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Edited Transcript of QTS earnings conference call or presentation 22-Feb-17 1:30pm GMT

Thomson Reuters StreetEvents

Q4 2016 QTS Realty Trust Inc Earnings Call

Overland Park Feb 22, 2017 (Thomson StreetEvents) -- Edited Transcript of QTS Realty Trust Inc earnings conference call or presentation Wednesday, February 22, 2017 at 1:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Stephen Douglas

QTS Realty Trust, Inc. - Head of IR

* Chad Williams

QTS Realty Trust, Inc. - Chairman and CEO

* Bill Schafer

QTS Realty Trust, Inc. - CFO

* Daniel - Dan Bennewitz

QTS Realty Trust, Inc. - COO of Sales and Marketing

* James - Jim Reinhart

QTS Realty Trust, Inc. - COO of Operations

* Jeff Berson

QTS Realty Trust, Inc. - Chief Investment Officer

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Conference Call Participants

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* Jonathan Atkin

RBC Capital Markets - Analyst

* Richard Choe

JPMorgan - Analyst

* Jordan Sadler

KeyBanc Capital Markets - Analyst

* Jonathan Schildkraut

Guggenhiem Securities - Analyst

* Matthew Heinz

Stifel Nicolaus - Analyst

* Simon Flannery

Morgan Stanley - Analyst

* Paul Morgan

Canaccord Genuity - Analyst

* Unknown Participant

- Analyst

* Eric Luebchow

Wells Fargo Securities - Analyst

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Presentation

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Operator [1]

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Good morning and welcome to the QTS Realty Trust Q4 2016 earnings conference call.

(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.

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Stephen Douglas, QTS Realty Trust, Inc. - Head of IR [2]

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Thank you, operator. Hello, everyone, and welcome to QTS's fourth-quarter and year-end 2016 conference call. I'm Stephen Douglas, Head of Investor Relations at QTS, and I'm joined here today by Chad Williams, our Chairman and Chief Executive Officer; and Bill Schafer, our Chief Financial Officer. We also are joined by Jeff Berson and additional members of our executive team who are participating in Q&A.

Our earnings release and supplemental financial information are posted in the investor relations section of our website at www.QTSdatacenters.com on the investors tab. We also have provided slides and made them available with the webcast and on our website which we hope will make it easier to follow our presentation today.

Before we start, let me remind you that some information provided during this call may include forward-looking statements that are based on certain assumptions and are subject to a number of risks and uncertainties as described in our SEC filings and 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, return on invested capital, 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 measures and a reconciliation into 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.

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Chad Williams, QTS Realty Trust, Inc. - Chairman and CEO [3]

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Thanks, Stephen. Hello and welcome to QTS's fourth-quarter and year-end 2016 earnings call. As you can see from the results we released yesterday, we delivered a strong worth order to close out another successful year of execution for QTS. A combination of our technology services platform delivered across our mega scale data center infrastructure continues to drive differentiation for QTS in the market.

On slide 3, it is our strong belief that customers are increasingly consuming IT infrastructure, resources in a hybrid it environment. We see it from the public cloud providers, we hear it from various contacts throughout the industry, and most importantly, we have consistently heard it and experienced it from customers.

As an example as of the end of 2016, the percentage of reoccurring revenue from customers using more than one of our C products is now 60%, which is up from approximately 40% as of the IPO. Due to a variety of factors, whether it is security, high-performance requirements, or infrastructure flexibility to access cloud resources proportions of hybrid IT, enterprise customers need a partner that can deliver a full suite of products that allow them to customize their infrastructure based on specific and unique IT requirements.

A customer may want a Colo or private cloud for large-scale, always on workloads like databases or messaging platforms but they may also need an on-ramp to a public cloud to take advantage of the elastic nature of certain workloads. We can do that seamlessly from a single pane of glass across multiple public and private cloud platforms while integrating all of the fundamentals of the data center into this view.

Another customer may be thinking about moving to a cloud environment but isn't sure how or when the transition will occur. Our integrated services platform gives us the ability to have a conversation with those customers about solutions that can deliver the flexibility and customization to solve complex IT requirements and always with QTS's premium customer service and industry-leading security and compliance support.

Not every enterprise application or requirement can be delivered in the same IT infrastructure environment. This is what we refer to as hybrid IT and is the foundation of QTS's integrated services platform. Our ability to capitalize on growing hybrid IT demands gives us the opportunity to continue to deliver consistent, long-term value to our customers and shareholders.

Next, on slide 4, I would like to reflect on what the QTS team has achieved during the past year. For the full-year 2016, we remain -- we maintained our strong momentum with healthy year-over-year growth across key financial metrics. We achieved record revenue of $402 million up 29% over 2015, including 33% growth year-over-year in connectivity revenue which now represents approximately 6% of our recurring revenue, adjusted EBITDA of $184 million was up 32% year-over-year, operating FFO of $141 million grew 35% year-over-year and operating FFO per share of $2.61 grew 14%.

We achieved an annualized unlevered return on invested capital of 14.8% for 2016 which is in line with our fully stabilized target level of 15%. The Return on Invested Capital reported in the fourth quarter and the second half of 2016 was well below our fully stabilized 15% target due primarily to new, lower utilized assets like Chicago and Piscataway. As we have discussed in recent quarters, we expect the Return on Invested Capital to remain below our 15% stabilized target over the course of 2017 and ramp over time as these newer mega data centers lease up.

Leasing trends remain positive across our product lines. During the year, we added 114 the customer logos up 28% from 89 customers added in 2015 and ended the year with over 1,100 customers in total. We signed new and modified leases during the year representing $48 million of incremental annualized rent, net of downgrades representing 21% increase year-over-year.

We reported annualized MRR churn of 5.6% for 2016 at the low end of our revised guidance of 5% to 7% and our historical target range of 5% to 8%. In addition, visibility into the future cash flow growth remains strong as a result of our backlog of signed but not yet commenced annual revenue of $43 million as of year-end. As we've said in the past, this number will continue to approach a more normalized level as we deliver on a few larger customer contracts over 2017.

Over the course of the year, we made numerous key investments in the business to position QTS for consistent, long-term growth. We've deepened our presence in existing markets like Atlanta, Dallas, and Richmond where we are seeing strong growth and we expanded our footprint into new markets like Chicago where we formally opened the state-of-the-art mega data center at the beginning of the third quarter.

When we acquired our Chicago facility it had a shell that supported 133,000 square foot of raised floor. As we look at the design of the site through the course of our development, we've been able to increase the capacity and the existing shell from 133,000 square foot of raised floor to 208,000 by adding a second story to the existing building. In addition, we still own the adjacent land on the 30 acre campus which allows us to build an additional 350,000 square foot shell that can support more than 200,000 square foot of additional incremental raised floor.

At full development, our Chicago campus will be able to support over 400,000 square foot of raised floor and 80 plus megawatts of power. This capacity will continue to drive the momentum and success we're seeing in this market.

We also added to our footprint through two separate opportunistic acquisitions that extended our growth path with a clear cost to build advantage. The first, a 360,000 square foot facility in Piscataway, New Jersey was acquired for $125 million in June of 2016, and we remain encouraged by the initial response from existing and potential customers in the markets that QTS's differentiated approach to services and support. In fact, during the fourth quarter, we were pleased to sign another expansion lease with one of the existing customers in our Piscataway site increasing their MRR with us by approximately 35%.

This new lease follows a 1.1 megawatt expansion by a separate existing customer and announced last quarter. Our success in just two quarters since acquiring the property of Piscataway demonstrates the value that customers see in QTS's high-end customer service and customized solutions.

We're also excited to have recently announced the incremental footprint expansion in the Dallas market to the acquisition of a 260,000 square foot facility in Fort Worth, previously owned by one of the largest insurance providers in the world for $50 million. This facility provides QTS immediate sellable inventory in one of the strongest tier1 markets in the US and strengthens the Company's position as a leading data center provider with significant incremental expansion potential.

On the services side, we enhanced our portfolio with the introduction of several new products, including QTS managed cloud and OpenStack cloud, the newly rebranded QTS government cloud, and availability of AWS direct connect out of our Chicago mega data center. Our technology services platforms afford us the opportunity to offer incremental value and solutions to our customers on top of the space and power and it enhances the overall growth opportunity with new and existing customers.

More than 50% of our revenue from C1 and C2 customers is generated from those customers that are also taking C3 services which is up from approximately 30% just three years ago. And, for these customers, the C3 contribution reflects a 35% increase in the overall data center spend with us, that is revenue that we would not have the opportunity to capture if we did not have the opportunity or capabilities for service that we do. We will continue to look to enhance our C3 portfolio services to drive valuable solutions to customers in complex IT environments and maximize the utilization of our real estate by as we say selling the cubic feet.

Turning to slide 5, I'd like to spend a few minutes discussing our recent acquisition in the Dallas market. On January 30, we announced the purchase of a 53 acre purpose built mega data is center campus in Fort Worth Texas for $50 million. The site was formerly owned and operated by Healthcare Service Corporation, one of the largest health insurance providers in the United States.

In conjunction with the acquisition, they have signed a 1 megawatt lease to remain the anchor tenant in the facility. Much like our acquisition of McGraw-Hill Data Center in New Jersey in 2014, this latest acquisition represents yet another classic example of the value of QTS's opportunistic approach to acquiring infrastructure. Our $50 million purchase price of the Fort Worth campus represents an upfront cost per megawatt of approximately $6 million, which will continue to support our ability to generate an above average return on invested capital in that market.

In addition, this transaction establishes a new strategic relationship with a leader in the healthcare insurance sector and provides potential opportunity to further support this customer's future hybrid IT requirements. QTS's differentiated focus on customer service, technology solutions, and security and compliance allows us to earn trust with enterprise customers and continue to unlock value enhancing opportunities like these.

The Fort Worth facility currently has 40,000 square foot of raised floor and 8 megawatts of gross power built out with the powered shell to double this. Ultimately, including the adjacent land, we believe the site can support a total of more than 300,000 square feet of raised floor and 60 megawatts of gross power.

Since opening up the facility in Irving, Texas in 2014, we have experienced tremendous success, well ahead of our initial expectations. In fact, including leases signed in our book but not billed backlog currently not reflecting in the occupancy and assuming all the rights of first refusals we have provided to customers or taken, we have committed approximately two-thirds of the total 275,000 square foot of raised floor capacity at the current Irving site. Based on that demand we have experienced since opening the facility just 3 years ago, we have begun the preliminary planning phases to expand the site in Irving on the adjacent owned land. This capacity, however, likely will not be available until 2018.

The facility will be acquired in Fort Worth is located 20 miles from our existing site and provides immediate sellable inventory for us to continue and satisfy future customer requirements in the greater Dallas market. It also strengthens our service capabilities by enabling and enhanced, high-availability solution through a dual footprint in market. Dallas continues to be one of the most attractive tier1 data center markets in the country, and it will remain a focus area of investment in future growth for QTS.

Moving on to slide 6. Our model enables us to provide solutions to the largest of enterprise customers while also meeting shifting IT needs for smaller entities and government agencies. For larger requirements, we continue to support growth and hyperscale of one of our largest customers, a leading global SAS provider taking another 1.2 megawatts, increasing their business with us by an additional 10% across two different QTS facilities. Their expansion is a testament to the continued appeal by even the largest hyperscale customers to QTS's mega scale infrastructure and service delivery.

Our integrated solutions also enable us to work with smaller, fast-growing companies is rapid growth requires a flexible IT solution incorporating hybrid and shifting infrastructure. In Q4 we signed a fortune 1000 digital media customer taking C2 and C3 services representing total annualized MRR of over $700,000 in our Dallas, Virginia and Irving, Texas site.

We designed a hybrid solution for them where we are providing a combination of space and power, a dedicated private cloud, and a cross connect into AWS. This is a great example of how our integrated services platform allows us to drive broader solutions for our customers and target a wider set of potential opportunities than our competitors.

Now, moving on to quarterly leasing performance on slide 7. For the quarter, we signed new and modified leases totaling approximately 11.6 million of net incremental annualized rent in line with our prior four quarter average, demand during the quarter was broadly distributed across our product mix.

Moving on to pricing. During the fourth quarter pricing from new and modified leases was 16% above our prior fourth quarter average, driven primarily by higher mix of C2 and C3 leasing volume. C1 pricing per square foot was up 9% relative to the prior fourth quarter average, reflecting healthy industry pricing dynamics and a higher mix of relatively smaller footprint deals signed this quarter was generally carry a higher pricing per square foot. Pricing for C2 and C3 new and modified leases was up nearly 40% as compared to our prior fourth quarter average due primarily to a few sizable C3 deals in the quarter.

Regarding renewals on a like-for-like basis where customers renewed contracts without a change in square feet, we experienced renewal rates for the fourth quarter of 2016, reflecting an increase in pricing of 4.7%, above the pre-renewal rates. We continue to expect renewal increases in the low to mid single-digits. Leasing commencements, pricing during the quarter declined four C1 due to the higher mix of larger C1 commencements which also drove increased commitment volume this quarter.

Lease commitments, pricing for C2 and C3 also was down due primarily to a higher mix of C2 leases which carry lower pricing per square foot. Overall, the pricing environment across our footprint remains strong and is consistent with the positive market trends we're seeing.

Regarding the two megawatts of leased space in Northern Virginia that we discussed last quarter involving a government customer that will churn in Q1, we continue to review our options. There are two primary options that we are evaluating, the first involves finding a government customer with the specific requirements for this unique space and signing them at a value that would warrant us extending our lease term in the facility.

The second option involves finding a short-term tenant for the duration of the remaining 2 years that we have left on the lease, adding value that would reflect a shorter-term contract but not materially change our financial performance. We will continue to analyze our options and push towards and enhanced result.

With that, as I'm sure you saw in our press release yesterday, we are excited to have announced that Jeff Berson our current Chief Investment Officer will assume the role of Chief Financial Officer effective April 3. Jeff has been a critical member of our executive team since our IPO, and his leadership across the business has enhanced our capabilities around capital allocation, strategic analysis, and long-term planning. I look forward to his continued leadership as the new head of our financial organization. Jeff will be succeeding Bill Schafer, who is transitioning to new role of Executive VP of Finance and Accounting. This change is part of QTS's proactive approach to C level succession planning and provides for a strategic, seamless transition in this key leadership position at QTS.

Bill will continue to lead our key accounting and finance functions within QTS indefinitely. I'd like to personally thank Bill for his contributions to our organization as our Chief Financial Officer for the past 7 years. His friendship, guidance, and steady hand have been and will continue to be a great asset to me and the rest of my executive team.

Knowing Bill as long as I have, I have full confidence in his ability to provide a smooth transition for Jeff into the CFO role, and I am excited about what QTS can achieve with their combined partnership in leading our financial organization. Bill's extensive accounting and audit experience in the REIT industry will continue to be an asset for QTS.

With that, I will turn it over to Bill Schafer to discuss our development pipeline, balance sheet, and Outlook in more detail. Bill?

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Bill Schafer, QTS Realty Trust, Inc. - CFO [4]

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Thanks, Chad. I appreciate your comments and look forward to continuing to work with our outstanding team at QTS. I have great confidence in Jeff's ability to step in and lead our finance organization. Since Jeff arrived in 2013, we have formed a solid partnership, and I am looking forward to expanding that partnership with him to further QTS's growth and strategic goals.

Moving onto development. On slide 9, for the fourth quarter, we brought on line 48,000 square feet of raised floor in our Irving, Texas and Suwanee facilities. As of the end of the quarter, our total build out raised floor was over 1.3 million square feet, which represents approximately 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 data centers. This capacity continues to provide us with enhanced visibility into our future growth at a known lower-cost and lower risk profile.

Currently we anticipate bringing on line 151,000 square foot of raised floor in 2017, which includes 28,000 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're seeing. We also anticipate bringing on line additional capacity in Atlanta, Piscataway, Santa Clara and our Vault campus in Northern Virginia. The total cost to bring this space on line is estimated to be approximately $250 million of which $141 million has been spent and $109 million will be spent in 2017.

Moving to slide 10, we believe we have significant liquidity capacity in our balance sheet with no significant near-term debt maturities. Recall that in December we amended our unsecured credit agreement, increasing the total capacity from $900 million to $1.2 billion. As of December 31, 2016, we had a total of approximately $571 million in liquidity in the business made up of availability under our credit facility and cash on hand.

Our fourth quarter ending net debt to annualized adjusted EBITDA was approximately 5 times, which compares the 4.6 times as of the end of last quarter. I would note that our year-end debt balance includes the $50 million purchase price for our acquisition in Fort Worth which officially closed towards the end of the quarter. Although we remain pleased with the strength of our balance sheet, we continue to monitor market opportunities to lock-in fixed rate, extended maturity debt, and other forms of long-term capital over time as we manage our balance sheet and capital structure.

Next, on Slide 11 with respect to financial guidance, we expect 2017, year-over-year revenue growth to be in the range of 11% to 13%, and we expect 2017 adjusted EBITDA to be between $203 million and $211 million. Our guidance assumes an approximate 100 basis point year-over-year decline in an align margin primarily due to a full year of ownership of lower utilization sites like Chicago and Piscataway and Fort Worth. However, as a result of the continued operating leverage in our business we expect our G&A cost as a percent of revenue to also decline. We expect the net impact will drive our adjusted EBITDA margin in 2017 in line with our margin in 2016 consistent with our commentary last quarter.

As our new our sites begin to ramp, we continue to expect incremental adjusted EBITDA margin expansion over the next few years. We also are guiding 2017 operating FFO to be between $151 million and $157 million or between $2.64 and $2.76 per share fully diluted.

We anticipate year-over-year sequential growth for revenue, adjusted EBITDA, and OFFO to be slower in the first half of the year as a result of the previously announced front-end loaded churn event during the year. In addition, for Q1, we currently expect a sequential decline in reported OFFO and OFFO per share, again reflecting the impact of churn that we discussed. We expect growth across our key financial metrics to reaccelerate meaningfully as we move into the back half of the year. During 2016, we recognized a total non-cash tax benefit from operating results of approximately $6.4 million associated with OFFO, which we discussed throughout the year.

For 2017, based on our preliminary analysis and forecast, we currently anticipate recognizing a reduced non-cash tax benefit amounting to approximately $3 million for the year, which is reflected in our current OFFO and OFFO per share guidance. As we did throughout 2016, we will continue to provide disclosure around tax benefits recognized to assist in comparing our results to prior periods.

Moving on to churn, our expectation for 2017 remains at our historical target of 5% to 8%. However, given the previously disclosed churn, we expect to end up at the higher end of that range this year. To support our future growth, we expect to spend between $325 million and $375 million in cash capital expenditures 2017.

Finally, last week we announced that we have declared a dividend of $0.39 per share for the first quarter of 2017, on an annualized basis, this represents an increase of 8.3% compared to our previous rate. We plan to maintain this rate through 2017 unless circumstances change materially.

Overall, we remain pleased with the financial success that we are achieving and the growth in our core business. We are excited about the incremental profitable growth opportunities we see in the market and believe we have positioned our balance sheet to support strong expectations for future performance.

With that, I will turn it back over to you, Chad.

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Chad Williams, QTS Realty Trust, Inc. - Chairman and CEO [5]

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Thanks, Bill. Looking back over 2016, we are pleased with the momentum of the business. We are motivated to constantly find ways to improve upon our business results and efficiency. The data center market opportunity for hybrid IT requirements is expanding.

We continue to believe that the right way to intersect our customers is through our integrated platform of highly compliant, highly secure technology services that can deliver comprehensive solutions to complex IT requirements. We also remain committed to being good stewards of our people and our surrounding communities.

The strength of our Company is QTS's powered by the people platform. And, I would like to thank our employees for their continued hard work and dedication in delivering premium customer service which continues to differentiate QTS in the market.

In addition, I would like to thank our customers and shareholders for their continued trust and confidence in QTS. Our goal is to be a world class business that focuses on creating long-term value through our emphasis on people, products, and performance. We will continue to invest and grow the Company with that goal in mind.

Now I would like to open up the call to questions, operator.

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Questions and Answers

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Operator [1]

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(Operator Instructions)

Jonathan Atkin of RBC Capital Markets.

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Jonathan Atkin, RBC Capital Markets - Analyst [2]

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Good morning. So I was interested if you could talk a little bit about the major developments that you've got going in Atlanta, Chicago, Irving and pre-leasing trends that you are seeing there. And then, as well as the product mix that ultimately you expect to see in Chicago a couple of quarters down the pike given your pipeline. And I have follow-up. Thanks.

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Chad Williams, QTS Realty Trust, Inc. - Chairman and CEO [3]

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Thanks, Jonathan. This is Chad, and thanks for calling in today. I'm going to let Dan talk about the product mix and the opportunity for Chicago, but our development has been balanced and we continue to see great opportunities really across the market. But Dallas and Chicago have been -- Dallas, as we talked about, has been just a super strong performer, and we continue to be able to deploy capital there and continue to lease. And Chicago got off to a fast start; but, Dan, do you want to add little color on the product mix?

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Daniel - Dan Bennewitz, QTS Realty Trust, Inc. - COO of Sales and Marketing [4]

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Yes, this is Dan. Chicago, first, take a step back. We opened in third quarter and saw a lot of success earlier, and we discussed that in our last earnings call. In the fourth quarter, with the addition of the AWS Direct Connect, we've seen a lot of great activity across our product portfolio. So obviously we have got C1 business there, and we see continued interest in that product. As well as our C2 and C3 offerings continue to grow; and quite frankly, we are leveraging the relationship with AWS and the ability to act as a hybrid IT solutions provider for customers who need Colo and managed cloud and help move into the public cloud.

I think the same thing is true for Dallas. Dallas has been a great market for us, both the Metro area there as well as the national market. We deploy our entire portfolio there, so we are very excited about the opportunity growing there as well as the ability to take advantage of two sites there to be able to offer multi-site solutions to our customers.

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Chad Williams, QTS Realty Trust, Inc. - Chairman and CEO [5]

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Jonathan, the other thing we have seen in Dallas is location does matter because traffic matters in Dallas. So when we're attracting the C2 and connectivity-type focused clients, the Las Colinas location and from downtown or to Fort Worth is just a very good location centralized in that. So from a retail standpoint, we continue to see good demand on all fronts to Dan's point.

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Jonathan Atkin, RBC Capital Markets - Analyst [6]

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Okay. And then on CapEx, if I add up the estimated cost to complete your ongoing developments, it looks like it is $109 million, and than the guidance for the year is $350 million. So can you talk a little bit about the Delta and the CapEx composition there? Thanks.

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Chad Williams, QTS Realty Trust, Inc. - Chairman and CEO [7]

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Thanks. I will have Jim Reinhardt who leads development for us talk about that.

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James - Jim Reinhart, QTS Realty Trust, Inc. - COO of Operations [8]

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Yes. As you mentioned, obviously, as our product continues to expand, we're able to add capacity relatively quickly at a low cost. So the additional capital is really going towards those sites that we have laid out and continue to see good development cost across the board.

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Jonathan Atkin, RBC Capital Markets - Analyst [9]

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Thank you.

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Operator [10]

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Richard Choe of JPMorgan.

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Richard Choe, JPMorgan - Analyst [11]

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Great. Thank you. In looking at the development schedule and all of the completion dates, it seems like it is pretty back-end loaded. Can you talk a little bit about what is going to be driving the growth in second and third quarters given those developments later on? And then also, can you give us a sense of how much fourth quarter is contributing to guidance in terms of revenue or EBITDA? Thank you.

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Chad Williams, QTS Realty Trust, Inc. - Chairman and CEO [12]

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Dan, do you want to take the inventory question; and then, Jim, you can follow up on the development back half.

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Daniel - Dan Bennewitz, QTS Realty Trust, Inc. - COO of Sales and Marketing [13]

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I think as you look at our business plan for the year, we have got sufficient inventory to be able to meet our objectives here across our product line. The development that we're putting in is going to drive the growth later in the year as well as into 2018. We feel good about that. We have a process where at least monthly we're getting together and sometimes more frequently to look at where is the demand going, where are we putting our capital, and how do we make sure we optimize that capital to where the demand is as well as what products are being demanded in those markets.

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James - Jim Reinhart, QTS Realty Trust, Inc. - COO of Operations [14]

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And some of the timing, also, is dealing with the book not build backlog that we have. We know those commencements are going to start and so we plan the capital spend to meet those needs.

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Chad Williams, QTS Realty Trust, Inc. - Chairman and CEO [15]

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As we have discussed, overall our portfolio is well-positioned to add inventory when and where we need it. Clearly, what you're seeing here is the first half that is really good to where we're seeing the current demand, and the second half where we actually have seen strong, historic growth. Obviously, if growth shifts to different markets, we will be able to move those dollars in that capacity to where we're actually seeing the deals land. But that is what we really believe is the great outlook given historic trends.

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Richard Choe, JPMorgan - Analyst [16]

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Great. And is there much in the guidance from Fort Worth, or is that relatively small?

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Jeff Berson, QTS Realty Trust, Inc. - Chief Investment Officer [17]

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Hey, Richard, this is Jeff. On Fort Worth, when we announced that deal, as you know, we are bringing on one megawatt from that core anchor healthcare customer. So we are excited about that. That is looking to hit starting on April 1 which is when that one megawatt is going to come in. Beyond that, we are enthusiastic in given that market and that location and that asset that we will be able to drive increased revenue in there. It's going to take us a little bit of time to convert that infrastructure into a multi-tenant environment; but towards the second half of the year, we will be ready to go out there and start selling.

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Richard Choe, JPMorgan - Analyst [18]

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Okay. Thank you.

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Operator [19]

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Jordan Sadler of KeyBank Capital Markets.

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Jordan Sadler, KeyBanc Capital Markets - Analyst [20]

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Thanks. Good morning. I was hoping for a little bit of clarification on the government customer churn event. Chad, in your prepared remarks you outlined two scenarios but maybe you could clarify. Is it [hesitant]? Has the original tenant moved out of the space?

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Chad Williams, QTS Realty Trust, Inc. - Chairman and CEO [21]

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Yes.

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Jordan Sadler, KeyBanc Capital Markets - Analyst [22]

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Okay. They have. So we should expect that that space should be vacant -- or maybe actually, what are you underwriting in your guidance in terms of that space?

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Chad Williams, QTS Realty Trust, Inc. - Chairman and CEO [23]

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Right now -- Jordan, this is Chad, thanks. The client has moved out, and we are in a bit of a repositioning of the space. Of course it is fully built out. It is build to a certification standard that is fairly unique. And with the location of it in Northern Virginia, the proximity of it to the federal marketplace, and quite frankly, some focus from our internal government services group, the team has made a pretty compelling case to say give us some time.

So that team is working through a series of conversations with that space. And if the right value connection can be made with somebody that needs secured coms, the separation and the certification of the skiff environment and a couple megawatts that come along with it, it is very unique. It is probably one of the most complete available skiffs in Northern Virginia today. So we're willing to take a little bit of time and let our federal team see if there's any opportunity.

At the same time, the parallel path is really Dan has the commercial team looking at what has been a market that has pretty much been constantly high occupation levels there in Northern Virginia and say, hey, if somebody in the neighborhood needs a couple megawatts and once we take down the space with the remaining term that we have, a couple years, and incentivized somebody to do that, that is another opportunity. It won't have a significant impact on our financials, but we're going to figure it out one way or the other. Being a good steward of capital, we want to make a good decision on it and move on. Dan, I don't know if you have anything you want to add to that.

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Daniel - Dan Bennewitz, QTS Realty Trust, Inc. - COO of Sales and Marketing [24]

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Hey, Jordan, this is Dan. So just to reemphasize, so we're pursuing multiple paths in parallel. As Chad said, looking at government clients who value the high security and the skiff aspects of that at the right price point, we will extend a long-term lease. In parallel, we are looking -- if there is a short-term leasing opportunities for requirements that are two years or less, is another option that we are pursuing in parallel.

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Chad Williams, QTS Realty Trust, Inc. - Chairman and CEO [25]

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And, Jordan, to answer your question on the guidance, what we are assuming currently in the guidance is that we retain the cost in that space, but that we don't re-let it. So there is upside there, although I will caution, if we can bring in a government contract or a government customer at the pricing that that skiff space can support, that can be some nice upside. The extent that we just bring in a commercial customer on a short-term lease for two megawatts, we're still happy to have it, but it's not a material change in the numbers.

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Jordan Sadler, KeyBanc Capital Markets - Analyst [26]

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Thanks. Then as a follow up, I want to just revisit the role that you are anticipating for 2017 that is about 32% of rents, with the biggest concentration really in C2. And I think in renewals, you had a pretty good quarter, and it sounded like low to mid single digits was the anticipated renewal releasing spread that you would expect to see. Is that the right read on things?

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Daniel - Dan Bennewitz, QTS Realty Trust, Inc. - COO of Sales and Marketing [27]

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Yes, this is Dan. I think, first off, we have the event that we just talked about that is in the numbers. So we think that the guidance is out there at 5% to 8%. It's going to happen earlier in the year as we have discussed. We feel good about where we are in terms of leasing as well as releasing spreads in terms of low single digits for rental increases and the return is 5% to 8% as well. So we feel good about both of those.

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Chad Williams, QTS Realty Trust, Inc. - Chairman and CEO [28]

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And, Jordan, just in terms of those contracts coming up for renewal, because your average contract length for C2 and C3 is typically three years, it stays pretty consistent. You will frequently see that because the C2 and C3 represents a good portion of our revenue, you'll often see those contract renewals coming up every year. But again, to Dan's point, the renewal rates are up and the churn is low. So we feel good that those are opportunities to increase pricing.

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Jordan Sadler, KeyBanc Capital Markets - Analyst [29]

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Okay. Thank you.

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Operator [30]

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Jonathan Schildkraut of Guggenheim Securities

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Jonathan Schildkraut, Guggenhiem Securities - Analyst [31]

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Great. Thank you for taking the questions this morning. So, I would like to start with what is going on from a demand perspective. Chad, as you look into 2017 maybe relative to 2016, are there any changes in the demand profile, the customer conversations that you're having which would either put QTS in a better or worse situation relative to 2016? Then I'd like to circle back to a question on the sale lease backs, if I could. Thanks.

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Chad Williams, QTS Realty Trust, Inc. - Chairman and CEO [32]

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Sounds good. Thanks, Jonathan. Good to talk to you. I have to say that we have been seeing a consistent engagement level. But what's most encouraging and even if you look at the fourth quarter is it's been an engagement level with customers moving forward on all of the product set. So we didn't -- as you all know, didn't sign any significant hyperscale. We had one hyperscale customer that did expand almost 10% of their portfolio with us in fourth quarter.

But what I loved about the quarter was the consistency across all of our products. And that is really a good thing for us because we think the healthiest environment is to be able to sell a healthy balance of all of our products across the portfolio. So I think we are net positive on 2017 in the opportunity for the hybrid IT environment to drive lots of different things, connectivity, clouds, access to public cloud and all the such.

We see good momentum across all sectors and obviously hyperscale, where we feel like we can be strategic and it is strategic within our platform and it meets our return hurdles, I think there is going to be a lot of that opportunity across the board in 2017. Dan, is there anything to add to that?

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Daniel - Dan Bennewitz, QTS Realty Trust, Inc. - COO of Sales and Marketing [33]

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Yes. Jonathan, this is Dan. Just to add on, we see the demand continuing to move toward this hybrid IT environment which is the mix of on-prem, all-prem cloud-based solutions. I think the customer example that Chad talked about is a great example of the type of conversations that we are getting into with customers and prospects. Where the solution is a hybrid mix of Colo, some managed cloud, as well as a managed public cloud.

In this case, it was Amazon. In that end-to-end solution, the customers we hope to position QTS as a go-to partner for customers that need to help migrate to this complex hybrid environment. So we definitely see that trend continuing, and we're positioning QTS as a player to bring innovation to that space.

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Jonathan Schildkraut, Guggenhiem Securities - Analyst [34]

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Great. If I can ask one question on the sale leaseback side. Obviously, you announced one early this year at some very attractive numbers relative to original construction costs. As we think about the move forward and enterprises maybe moving out of their own assets and so maybe some more of these opportunities around sale leaseback, how should we think about QTS viewing the opportunity to invest in these types of projects versus further development inside the assets you have? Is it a simple cost equation, or is there more that goes into it than that?

And from our seat as investors and analysts, I think one of the challenges that we have with sale leaseback transactions is that we don't know the quality of the asset. That is if QTS are one of your peers builds an asset, we have a much greater visibility into the quality of that asset, versus a sale-leaseback transaction. The second part of that question is, how do we get comfortable that the assets that are out there or the assets that you buy or other peers buy, what are the questions we should be asking to get comfortable around that asset quality? Thanks.

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Chad Williams, QTS Realty Trust, Inc. - Chairman and CEO [35]

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Thanks, Jonathan. All great stuff. Let me think where I start here. I think the best discipline that you're going to see that QTS has is that we don't have to go do stuff because our ability to double our platform to your point exists within our portfolio today. So the work that we have done over the last decade has put us in a position. And I think I say that because the best discipline around that is not having to go try to create transactions for the sake of growth.

We have tremendous growth within our portfolio today, and so that gives us good discipline on the return on invested capital and the focus because I think there is a very, very differing view of what infrastructure looks like on sale leasebacks. And I think it is very astute of the market to recognize that.

I would say that the two transactions that we have done in this space in 2014 and the one here, I don't put this up as you are going to be able to count on this like clockwork because it is not that. It is opportunistic, and it is also a part of our unique ability to have conversations with these kinds of clients at a whole different level. The largest health insurance -- or one of the largest health insurance providers in the world that decided that they needed a more flexible hybrid IT approach was more of a connection between our CTO and that group of technologists to have a conversation about how and what they do versus what they could return to put on their balance sheet.

I don't want to speak for them, but the capital was one component, but really the technology, the platform, the partnership, the security, the compliance, that is what has unlocked our two biggest transactions in this space. And that is the investment in our people, our technology and our platform that enables us to have these conversations. I would like to say uniquely that there is not a bunch of people in those rooms, and that is a unique way to build partnerships and drive that. So, we are excited about that.

As far as the quality of the asset goes, love to get people there because it is institutional grade, one of the highest qualities that you could ever build to. And the economics that were behind that and the value of that infrastructure-rich, low-basis asset is going to be a spectacular investment for us. And most people don't know this, but Facebook made a lot of conversation in the Fort Worth market with building a large campus which is adjacent to us.

So when you think about connectivity and the community around us, it is a data-center-rich community around us. And we don't think that has a negative impact on our ability to build our product set there with the richness in fiber and power and infrastructure that sits there in the Fort Worth market. So we're excited about all of those things, our neighbors, the building, the asset quality, and couldn't be more excited to get going on it.

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Jonathan Schildkraut, Guggenhiem Securities - Analyst [36]

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Great. Thanks for taking the questions.

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Operator [37]

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Matthew Heinz of Stifel.

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Matthew Heinz, Stifel Nicolaus - Analyst [38]

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Thanks, guys. If I just look at the revenue guidance on a dollar basis and annualized fourth quarter -- annualize the fourth-quarter run rates, step that down by the $10 million of churn, I get to about $40 million, an implied dollar increase in revenue next year. And $20 million of that coming from the backlog.

I'm just wondering, historically, transitioning into the next year, how is your outlook compared? It seems to be about 50/50 broken down between backlog, commencements, and new leasing? I'm just curious if I am looking at that the right way, and how that is compared to your historical guidance.

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Jeff Berson, QTS Realty Trust, Inc. - Chief Investment Officer [39]

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Hey, Matt, this is Jeff. You are looking at that the right way. We love the fact that typically when we start the year, and this helps us with visibility, a good portion of what we are going to achieve during the year is already been booked and is sitting in that book not build back log. But we also drive incremental revenue during the year through what we call Go Get, which is deals that book and bill during the year and drive revenue there.

Typically what happens on that book and then builds Go Get during the year is there is a lag. Because once you have book deals, again, if it is C2 or C3, it could take a couple months for that to start driving revenue. If it is C1, that could take six months or even much longer than that for larger deals. So that balance is about right.

You see a little more pressure when you look at the 2017 numbers because we do have the churn event early in the year which hits revenue right in January, and then the deals that we will continue to anticipate that we're going to book and bill during the year ramp over the course of the year. So you do see a little bit more pressure coming from that front-end loaded churn, but overall, the momentum that we are anticipating in the guidance, the bookings, and the acceleration of those bookings and profitability is very consistent with what we have achieved in the past.

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Matthew Heinz, Stifel Nicolaus - Analyst [40]

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Thanks. And it looks like there was -- well, a slight uptick in the C3 business this quarter, getting that business back on track. What do you see moving forward there? Obviously a good quarter for C3 bookings. What's implied in the guidance or outlook, if you will, around that business; and what gives you the encouragement that that business is set to get back on track?

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Daniel - Dan Bennewitz, QTS Realty Trust, Inc. - COO of Sales and Marketing [41]

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This is Dan. I think you've seen, you've talked about it. You've seen an uptick, and we're pleased with the progress on our bookings performance. I think as we roll into 2017, the discussion we had earlier on a call around hybrid IT, our C3 solutions, we're coming out with new capabilities around public clouds and being able to manage, for example, OpenStack clouds.

We think the demand is moving that way. We're very pleased with our portfolio in the C3 space as well as the opportunity pipeline as we roll through 2017. So the way I'd answer that is we feel very good about that, and we see the trends that you talked about continuing.

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Chad Williams, QTS Realty Trust, Inc. - Chairman and CEO [42]

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Matt, I think you're also seeing the encouragement and completion of really having the engine running on the C3 side of the business after the full integration of the Carpathia Team and the QTS Family and the benefit of really having momentum headed into a year and having things where people are aligned, understand the goals, the objectives, the hybrid products. Dan has done a great job with the teams on really making sure the engine is ready to get going and really adding value to the overall stack this year. And I think that is what you're going to see as we execute through the year.

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Matthew Heinz, Stifel Nicolaus - Analyst [43]

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Okay. Thanks a lot guys. I appreciate that.

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Operator [44]

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Simon Flannery of Morgan Stanley.

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Simon Flannery, Morgan Stanley - Analyst [45]

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Great. Thank you very much. Good morning. A quick clarification on the churn. So if we take out the churn in Q1, is the underlying churn still within the normal range, or is there some other churn events that you might expect to keep it at the high end?

And then just a broader question, we've seen Verizon and Century Link and others make some asset sales in this space. How would you characterize the competitive environment out there? You are obviously getting larger as are some of your competitors, but is the crowd thinning out here? Are you seeing fewer, stronger competitors as you look for a bid for some of these contracts?

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Daniel - Dan Bennewitz, QTS Realty Trust, Inc. - COO of Sales and Marketing [46]

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Yes. Simon, this is Dan. So on the first part of your question around the churn, the guidance is still between 5% and 8%. We think it's going to be on the high end given the churn event that you talked about which is in the first quarter. So that -- we feel good about that guidance. And with the churn event in the first quarter, obviously, there's a bigger impact in the first quarter there.

For the second part of your question around sales leaseback and other competitors, I will turn that to Chad.

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Chad Williams, QTS Realty Trust, Inc. - Chairman and CEO [47]

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So if you are talking about the type of assets like we just bought in Fort Worth, I think those are unique in the standpoint of the point earlier which is we're at the table because we bring an integrated services approach and can work with their IT teams to really figure out how to unlock the in-source to out-source. And that is really where we have had a uniqueness that that room is a fairly small group of people that can take on the real estate, the integration, show a history of doing that, and have the technical folks to walk people through that.

If the question is about broader M&A, I don't really know. It's been a pretty competitive environment, but we just really haven't focused a lot on that type of stuff. We've been more focused on our just ability to grow with our own platform, invest in our own platform, and look for opportunities opportunistically through the deal in Fort Worth.

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Simon Flannery, Morgan Stanley - Analyst [48]

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I think the question was also just about the leasing -- the competitive environment from the leasing side.

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Chad Williams, QTS Realty Trust, Inc. - Chairman and CEO [49]

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I will let Dan take the leasing competitiveness.

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Daniel - Dan Bennewitz, QTS Realty Trust, Inc. - COO of Sales and Marketing [50]

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Simon, I think first off, leasing it is a very competitive environment out there, but we see rational behavior out there. We see supply not getting too far ahead of demand. So in our markets we think that is relatively balanced, and it doesn't take away that every deal is very competitive. And while we're trying to position QTS as being a unique partner to CIOs to be able to help them in a complex environment that spans multiple different IT deployment models. So our ability to do that should help us position us better to be a better integrated solution to clients and be able to win. I hope that answers your question.

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Simon Flannery, Morgan Stanley - Analyst [51]

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Great. Thank you.

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Operator [52]

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Paul Morgan of Canaccord.

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Paul Morgan, Canaccord Genuity - Analyst [53]

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Hi, good morning. If I look at the composition of your booked-not-billed pipeline by year, what is the potential for the $9 million in incremental revenue getting pulled forward from what is now 2019 and beyond into 2017 or 2018? And then did you see that in terms of the change sequentially versus last quarter? Did any of that activity take place to boost what you see, the revenue ramp from the pipeline into 2017?

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Jeff Berson, QTS Realty Trust, Inc. - Chief Investment Officer [54]

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Hey, Paul, this is Jeff. We absolutely do see circumstances, particularly with some of the larger and hyperscale cloud customers that they are building in longer term ramps. And then we and they get the benefit that as their business accelerates faster than their expectations, they pull some of that up. So we have had some benefit from deals getting pulled up over the course of 2016, and we'd be thrilled to see some of that happen with the booked not billed.

We don't build that into our assumptions, and we certainly -- we basically are building in the expectation that customers are ramping along the initial schedule, but we do build in the flexibility and availability typically in space so that if customers do want to pull up we can be responsive and support their needs and pull up that revenue as well.

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Paul Morgan, Canaccord Genuity - Analyst [55]

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Okay, great. And then just in terms of the CapEx, just to be clear, the $350 million versus what you mentioned as your cost to complete your existing projects, could you add any more color about where that incremental capital is going to be deployed and maybe what markets, what assets? And then what's embedded in your FFO guidance in terms of funding the $350 million?

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Jeff Berson, QTS Realty Trust, Inc. - Chief Investment Officer [56]

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The difference between the $250 million, which is really our cost to construct the data center for space and power, and the $350 million is the additional capital we put in sometimes for customer capital to help them build out their footprints from a computer server and other aspects, and that drives the bulk of it. That is spread across the portfolio fairly evenly and consistent with our revenues and not really determining where the customer load goes versus any specific projects.

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Paul Morgan, Canaccord Genuity - Analyst [57]

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So that doesn't include anything like another phase that would be announced later this year that would be incremental from here?

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Jeff Berson, QTS Realty Trust, Inc. - Chief Investment Officer [58]

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That is true.

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Paul Morgan, Canaccord Genuity - Analyst [59]

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So then in terms of, for the balance sheet, funding the -- that spin, what it would look like, I think you mentioned a debt angle, but what you think of it in terms of the guidance?

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Bill Schafer, QTS Realty Trust, Inc. - CFO [60]

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This is Bill. We'll continue to manage the balance sheet consistent with how we have done it in the past. At year end, our debt-to-adjusted EBITDA was five times. We've been comfortable going above that in the backlog that we do have. We will continue to look at accessing capital in different fashions. We watched the long-term debt markets. We watched the equity markets. There's -- we expanded the credit facility in the fourth quarter, so we had nearly $600 million of liquidity, more than enough to fund the capacity that we are anticipating.

But, like I said, we will continue to manage the balance sheet as we have in the past, be prudent about it. And some of those things, like you said, between debt, between equity, between fixing some rate through swaps, we will consider ATM, et cetera. So there's just a number of things.

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Paul Morgan, Canaccord Genuity - Analyst [61]

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And that is contemplated in your FFO guidance, it's not just assuming it all goes on the line and everything else that gets done gets adjusted in guidance?

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Bill Schafer, QTS Realty Trust, Inc. - CFO [62]

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Yes.

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Paul Morgan, Canaccord Genuity - Analyst [63]

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Okay, thanks.

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Operator [64]

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Frank Lawson of Raymond James.

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Unknown Participant, - Analyst [65]

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This is Alex in for Frank. I'm just following up on the C3 question from earlier and given where you are trying to position yourself as a hybrid IT solution. Has that changed who you're competing against in the market maybe over the past six months or so that gives you confidence on growing that business? And then I have a follow-up.

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Daniel - Dan Bennewitz, QTS Realty Trust, Inc. - COO of Sales and Marketing [66]

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Alex, this is Dan. I think the market out there we're competing with has stayed relatively the same over the last six months. I think the number of players that we compete with in the C3 space is relatively limited. We're not trying to be a public cloud provider. I just want to stress that. We look at those public providers as, A, hyperscale customers to us; and, B, partners of us as we want to be part of the customer's on ramp to public cloud. So the people we compete against has been relatively stable. Again, a very competitive environment and one that is changing out there in terms of the solutions. But the competitive set is relatively consistent.

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Unknown Participant, - Analyst [67]

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Okay, great. And then on the model, the recurring CapEx is higher in the quarter. I think you are now the third data center provider to report higher maintenance CapEx. I'm just curious if anything has changed across the industry in terms of what is being included in that number.

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Chad Williams, QTS Realty Trust, Inc. - Chairman and CEO [68]

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No. This has been very consistent since the time we've been capturing this data. We continue to report it in the same way, and so you will typically see that number run pretty low. It does have lumping points where you'll go in and do a major upgrade as things get towards end of life. But otherwise, it pretty much stays on the same range throughout the time.

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Bill Schafer, QTS Realty Trust, Inc. - CFO [69]

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And because we have our own data center operations team that is on-site on a regular basis, there is also a lot maintenance CapEx that frankly just gets incurred from our current staff and put into the P&L. And it doesn't show up in that maintenance CapEx side. So there's a lot more ongoing CapEx to support the facility that's also in the P&L.

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Daniel - Dan Bennewitz, QTS Realty Trust, Inc. - COO of Sales and Marketing [70]

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It shows up as maintenance expense versus CapEx, that's correct.

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Operator [71]

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Eric Luebchow of Wells Fargo.

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Eric Luebchow, Wells Fargo Securities - Analyst [72]

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Hi, everyone. Just one quick one. In Chicago, I saw you had a nice pick-up in occupancy. Are there any particular customer verticals there where you're seeing particular success? And then on the 28,000 square feet you have in your development pipeline, is that to satisfy the anchor tenant lease you signed in Q3, or will you also have new marketable capacity that is coming online in 2017 as well? Thanks.

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Daniel - Dan Bennewitz, QTS Realty Trust, Inc. - COO of Sales and Marketing [73]

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Eric, this is Dan. In Chicago, I've characterized the demand as across multiple industry verticals. We've got interest from SaaS cloud providers, which are more of a national market that want to be in Chicago. And within the Chicago land and Chicago metro area, we see the demand quite strong across financial services, manufacturing retail, et cetera. So we have been very pleased with that and where we are, both in the Chicago market from a location being in the city as well as our broad portfolio that we can be attractive to multiple industry verticals there. I'll turn it over to Jim for the second part of the question.

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James - Jim Reinhart, QTS Realty Trust, Inc. - COO of Operations [74]

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Yes, Eric. That initial expansion in the first quarter in Chicago is mostly tied to the growth of our largest hyperscale customer that is in that facility, and then the additional expansion throughout the year is tied both to that growth as well as additional growth.

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Eric Luebchow, Wells Fargo Securities - Analyst [75]

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Okay. Thanks guys.

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Operator [76]

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The next question is a follow-up from Jonathan Atkin of RBC Capital Markets. Please go ahead. Jonathan, from RBC, is your line open?

It looks like there are no additional questions at this time. This concludes our question-and-answer session. I would like to turn the conference back over to Chad Williams for closing remarks.

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Chad Williams, QTS Realty Trust, Inc. - Chairman and CEO [77]

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Thanks, everybody. I know we ran a little bit over today, but we had a lot of good questions. Remember that we are available all day today and any time this week and would love to follow up with any of the questions or answers. Thankful for a successful year with our QTSers this year and look forward to an exciting 2017. So thank you for your trust and confidence and look forward to seeing you all as the year unfolds. Thank you very much.

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Operator [78]

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The conference is now concluded. Thank you or attending today's presentation. You may now disconnect.