QTS Realty Trust, Inc.
Q3 2014 Earnings Call Transcript

Published: 3 Nov 2014

[Operator:]

Hello and welcome to the QTS Realty Trust Third Quarter 2014 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 Mr. Jeff Berson, Chief Investment Officer. Please go ahead, sir.

[Jeff Berson:]

Thank you, Denise. Hello everyone, and welcome to QTS's third quarter 2014 conference call. I'm Jeff Berson, Chief Investment Officer and Head of Investor Relations at QTS, and I'm joined here today by our presenters; Chad Williams, our Chairman and Chief Executive Officer and Bill Schafer, our Chief Financial Officer. We're also joined by Dan Bennewitz, our Chief Operating Officer, Sales & Marketing and Jim Reinhart, our Chief Operating Officer of Operations. Our earnings release and supplemental financial information are posted in the Investor Relations website section of our Web site at www.qtsdatacenters.com on the Investors tab. We also provided Slides and made them available with the webcast on our Web site, which we hope will make it easier to follow our presentation today. Before we start, let me remind you that some information provided during this call may include forward-looking statements, that are based on certain assumptions and are subject to a number of risks and uncertainties as described in our SEC filings, and actual 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, 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 Web site. And now, I'll turn the call over to Chad.

[Chad Williams:]

Thanks Jeff. Hello and welcome to the QTS third quarter 2014 earnings call. We are pleased to be speaking with you today to update you on the continued momentum at QTS. On Slide 4, for the third quarter, we achieved record revenue and continued strong year-over-year growth. This was driven by our fully integrated technology services platform, supported by our 3C product mix, which has continued to drive strong leasing activity, providing continued confidence and visibility for our future performance. The engine of our business, C2 colocation and C3 cloud and managed services continue to enable our consistent growth rates. Even our C1 business is very different from typical wholesale providers. Our median C1 customer is approximately 3,500 square feet and 0.5 megawatt. This smaller wholesale customer supports our model of customer diversification and higher pricing metrics and typically our C2 customers whose needs have grown and transition to our C1 custom datacenter product. In addition to our smaller C1 customers, the scale of our facilities enables us to benefit from our accelerated growth opportunity from the strategic large C1 customers. This blended services has supported our growth over the last year, and our product mix has enabled us to drive stable core performance, with predictable C2 colocation leasing, mixed with accelerated growth enhanced by our certain quarters of significant C1 and C3 activity. For example, during the fourth quarter of 2013, in addition to our continued growth in C2, we experienced strong leasing activity in our C1 product. Then during the first quarter of this year, as we rolled out our new cloud services, our C3 business ramped significantly and drove strong performance. Last quarter, our incremental net new leasing hit a record high based on a combination of strong C1 and strong C3 sales. These periods of strong performance were all based on the consistent growth through our core C2 colocation engine, with enhanced performance balanced by our broader product mix. This quarter is another good example of our ability to drive enhanced growth above our core performance, based on strategic large C1 business opportunities. We had a significant customer win during the quarter for 19 megawatts. This new lease was based on a 12 megawatt, seven year lease in our world class Richmond facility. The customer saw the value provided in our Richmond datacenter based on our mega-scale infrastructure, differentiated security and compliance support, attractive Mid-Atlantic location and access to low cost power. This customer also signed an expansion contract with QTS for an additional 7 megawatt in our Atlanta-Metro facility, where they already have a significant footprint but expanded based on their increased needs and their appreciation of our premium customer service. These contracts will provide QTS with a path to significant growth in '16 and beyond and as well as drive significant capacity utilization in our Richmond and Atlanta-Metro facilities. As a result of the C1 contract on top of solid core C2 and C3 performance, we achieved a record $25.6 million in annualized net incremental leasing activity during the quarter. As a result of this significant leasing momentum, our booked but not billed revenue now represents $63 million of annualized MRR, which has grown consistently during 2014 and is now at a record level. In addition to our strong quarterly performance and backlog, we have continued to experience attractive pricing trends across our business. Lastly as we announced on our call last quarter in July, we closed on another low basis mega datacenter in Chicago, which we plan to open in 2016. Through this $18 million acquisition, we now have a facility that can support approximately 215,000 raised floor square feet with 30 acres in downtown Chicago that can ultimately double in capacity. We believe this represents a strategic opportunity, with strong market dynamics and a great location. In addition, the scale and low cost basis fit well with our mega scale facility strategy and our low cost to build metrics. All of this supports our continued high level performance and the successful execution of our business strategy. On Slide 5, the financial performance that we will walk you through today is a direct result of our differentiated strategy, which is to provide a fully integrated technology service platform that sits on top of world class real-estate. We are driving strong revenue growth through our fully integrated 3C product mix, C1 customized datacenter, C2 colocation and C3 cloud and managed services. This mix is supporting strong growth from existing customers and our ability to successfully attract new customers. It also is a key differentiator that will support our strategy to target sophisticated enterprise customers who were currently operating in-house datacenters. We believe these customers will increasingly look to outsource these operations to providers that can offer the high level operations, technology services and security and compliance that QTS layers on top of our world class infrastructure. We leverage this world class infrastructure and real estate to support the cost efficient delivery of our datacenter services. This infrastructure has been developed through a proven ability to acquire infrastructure rich property at a low basis, which enables our low cost to build metrics of approximately 7 million per megawatt across our portfolio. On a fully stabilized basis, it also supports our scale and capacity advantage, which enables us to add incremental capacity and just in time capital efficient approach. Together, this fully integrated technology services platform and world class real-estate supports our strong growth, returns on capital and solid pricing and customer retention metrics. Now, on the third quarter performance. As seen on Slide 6, our strategy continue to result in strong performance for the quarter across our portfolio. We experienced healthy year-over-year growth. We also achieved an annualized unlevered return on invested capital of 15% for the third quarter of 2014. This ROIC remains at our target of 15% plus unlevered returns on a fully stabilized basis. As we mentioned on the last few earnings call, this return can potentially dip low 15% target, based on the timing of new facility development and bringing significant space online, as we did in the third quarter. In addition, our booked but not billed backlog supports our confidence in maintaining strong returns in the future. Next on the Slide 7, our performance and success is driven by our customers continuing to value QTS. As evidence of this, we have a number of wins in the quarter across our national footprint that demonstrates customers are continuing to choose QTS and grow with us. Our model enabled these customers' expansions with scale and product flexibility that support our customers growth. This is the reason, that approximately 50% of our growth comes from existing customers. First, in our mega scale datacenter in Suwanee, one of our customers signed a significant lease expansion with us, while migrating to our C1 offering from our C2 platform. This customer, a leading provider of cloud based communication services has been with QTS since 2005. The customer will double its existing space and will now have over 6,700 square feet of raised floor and 1 megawatt of power. This is the hallmark of QTS model. Customers do not have to leave the QTS family as their demands increase, but rather they can stay with us because we have the flexibility and product offerings as well as the scale to meet their evolving needs. These customers continue to grow with QTS due to our premium customer service, powered by our people and our flexibility to work with them on the important transition from C2 to C1 services, and we're excited about the continued and expanding relationship. Next, we recently expanded with a large leading global web 2.0 technology provider to the third QTS site, in our Atlanta-Metro mega scale datacenter. This customer started recently with QTS and has quickly ramped at three sites; with our Jersey City and Dallas-Fort Worth facilities in addition to now Atlanta-Metro. In this last expansion this customer increased the total space leased from QTS by over 40%. In addition to their multisite footprint, this customer is also a multiservice user, utilizing both C2 and C3services. We're excited this customer has recognized the value that QTS provides in our nationwide footprint and breadth of services, and we look forward to supporting them as they continue to grow their needs. Finally, we recently signed a very exciting new deal with one of our largest strategic customers for a total of 19 megawatts in multiple QTS facilities. This customer is looking for a new location to support their growth with significant need of 12 megawatts of power. After a national review this customer chose our Richmond facility based on the mega-scale infrastructure and powered shelf capacity that QTS offers in that location. In addition, the service level that we offer in Richmond paired with our high level security and compliance and a key Mid-Atlantic location made Richmond a good fit for this customer need. The decision was also supported by the advantaged low cost of power in Richmond. In addition to the new space in Richmond, this customer also signed a new expansion lease in our Atlanta-Metro datacenter for 7 megawatts of additional power. Through the new contract in Richmond and the expansion in Atlanta-Metro, this customer is almost doubling their square feet with QTS over what they currently occupy. Additionally, this will drive significant utilization and operating efficiencies at Richmond while leaving continued capacity for future development. We believe the increased utilization in Richmond will drive significant efficiencies for future growth and contribute to overall performance and return on capital profile for years to come. Our remaining capacity in Richmond represents the most advanced infrastructure we own from a physical and electrical and cooling perspective with security and compliance capabilities that are some of the most advanced in our portfolio. This deal increased our booked but not billed backlog to a new record level at the end of the quarter. It will drive minimal revenue growth in 2015 during the build-out of the space, but will support significant visibility and growth in 2016. As the customer ramps into this space towards the end of 2015, and as this contract has just recently been signed and due to the scale of the build-out and the ramp cycle, we are still finalizing our development priorities for 2015. We look forward to reflecting these development plans and providing further details on the implications of this strategic transaction along with a full 2015 guidance on our Q4 earnings call. As I've said in the past, we continue to do large C1 deals that are strategic and profitable for QTS. We have brought in a large anchor tenant to Richmond demonstrating the significant value of this facility and continuing the momentum that we have building there this year. None of this would be possible without our mega scale datacenters that allow us to be flexible and strategic in winning large deals, while maintaining strong profitability and return on invested capital. I just can't say enough for the sales team and all the people in QTS that helped capture this transformational deal. On Slide eight, our sales growth and continued momentum and in particular this significant new contract can be seen in our third quarter leasing performance. During the quarter, we signed new and modified leases representing $25.6 million of net incremental annualized rent. This leasing activity represents by far the strongest leasing quarter we've had in our history. After a record second quarter, we have increased our leasing again by approximately 45%. I'd like to note, while we are pleased with this leasing activity, this level of incremental leasing is far above the typical leasing activity we expect to see in the future. It is evidence that our integrated platform provides stable performance and growth from our core engine of our business, C2 and C3 services, while C1, due to a 43% utilization of our powered shelf capacity can provide periodic significantly enhanced performance, accelerating growth and future financial visibility. The continued momentum in our leasing activity is driving our record annualized booked but not billing backlog of $62.6 million, a 53% increase over the record backlog at the end of the second quarter. This signed and committed backlog supports solid growth revenue, de-risking 2015 and driving growth in 2016. In addition to our exciting customer wins and increased backlog, we also continue to invest in our services and product offerings. We at QTS are powered by our people and we continue to innovate, develop and enhance products and services as we identify ways to integrate our technology services platform to accelerate growth and grow our business. We recently launched a new cloud service, QTS Disaster Recovery as a Service. This service is a full-featured enterprise grade disaster recovery offering to meet the needs in today's hybrid IT infrastructure. It provides solutions for virtual to cloud environments as well as physical to cloud environments, and its aim will buy our national network of connectivity infrastructure. This service also complements our QTS Enterprise Cloud and QTS Federal Cloud offerings, which we launched earlier this year. We also have continued to invest in rolling out QTS Critical Facilities Management or CFM service platform. We believe CFM will enable QTS to further unlock the largely untapped enterprise outsourcing market. Our CFM services target enterprise customers who would be enthusiastic about outsourcing their internal datacenter needs, but have been reluctant because they require a provider with a technology services platform to work with them on this transformational IT change. QTS is leveraging our strong integrated technology services platform, customer support and high-end security and compliance to meet the needs of these enterprise users. Through our CFM platform we can either manage customer owned enterprise datacenter facilities, take ownership of infrastructure or both. This service also puts QTS at the table as a critical datacenter advisor with our CFM customers as they work through their IT planning cycles each year. Our CFM service was recently launched with the New Jersey acquisition that we announced last quarter. We believe that our investment in services like CFM and Disaster Recovery, while temporarily increasing cost and investment in our business will continue to differentiate QTS in the market. These services also support our model to drive capital efficient growth and performance, by offering our customers differentiated solution for their infrastructure needs. Now onto pricing trends. As detailed, on Slide 9, in addition to growth in our leasing activity we continue to see evidence that our differentiated strategy supports pricing stability. Third quarter pricing from new and modified leases for C1, in aggregate were influenced by the large C1 deal that I just discussed. On a consolidated basis, you'll see variability in our pricing per square foot quarter-over-quarter depending on product mix. Pricing for C2 and C3 new and modified leases averaged $1,033 per square foot for the quarter, in line with our prior fourth quarter average. Regarding renewal, on a like-for-like basis for customer's renewed contracts without change in square feet, we experienced renewal rates for the third quarter in 2014 on a normalized basis increasing 3.6%. This increase excludes two customers whose needs grew and as they continue to expand their business with QTS, qualified for a blended product mix and different pricing. These two mix changes brought the overall renewal rates down to a net decrease of 2.9% from the pre-renewal pricing rates. As we have discussed in the past, this number will fluctuate by customers changing their product mix with C3 services during different periods. While we do experienced volatility in renewal rates, the 3.6% normalized increase in third quarter renewal rates is consistent with our past performance of normalized renewal pricing increases in the low to mid-single digits. Lease commencement pricing during the quarter improved significantly due to higher percentage of C2and C3 activity. When compared to our prior four quarter average and higher pricing per square foot across our products, by product mix pricing on C1 commencement was 24% higher than the prior four quarter average. Pricing on C2 and C3 commencements was also up 11% from the prior four quarter average. We believe that when adjusting for product mix, deal size, and market, our current leases, commencements, and renewal rates are consistent with our trailing results and continue to demonstrate the stability and positive trends being driven by our 3C business model. In summary on Slide 10, QTS continues to build on the momentum that has been taking place throughout 2014. Our growth and profitability trends are continuing to demonstrate the strength of our business model. In addition, our leasing momentum, pricing stability and record backlog gives us continued confidence that our profitable growth will continue. We are driven by our fully integrated 3C product platform that differentiates QTS in the market. In addition, our tremendous capacity with the ability to grow our raised floor footprint from 927,000 square feet to 2.1million square feet within our currently owned and controlled power shell enabled us to deliver these products at a known cost with lower risk and supports our confidence in delivering our targeted 15% plus return on invested capital fully stabilized over our national footprint. We believe strongly that this approach is the right way to continue to build our business delivering strong growth in a profitable, low risk and capital efficient manner. Now I will ask Bill Schafer to discuss our financial performance, capital plan and balance sheet. With that, over to you Bill.

[Bill Schafer:]

Thanks Chad. And I'd like to say hello to everyone as well. So, the third quarter results as seen on Slide 12, we have continued to demonstrate strong and accelerating growth. On the top line we achieved record revenue and profitability. Operating FFO and operating FFO per share were down slightly from the second quarter of 2014. As we discussed during our second quarter call, the 300 million unsecured note financing which closed in July resulted in higher interest expense in the third quarter. This was partially offset by our ongoing revenue growth including the benefit associated with the initial transition on facilities management of our newly acquired New Jersey facility. As a reminder, the benefit of the 300 million financing was to fix our rates, extend our maturities, and improve our liquidity as well as support growth from our New Jersey facility and partnership with Atos. In addition, utility costs were much higher during the third quarter as compared to other quarters during the year. We expect to continue our growth and momentum on operating FFO and operating FFO per share heading into the fourth quarter. As outlined on Slide 13, our business has also continued to benefit from increasing margins due to operating leverage in our cost structure. Adjusted EBITDA margins increased during the third quarter by approximately 220 basis points over the prior year third quarter. This was largely driven by G&A as a percent of revenue dropping to 19.1%, which is lower than we have typically experienced and below our expectations for the near future. This was primarily caused by increased revenues especially increased recoveries from our C1 tenants due to higher utility costs as discussed above and the acquisition of our New Jersey facility. As we continue to grow and invest in our business, we expect that G&A as a percent of revenue will average in the low 20% level on an annual basis. In addition, our NOI margin was down sequentially due to seasonality associated with facilities as previously discussed. Although, we are pleased with our ability to continue to improve margins as our business scales, we will continue to work to find the balance between increasing margins and continuing to invest in the product and service side of our business. As Jeff mentioned, during the quarter, we have increased our investment in our C3 products including cloud development, CFM and other services such as Disaster Recovery. In addition to the upfront investment, these services tend to have lower margins offset by significantly enhanced return on capital. While we continue to support our target EBITDA margins approaching 50% over the next few years, we also expect to see some impact on margins and return on capital driven by our product mix. On Slide 14, our backlog of annualized booked-not-billed revenue from signed, but not yet commenced leases was nearly $63 million of annualized revenue as of September 30, 2014. As Jeff mentioned, this was record high for the company, well above our last quarter's higher record of $41 million and gives us great comfort on the growth embedded in the business today. We expect leases representing approximately $10 million of annualized MRR to commence in the balance of 2014, which will contribute an additional 2.2 million of MRR in 2014. And leases representing approximately $22.8 million of annualized MRR to commence in 2015, which will contribute approximately $11.9 million of MRR in 2015. A significant portion of MRR will also commenced in 2016. For the period through 2015, this backlog represents a modest improvement over our 2015 backlog as of last quarter. The majority of the increase in backlog is expected to occur in the 2016 and beyond. Although, this backlog has not significantly altered our expectations for 2015, it had de-risked those expectations. More importantly, this gives us great comfort in the future of QTS and visibility that we have for growth in 2016 and beyond. The stability of our customer base also was evident in our low churn for the quarter. Rent churn is the MRR impacted customers completely leaving the QTS platform in given period compared to total MRR at the beginning of the period. Churn for the third quarter was 1.1% and churn for the first nine months of 2014 to 4.7% providing further confidence in our expected business plan of 5% to 8% annual churn. Regarding developments on Slide 15, we brought online approximately 83,000 square feet of raised floor during the quarter effectively delivering the full July to December 2014 development plan that we laid out at the end of Q2. We did fill at a cost in line with our expectation of developing space at less than $7 million per megawatt. During the quarter we added raised floor at a number of facilities, which includes approximately 28,000 square feet in Dallas-Fort Worth that was substantially pre-leased, 25,000 square feet at our mega-scale datacenter in Suwanee, 11,000 square feet in Richmond; 10,000 in Atlanta-Metro and finally 9,000 square feet in our Sacramento datacenter. We do not have plans to bring on additional space online in the remainder of 2014, but we are well underway our development for several of our sites for 2015, including the second part in our Dallas-Fort Worth datacenter. Based on working online all of our second half 2014 development plan during Q3, our utilization dropped third quarter to approximately 84%. This number represents the occupancy rate as of September 30, 2014 and not the leased rate as it excludes the booked-not-billed backlog. This was also a result of the first part of our Dallas facility coming online which is already pre-leased. We expect our utilization to increase during Q4 as we continue to grow our business with that plans for new phase coming online. Due to our Q3 development, we have now expanded our total build-out raised floor for approximately 927,000 square feet still only 43% of the total powered shell raised floor capacity of 2.1 million square feet in our existing facilities. This capacity provides us with continued comfort, where we control our future development and know lower costs and lower risk path to support our future growth. On Slide 16, CapEx spend is based on market demand, successful leasing and our flexible capital efficient model which drive strong returns. We continue to develop in small incremental space in response to customer backlog and real-time demand. Real-estate related capital expenditures excluding acquisitions incurred during third quarter were approximately $38 million. A breakdown of those capital expenditures is summarized in the supplemental information provided with our earnings release. Given our successful leasing momentum in Dallas and the acceleration in development of additional capacity to meet this demand, we expect aggregate capital expenditures for 2014 to be approximately $200 million. As further, evidence of our success based capital spend, embedded in our capital plan for 2014 and beyond is approximately 160 million of remaining development cost relating to our $62.6 million booked-not-billed backlog. Our continued growth in capital efficiency drove an annualized return on invested capital for the third quarter of 15%, for a business that still has tremendous capacity available to drive incrementally higher returns. This continues to meet our target level of 15%, but will vary based on the timing of new development projects, acquisitions and other expansion opportunities. As Chad mentioned, we expect to see average returns drop during the quarter, as we have brought certain projects under construction online including our Dallas-Fort Worth facility. Even with this early development cycle, we are pleased that the unlevered return on invested capital continue to hit our stabilized target level of 15% and note that this level will continue to fluctuate around the timing of new development. Moving to Slide 17, I will review our resulting balance sheet position. As we discussed on the second quarter earnings call on July 23, we completed the issuance of $300 million of senior unsecured notes due in 2022. Proceeds were used to repay $75 million outstanding under our unsecured term loan with the balance being used to repay amounts outstanding under our unsecured revolving credit facility. As of September 30, 2014 our total debt is $591 million including capital leases. Our debt to third quarter annualized adjusted EBITDA was approximately 5.7 times. While, we'll continue to target a long term stabilized debt-to-EBITDA ratio of less than five times our backlog of over 62.6 million gives us great comfort in our ability to continue to manage our balance sheet, support our current leverage and de-lever as our business grows. As we have said in the past, we are comfortable with leverage above five times as we pursue certain growth opportunities that require upfront capital and have clear path of deleveraging as revenue increases from the additional investment. We will continue to review all methods to invest in our future growth, and are open to various financing options for our business. As we deliver on the strong backlog that we have developed, we can commit that, as we review various alternatives to fund our business, we will continue to build shareholder value by investing in opportunities, with strong return on invested capital and managing our risk with capital efficient non-speculative investments. Additionally, we believe we have significant liquidity capacity in our balance sheet. As of September 30, we have total of approximately 395 million liquidity in the business made up of availability under our credit facilities and cash. We remain pleased with the strength of our balance sheet including one year term debt maturities and our available liquidity. Finally, on Slide 18, we are reaffirming our 2014 full year guidance of adjusted EBITDA of $97 million to 101 million, operating FFO of $73 million to $77 million and operating FFO per share of $1.95 to $2.05 per share. We continue to expect revenue growth in the mid to high teens compared to 2013 and annual churn of 5% to 8%. Regarding our capital expenditure plan, excluding acquisitions, we continue to expect total 2014 capital expenditures of approximately $200 million. Regarding 2015 guidance, as Jeff mentioned earlier, given the size and capital needs associated with our booked-not-billed backlog, we are currently working through our 2015 development priorities, capital allocation and financial expectations. We do not expect our recent contract expansions to materially change our expectations for 2015 has a vast impact on our financial performance will occur in 2016 and beyond. We will be managing the capital expenditure requirements in 2015 to deliver the space that has been contracted and reviewing our capital expenditure plan accordingly. We will provide further details regarding our capital plan and full 2015 guidance during our fourth quarter earnings release. Overall, we are pleased with the financial success we are achieving and the growth in our core business. We are excited about the incremental profitable growth that is supported by our significant backlog. And finally, we're pleased with our balance sheet and liquidity supporting strong expectations for future performance. With that, I would turn it back to you Chad.

[Chad Williams:]

We're excited at the momentum of the business and the growth that we continue to achieve. We are pleased that the engine that drives our business is our core C2 colo and C3 cloud and managed service products. These services have continued to support profitable and predictable results. We also appreciate the accelerated growth created by our C1 product capabilities and scale capacity that was demonstrated in our third quarter results with our recent significant new contract extension. Not only will this win accelerate revenue and drive significant utilization and efficiency in our Richmond datacenter, we were able to deliver this capacity with strong profitability and return on capital metrics based on our low basis and significant capacity in this mega-scale facility. In addition to our product differentiation, our world-class infrastructure is further supporting our financial success with our mega-scale owned facilities at a low basis we've only utilized 43% of our raised floor potential in our existing owned and controlled powered shell. This provides QTS with significant capacity to more than double our operating platform within our existing footprint. In addition, this capacity combined with our product mix gives QTS multiple options to grow our business including the capacity to pre-lease large blocks of space and build-to-suit for customer specific requirements within our current facilities. In addition, we drive capital efficiency by operating our platform at a high level of utilization of floor space as a percentage of what we have built out. This model has supported our operating leverage, low cost to build and enabled QTS customers to continue to grow with QTS. All this supports the financial performance that we have demonstrated including our strong growth and leading 15% plus percent targeted fully stabilized return on invested capital, none of this would be possible without the exceptional efforts and capabilities of our people. We are powered by our people, driven by our core values and are proud of the 450 plus employees at QTS who are delivering premium customer service every day to our 850 plus customers with the right flexibility and scale that truly drives QTS's success. Thank you to them. Now I would like to open up the call to questions. Operator?

[Operator:]

Thank you. [Operator Instructions]. And our first question will come from Simon Flannery of Morgan Stanley. Please go ahead.

[Simon Flannery:]

Bill, could we talk a little bit more about margins. First, G&A its potential revenues, you're saying anticipate this will return to a low 20% level on an annual basis. Is that something that we're going to see a big step-up in Q4 or into 2015? Just wanted to clarify that statement. And then the commentary around the change in business mix and the margins. Should we anticipate that 50% is sort of more a medium to long-term target in the next several quarters we're going to be bouncing around this mid-40%s level, any clarification there would be great?

[Bill Schafer:]

I think on your last point there on the overall EBITDA margin, yes, I think it is something that will be in the mid-upward 40s and growing gradually over the next few years. With regards to the margins, you know the third quarter operating margins are always tend to be at the lowest given the significant change in utilities. I think we have a little bit too with the product mix with Princeton coming on, we contribute a little bit to that given the higher recovery level there also. I think it's more basically pretty well balanced and will be. And from a G&A perspective, we probably get hit a little bit higher in the first half of the year with some of the G&A related expenses, and then that tails off in the second part of the year. So we're looking at that roughly on an annual basis probably closer to in that low 20% area.

[Chad Williams:]

And Simon this is Chad. We want to also be mindful that we want to continue to invest in our business. As we talked about in this quarter, our CFM, Critical Facilities Management business launch, our continued investment in cloud and FedRAMP and the products that were driving our business, we feel are strategic and core to the success and as we're comfortable with over 400 basis points of improvement on our margin over the last year or so, we're going to continue to focus on that margin expanding and it will approach 50%, but it will be in the next few years as we build into our model and scale and efficiency, because we want to stay and continue to be very innovative in driving our products and our services to our clients. That is what the clients are demanding and wanting and what we are connecting with our solutions on. The one other thing I might add to that is third quarter is always the highest expense on utility perspective from a utility cost perspective. So that's always something that drives it too, but just a few comments there.

[Operator:]

The next question will come from Barry McCarver of Stephens Inc. Please go ahead.

[Barry McCarver:]

So I guess the first question, just on the guidance and I'd point to both the rental churn guidance and total revenue growth given the growth on first three quarters of the year going into 4Q looking at the full year numbers, I mean it suggest that, you could very easily come in on the low end of the churn guidance and in the high end of the revenue guidance, not even a little higher. Am I missing something that's coming in the fourth quarter or we're just trying to be little conservative?

[Chad Williams:]

Barry, its Chad. Appreciate the question. And we continue to be very excited about the business and the flow, -- Dan and the sales team has done a great job to continue to improve churn, I can tell you it's a board conversation on a repetitive basis that we want to keep the customers we have, we want to minimize the churn number, we want to over perform that, but we also want to be careful and calculated and calibrated as we march forward. And I would say also that, we are very encouraged with the record booked but not billing of $63 million. It is an impressive number for this team and I think we also try to calibrate that that's not something we want to try to set the tone for each quarter, but it certainly, as we build our business have the ability with our product mix to bring in strategic, profitable C1 business, where it makes sense for the platform and I think you saw that in this quarter. But I also would tell you that, even though we have great visibility going into '15 most of the large strategic business that we just announced on that 19 megawatts is really not going to affect '15, it's really going to be backend loaded and into '16. So we want to be calibrated on what we're doing and the expectations we're setting, because we always want to be respectful of making sure that we do what we say we do and drive our business the appropriate way.

[Jeff Berson:]

Yes, Barry. This is Jeff. The other thing I'd comment on is really to guidance is I mean FFO and an FFO per share standpoint, if you recall we did execute the bond transaction in July and we were pleased with it. It pushed back the maturities set our rates at a good level, but we did that which also increased interest expense, we did that without change in our FFO and FFO per share guidance and we're pleased that we're able to effectively work through the balance sheet without seeing the dilution on FFO and FFO per share growth. But that was also a factor, in terms of how we're setting our guidance at this point.

[Bill Schafer:]

Yes. And it was more at the end of July versus the beginning of July, when that deal came in place. So we'll get the first full quarter impact on the interest in Q4.

[Barry McCarver:]

Sure, that's a very good point. And then Chad back to one question for you. On that sizable 19 megawatt sign and the fact that it's coming in, it sounds like that's coming in pretty late in 2015. Is that timeframe of the announcement versus it goes into commences, is that just because of the size of the deal, or it just takes [indiscernible] has given some time to build that out and get it ready?

[Chad Williams:]

Well, it is very -- and what's great about it is keep in mind with our powered shell capacity we do have the opportunity when we're talking strategic C1 deal to actually walk people around and show them where they would be within our facility, right? That's the beauty of having the powered shell capacity, you can sell it and operate it, but there is a build-out function that will happen on both the 12 megawatt deal in Richmond and the 7 megawatt deal in Atlanta-Metro. And so think about that as kind of a build-to-suit, right? We are pre-leased and pre-sold and we'll be building and delivering that and you're right, it will deliver latter half of '15 and really you'll see the ramp of that in '16.

[Barry McCarver:]

Can you share is that incremental new capacity for the customer or is that capacity that's coming from another provider into QTS?

[Chad Williams:]

It is a combination of Metro, it's a continued expansion of an existing footprint and new demand for them. And Richmond is an organic national procurement deal that could win anywhere and land it in Richmond because of the value prop, the premium customer service, the scale that is second to none at the Richmond facility and cost of economics on power and a number of things. So, that could win anywhere, they chose Richmond. We're ecstatic about that and that is net new site for the customer.

[Operator:]

Our next question will come from Stephen Douglas of Bank of America Merrill Lynch. Please go ahead.

[Stephen Douglas:]

Great. Thanks for taking my question. I guess first, and I know you're not giving your guidance for next year and you mentioned that you're still kind of the planning of a budget, but I'm wondering if you may be able to provide some thoughts just kind of direction and where you see the development CapEx going relative to the 200 million this year, just given the visibility that you have? And then second, maybe if you could provide a quick update on where we are in the process for trying to get a PLR for the managed services business would be great? Thanks.

[Chad Williams:]

Great, Stephen, great. This is Chad, and great to have you on the call. CapEx, I think to your point, the company's been on a path for '14 to be at a $200 million capital investment level, which has been the projected amount and we'll be on top of that for the year. I think that one thing that changes in our business as we continue to raise the booked but not billing number from a $63 million number, it does give us a lot of insight on build-to-suit or pre-leasing of our capital pool. So if you think about that number, I think we've disclosed on the booked-not-billing is about a $160 million, of course that's not all going to be spent in ’15, but it is kind of a completion to deliver the booked but not billing revenue that we talk about. You can see that, our investment committee, we pride ourselves with our investment committee meeting monthly and being very flexible and accommodating to Dan Bennewitz and the sales organization and the operations to make sure that we have just in time delivery for space and power. So we that we keep the engine of our business C2 always with inventory in our C2, C3 business with the availability of pool and do strategic profitable C1 business. So, we will be working through that and we are working through that now. But you can imagine that with that kind of capital we are thinking about it as we always do to be very flexible and also to be very thoughtful about the capital. But I would, we're going to drive through that and it will be a process that we finish up here towards end of the year and we'll back up to the Street with it. On the PLR, we continue to make progress. I know that ours a little different situation and we are working and seeking some things that are pretty known in the industry for interconnection and pretty well settled. But I do know that everybody knows that the IRS has been busy with lot of things and as they work through some things, we are hearing encouraging things that they are starting to move that process forward as they did a complete review of the REIT rule and reaffirm some things and we have seen some things like Windstream kind of get the engine going again and we're excited that we'll have some definite clarity on that in the coming quarters or month as we move forward and we'll look forward to getting that and bringing that to the street.

[Jeff Berson:]

And Stephen, this is Jeff. Just to make sure that the comment on CapEx was clear to you. What we're not saying is that, that sort of base of 214 million and 160 million that would be required to deliver the full booked-not-billed over a multiple year period is aggregate, right? What we're telling you as part of the 2015 guidance process that we're going to be doing through over the next couple of weeks and months is to reassess how we're allocating capital and where we're putting that capital to be much more mindful of the incremental capital opportunities we have through the booked-not-billed.

[Operator:]

And our next question will come from Jordan Sadler of KeyBanc Capital Markets. Please go ahead.

[Jordan Sadler:]

I wanted to follow-up on the 19 megawatt leases. Well, can you talk about maybe the primary drivers of that tenant signing in the Richmond and maybe expanding in Metro and maybe how you win a deal like that? And as a follow-up, what the opportunity is to win or see additional or incremental C1 customers of this scale sort of enter the portfolio and sort of -- over the sort of near to mid-term?

[Chad Williams:]

Hey Jordan this is Chad. I'm going to take the first part and then I am going to let our Head of Sales, Dan Bennewitz kind of talk more directly about the client. You know, I do think that when you're sitting on 937,000 operating square feet with 2.1 million square feet of operating powered shell that you can build into. It does give you the ability to have it scale and strategic opportunities and think about things a little differently instead of having constraints in that capacity. At the same, we are not out on the street chasing low price C1 big bulk deals, it's not our business. Our business is to provide solutions that make sense for our business strategically from a client perspective and profitable from a return perspective. And as we pull those levers and think about that, it is very encouraging to have the ability to sit down with the sophisticated customer and be able to put deals of this size and scale together. And guess what, that 12 megawatt they take in Richmond, there is still ample capability to continue to do deals in Richmond, but we want to be thoughtful about them being strategic and profitable in our returns. Dan, you may talk more specifically about the customer and how your team did a great job winning that deal.

[Daniel Bennewitz:]

Yes. This is Dan. So first off, there an existing customer in Atlanta have been with us for multiple years and have experienced the level of customer support service, robust infrastructure that we deliver to them. And as Chad said, they were looking for incremental capacity been doing a national search. So this is incremental growth, and we are very excited and obviously delighted that we're able to be successful with Richmond as a solution. Richmond for this client is a fit, A, because of the solution that we're able to provide to them. As I said before, they are familiar with our robust infrastructure. The way we provide customer service, the high level of infrastructure that we have. They are also very interested in a high level of compliance and security that we are able to deliver. Richmond, in addition from a connectivity point of view, met their needs. All those together ended up with Richmond being selected and so we're delighted. That adds to the other ones we had earlier this year in Richmond. We have had a 3 megawatt deal earlier this year with a financial services firm. So we've had multiple wins with Federal government clients in Richmond. So we put a focus on Richmond and we're seeing the benefits of that. We're very excited with the growth that we're seeing in Richmond.

[Chad Williams:]

And Jordan one thing I might add to that is, you think about C1 business, our cost to build metrics are very attractive, Jim and his team have done a great job of getting our cost per megawatt at very attractive bases with our infrastructure rich acquisitions. But you shouldn't think about it as being a low return deal, just like in the Atos, McGraw Hill transaction the 10 plus cap rate going in, in place was not the best cap rate. It is about crafting a solution that brings the service, the capability of platform, the compliance with security. So when I say, we're not just interested in every C1 deal, what I am saying is we want deals that makes sense, because we're going to need to get paid on a profitable level for each deal we do as we drive our business. And we really do think about that at the investment committee level and the transactional level that we want to grow our business, we want to be industry leading growth and we wanted to be the right growth, the growth customer, the right profitability profile and to Dan's point, Richmond has got tremendous momentum. I stood there in January at the sales kickoff meeting which was hosted in Richmond, I said it's the year of Richmond. What's great is I can say that all I want, that the sales team, the operations team has delivered that for us this year and we are so excited about that at QTS.

[Jordan Sadler:]

I guess, I'm keying off of, the way this was worded a little bit in your press release which is that they chose Richmond and Metro after a nationwide search. I'm curious Dan, can you talk a little about the competitive set as the customer search nationwide for other potential sites, I mean how many sites are there that can accommodate this type of customer requirement?

[Dan Bennewitz:]

Well, the other -- the market -- there is a wide -- they start off with a wide aperture across U.S. both West Coast to East Coast, North to South and went through a very methodical and obviously vigorous process. So, there were multiple other opportunities for this client to go a different path. And we -- thus we were very delighted with the inclusion and because of -- I think now when what we talked about both the infrastructure, the compliance and security, the great customer service and satisfaction. But I'll say also the trust they have in QTS is a part.

[Jordan Sadler:]

Thanks. I think I'll ask another quick follow-up. Yes, just curious if you could give a little color on the Federal Cloud business and you guys are now FedRAMP ready and just -- what you expect in terms of velocity of leasing in terms of backlog with Federal Government?

[Chad Williams:]

Sounds good and appreciate it. From our perspective FedRAMP has been a project that's that something we pursued and its parts of the -- of our commitment to compliance and security, so it's -- there is only about 12 FedRAMP certified providers in the U.S. or in the world for that matter, and a lot of people are trying to strive the organization to get there. I think we started this a long time ago, we think it's going to have a big impact on our business, but we also know is that FedRAMP process has been like in maybe IRS case less than quick on the timing of things. So it's been a little frustrating for our team to kind of hurry up and a wait a little bit, but we're at a point now, we get a distinctive point as we become eligible now and we do think that will drive business and has been driving business from that same point. I'm going to let Dan talk a little bit about specifically on the FedRAMP.

[Dan Bennewitz:]

Yes Jordan, and we made a conscious investment and been in the investment compliance and people and process and technology to be FedRAMP certified and we've seen frankly earlier this year, we've seen a number of our wins have been because we were growing through the FedRAMP process. With FedRAMP Ready notation that we're able to have now is a result of the Federal government make a decision to highlight this for those providers like QTS, we're going through the FedRAMP process. So, we think this is actually a great milestone. It's not like the kind of just run off in the starting line, we're off on the race, we've been in the race for a while certainly through this year and this is a great validation of the progress that we're making. It also validates the partners that we have in terms of co-file proclivity and PWC, who are all very respected entities in the market and a lot of us to be promoted as FedRAMP ready. I think this will help us continue the momentum we had. Some of the wins we highlighted in prior quarters, we've had some this past quarter, our wins in the Federal government we're very excited with the momentum we have in the Federal space, a lot of that is in Richmond, some of our Federal Cloud businesses that we've won obviously is based in Richmond, but also leverages our other datacenters as our clients build-out their cloud infrastructure. So, this obviously is a great milestone for our Federal Cloud product. It's also a great validation for Federal business in our other C1, C2 businesses.

[Chad Williams:]

And what we love about it and we talk about it a lot, I know everybody hears it a lot is, what we love -- what I love about it is the integrated product gives us a basket of products, so we're not relying upon the Federal Government to deliver a huge cloud business to us, but it is certainly a complement to our business and our service and our offering, we think it will be a growth engine for us. One comment back Jordan to you on the inventory for large deals. It is very safe to say as you know that there is a not a lot of capacity that large to handle that 12 megawatt deal in Richmond. So you could imagine that people in Northern Virginia that might want to be sub-leasing space was very active. And you can also assume that there was build-to-suit opportunities put in front of this client. And Dan and the team and the operations team had to deliver through all of that and the cost of power in Richmond, it all came together and it was a team effort and they did a good job and we're excited about that victory.

[Operator:]

Our next question will come from Matthew Heinz of Stifel Nicolaus. Please go ahead.

[Matthew Heinz:]

I was just hoping you can provide a little bit of detail on the dynamics behind elevated property expenses in the quarter. I understand that Princeton had an impact on a dollar basis, but on a percentage basis, I guess it seemed a little high. And then maybe when you expect NOI margins can sort of normalize back towards the mid-60% range going forward?

[Bill Schafer:]

As far as the expenses, yes, Princeton did have an impact on that, it was probably neighborhood of about 1.6 million. Utilities though in general like I said in the third quarter were up pretty significantly quarter-over-quarter. Again, I think those months, there is a lot more usage on the cooling aspect of things and they went up pretty significantly, not unlike previous years. It's more of the seasonality. They required a little bit too in the repair and maintenance type area that will fluctuate from quarter-to-quarter, but nothing really out of line from what our expectations were.

[Matthew Heinz:]

And then as a follow-up, just have another question on the FedRAMP announcement. I just wanted to understand and sort of make sure that I understand really what the readiness status implies. And how far along are you in the process of submitting a third-party assessment paperwork? And then maybe when might we expect you to have the green light to allow Federal agencies to come in and perform their own due diligence on the product, or is this already happening?

[Daniel Bennewitz:]

Yes Matthew, this is Dan. I'll try to answer that. So first off, the FedRAMP Ready status identifies cloud service providers who are in the FedRAMP assessment process. It includes -- there are a couple of steps here to complete to get this notification. One is you have to have initiate the review of the documentation with the FedRAMP PMO, the Project Management Office, have already gone through the FedRAMP PMO Readiness Review and are in the process of working with a third-party crediting organization, for us it's [indiscernible]. So all those three check marks have to be made to get this. And so we are there, and we are actively discussing how do we continue that progression. Obviously, we're interested in accelerating that. And so I think to give you a timeframe on that given that the unpredictability of the Federal government, but we're active there and I think it's another step in confirming our ability to deliver this type of secured cloud product to Federal customers.

[Chad Williams:]

I'll add one thing to that. So you should think about that work being multiple quarters over a year. So it's not something, the three steps that Dan just said came out quickly, but they are not quick steps. So it's a very extensive process we've been working on this for some time and feel like we do have an advantage from being in a right position at the right time. The other thing I'll note is, the enterprise customers that aren't necessarily Federal agencies are looking at this as being a very big accreditation grab for them. And I'm not saying that everything that government does is perfect, but I will say that FedRAMP project that they have outlined for security and compliance is at the highest level of today's security, because I do think the influence of NSA and different organizations do drive security and compliance in the Federal Cloud at very high priority and they know what they are doing in that regard. So I think it does validate our services in multiple areas besides just the government. And the other thing is, I don't think I would want to characterize that you should expect that this is going to ramp up and significant contracts wins are going to come in. We have had some very unique and great wins in that, but we are not counting on that this to be something that significant government wins just roll in the door now. It is something that will build over multiple quarters and will be something we think that in the long-term will be an enhancement to our product and delivery and capability.

[Bill Schafer:]

And Matt, this is Bill again, just kind of going back on the expense side of things. I also want to point out a lot of those expenses are actually recovered, you will notice that a large increase in the overall recoveries. And so what that does is just increases the overall revenues, but there is not really profit in the reimbursement associated with those expenses, so it does have tendency to kind of put a little pressure on that margin.

[Operator:]

The next question will come from Tayo Okusanya of Jefferies. Tayo, please go ahead.

[Tayo Okusanya:]

First of all fantastic quarter. Well done. First question about Chicago. Just curious what the plans are there? Great market. You have an entry in there, and just how quickly you could expect to ramp up in Chicago?

[Chad Williams:]

Hi Tayo, it's Chad. Thanks a lot and we as you know look for a long time before we go someplace, because we like I call it, hang around the goal long enough to find the right value. And the infrastructure rich SunTimes facility being in downtown Chicago about a mile and half from the iconically full for 10 year 350 Cermak building which is not lost on us. It's just an unbelievable entry point into Chicago. It's got 30 acres of land and the scale that really fits the true meeting of our mega datacenter and we're just excited and I am going to let Jim Reinhart who runs development operations, talk to you about some of the work that they're doing as we are still on track to bring Chicago online in '16 and are excited about that.

[Jim Reinhart:]

Tayo, obviously we're excited about Chicago. The supply demand characteristics we think make it a very attractive market and we're looking forward to getting that facility running as soon as possible, currently, we are targeting sometime in 2016. We're obviously looking at the best way for us to get that asset so it is sellable, while Dan is continuing to build the pipeline and obviously we'll update you guys on specificities of that when we lay out our 2015 capital plan.

[Tayo Okusanya:]

And then just in regard to the 2015 capital plan, if I heard you correctly in regards to the current booked but not billed, where you're going to have about $160 million of development cost associated with that?

[Chad Williams:]

Yes, the only thing to seeing about that is you shouldn't expect that to be all spent in '15 because that's for the full booked but not billed which will not all deliver in '15, so there is a little bit of -- of $160 million is the total number. We delivered the $63 million booked but not billed that will not happen at all in '15.

[Tayo Okusanya:]

Yes, but it will not happen all in '15, okay.

[Chad Williams:]

Yes.

[Tayo Okusanya:]

And then just one last question in regards to the 19 megawatts that was signed again it's all C1 products. Just curious again, although I know it's part of a broader solution for all your datacenters, specifically for the C1 -- for this particular C1 product, at the price point your final lease is at, what's the implied yield?

[Jeff Berson:]

Tayo, this is Jeff. Out of the courtesy for the client and making sure that as we think about pricing per client, we don't put out that kind of specificity, but hopefully what you heard loud and clear is, because of the cost to develop that infrastructure in Richmond, because of some specific development opportunities that we looked at in delivering that service to that client, we are very comfortable that it is at attractive returns. We're also comfortable that it will not impact our broad targets to the markets and to ourselves of achieving that 15% plus on unlevered return on capital on a stabilized basis across our portfolio. And so we still expect to hold ourselves to those standards and we don't think this will have an impact on that.

[Bill Schafer:]

And Tayo, and it is a great question, as I said earlier, as we competed against the national footprint you can imagine that some people in Northern Virginia were very price focused. That did not carry the day, this deal fits our strategic footprint and profitability profile and will not hurt the ability for us as a platform to just point to drive kind of the fully stabilized 15% plus return, which is really the way we like to bring the business back together and to make sure that we're doing things to drive and reinforce that. The one thing I'll say about capital is, as we are on target this year for a couple of hundred million dollars of capital, I think it is safe to say that it won't be less than 200 million in '15 and we'll work through that. But we are shifting and looking at priorities and allocation with the investment committee, as we speak and talking about how to refine that to best deliver these large new deals in a built-to-suit, just in time delivery approach, but at the same time providing Dan and the sales team the ample capability of products and space where they needed to continue to drive our engine C2 and C3 business.

[Chad Williams:]

And Tayo, one last thing I'd point out, if you think about half on the implications of this deal is that as we've seen in all of our facilities as utilization in those facilities goes up, incremental revenue in those facilities continues to typically hit our business at a higher and higher return on capital, and so the other value of this amount of space coming in from Richmond is its bringing utilization in Richmond to a significantly higher level. And with that incremental utilization it drives the operating efficiencies that enabled us to bring on those next customers at higher returns just because of the cost and operating efficiencies there.

[Operator:]

And ladies and gentlemen, that will conclude our question-and-answer session. I would like to turn the conference back over to Chad Williams for his closing remarks.

[Chad Williams:]

Well, thanks again, we appreciate everybody's time and the energy today on the call. We also appreciate our investors, we know we are good -- have to be good stewards to capital, we want to create value, we want to drive our business. That's based on our people and our core values, we continue to appreciate the confidence in our platform and our business. I want to thank our people around the country to make this happen and the confidence in the investment community for the trust and confidence with your capital. We look forward to continuing to drive our business, and in closing today, I must say, we believe, go Royals, game seven tonight. Sorry all the Giants fans because we are taking the World Series. Thanks everybody.

[Operator:]

Ladies and gentlemen, the conference has now concluded. We thank you for attending today's presentation. You may now disconnect your lines.