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Executives

Jeff Berson – Chief Investment Officer and Head-Investor Relations

Chad Williams – Chairman and Chief Executive Officer

William Schafer – Chief Financial Officer

Dan Bennewitz – Chief Operations Officer-Sales & Marketing

Analysts

Tayo T. Okusanya – Jefferies LLC

Jordan Sadler – KeyBanc Capital Markets, Inc.

Lisa Lam – Morgan Stanley & Co. LLC

Stephen Douglas – Bank of America Merrill Lynch

Andrew L. Rosivach – Goldman Sachs & Co.

Austin Wurschmidt – KeyBanc Capital Markets, Inc

QTS Realty Trust, Inc. (QTS) Q4 2013 Earnings Conference Call February 20, 2014 10:00 AM ET

Operator

Good morning and welcome to the QTS Fourth Quarter and Year-End 2013 Conference Call. All participants will be in listen-only mode. (Operator Instructions) Please note this event is being recorded.

I would now like to turn the conference over to Jeff Berson, Chief Investment Officer and Head of Investor Relations. Please go ahead.

Jeff Berson

Thank you, Laura. Hello, everyone and welcome to QTS’s fourth quarter and year-end 2013 conference call. I’m Jeff Berson, Chief Investment Officer and Head of Investor Relations in 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 and Marketing and Jim Reinhart, our Chief Operating Officer, Operations and Development, who will participate in the Q&A.

Our earnings release and supplemental financial information is posted in the Investor Relations section of our website at www.qtsdatacenters.com on the Investors tab. We’ve also 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, 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, to further information regarding our use of these non-GAAP financial measures and a reconciliation of them to our GAAP results. These documents are available on the Investor Relations page of our website.

And now, I’ll turn the call over to Chad.

Chad Williams

Thanks, Jeff. Hello and welcome to our 2013 fourth quarter and year-end earnings call. We’re excited to be speaking with you today to report strong 2013 performance and significant momentum headed into 2014. For our fourth quarter ended December 31, 2013. We achieved adjusted EBITDA of $21.2 million and operating FFO of $16.4 million. We also head into 2014 with strong momentum based on our fourth quarter leasing activity, which was one of the strongest quarters in QTS history.

Today, I will review our strategy and growth initiatives, sales results and development pipeline, which drove this performance. Bill will then provide a summary of our fourth quarter and full year 2013 financial performance, our capital plan for future development, as well as provide our 2014 guidance. We will then open up the call for questions.

Let me begin with a quick recap of our QTS strategy, which has provided our company with a unique opportunity to drive industry-leading growth and returns on capital, and has driven the performance for our fourth quarter and full year 2013 results.

On slide three, core to the QTS strategy and business model is driving revenue growth through our differentiated technology services platform, supported by our 3C product mix. This consists of C1, customized data centers, C2 co-location and C3 cloud and managed services. We offer these products in a fully integrated technology services platform through a solution based sales approach powered by our people, with a diligent focus on delivering premiere customer experience.

QTS delivers our services leveraging our world-class infrastructure, consisting of large-scale owned data centers. Our approach focuses on mega-scale data centers, acquired at low initial cost with significant infrastructure. This enables us to meet our customers’ needs on an extremely cost-efficient basis. Ultimately, our ability to drive revenue growth with cost-efficient delivery of our services supports strong capital efficient growth, which is a key factor by which we drive our allocation of capital and strategic decisions. We have grown and will continue to grow our business while looking to maintain our targeted, unlevered, fully stabilized return on invested capital across our portfolio of 15%.

As detailed on slide four, our product mix is core to our revenue growth strategy. We believe that that today’s CTOs and CIOs, running large corporate IT environments require a data center provider with flexible solutions to meet the very needs of their IT environment. The vast majority of these enterprise customers need multiple products, including the scale of traditional wholesale provider, the flexibility and service of Colocation provider and the deeper technical expertise offered by traditional cloud and managed service providers.

Our fully integrated product mix supports our growth by enabling us to engage in a larger potential market, including the fast-growing hybrid cloud and managed service market. It also enhances our growth potential by offering solutions, which meet the needs of sophisticated enterprise customers, and we believe we are the only provider to offer all three services at scale.

Our product mix also enables us to drive growth from our existing customer base, as we grow with our customers. in addition, we can upsell services to support customers, increasingly diversified in highly compliant secured environments, a further benefit from our integrated and flexible service offering that is enabling the QTS sales force to provide a solution for our customers. This drives strong pricing of our products.

Finally, our sales approach and value proposition for our customers not only drives our revenue growth, but also strengthens our overall customer relationship by offering hybrid integrated solutions for our customers, we believe we’re enhancing our retention and supporting strong, stable and growing relationships.

As seen on slide five, our strategy continued to result in strong performance during our fourth quarter year ended December 2013. During the quarter, our operating leverage was demonstrated by our operating FFO growth of 140% versus the fourth quarter of 2012 and adjusted EBITDA growth of 45% over the same period. We achieved 23% growth in net operating income versus the fourth quarter of 2012 and top line revenue increased 24%. We also achieved an unlevered return on invested capital of 15.7% for the fourth quarter 2013.

Our growth was driven by our new and existing customers in each of our 3C product offerings across our national platform. We ended 2013 with a total of 884 customers. This customer density creates a digital ecosystem that is supported by our communication and network product offerings with over 500 interconnected network providers and more than 12,000 interconnections.

The increase in our customer base during 2013 will also further support future growth. Given our ability to grow with our existing customers during 2013, approximately 61% of our net incremental leasing activity came from existing customers.

This demonstrates our ability to drive more revenue from our customers over time. Customers also continue to value our product mix. During 2013, the number of customers using more than one of our 3C products has continued to grow and represented 40% of our MRR.

Continuing on slide 6, our financial performance was enhanced by the continued success of our QTS Powered by People premium customer service and in-house 3C sales force. We continue to see the benefits of investing in our own internal sales force, which enables us to go to market specializing byproduct and industry to better support the needs of our customers.

Our sales force understands and sells the differentiated value of our products, along with the solutions that our customers require. We count on our team to differentiate how our solutions solve our customers’ business needs, and to evaluate our sales discussions above commoditized space and power pricing negotiations.

Finally, we believe that having an internal sales team gives us good visibility on pipeline and customer demand. This insight is critical in helping us allocate our resources to capture opportunity in the market. Our sales growth and momentum can be seen in our fourth quarter leasing performance.

During the fourth quarter, we successfully signed new and modified leases, representing approximately $9.3 million of net incremental annualized rent. This leasing activity represents one of the third strongest leasing quarters we had in our history. This is almost double the leasing activity we saw in the fourth quarter of 2012, and up over 12% from an already strong third quarter 2013.

For the year ended 2013, our net new leasing activity represented $43 million, up 71% from 2012. We are extremely excited with the strength of our leasing activity, which is driving our strong book but not billed backlog and our confidence in that continued growth in the business in 2014.

During the fourth quarter we won significant new customers, as well as exciting expansions with customers, who continue to grow with QTS. One new customer is a large healthcare enterprise, who selected QTS based on our high performance, highly compliant C2 solution in Atlanta Suwanee in Sacramento data centers. This was due in large part to our industry-leading HIPAA compliance, as well as our premium customer service. In addition we successfully attracted new customers across multiple industry verticals including retail, technology, and software as a service.

We have continued to enhance our product development to provide market leading security and compliance to our existing enterprise customers. QTS initiated a deliberate focus on security and compliance a number of years ago. As a result, we believe we have distinguished ourselves in the market with our extremely high level of physical and data security and regulatory support.

We believe customers increasingly require and value these services. Our dedicated corporate compliance team is unique in the industry, enables us to offer our customers industry-leading compliance capability, including SOC 1, SOC 2, HIPAA, PCI, and later this year, FedRAMP compliance requirement, supporting our QTS Federal Cloud service.

We are also excited by the significant expansions in our platform across our portfolio, by number of customers including some of the world's largest Internet-based companies such as Auto Trader and CareerBuilder. These significant expansions exemplify our ability to grow with our existing customers. It also demonstrates the value of our mega data centers across our national portfolio including Atlanta, which continues to be an industry-leading Tier1 growth market.

Our customer expansion activity is also carried in to 2014. Already this year, we have two significant C3 customer expansions. Both have been QTS customer for several years, and count on QTS to provide not only the superior service delivery and high performance, which they have experienced, but also the ability to provide high levels of security and compliance that their future growth requires.

I want to stress that our C3 customers are enterprise customers with requirements for high levels of security and compliance and performance and commit to QTS over multi-year contracts.

In addition to growth as detailed on slide 7, we continue to see evidence that our differentiated strategy supports our price stability. From a pricing standpoint our fourth quarter product mix has resulted in new and modified leases averaging an annual rate of $351 per square foot, in line with our trailing four quarter average.

In addition pricing for our C2 and C3 new and modified leases rose 16% over the trailing four quarter average.

Regarding renewal on a like for like basis, where customers renew contracts without change in square feet, we experience renewal rates for the fourth quarter 2013 at a weighted average rental rate of $922 per square foot. This pricing was impacted by C2 customer that changed its product mix resulting in a lower rate per square foot.

As a result of the overall renewal rates for the fourth quarter were 1.1% below the pre-renewal pricing rates. Without the impact of the one customer, our renewal rates for the quarter were 3.3% above the pre-renewal pricing rates. Our prior four quarter average renewal pricing was also up 1.6% above the pre-renewal rates.

We also experienced significant growth in lease commencements during the quarter, driven by sizable C1 expansions and C1 lease renewals. As a result of this significant volume during the quarter, the overall rate per square foot for the commenced leases overall and for our C1 product was below our four-quarter average.

The Q4 2013 C2 and C3 volume and leasing rates were in line with our 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. It is important to note that our blended pricing will vary based on leasing mix from quarter to quarter, and the fact that our pricing includes our cloud and managed service product, which doesn’t take up significant space.

Overall, we continue to see strong market conditions supporting the engine of our business, which is C2 colocation and C3 cloud and managed service product across our national footprint. We also see positive market conditions for our C1 customized data center services. It’s important to note that although we have a handful of very large C1 customers, our typical C1 customer is different than most wholesale data center providers.

Our median C1 customer occupies approximately 3,300 square feet and approximately 500 kilowatts of power. This is significantly smaller than what we believe the industry average for a wholesale customer. A number of these customers were QTS C2 colocation customers, whose business grew and the scale and breadth of our product enabled them to stay and grow with QTS.

We also focus on our C1 product in a mega site in Atlanta, Richmond and soon Dallas. These facilities have the scale to support a C1 business with attractive economics and in markets with historically low cost of power. As part of our QTS strategy, we will look to bring on C1 customers early in the leasing cycle of these new mega site to accelerate revenue. We will then look to diversify our customer base with highly profitable C2 and C3 customers over time.

In summary, we are very pleased with our results for the fourth quarter and for 2013. We have grown our business through important new and existing customer expansions, we have continued to demonstrate momentum with strong leasing activity, and we continue to maintain price stability. This performance illustrates that our solution selling and our fully-integrated 3C product strategy along with our premium customer service is delivering differentiated value to our customers, and will continue to support our revenue growth.

On slide eight, the second key aspect to our strategy is leveraging world-class real estate infrastructure to support the cost-efficient delivery of our data center products. This infrastructure consists of a national platform of 10 data centers, comprising 3.8 million gross square feet, which is 92% QTS-owned.

A core factor in our real estate platform is our proven ability to acquire infrastructure-rich properties at low basis. My belief is basis lasts forever, and the low basis in our existing platform will continue to allow us to scale and develop our facilities at a cost advantage for years to come.

Going forward, we will continue to look for opportunities to acquire assets at low cost that are infrastructure-rich in strategic new markets. This can be accomplished either by buying or repurposing non-data center facilities, or acquiring enterprise-owned data centers that are under-utilized by their current enterprise owners.

We believe that a large number of enterprise customers, who would be enthusiastic about outsourcing their internal data center needs. They require, however, a data center provider with a technology services platform to work with them on this transformational IT change.

Through our 3C product portfolio, we can offer the combination of real estate ownership and technology services to these potential group of new customers. Another factor that drives our cost efficiency as well as supports customer growth is the scale of our facilities. QTS mega-scale facilities in Atlanta, Richmond, and Dallas markets include two of the largest operating data centers in the world.

The scale of these facilities enables us to drive significant efficiencies off the fixed cost basis in the data center. Our scale also supports our sales effort as it enables us to attract customers looking for clear expansion path for future needs and supports our 3C product offering.

On slide nine, our scale facility supports significant amount of capacity in our current footprint. In fact, with approximately 690,000 square feet of operational raised floor currently developed, we have the utility power and building shell necessary to more than double to 1.8 million square feet without new acquisition or Greenfield development.

Being only 38% utilized on our portfolio available for redevelopment gives us visibility for future growth, which is in our control at a known cost. It also enables us to continue to meet the growth at a low cost to build metrics averaging under $7 million per megawatt.

Finally, on slide 10, we believe our strategy of growing revenue through an integrated technology services platform and a C3 product mix powered by our people is differentiated in the market. This platform sits on top of the world-class real estate infrastructure that enables cost-efficient delivery of our services. It has been a key to our success thus far and helped us build a financial model that includes strong top-line growth and operating leverage to produce sector-leading growth in operating profit.

We have delivered this growth through a focus on capital efficiency driven by our large mega-scale facilities and higher-end product mix, that we believe separates QTS from our competitors. This ultimately drives our core metric in measuring the success of our business, which is our targeted 15% plus unlevered return on invested capital for our fully stabilized portfolio. In 2013, we achieved an unlevered return on invested capital of 15.5%, and will continue to focus on this metric as evidence of our successful execution of our QTS strategy.

Now, I will ask Bill Schafer to give you further color on the financial performance, the capital plan, and the balance sheet management. With that, over to you, Bill.

William Schafer

Thanks, Chad. And I would like to say hello to everyone as well. I will begin my remarks today first by reviewing our fourth quarter and year-end financial results. Second, I will provide an update regarding our capital spend plan, balance sheet and borrowing capacity. And finally, I will provide commentary on our guidance for 2014.

For the fourth quarter results, as seen on slide 12, we have continued to demonstrate strong and accelerating growth. In addition to strong top-line momentum, our operating leverage continues to drive increasing margins, which supports even stronger growth in our operating profit.

For the quarter ended December 2013, our operating FFO was $16.4 million, an increase of 140% over our fourth quarter 2012. Our fully diluted operating FFO per share for the fourth quarter was $0.47 per share. Our fourth quarter adjusted EBITDA was $21.2 million, an increase of 45% over our fourth quarter of 2012. And our net operating income, or NOI, for the fourth quarter was $30.4 million, an increase of 23% over Q4 2012.

NOI was negatively impacted during the fourth quarter by an increased bad debt reserve primarily associated with one customer of approximately $500,000. On the top-line, revenue for the fourth quarter was $47.4 million, a 24% increase over the fourth quarter of 2012 and our MRR, or monthly recurring revenue, was $14.1 million at December 31, a 19% increase over the December 31, 2012 MRR.

Without the impact of the Sacramento acquisition in December 2012, revenue growth from fourth quarter 2012 to fourth quarter 2013 would have been 16%. We also saw strong sequential growth during the fourth quarter.

Looking at Q3 to Q4 sequential performance, operating FFO grew 22%, adjusted EBITDA grew 8%, NOI grew 4%, total revenue grew 3% and MRR grew by 2.5%. From a 2013 annual basis, we also experienced significant growth and operating leverage. Our operating FFO for 2013 was $49.5 million, an increase of 94% over 2012.

Our adjusted EBITDA was $75.4 million, an increase of 36% over 2012 and our net operating income was $112.6 million, an increase of 24% over the prior year. On the top-line, revenue for 2013 was $177.9 million, a 22% increase over 2012.

As you can see from our growth and outlined on slide 13, our business benefited not only from strong top-line performance, but also from increasing margins due to operating leverage in our cost structure.

General and administrative expenses were approximately 20.8% of revenue during the fourth quarter, down from 26.5% during the fourth quarter of 2012. This operating leverage resulted in adjusted EBITDA margins increasing by approximately 630 basis points to 44.8% in the fourth quarter of 2013.

We expect these margin trends to continue as our business will continue to realize efficiencies of scale by leveraging our current resources to minimize expense growth. We are targeting the EBITDA margins approaching 50% within the next few years as we continue to leverage these operating efficiencies.

On slide 14, our backlog of annualized book not build revenue from signed but not yet commenced leases was $28.2 million as of December 31, 2013. We expect leases representing approximately $13.5 million of annualized MRR to commence in 2014, which will contribute an additional $9.5 million of MRR in 2014.

Leases representing approximately $8.4 million of annualized MRR to commence in 2015 and the balance of $6.3 million of MRR to commence in 2016 and beyond. The stability of our customer base was also evident in our low churn for the year. Rent churn is the MRR impact of customers completely leaving the QTS platform in a given period, compared to the total MRR at the beginning of the period. Churn for the fourth quarter was 2.3%, and our 2013 full year churn was 5.7% in line with our business plan of 5% to 8% of annual churn.

On slide 15, from a development standpoint, we will continue to manage our capital to support our growth with a focus on flexibility and capital efficiency. This led to an ability in the fourth quarter to continue to grow our business, largely through the capacity available at the end of the third quarter.

During the fourth quarter, we placed in service only $12 million of additional development capital, primarily directed towards bringing on 15,000 square feet in Suwanee. In addition, we took approximately 66,000 square feet out of service from our Atlanta metro facility to redevelop as new saleable square feet that will come back into service in early 2014 at relatively low development costs.

As we have discussed in the past, we had a large C1 customer who was located in both our Atlanta Suwanee and Atlanta metro facilities. This customer previously renewed their lease with us and as part of that renewal, consolidated their business into a smaller footprint in Atlanta metro.

I should mention that this contract renewal, we significantly increased our pricing per square foot, coming from this customer, while freeing up space to resell in both Suwanee and metro. The incremental space in Suwanee was converted for resale last year and is now coming back online. This is providing us the capacity to continue to grow Suwanee at low development costs.

The majority of the recaptured space in Atlanta metro is being converted to accommodate another large C1 customer that began billing in January 2014 and will continue to ramp through the third quarter. The balance of the recaptured Atlanta metro space will be used to accommodate our C2 product.

Our total raised floor footprint at the end of 2013 was approximately 690,000 square feet out of approximately $.1.8 million of powered shell capacity. Of this available capacity, we have a plan to bring on nearly 190,000 square feet by the end of 2014, predominantly in our Atlanta and Richmond markets, as well as opening our new Dallas facility by mid-2014 with 26,000 square feet coming online in that market.

The total cost for this new capacity is estimated to approximate $157 million, which reflects our continued ability to bring space online at costs below market and below our average of 7 million per megawatt. From this $157 million budgeted cost, approximately $85 million has already been spent, another $72 million is budgeted to be spent during 2014 to bring this 2014 capacity online.

From a capital spend standpoint on slide 16, we have and will remain focused on spending capital efficiently, and in a flexible way to manage market demand and drive strong returns. Real estate related capital expenditures during the fourth quarter were approximately $57 million and were approximately $171 million for the 2013 full year.

A breakdown of those capital expenditures is summarized in our supplemental information, provided with our earnings release. For 2014, we anticipate capital expenditures of between $150 million and $200 million, approximately $72 million will be spent on capacity expected to come online during 2014.

The remainder will be used for capacity to come online in 2015 and beyond. We will continue to actively review our capital plan and maintain the flexibility to reallocate capital dollars, based on opportunities where we see growth and the best returns.

This strategy has been a effective in managing our inventory and driving capital efficiency. In fact, our continued growth and capital efficiency drove an annualized return on invested capital for the fourth quarter a 15.7% and 15.5% for the year ended 2013 for a business that still has tremendous capacity available to drive incrementally higher returns.

This exceeds our target level of 15%, but will vary based on the timing of new development projects and other expansion opportunities. For example, we do expect to see average return drop to below our 15% target in mid-2014, as we bring certain projects under construction online including our new Dallas facility. We anticipate returns moving back to the 15% levels by the end of the year.

Next on slide 17, I will review our balance sheet. As of December 31, 2013, our total leverage was $348 million and our debt to fourth quarter annualized adjusted EBITDA was approximately 4.1x. We anticipate our leverage level to increase over the near-term as we continue to execute our capital spending plans in connection with the ongoing expansion of our existing data center facilities. Although, leverage could grow to over 5x in the near-term depending on growth opportunities, we will target a long-term stabilized debt-to-EBITDA ratio of between 4x and 5x.

As of December 31, our total liquidity including the available balance on our credit facilities of approximately $325 million and cash on hand of approximately $5 million, aggregated to over $330 million. In addition, this week, we increased the available capacity on our revolving credit facility by an additional $50 million, further increasing our liquidity.

Finally, on slide 18, with respect to guidance, we expect 2014 operating FFO to be between $73 million and $77 million, or between $1.95 and $2.05 fully diluted per share, and adjusted EBITDA to be between $94 million and $99 million. In addition to our 2014 financial guidance, we have a financial model that anticipates annual revenue growth in the mid to high-teens over the next few years.

We expect this revenue growth to be accelerated at EBITDA line based on operating leverage, which we believe will result in EBITDA margins approaching 50% in the next few years. A model also anticipates rental churn of 5% to 8% per year and capital expenditures in 2014 of $150 million to $200 million.

Due to our anticipated growth rates, which occurs sequentially over quarters, naturally, in the past, a higher percentage of our annual revenue has occurred in the second half of the year, as compared to the first half. Also there is some timing and/or seasonality that impacts operating expenses, and general and administrative expenses.

For example, our general and administrative expenses are often higher in Q1 due to higher levels of payroll taxes and professional fees. To that point, our Q4 2013 general and administrative expenses are much lower as our health insurance costs came in favorable for the year.

As a result of these factors, we are anticipating modest sequential growth in Q1 2014, which will ramp over the course of the year. This expected ramp is supported by our backlog, pipeline and leasing activity as described earlier.

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

Chad Williams

Thanks, Bill. We’re excited at the momentum of the business and the growth that we continue to achieve. We believe that our revenue model based on our differentiated 3C product offering is driving our success, and meeting the needs of our enterprise customers. We are growing our business with new and existing customers, supporting strong and stable rents per square foot and supporting customer retention through our Powered by People premium customer experience.

This fully integrated technology services platform sits on top of our world-class infrastructure with our mega-scale owned facilities at low basis; we have significant capacity to more than double our operating platform with our existing footprint.

This model has supported our operating leverage, low-cost ability and enabled customers to continue to grow with QTS. All of this drives our return on invested capital, but we continue to use to drive our business decisions, and it has led to our success in delivering the right products to the right customers at the right time.

Now, I’d like to open up the call to questions. Operator?

Question-and-Answer Session

Operator

We will now begin the question-and-answer session. (Operator Instructions) And our first question will come from Tayo Okusanya of Jefferies.

Tayo T. Okusanya – Jefferies LLC

Good morning, everyone. Congrats on really, really solid results and guidance. I just wanted to talk about Richmond a little bit, if you could just give us some color on what’s happening within that market?

Chad Williams

Hey, Tayo. great to be on the call and thanks for the question. This is Chad Williams. It’s a great market, we continue to see good growth and opportunity in Richmond, not only from the Virginia market, which we consider ourselves in, but also the opportunities to talk to people about the New Jersey market, the proximity and distances, is very complimentary of that and power cost basis continues to be very attractive to those customers. But we also are having very relevant conversations with the customer and impact in North Carolina.

So I think from our standpoint, we think about it as a regional, northeastern market, certainly in Virginia, and been one of the largest markets in the country. And on a point to that, as Virginia has hundreds of megawatts of load in that market with existing customer base, we think we have a unique opportunity also to talk to those customers about the disaster recovery opportunities.

So when you think about the latency and the proximity being 90 miles or so from Northern Virginia, we think it sets us up to have a terrific opportunity to have very substantial conversations with those customers about DR and opportunities to replicate in close proximity.

And the last thing I’d say is that Richmond market for us became on the basis of how QTS has built our business, which has been terrific acquisitions, super rich infrastructure sites, 1.3 million square feet. It will continue to allow us to build on an economic scale that’s very unique in the marketplace. We’ll be able to drive growth for years to come in that market, because of that. But it also sets us up for our federal initiative and federal market. We’ll be launching the federal cloud in Richmond in the highly secured, highly compliant data center, 500 foot setbacks. premium security and compliance initiative will surround that site.

So when you think about it, it’s a unique proposition, it’s a huge piece of infrastructure, it gives us terrific cost and basis for years to come and we just think Richmond’s going to be and continue to be a great market.

Tayo T. Okusanya – Jefferies LLC

Great. That’s helpful. And then kind of going to the Dallas development, I believe you mentioned that you expect yields to decline slightly in the middle of the year as that comes online and then pick up later on. Is that simply because the initial ramp-up is mainly larger C1 customers?

Chad Williams

Yes. I think keep in mind; Dallas is going to be a more of a impact for us in 2015 versus 2014. We are – just came back from Dallas this week, the project’s on track and on time. We continue to be very excited about the opportunity to be in a market that consumes 20, 30 megawatts of power a year, and has done that consistently. I think we’re very excited about the opportunity that have our suite of services and our fully integrated technology platform with our 3Cs coming online in Dallas, and a little bit of perspective. We’re building Phase 1, which consists of about 25,000 square feet and comes on in July and we’re excited about the opportunities that are ahead of us there.

Tayo T. Okusanya – Jefferies LLC

Could you just kind of give us a little bit more color again on the yield dip in the middle of the year? What’s really driving that?

William Schafer

Yes. This is Bill. And as we bring the development online if you look at our calculation of how we define the return on invested capital, those assets that are placed in service. So, as we place those assets in service, from day one, it doesn’t necessarily have a huge amount of return on that, but it just ramps over the quarters.

Tayo T. Okusanya – Jefferies LLC

Okay.

William Schafer

It’s really related to the timing of which that capital comes online.

Chad Williams

We will probably have, like we’ve done on other mega sites to accelerate revenue, we’ll probably look to do some C1 business, as we open Dallas, both our C1 and C2 product. but that could be a tendency that certainly has paid dividend for us as we built the assets up early in the cycle.

Tayo T. Okusanya – Jefferies LLC

Makes sense, thank you so much.

Operator

And our next question will come from Jordan Sadler of KeyBanc.

Jordan Sadler – KeyBanc Capital Markets, Inc.

Thank you, and good morning.

Chad Williams

Good morning, Jordan.

Jordan Sadler – KeyBanc Capital Markets, Inc.

Hi, I wanted to talk a little bit about sort of the sales funnel as we’re sort of setting up here for 2014. It sounds like there’s some momentum on the C3 side early in 2014. But as you look at sort of the sales funnel, how is it weighted? Are you seeing any dynamism or shift within the overall product types?

Chad Williams

Jordan, I’ll let Dan take this a little bit here. But my overview is that we are continuing to see an allocation that’s fairly similar to historical trends with us for our business. The engine of our business continues to be our C2 and C3 business with almost 60%. Our C1 at 40%, but the average customer being 3,300 square feet in that C1 product type, which we think is very different than our competitors. But we continue to see the allocation be fairly similar. You are right. We had a couple of significant customer expansions, mostly revolving around our product and focus in cloud is on a highly secured, highly compliant cloud type customer and as they come and grow with us, we’re continuing to get them the opportunities to do that, we continue to see growth. But I would say overall, the allocation continues to be very similar to what we’ve seen. And Dan, I don’t know if you have something to add to that.

Dan Bennewitz

Yes, Jordan. This is Dan. I’d just to add to it, I’ll go by product. So C1 is obviously lumpier. We see consistent growth in our pipeline on that and we today, don’t fully see the impact of Dallas given that that’s a second half opening. So we see continued growth there. C2 as Chad is our bread and butter execution engine. We continue to see that pipeline – our opportunity pipeline grow and again, we don’t see fully the impact of Dallas on that yet. So we think that’s ahead of us.

The cloud, we announced earlier this year our federal cloud, we announced our enterprise cloud both of which complement our managed our managed cloud that’s been out there for a while. and so that’s a much smaller piece of our business, but again, steady pipeline growth, and we feel good about that.

Jordan Sadler – KeyBanc Capital Markets, Inc.

Are the lead times on cloud, Dan, are they similar – more similar to C1 than they are to C3 just because of – sort of just ramping customers on your platform and getting them comfortable with the sale?

Dan Bennewitz

I would characterize the C3 is more similar to C2. In many cases, it’s faster than C2, and as in the benefit of cloud, is that we sign long-term contracts as we said, our median customers about 7,000 MRR. But there also – that once they do that, they’re able to grow. So we see incremental growth happening in C3, which is different than C1 contract with a contract, it’s a ramp over a period of time. So they are very different.

Chad Williams

And Jordan that certainly from QTS’s perspective, one of the things that we feel that the 3C supports, right? It’s the ability to book and bill in cycles that lets us be able to consistently execute our business and our growth strategy. The two customers that we talked about, who signed significant expansions within C3, to Dan’s point, when you have the teams of people and compliance and security and systems that are set up to deliver that, those customers will be billing and ramping almost immediately after signing. So, it’s a great opportunity to kind of stabilize and continue to allow us to do very quick book-to-billings and it’s something that drives our business.

Jordan Sadler – KeyBanc Capital Markets, Inc.

Okay. And then for Dan or Bill, I had a question on the bad debt reserve taken in the quarter; we don’t see those too often. What was the nature of that? Where was it? And how did it come about?

William Schafer

Yes, this related to one customer that we had, who had a number of customers, and basically lost a major customer of theirs, which significantly impacted their cash flow. We have kind of restructured their lease arrangement, but as a measure of conservatism, pretty much reserved some of the historical past amounts that had accrued relating to that one customer.

Jordan Sadler – KeyBanc Capital Markets, Inc.

Okay. And the last question I had was just on the renewals, upcoming for 2014, which I think 23% of rent total rolling. What’s the assumption on the releasing spread? I saw the 5% to 8% churn, but curious about the releasing spread.

Dan Bennewitz

Yes. So Jordan, this is Dan. So, we look at throughout 2014, we see the releasing spread is low single-digits. As a play it may be lumpy by quarter, but for the year we see low single-digits.

Jordan Sadler – KeyBanc Capital Markets, Inc.

Positive, okay. Thank you.

Chad Williams

Thank you, Jordan.

Operator

And the next question will come from Simon Flannery of Morgan Stanley.

Lisa Lam – Morgan Stanley & Co. LLC

Hi, this is Lisa for Simon. Thanks for taking the question. Can you talk a little bit about your upcoming expansion plans? And I know you have Dallas coming online in the second half of this year, but do you have anything else that you’re looking at, or any markets that you would like to enter?

Chad Williams

Well, I would tell you that very consistently with how we’ve run the business is that the best opportunity continues to be for us, the discipline around the ability to double our existing platform. We feel like we have a great national footprint, it’s spread out, it’s allowing us to continue to grow and we want to be very thoughtful that our known design having 1.8 million square feet of powered building shells with proven customers in those buildings, and operations teams to operate them and a very known cost around those continues to drive great discipline around how we think about expansion.

I will tell you that, we will continue to be consistent around our philosophy, which is unique in the marketplace, that we feel like that even though some of the people have said you kind of got lucky in Suwanee and Metro and Richmond and Dallas. We think there’s a discipline around the team’s thought on how we’re going to develop.

So, we’re going to continue to think about opportunistic, very infrastructure-rich properties in cities that would support our 3C product offering and the other thing that we think about is with our, powered by our people, and compliance and security and IT integration teams, we do think we have some unique opportunities that could allow us to have very interesting conversations, which our sales solutions approach allows us to have with customers and may have underutilized data centers in strategic cities.

But I would come back to the point that, much like we’ve done is that we have the ability to double our operational square footage in terrific markets that we’re seeing growth, and we’re going to continue to execute our business with that, with the overarching theme that we want to stay on target for our 15% plus fully unleveraged return against capital.

Lisa Lam – Morgan Stanley & Co. LLC

Great. Thank you.

Operator

And next we have a question from Stephen Douglas of Bank of America.

Stephen Douglas – Bank of America Merrill Lynch

Great, thanks for taking the question, and congrats on the quarter. My question is on public cloud. We get a lot of questions from investors asking about what the impact cloud will have on traditional data center businesses. On the one hand, because you could argue the faster adoption of cloud means, faster adoption of outsourcing in general, which should be a good thing for you guys. On the other hand more computing capacity moving to the public cloud, potentially means your servers resided in, maybe, a QTS data center. So, I guess I’m wondering if we could maybe get your take on the public cloud, how it’s changing the data center sector today, and how you think it evolves in the future. Thanks.

Chad Williams

This is Chad; I’ll let Dan kind of take this on here in a second. But just overarching, I think whether you’re talking about the public or private clouds or any cloud. I think what is consistent and encouraging from our standpoint is the content and delivery of these services are driving tremendous growth across a platform that we continue to see dynamically grow.

I think uniquely with our 3Cs, meaning that we can play in large strategic C1 relationships, I think you could often say that as the big public clouds drive business, it’s nice to have a bucket that makes us relevant. I think from a C2 colocation in cloud, I think what’s you then have to kind of step into the product of is, what is our cloud.

Our cloud is very different than the public cloud providers. we are dealing with the security and compliance around the uniqueness of our people and the capabilities that they have around the compliance and regulatory requirements of enterprise-type customers that are strictly focused on performance-driven application and security needs that they have.

They’re signing multiyear contracts that typical customers do at about $7,000 a month in billing and most of those customers actually care, where that cloud exists. Meaning that it needs to be in a physical, secured, hybrid environment. And that hybrid environment is driving pieces of their colo business and their cloud because none of these environments we see are monolithic, where they have all of one thing, they all can’t go to the cloud and that’s the hybrid market that we think is very powerful. And Dan, you may want to add something to that?

Dan Bennewitz

Yes. Just to add a couple of points. First is, we look at the cloud and software as a service enterprises as both customers and additional prospects as Chad said. So, we look at them that way, not necessarily as competitors. Second is we’ve just announced our federal cloud and our enterprise cloud, which complement our managed cloud that’s been out there, we’ve had success with.

Our target segment are those customers that really do require and value the highly compliant, highly secure, knowing where your data is, a commitment in terms of expectation on what they’re going to spend and what performance they should get. And every customer is having a cloud discussion of one degree or another.

So, for our approach to be able to offer a solution to their hybrid needs, our cloud offering complements our C1 and C2. I just say this market, depending upon what analyst you read, is $100 billion plus. So, for us to be widely successfully, we don’t even need to move the needle in terms of market share in that environment.

So, we’re going to be very disciplined to go after the segment that you place to our strengths and it’s complementary with our other customers out there. So, we feel very good about it. It’s a great opportunity to be able to provide these hybrid solutions to our customers.

Stephen Douglas – Bank of America Merrill Lynch

Great. Thanks guys.

Operator

(Operator Instructions) And our next question will come from Andrew Rosivach of Goldman Sachs.

Andrew L. Rosivach – Goldman Sachs & Co.

Hey, good morning guys.

Chad Williams

Hey, Andrew.

Andrew L. Rosivach – Goldman Sachs & Co.

How are you?

Chad Williams

Fine.

Andrew L. Rosivach – Goldman Sachs & Co.

Maybe a quick one for Mr. Schafer. On your guidance here $1.95 to $2.05, but obviously, this is a company that’s in pretty big growth mode. Maybe you could give how the quarters lay out, maybe where the fourth quarter of 2014 annualized you think will be?

William Schafer

Could you repeat the last part of that question?

Andrew L. Rosivach – Goldman Sachs & Co.

Just the fourth quarter of 2014 annualized, which I’m guessing is going to be higher than the full-year number.

Dan Bennewitz

The fourth quarter of 2014 is annualized, yes.

William Schafer

Again, we basically – again, I think the guidance that we put out there we’re showing that basically ramping throughout the year. It’s not something that we haven’t put out specific quarter guidance and to that point; I mean I think you’ll see growth kind of consistent with how we’ve operated in the past from quarter-to-quarter, year-over-year and that time we will look at it from our perspective.

Andrew L. Rosivach – Goldman Sachs & Co.

Okay.

Chad Williams

And I add to that from bill's perspective, where we’ve typically seen the businesses, this business has then have seasonality to it, right? When you come into the end of the year, coming into the first of the year, when you're running an enterprise level customers critical applications, whether it’s in C1, 2 or 3 for us. There is a period of time, where your customers are going to have credit – most or lot of the transactional based customers are doing freezes on their environments during that period of time.

So, it’s very typical and historical for us to see the general trend to that business to be more weighted towards the second half of the year. And also the book but not billed segment that we have, which is historically at a tie, does it really – it's ramping throughout the year and most of that impact will be seen in the second half. So, for a couple of those dynamics I think we continue to see the trends be normal and we feel good about the performance in the future.

Andrew Rosivach – Goldman Sachs

You can see where I'm going with the question, is when you look at your booked-not-billed there's really more than $2 of earnings power now sitting in the company.

Chad Williams

Right. And you just got to take into account the ramping nature of that, which doesn't materially impact first quarter as much as it does, the second half of the year, which also makes us feel good to your point that we do have good visibility in growth as we kind of drive that and have good trends to be able to build the business upon, which is the reoccurring nature of this business is what gives such a nice growth opportunity for performance and seeing it.

Andrew Rosivach – Goldman Sachs

Terrific. Thanks for that Chad.

Operator

Thank you. And our next question is a follow-up from Jordan Sadler of KeyBanc.

Jordan Sadler – KeyBanc Capital Markets, Inc.

Hi. I guess following up on the question on the cloud, curious if there was any light you could shed on the types of applications, your C3 customers are deploying into that cloud.

Chad Williams

Yes. Dan do you want to talk about that a little bit.

Dan Bennewitz

Yes, Jordan. So, I'll give you some examples, some used cases. One is a company is providing an email archiving, so the email archiving, the application run in our infrastructure. Another customers providing mobility technology to service providers again they're expertise on the application and it rides on our infrastructure as a service cloud platform.

So, those are just two examples. Another example I give you is a healthcare enterprise running their service to healthcare providers. Again they are spending their time on the application and it rides on top of our infrastructure as a service offering. Those are the types of customers that we are going after. Again the healthcare customer they concerned about HIPAA compliance and data security. The other customers are concerned about performance; committed performance the ability to meet their growth needs, when they need it and so that’s again, just different use case examples for cloud.

Jordan Sadler – KeyBanc Capital Markets, Inc.

Okay. And then the other one I had was on the customer leaving Metro for Suwanee, and then backfilling Metro. I think, Bill, in your commentary, you gave a positive mark to market on a per square foot basis. I was curious, is it positive on a per megawatt basis as well?

William Schafer

Absolutely.

Chad Williams

Substantially.

William Schafer

Yes.

Jordan Sadler – KeyBanc Capital Markets, Inc.

Substantially. That's the customer and then backfilling the Metro space with the new C1 customer, same thing? Or the C2 customers, rather?

Chad Williams

Yes.

William Schafer

Yes. There is a good chunk of that space that is really the C1 customer and smaller portion will be redeveloped to accommodate additional C2.

Chad Williams

Customers both at higher rates.

William Schafer

Both at higher rates

Jordan Sadler – KeyBanc Capital Markets, Inc.

And can you give us order of magnitude on the mark to market there?

Chad Williams

Well, one of the things I think would be a guidance trend here would be is that, that customer was historically a very early customer that had a pricing level that was commensurate with being the anchor client in the facility, when it opened in 2007. And I think that it would be a very safe to say that customer that we have a great relationship with and have provided service to, was very constructive in their consolidation, which was also very constructive for us to see a material increase on a KW or per square foot metric. And we were happy to take back that space, as Metro's been a significant grower in the portfolio. So, it’s just been a win-win for us all the way around.

Austin Wurschmidt – KeyBanc Capital Markets, Inc

Hey guys, it’s Austin Wurschmidt here with Jordan, I just had one quick one. I was curious in the mid-to-high teens revenue growth in guidance, how much go-get is assumed within that assumption?

William Schafer

It’s a number I think consistent with our historical perspective. Maybe adjusted slightly because we do have another property that's going to be coming online middle of the year.

Austin Wurschmidt – KeyBanc Capital Markets, Inc

Okay thanks.

Operator

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

Chad Williams

Well, I just want to thank everybody for our second analyst call as a public company earnings call as a public company, very exciting time. I think in closing QTS feels extremely excited about the performance in the future, driven by the momentum in the leasing, but also because of our products, and the structure in which we built the company powered by our people foundationally on world-class infrastructure, surrounded by our product offering in the hybrid 3C market that’s allowing us to have the right conversations with the customers that’s allowing us to have industry leading growth and operating leverage that continues to improve. And we are just excited about the opportunity to continue to drive our business. We appreciate the confidence and execution of the investor community in the company and we will continue to march forward and execute our business and look forward to talking to you all next quarter. Thank you very much.

Operator

The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.

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