throughout the year by capitalizing on a growing market opportunity. The industry is rapidly pivoting to hybrid solutions and QTS is well positioned as the only fully integrated hybrid datacenter provider in the sector. We remain focused on generating long-term, consistent financial results through an emphasis of our people, products, and performance. The foundation of QTS’s differentiated platform is our 750 plus employees delivering premium service to our 1100 plus customers, each and every day and I’d like to thank them for their continued hard work and commitment. I would also like to thank our customers and shareholders for their continued trust and confidence in QTS. Now I would like to open up the call for questions. Operator?

[Operator:]

Thank you. We will now begin the question and answer session. [Operator Instructions] And today’s first question comes from Matthew Heinz of Stifel. Please go ahead.

[Matthew Heinz:]

Hey, thanks. Good morning guys.

[Chad Williams:]

Hey, Matt.

[Matthew Heinz:]

If you could just go to the leasing in the quarter, regarding some of the C1 deals flipped out, are there transactions that you feel like you could have closed in 1Q, had you pushed a little bit on price? And in terms of the sales force expansion, was that decision made in part due to your execution in the quarter or do you think more pointed towards attacking the sales line you see out ahead of you?

[Chad Williams:]

So, Matt, I’ll take that at the beginning and then hand off to Dan, but I would say on the particular C1 deals that flipped, those deals are more solution deals and were timing and process-driven. The pricing and the conversation on that had kind of ended well in advance and just working through the process and timing of different solutioning was more of the focus on that. And then the sales force is more about the opportunities that we see and that the company is just growing, the platform is growing, the locations are growing, and the momentum we see. But, I’ll let Dan kind of take on both those.

[Dan Bennewitz:]

Yes, Matt. This is Dan. So, specifically to the sales force, we want to be able to get after more of the market opportunity out there. So that’s why you see us increasing our sales capacity and in conjunction with that, we’ve got plans in place to expand our channel capacity. So we can get after more of that market opportunity.

[Matthew Heinz:]

Okay, thanks. I appreciate that. And then, with respect to the sales force expansion, what sort of the impact I guess, Jeff, should we think about on the G&A line as we move throughout the year relative to 1Q levels? Do you see it kind of flat growing from here in line with top-line growth? How should we think about that?

[Jeff Berson:]

Yes, Matt, when we gave the G&A guidance last quarter, that was already with the sales expansion in mind. So, our expectation is consistent with where we were at last quarter. And just to summarize sort of where that is, G&A as a dollar amount will likely continue to grow. G&A as a percentage of sales and the operating leverage that we are getting in the business has improved consistently over the last three years really and we expect it will continue to given NOI margin is coming down little bit based on some of the new facilities that are underutilized. As we mentioned last quarter, we like the fact that the G&A operating leverage is balancing that out. So you are seeing margins that we expect over 2017 and remain in line with where we were last year.

[Matthew Heinz:]

Okay, thanks very much.

[Jeff Berson:]

Thank you.

[Operator:]

And ladies and gentlemen, our next question comes from Andrew DeGasperi of Macquarie. Please go ahead.

[Andrew DeGasperi:]

Great, thanks for taking my question. First, maybe can you talk about your C3 pricing where it’s been and what do you think is lot of the sustainable? And then secondly, maybe, can you talk about the channel partner bookings, you mentioned that 30% target, where do you see that going longer term?

[Dan Bennewitz:]

Yes, Andrew. This is Dan. So on the C3 pricing, we do see that’s sustainable here and if you get underneath that, again the way you look at the market opportunity is we are seeing the collocation opportunity it’s still a strong market. We are seeing a shift where a greater percentage of those collocation opportunities involve a service is wrapped – or a more managed service is around that. That’s what our hybrid approach where we look at C2 collocation along with cloud and managed services we think has an advantage in the market to provide more of a total solution to the customer. Obviously, the pricing is longer there as well as the stickier customer when we are able to provide some of those managed services. In terms of the channel, 30% is a good stake around that that we have right now in long-term as we grow the platform, we’d like to have the channels contribute in the 30% range. So we think that’s a good number to keep in mind.

[Andrew DeGasperi:]

Great, thank you.

[Operator:]

And our next question today comes from Jonathan Atkin of RBC Capital Markets. Please go ahead.

[Jonathan Atkin:]

Thanks. So I wondered if you could talk a little bit about the cross connects and the ground reality can in terms of count and their contribution to revenues and how that might trend going forward? And then the NOI, it looks like it was down just a pad and both Richmond and Piscataway, I wonder if you can talk a little bit about that? Thanks.

[Jeff Berson:]

Hey, Jonathan, it’s Jeff Berson. So cross connects, we’ve continued to grow the cross connects. We are very pleased with where we are and that from a revenue standpoint, it’s – as we talked about a couple of quarters ago that 6% of MRR, that’s been growing historically at North of 15%. So we feel very good about that. And in terms of the number of cross connects, we are at 10,000 and rapidly growing that. The revenue per cross connect is relatively low as we’ve discussed in the past, historically we haven’t charged for that. But we have been shifting as customer renewals come up and new customers come in. When you look at what we’ve got with the AWS direct connects in Chicago, an increase in that network strategy. We are excited about continuing and drive value of that cross connect business.

[Dan Bennewitz:]

And I think the second question was around NOI, this is Dan. We had a couple of situations where we have the first quarter events which we’ve talked about before as well as in Piscataway as part of the acquisition. We disclosed at the acquisition that there was a customer we get in the first quarter here. So, we continue to look at where we can – for customers who have ultimately lower margin space and power with us. Areas where we can consolidate them and then free up that space and power that we can go after and so higher margin and more richer collocation and other ship out space and power and other services with that. So I think you will see that. Maybe a short-term impact that you see here in the first quarter, but in long-term, it’s going to be accretive and net positive.

[Jonathan Atkin:]

And then Richmond?

[Dan Bennewitz:]

Richmond is a similar situation. We have some expansion going on there. As part of the expansion, we had some rent abatements that the short-term impact in first quarter that again accompanies the longer-term growth.

[Jonathan Atkin:]

Great. And then just wanted to help you on the channel program, if you could just elaborate a little bit, how much of that might grow incrementally, because of your relationship with the AWS? Could this expand to other folks like Microsoft? Is it going to be systems integrators, we saw as agents, can you talk a little bit about the mix with those channels and how you are growing that?

[Dan Bennewitz:]

Yes, I think the way we look at it is, it’s not all splitting like peanut butter. There are, if you will, there is agents, there is remarketers, there is systems integrators which is the service model and then you have technology partners that could be the large public cloud providers as well as some of the technology providers and as we look at that, and we attack each market and each product, we have a different mix. For example, brokers play a larger role in C1 space. In the C2, C3 space, we see a lot of opportunity with the public cloud providers as well as sort of the emerging local partners that are playing more in the public cloud space. So, as we clearly look at it and as we look at it market-by-market, as well as by product, and again, we are looking at it, how do we get access to more of the market opportunity and where the opportunity is going today and tomorrow versus where it was in the previous time.

[Chad Williams:]

And, Jonathan, the only thing I might add to that to Dan’s point is that, our hybrid approach, our flexibility and scalability and ability with our service delivery platform to complement our services on top is differentiating us in all of that channel, right. Everyone uses a different piece of it, but they all have an ability that our solutions help unlock opportunities for their needs and that’s where I am most excited is that, it’s just a differentiated approach and we are utilizing our technology and our people to really drive that differentiator in the market.

[Jonathan Atkin:]

Thank you.

[Operator:]

And our next question comes from Jordan Sadler with KeyBanc Capital Markets. Please go ahead.

[Jordan Sadler:]

Thank you. Good morning. So, I am going to follow-up Chad a little bit on the leasing and some of your prepared remarks, you’ve talked about hybrid IT infrastructure accelerating and you guys have certainly been out front in talking about positioning yourself for the movement. Yet, here we are with the 1Q report falling well short of, what I would think expectations would be on the leasing front. So, it seems like there is a bit of a disconnect relative to your positioning in the opportunity you’ve been positioning yourself for. So, can you maybe expound on maybe how or where you guys seem to be misfiring?

[Chad Williams:]

Yes, I would like to not characterize it as misfiring. I will say that, first quarter did not meet my expectations or the company’s expectations for what we had for leasing, but it is a three months period of time and I am not – I’ve never said our strategy based upon what a three month period would demonstrate, but your point is well taken that, our approach is the solution that we feel confident about because our customers continue to drive that and have those type of conversations. This quarter, we did have some deals slip into 2Q and beyond, but for example, we were happy to see that our C3 business continued to accelerate and have 15% annualized growth from – for year-over-year. And we continue to see customers buying more, utilizing more of our services. Dan brought in and he talked about in his reports 40 new logos while the important part of that is, is that, logos come in and 50 plus percent of our business comes from those logos continuing to expand. So to bring 40 new people into the platform I would say, is a very strong testament to hybrid IT gears as solutions that is being valued and driven. And of course, you know, we don’t chase every large C1 opportunity. We are capable, have the scale, the opportunity, the expertise to do that, and where it is strategic in markets that we have the great value prop and it meets our return hurdles, we will pursue them. But at the same time, that’s not all about absolute growth. It’s about how do find the right balance of providing our IT, our hybrid IT stack bringing in new enterprise logos at a robust pace and then driving those solutions around how to optimize and build their business going forward and see the growth come off those new accounts, logos that are coming in. So, I would say that, from our standpoint, disappointing absolute numbers. Absolutely committed to hybrid will be the future of this business and the way that the cloud is ramping and driving and digitizing our platforms. It is the future of the IT stack for every CIO and CTO. They will have to be able to have the digitization hybrid story. They will have to touch public clouds, private clouds and the ability to optimize both for more space to small space. And I think our platform has the people, personnel and capabilities to do that better than anyone in the market. And I hope that as we continue to go and continue to prove this year, that we will continue to be robust in our growth and our opportunity to still be an industry-leading in the growth category.

[Jordan Sadler:]

As a follow-up, I would say, anybody listening to this call would not view you guys or the lighter quarter to be a function of lower than expected C1. You’ve done last four years $40 million a year plus or minus on average of new leasing activity predominantly in the C2, C3 categories. C1 has been piece for sure that might even drive the leverage of the $50 million if you included it. But, I feel the C2, C3 is probably your bread and butter and as it relates to the hybrid IT infrastructure, your bread and butter, so, I am interested in – the C1 opportunity for you guys, of course, but, what is it about the C2, C3? Are we also going to expect an acceleration on that side of things?

[Chad Williams:]

Well, I think, the thing that I still go back to and I realize that the market and people from the outside always put people in different buckets. I still think the strength of QTS is that we have three distinguished buckets and in the past, we’ve done hybrid scale before it was called the hybrid scale, right. We did 19 megawatts of leasing a couple of years ago and so, there are those opportunities and were they are strategic and were they are aligned, we really embrace all three aspects of our business, because we think the strength of it is to have the flexibility and scalability for a C1, C2 and C3 is not lost on that the last three quarters were record leasing, this quarter was not. We’ve had different periods in our growth back in 2015, we had a very similar quarter and then came back in. So this business doesn’t always work exactly perfect as far as new leasing. I’d like to say that our performance for the quarter was very strong and I don’t want that to be lost, but everyone keys in on the leasing and then wants to go to strategy. I am committed to the strategy that we have laid out, because our team and our customers are talented. That is the direction in future of what we are doing. It takes people, personnel and technology and platform to do that and I will continue to see that C2 retail and services will be a huge part of that opportunity, because keep in mind, we love the pricing metrics and driving a higher price per square foot on our platforms because that is an important part of our ability to continue to think about our return on invested capital and drive efficiency and customer diversification. But all three play an important part and you will see them continue to play a part of how Dan and the sales teams execute, but, Dan, I don’t know if you have anything to add to that. .

[Dan Bennewitz:]

Jordan, as a follow-up, the only thing I’d ad Jordan is, if you also look at the pricing, so our pricing is up pretty significantly. We think that’s indicative of this notion of collocation with the services wrap or more managed services around that allows us to have a richer offering to clients. It also allows them we think to be stickier clients with us.

[Jordan Sadler:]

And I appreciate that you guys are getting good pricing. Do you think or should we expect that your returns and return expectations will be maintained? We’ve heard on other conference calls that, expectations maybe drifting down a little bit on the C1 side in particular?

[Chad Williams:]

Yes, I mean, Jordan, if you are going to focus your business about huge growth and chasing really a singular focus of hyper scale, which by the way that C1 to us when we done it from the beginning and we think is an important part of our business and we will continue to have a focus to that area. But it will – if your company that’s structured just to chase that, it will impact your returns, that’s why I think that strength of QTS is how do we find the balanced and capital efficiency to think about those three buckets, C1, C2 and C3 in our world and balance that to say, we don’t have to win every big deal. We have to win the right deals and then balance that with our selling – what I like to call t he cubic feet, the ability to put disk services into our business, make our customers rely upon us more be a better partner and drive better revenue on a per square foot basis. And finding that balance is what we work hard on every month to make sure, but if you are solely focused on just large-scale deals, you are going to grow on an absolute basis, maybe faster, but at the same time, that doesn’t come without some competition and some strategy and some pressure on returns. I think, we only talk about our returns of 15 plus percent on a fully stabilized basis. And again, fully stabilized means that we have to have time to take underutilized facilities and utilize them and build and sell concentrated customer portfolios at smaller square feet and smaller increments. But we’ve done that and if you look at Suwanee and Metro and some of our more mature assets that have been in the portfolio with me for ten plus years, you can see that our returns have the opportunity to meet the expectations we set and sometimes it exceed those over long periods of time and that’s what we are playing. We are playing long though and we are playing about how do we build and grow consistently and profitably in our business.

[Operator:]

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

[Robert Gutman:]

Hi, thanks for taking the question. Could you give us an update on progress in redeveloping the 8 megawatt datacenter you acquired from HCSC in Dallas earlier this year? And can you provide a current outlook on the Dallas market?

[Chad Williams:]

Yes, I am going to let Dan take the Dallas market comment and maybe have Jim speak to the development – redevelopment on Fort Worth.

[Dan Bennewitz:]

Yes, this is Dan. So, the second question first, is we still are very excited about the opportunity in the Dallas Fort Worth market. That’s obviously a large local market in Texas as well as a great destination market nationally and that’s why we continue to deploy capital there both in our Irving datacenter, as well as in our Fort Worth datacenter. Jim, do you want to talk about developments?

[Jim Reinhart:]

Yes, we are excited by that asset. It’s a world-class asset in a great location. We found the opportunity in acquiring that asset to not only keep the existing center and form a long-term relationship with them also to redevelop that asset, we think one of the best – for QTS. We will be launching our initial deployments there this quarter and then later on the year we will also be adding additional capacity we see in future market growth and see again it’s going to be a great asset that we can develop under $7 million a megawatt and look forward to the expansion there.

[Robert Gutman:]

Great, thank you.

[Operator:]

And our next question comes from Paul Morgan with Canaccord. Please go ahead.

[Paul Morgan:]

Hi, good morning. Just in terms of the guidance, kind of versus the bookings in the quarter. So, you really read over the lines of your guidance, and things like EBITDA for example, I mean, you obviously talked about how Q1 was below plan. Would you characterize kind of the – in the context of your guidance is being just sort of the volatility that you incorporated and your talks about in range or were there other offsetting positives that in the quarter or that you are seeing that leads to be confidence that kind of the full year looks about the same as it did three months ago?

[Jeff Berson:]

Yes, Paul. This is Jeff. So, we reiterated our guidance and as Chad said, although the quarter from a leasing standpoint wasn’t exactly what we are looking for. From a margin standpoint, we felt very good. From a pricing standpoint, we felt very good and when we are building out our guidance, we recognize that the world doesn’t happen in a straight-line and there is some volatility in the business. Given that we are seeing it strong April and we are seeing a great pipeline and backlog for the rest of the year, we continue to be comfortable with our guidance and we are always building in the fact that there are going to be pluses and minuses over the course of the year. So, again, mirror what Chad said, we weren’t happy with the leasing in Q1, but it in no way changes our outlook in the business and the opportunities we are seeing and continues to support the guidance we put out.

[Paul Morgan:]

Great and then just, in terms of the your Northern Virginia asset, I heard you say that you expect to announce some things sort of by the end of the year, I guess, and I know it kind of allows or maybe you contemplated kind of coming to an earlier decision, is there any sort of events, just give an update on kind of what you are thinking and kind of why sort of the end of the year is kind of like under?

[Chad Williams:]

Yes, we continue to kind of work through that, obviously the tenant lease just expired in February. We’ve been actively kind of taking on the opportunity to optimize that event. Obviously the best outcome would be is to take a unique set of space which consists of a couple megawatts of power that was built to a pretty unique standard within the federal, state and maybe try to find that systems integrator or federal entity that we might be able to go in and utilize our contractually available lease extensions and just try to replace that for a like-for-like kind of client. We have had a few showings already since we’ve been able the contracts expired. And we are actively kind of pursuing that. We think it’s worth a little bit of time if that was able to be replaced. Obviously, the other aspect, we could just take the two megawatts of space and think of it as somebody’s swing space or flex space and be aggressive on the pricing and relapse kind of a couple megawatts in a market that doesn’t have a lot and we will – Dan’s team is kind of pursuing that as a parallel path. And then obviously, the lease expires, our underlying lease expires in February of 2019 and there is always a conversation where you could have a conversation about an early ETF. But obviously, we think the first two are the things that we should be focusing on and optimizing right now. We are going to focus on that and stay tuned as soon as we have an update on that this year. We will come back and talk to you about it.

[Paul Morgan:]

Great, thanks.

[Chad Williams:]

Thank you.

[Operator:]

And our next question today comes from Richard Choe with JPMorgan. Please go ahead.

[Richard Choe:]

Great, thank you. It looks like the sales funnel is pretty significant. What’s your visibility on closing these deals in the next quarter? Or is it the whole year, can we get a little sense on timing, given kind of maybe what’s from Q1 into later this year?

[Dan Bennewitz:]

Well, this is Dan. So, if I go back to your – so we are pleased with the April results and what we see, ahead of the short-term, when we talk about the opportunity funnel, that’s a longer term view. So, think six to nine months out. So it is, as we talked about in the prepared remarks, it’s a robust sales pipeline. We are excited about that. Our visibility in that is also – gives us confidence that we ought to be expanding our sales capacity and the work that we talked about already on expanding our channel capacity. So, we are optimistic, not only about the second quarter, but also about the second half of the year.

[Richard Choe:]

Great, and the pricing on C2 and C3 were solid, but is there anything to be taken away from the pricing on C1 this quarter? I guess, given that, it’s a little bit lighter or should people to be worried or is it just kind of a one quarter type of thing?

[Dan Bennewitz:]

That was a one quarter, one deal that was related to our acquisition in Fort Worth. As we got that customer included as an accurate client, we consolidated the space. That’s a – just, you know lot of small numbers. We feel very good about it, where we are in C1 placing, not only for the quarter but also for the rest of the year.

[Richard Choe:]

Great. Thank you.

[Operator:]

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

[Frank Louthan:]

Great, thank you. So just to clarify that C1 business that kind of get pushed out. Is it some of that incorporated with what you are discussing as the – through the projects you’ve already made this quarter, has that been traded away moves that, and it moves any of that business? And then, can you give us more detail on for the AWS support model? What we need to – what can we expect as you ramp up that as your CapEx, a more investment in people and so forth that you are going to have to make ahead of that? Where are you in the process to have a up to a full month report model there?

[Dan Bennewitz:]

Yes, this is Dan. So the first question is, we – from a C1 point of view, those opportunities where we feel very good about where we are in the process for not only for the quarter, but also for the second half of the year. In terms of the AWS, I think, we are in the process of gearing up and when I say, gear up, that was I feel I mean, additional people, I mean, training our people. But around coming out with different offerings that take advantage of our relationship with AWS, particularly given the direct connect nodes that they have in Chicago. So, as this market shifts to more of a hybrid environment, we are seeing more of the collocation opportunities transition from just space and power to meeting services wraps around it. Whether it involves AWS or involves just managing a little bit more stacks, it could be managing the hardware around that and as we get into AWS, be able to have a story with the customer, that we can help you get to AWS, we can help you manage that AWS will grow, that’s a pretty attractive opportunity that they can look in QTS as single point of contact to be able to provide that capability. So, I think we are approaching this in a very measured and optimistic approach.

[Frank Louthan:]

Okay, great. Thank you.

[Operator:]

And our next question comes from Jon Petersen of Jefferies. Please go ahead

[Jon Petersen:]

Great. I am just curious you talked a lot about accelerating pricing in your C2 and C3 business, kind of especially C3. Can you give us kind of more of a high level and put ranges around it as what you think the mark-to-market is on your different segments of your business? And are you guys implying that we should expect leasing spreads over the coming quarters to accelerate relative to what we’ve seen over the last couple of years?

[Dan Bennewitz:]

Yes, we think, overall, we think that, when we look at our numbers in the first quarter, we feel comfortable about the re-leasing spreads be in the low single-digits. We feel good about that. Same thing for C1, as those leases come up, we feel very good about where they – to market and think that we have some upside on that moving forward in the low single-digit range, just as we look at for C2 and C3.

[Jon Petersen:]

Okay. So, I mean, you guys talked a lot about how pricing is up quite a bit for C3. I mean, it kind of sounds like the leasing spreads should accelerate a little more, and I guess, am I reading too much into that or was it more of a mix that what you are actually leasing?

[Dan Bennewitz:]

Well, think about – think about if you have a – you have one scenario which is your customers requiring space and power, that’s a certain price point, if that same opportunity includes of services wrapped around that, we are managing the hardware, we are managing the more managed services, for example including AWS, the price of that one deal just got more richer. I think that’s what we are seeing here as we look add value to – if you will, traditionally has been a space and power acquisition. As we think that’s helpful to pricing as well as the value of that solution that we are providing to that client.

[Chad Williams:]

And Jon, I think the two trends that you are seeing is, on new leases getting signed, you are seeing the pricing there move up, because more and more customers are coming into the QTS platform with a hybrid position where they are taking more services upfront. So that’s why you are seeing that pretty big jump in the C2, C3 new lease pricing. On the renewals, when customers are with us, as those contracts come up for renewal, they tend to actually increase pricing and increase service even more which is why you are seeing that sort of 2% to 4% average renewal spread on top of upfront leasing that’s growing.

[Jon Petersen:]

Okay. It’s helpful, and I guess another question. Maybe I am reading too much into this, but there it seems like there has been a lot of conversation around hybrid cloud and how you see the growth from that. I know that can be kind of related to – I feel like on the last few earnings calls there has been a lot of talk about security and compliance and I don’t think I heard that really spoken about very much at all. Is that still a trend in the market that you are seeing growing? Or are you more kind of enterprise hybrid cloud more what you guys are shifting towards today?

[Chad Williams:]

Jon, this is Chad. I mean, just from the security and compliance comment, it is who we are and it is the future of IT. So, to us, it is a core product and core offering that we have to help in solution our customers around. I’ll let Dan take the hybrid growth story.

[Dan Bennewitz:]

Yes, I think when we start talking with clients about more than space and power, compliance and security is top of mind and we see that happening both across the different industries that we play in as well as in the government space. So, we – that is still a key differentiator for us. Customers, when they look to QTS, and they are looking for a service provider to provide more services to them. They also ask a lot of questions about what does this compliance mean? Are you meeting these standards? Are you meeting those standards? And then, how do you provide the security services around that?

[Jon Petersen:]

Hybrid cloud growth.

[Dan Bennewitz:]

And I think part of that is also related to hybrid cloud growth. So, compliance is really integral to all that. We don’t mean this, because we did mention this. I mean, it’s not important, it’s actually very, very key to all of our discussions with prospects as well as current clients.

[Jon Petersen:]

Gotcha. And then I guess, maybe just it sound a little more, are you seeing in terms of conversation with prospective clients, is that more of a topic today than it was a year ago? Is it about the same? What kind of expanded and - people focus on security and compliance?

[Dan Bennewitz:]

I think the way to characterize it is maybe, last year, it would checked the box and onto the next question, now, as people are in discussions, what do you mean, when you check the box, what does that mean, and it’s a deeper discussion and wonder they are looking for us to have depth in terms of people capabilities as well as do we have compliance standards and do we have processes to actually deliver that level of compliance and security.

[Chad Williams:]

Yes, Jon, one other thing to highlight that, and I think from our perspective, at least from our knowledge, we are the only datacenter operator that put a system in the organization under our CTO’s office. So, what that means is that the Chief Information Security Officer, he has a team of people that work hard every day internally and externally facing one way to categorize that – is that I don’t know of any hybrid cloud conversations that we are having, selling or prospecting that that sits on office in the compliance and security team aren’t part of the sales process. So, I am not sure how everybody else is solving that conversation, but I can tell you QTS’s investment a number of years ago, first focused on compliance and security and then we eventually moved into a CISO structure. Andrew Wild and that team are involved in every aspect. Andrew speaks around the country on behalf of security and compliance topics and proudly represents QTS and how we think and talk about that. And I know Dan and the sales team rely upon that significantly to have that office set up of people dedicated to that function in helping our solutions bridge their solutions in that need.

[Operator:]

Thank you. And our next question comes from Eric Luebchow of Wells Fargo. Please go ahead.

[Eric Luebchow:]

Hi, good morning. I just wanted to touch on the sales force expansion. How long do you think it will take for you to increase your sales force to where you need it to be? And then, on the channel program, how does the economics of that compares to utilizing your direct sales force and could that have any margin impact over time as you expand to those partners?

[Dan Bennewitz:]

Yes, this is Dan. I think the way to think about the sales force expansion is by the end of the year, we expect to be where we need to be for our long-term planning. And the way we think about the channels, having a channel program obviously comes with a cost and so, when we look at our channel program our channel terms and conditions, we incorporate that. I don’t think that you should include sort of the change in the margin for us where it will be coming from – because all this planning is in the guidance we’ve already given as well as in our growth planning and trajectory.

[Eric Luebchow:]

Okay, great. Thank you.

[Operator:]

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

[Simon Flannery:]

Great, thank you very much. Good morning. Jeff, you talked a little bit about the ATM program and the leverage. Can you just update us on your thoughts on the right leverage ranges and where you want to be over the long-term and how you think about the ATM program? And then, maybe for Dan, there is a couple of top-ten customer contracts coming up at the end of the year. Can you just update us on how those conversations are going?

[Jeff Berson:]

Sure, Simon. This is Jeff. So, from a leverage standpoint, we like a long-term leverage target of at or around five turns EBITDA. But we have operated at levels above that, frankly more often and not in the past and are very comfortable at the level we are today, given the book not billed type of backlog and the visibility that we have. So we feel like we’ve got an appropriate balance sheet and we are comfortable with the leverage we’ve got. The nice thing about the ATM plan is it does enable us to manage that leverage over time in a more gradual equity process and more discipline in terms of equity proceeds to keep leverage in check. That’s why it’s there, it gives us the ability to manage that level without over-equitizing the business and we’ll look to take advantage of it periodically over the future.

[Dan Bennewitz:]

Yes, Simon, this is Dan. On your question on the top customers, I would say there is five that we reported supplemental that had 12 months or less as term. Their number is six through ten. A couple of points, all are long-term customers. We are obviously in regular discussions with them. The good thing I think is, number one, they are in multiple datacenters with us. One is in six datacenters. We’ve got one at two datacenters and the rest are in two datacenters as well as there are multiple through stated contracts. There is a lot of contracts that come up, but we are in constant discussions with these customers. And I’d say, QTS is pretty integral to their IT, either as the IT partner or as a top IT partner to them. So, we feel good about them. We obviously, this is something that we are spending time on and obviously, we like them as these contracts expire and to do as we want them to renew, obviously with low single-digit price increases. But also we are working, how do expand the service portfolio by taking advantage of.

[Simon Flannery:]

And is that’s something that you would wrap up well ahead of contract expirations. You might have that done next quarter or is it typically go down to the last three months or so?

[Dan Bennewitz:]

I think you see, all the above, and again I think, part of it is, as these are not situations with not just one contract, there is multiple contracts that come up. So you see there, that’s a blended average term. So, I’d say every month, there is something coming due that works extending, renewing, growing as part of these customers.

[Simon Flannery:]

Okay, thank you.

[Operator:]

And today’s next question comes from Vincent Chao of Deutsche Bank. Please go ahead.

[Vincent Chao:]

Hey, good morning everyone. Lot of my questions has been answered here at this point, but, I just want to confirm on the guidance. I didn’t see a specific reiteration of the revenue growth outlook or the NOI margin outlook, but I did hear a couple things, volumes were low obviously in the quarter, but then margins were a little bit stronger. So is that algorithm changing a little bit, so that EBITDA holds steady, but maybe the margin decline which is I think was previously talked about at the 100 basis points, maybe as a little less and revenue growth maybe a little low as well?

[Bill Schafer:]

Now, we’ve got no change to our guidance and continue to be comfortable with the original assumptions and guidance we’ve put out. So, as I mentioned earlier, some of the volatility seizes our book into that and we feel good there is many strong points in the quarter as they were from the leasing side. So, all of the numbers that we put out we continue to stand behind.

[Vincent Chao:]

Okay, thanks for that clarification. And then on the pipeline side of things, the visibility, that you have into April, it sounds like those are not necessarily booked at this point, but I guess, given the – where you are in the leasing process, I mean, it typically or historically, what percentage of those types of deals were sort of at this stage closed at this point?

[Dan Bennewitz:]

Yes, this is Dan. So, we really characterize it is, our April results show what has been signed and where we are in terms of finalizing the deals that the customers gives us visibility, as we said is equivalent to the level of net bookings for the full first quarter here. So, I think we see that where we are snapshot right now and we feel good about where the rest of the quarter is going to take us.

[Operator:]

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

[Chad Williams:]

Well, thank you for everyone’s time today. We continue to appreciate and the partnership and opportunity and look forward to speaking with you all next quarter and seeing a lot of you at NAREIT. Thank you.

[Operator:]

And thank you, sir. Today’s conference has now concluded and we thank you all for attending today’s presentation. You may now disconnect your lines and have a wonderful day.