QTS Realty Trust's (QTS) CEO Chad Williams on Q4 2015 Results - Earnings Call Transcript

| About: QTS Realty (QTS)

QTS Realty Trust, Inc. (NYSE:QTS)

Q4 2015 Earnings Conference Call

February 23, 2016 10:00 a.m. ET

Executives

Stephen Douglas - Head of IR

Chad Williams - Chairman and CEO

Bill Schafer - CFO

Dan Bennewitz - COO of Sales & Marketing

Jeff Berson - Chief Investment Officer

Analysts

Richard Cho - JPMorgan

Robert Gutman - Evercore ISI

Vincent Chao - Deutsche Bank

Lisa Lam - Morgan Stanley

Jordan Sadler - KeyBanc Capital Markets

Jonathan Atkin - RBC Capital Markets

Matthew Heinz - Stifel

Operator

Good morning, and welcome to the QTS Realty Trust Fourth Quarter 2015 Earnings Conference Call. All participants are in a listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note that this event is being recorded.

I would now like to turn the conference over to Stephen Douglas. Please go ahead, sir.

Stephen Douglas

Thank you, operator. Hello everyone, and welcome to QTS' fourth quarter and year end 2015 conference call. I'm Stephen Douglas, Head of Investor Relations at QTS, and I'm joined here today by our presenters, Chad Williams, our Chairman and Chief Executive Officer; and Bill Schafer, our Chief Financial Officer.

Our earnings release and supplemental financial information are posted in the Investor Relations section of our Web site at www.qtsdatacenters.com on the Investors tab. We also provided slides and made them available with the webcast and on our Web site, which we hope will make it easier to follow our presentation today.

Before we start, let me remind you that some information provided during this call may include forward-looking statements that are based on certain assumptions and are subject to a number of risks and uncertainties as described in our SEC filings and actual future results may vary materially.

Forward-looking statements in the press release that we issued yesterday, along with our remarks today are made as of today and we undertake no duty to update them, as actual events unfold.

Today's remarks also include certain non-GAAP measures, including FFO, operating FFO, adjusted operating FFO, MRR, EBITDA, and adjusted EBITDA. We refer you to our press release that we issued yesterday and our periodic reports furnished or filed with the SEC for further information regarding our use of these non-GAAP financial measures, and a reconciliation of them to our GAAP results. These documents are available on the Investor Relations page of our Web site.

And now, I will turn the call over to Chad.

Chad Williams

Thanks, Stephen. Hello and welcome to QTS' fourth quarter year end 2015 earnings call. I am pleased that 2015 represented another successful year of the execution and growth for QTS.

Our differentiated strategy and approach to products and infrastructure continues to be the foundation of QTS' success. As seen on Slide 3, we believe our fully integrated three C product offering is one of the most comprehensive solutions based in the market, and continues to drive strong growth for the company. We offer this product mix overlay with our industry-leading security and compliance capabilities to over a thousand sophisticated enterprise customers who value QTS' premium customer service.

QTS' integrated technology services platform sits on top of our world-class mega data center infrastructure, which supports the cost-efficient delivery of our data center products and services. QTS has proven its ability over time to opportunistically acquire infrastructure-rich properties at a low basis, and to redevelop them into data centers. We have consistently executed on this strategy, beginning with our mega data centers in Atlanta-Metro and Suwanee, followed by Richmond, and Dallas, and we'll further demonstrate our ability to identify these unique opportunities with our planned launch of Chicago later this year.

This approach allows us to build a below market cost which supports our overall capital efficiency. It also supports the significant capacity in our current facilities, which gives QTS the ability to double our business in our existing powered shell, de-risking our growth at an attractive incremental cost. Together, our product mix and data center infrastructure provide us the opportunity to drive strong growth, and return on invested capital, stable pricing, and high customer retention.

Next on Slide 4, I would like to take the opportunity to reflect on what the QTS team has achieved during this past year. For the full year 2015, we continued our strong momentum with healthy year-over-year growth across all key financial metrics. We achieved record revenue of 311 million, up 43% over 2014; adjusted EBITDA of 140 million, up 40% over 2014; and operating FFO of 104 million, up 40% over 2014.

Over the course of the year, we made numerous key investments in the business, positioning QTS for long-term growth. We deepened our presence in existing markets with incremental investments in Atlanta, Dallas, and Richmond mega data centers, and saw outsized growth opportunities in these locations.

We made significant investments in our downtown Chicago mega data center, putting QTS in a position to open that facility in the second half of 2016. In addition, we enhanced our service offering with the introduction of several new products, which was further enhanced by the acquisition of Carpathia.

Lastly, we grew our customer base to over a thousand customers who value our multi-service capabilities. Over the course of 2015, the percentage of revenue from customers using more than one C product grew from an approximately 40% to over 50%.

During the year, we achieved an annualized unlevered return on invested capital of 15.8%, which is above our target of 15-plus percent on a fully-stabilized basis. In addition, visibility on our future growth remains strong, based on our high level of booked, but not billed backlog of nearly 48 million at the end of fourth quarter.

As we've said in the past, this number will continue to approach a more normalized level as we deliver on a few large customer contracts over the year. This signed and committed backlog supports solid revenue growth, de-risking 2016, and driving growth into 2017.

Turning to Slide 5, I want to spend a few minutes providing an update on Carpathia. You may have seen an announcement several weeks ago that we have substantially completed the organizational integration of Carpathia, approximately six months ahead of schedule. This represents a major milestone for our team, and I'd like to thank the various integration teams for their hard work and efforts getting us to this point.

Now that we are operating as an integrated organization throughout 2016, we will continue our focus on performance and execution of the plan to ensure we are able to maximize the potential benefits from the combination. We will continue to incur modest integration cost over the course of 2016.

One area of integration in particular that we are focused on is the migration of certain Carpathia customers from leased facilities to QTS-owned facilities, and markets where we have footprint overlap. This migration effort will allow QTS to more effectively support customers from an operational standpoint within our own facilities, reduce our ongoing property cost by eliminating a portion of the rent expense, and convert leased revenue to owned revenue.

As this migration processes, we believe the ultimate value creation in QTS can be significant. Near the end of last year, we started having conversation with customers about potentially migrating to one of QTS' own facilities, and we are encouraged by the early feedback. For example, one of our customers representing a little over a half a million dollars of MRR annually recently agreed to migrate this year from a non-strategic leased asset to a core QTS data center. We are in advanced conversations with many other customers, and look forward to updating you on the progress of this initiative over the coming year.

In addition, our sales organization, under Dan Bennewitz, our COO of Sales and Marketing, continues to see positive results from operating as an integrated go-to-market team.

On Slide 6, I'd like to highlight some of the key customer wins in the quarter. The first customer is a leading enterprise and federal cloud software and services company. This customer selected our Northern Virginia and Dallas date centers for C2 Colocation and C3 Cloud and Managed Services, based on the reputation in the market and industry for leading security and compliance capabilities.

We'll be assisting this customer in facilitating their FedRAMP accredited [ph] platform to target federal government customers. This is a great example of the enhanced value we are able to generate through the combination with Carpathia, by blending our strong C3 security and compliance capabilities with the owned and scalable infrastructure within our facilities.

Together with another large C1 contract signed earlier in 2016, with one of the largest and fastest growing cloud service providers, this deal illustrates that our combination of footprint, scalability, and security in compliance capabilities continues to appeal to a wide variety of industry verticals, including cloud service providers. In fact, keep in mind that some of our largest public and private cloud and software as a service players in the market are significant C1 customers for QTS. Our cloud customers, in particular, view our security and compliance capabilities as a key differentiator in the market, and we are seeing a strong pipeline of demand coming from this vertical.

Next, I'd like to highlight two customer wins in our Dallas-Fort Worth data center. Dallas continues to ramp at a terrific pace for QTS, and we remain very excited about the market. One of our customers, another leading software as a service provider, is expanding their footprint to support one of their new divisions by an additional two megawatts in our Dallas data center, increasing their total power across our footprint by more than 25%. We have a long-standing relationship with this customer, in multiple QTS data centers, and we're excited they have decided to continue to expand with QTS' facilities. Their expansion is a testament to the investments we continue to make in ensuring a premium customer experience.

Also in the fourth quarter, we signed a new C1 customer in Dallas. This customer, a Fortune 500 clinical lab company, chose QTS based on our ability to design to their exact physical environment, and security requirements, and provided additional flexibility options into their contract to accommodate additional C3 services. This is a great example of how our customized solution-based approach to customer infrastructure requirement is driving growth in our business. Uncertainty around future cloud deployment plans remain significant among enterprise customers as technology continues to evolve. Our ability to build flexibility into customer contracts, that allows them to move from a Colocation environment to a C3 Cloud and Managed Service environment, is unique in the marketplace, and a valuable differentiator for our ability to win new QTS business.

These are just a few example of success we're experiencing in Dallas. So turning to Slide 7, let me take a step back, and provide some context around what we achieved in the market. We officially opened our mega data center in Dallas-Fort Worth in the third quarter of 2014. Over the course of 2015, we saw significant leasing, and that momentum has carried over into 2016. As of the fourth quarter, 2015, NOI at our Dallas facility represented 7.2 million of annualized basis, up 18% sequentially and nearly five times year-over-year.

Driven by the success and demand we are seeing in the market, we plan to bring an additional 38,500 square feet of raised floor online in Dallas in 2016. This will increase the total developed raised floor by more than 70%, almost 100,000 square feet, representing approximately a third of the entire capacity of the existing powered shell. To accomplish this all in a little over a year demonstrates tremendous execution by our sales organization and operations teams. And we remain very excited about the opportunities in that market.

Moving to Slide 8, we'll look to replicate our success in Dallas in our next major geographic expansion, Chicago, which is on schedule to open in the second half of this year. As you may recall, we completed the acquisition of the former Sun Times Press facility, a 370,000 square foot building located on 30 acres in downtown Chicago, for approximately 18 million in July 2014. Facility can initially support 133,000 square feet of raised floor with land adjacent to expand and more than double that.

In addition to multiple carriers connecting directly to our facility, we will also have a dark fiber connection to primary carrier hotels in downtown Chicago to enable our customers to access to extensive interconnection in fiber connectivity. This network density in addition to our offering some of the largest purpose-built data center capacity in downtown Chicago paired with QTS' service and flexibility should provide a unique opportunity to potential customers in this high capacity Tier I market.

As is typical with the initial phase of new development and given relatively high build cost in Chicago compared to other QTS markets, we would expect the opening of our Chicago facility to slightly reduce our overall return on invested capital. As a result, we expect to see that our return on invested capital modestly dip below our 15 plus percent target in the second half of this year, ramping back up as Chicago develops over time.

Moving on to some details on Q4 leasing and pricing on Slide 9. During the quarter, we signed new and modified and leases representing approximately 9.8 million of net incremental annualized rent. This leasing performance is approximately 16% above our prior four quarter average of 8.5 million and was primarily driven by several large C1 deals signed in the quarter as well as incremental C3 revenues stemming from the Carpathia acquisition.

Including in the 9.8 million of incremental leasing above, we had a C3 dedicated cloud customer who renewed their contract by choosing to forego a server technology refresh during the quarter. In this case, the customer had the option of paying a higher price to compensate us for the cost of the technology upgrade or continuing their service utilizing the fully depreciated equipment at a lower price point.

Given the QTS build the full cost of the customer equipment into our C3 contracts, the customer's decision to retain their depreciated gear resulted in decreased pricing that led to an approximately $2 million downgrade, with no incremental associated CapEx. Excluding this downgrade, our net leasing would have been approximately 11.8 million representing a 40% increase over the prior four quarter average.

QTS will continue to price the cost of customer equipment for our dedicated cloud services into our customer's contracts as a way to ensure we are getting appropriate returns on our C3 services. More broadly, this reflects our continued focus on making sure we are getting the right returns across our entire business.

Next, fourth quarter pricing for new and modified leases was up across C1, C2, and C3 compared to the prior four quarter average and in line on a total basis driven by our product mix.

Regarding renewals on a like-for-like basis where customers renewed contract without change in square feet, we experienced renewal rates for the fourth quarter of 2015, reflecting an increase in pricing of approximately 2.3% above the pre-renewal pricing rates. This is consistent with our expectation of low to mid single-digit renewal rate increases on a go-forward basis.

Lease commencements pricing during the quarter was 43% higher compared to our prior four quarter average. With pricing up in both our C1 and C2 and 3 business compared to the prior four quarter average. This meaningful increase in C2 and C3 pricing was driven primarily by several customers who ramped their C3 cloud services with minimal incremental square feet needed to supply those services. Overall, we remain encouraged by the pricing environment across our footprint.

In summary, we are pleased with the moment in the business and remain confident that our differentiated approach to these services, infrastructure, and security and compliance would continue to differentiate us in the market and drive our growth and return on capital.

Now, I will ask Bill Schafer to discuss our financial performance, capital plan, and 2016 outlook. With that, over to you Bill.

Bill Schafer

Thanks, Chad, and good morning everyone. As you can see on Slide 11, we are continuing to generate strong and accelerating growth across all of our key financial metrics on a year-over-year basis.

The strong moment in our business can be seen across our entire portfolio as we continue to experience consistent NOI growth in our major markets. Year-over-year, Q4 annualized NOI increased 10% in the Atlanta market. Richmond continued strong year-over-year NOI growth of approximately 53%, and our California market NOI increased close to 8% with limited available capacity.

Our Dallas mega data center, which opened in Q3 2014, continues to experience significant growth as Q4 annualized NOI increased nearly five times year-over-year. In addition, our other facilities experienced year-over-year growth of 11% in Q4.

On Slide 12, our backlog of annualized booked-not-billed revenue from signed but not yet commenced leases stood at 47.7 million of annualized revenue as of December 31, 2015. The high level of backlog continues to give us great comfort and visibility on the growth embedded in the business. As we have noted in the previous quarters, we continue to expect this booked-no-billed backlog to decrease over the course of 2016 as deliver on a few previously executed large C1 commitments over the next year.

Our continued low churn in the quarter demonstrates the underlying stability of our customer base. 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 2.2%, bringing our churn for the year to 4%.

On Slide 13, capital expenditures incurred in the fourth quarter were approximately 66 million, bringing our total full year 2015 capital expenditures to 312 million, excluding acquisitions. Our continued growth in capital efficiency drove an average annualized return on invested capital for the fourth quarter of 15.8% for a business that still has tremendous capacity available to drive incrementally higher returns. This continues to meet our target level of 15%, although it varies based on the timing of new development projects, acquisitions, and other expansion opportunities.

Turning to development on Slide 14, for the fourth quarter, we brought online approximately 45,000 square feet of raised floor across the platform. This included approximately 30,000 square feet at our Richmond mega data center and 15,000 square feet at our Atlanta-Metro mega data center, in line with the development plans we disclosed last quarter.

As of the end of the quarter, our total built out raised floor was over 1.1 million square feet, which represents approximately half the total powered shell raised floor capacity of 2.2 million square feet in our existing facilities.

Also keep in mind that own land adjacent to all of our mega data centers that allow us to double our power shelled capacity. This capacity provides us with comfort that we can control our future development at a non -- lower cost and lower risk path to support our future growth.

Currently, we anticipate bringing online 125,000 square feet of raised floor in 2016, which includes 14,000 square feet of raised floor in Chicago as part of our official launch later this year, and 38,500 square feet in Dallas given the strong moment we are seeing in this new facility. We also anticipate bringing online additional capacity in Atlanta, Richmond, Santa Clara, and Jersey City. The total cost to bring all of this space online is estimated to be approximately $212 million, of which, $122 million has been spent and $90 million will be spent in 2016. Our 2016 redevelopment plan will likely be front-end loaded as we continue to deliver space to support our booked-not-billed backlog and invest to bring Chicago online in the second half of the year.

Moving to Slide 15, I will review our resulting balance sheet and liquidity position. As of December 31, 2015, our total debt outstanding including capital leases were $872 million. Our debt to fourth quarter annualized adjusted EBITDA was approximately 5.3 times. Additionally, we believe we have significant liquidity capacity in our balance sheet. Recall that in October we amended our unsecured credit agreement increasing the total capacity to $900 million from $650 million.

As of December 31, 2015 we had a total of approximately $385 million in liquidity in the business, made up of availability under our credit facility in cash.

We remain pleased with the strength of our balance sheet including attractive interest rates, no near-term debt maturities, minimal secured debt, and significant available liquidity. We are continuing 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 16, with respect to financial guidance; we expect 2016 adjusted EBITDA to be between $177 million and $185 million and operating FFO to be between $125 million and $130 million, or between $2.54 and $2.64 per share fully diluted.

I would like to point out that our 2016 operating FFO guidance includes an estimated non-cash tax benefit of between $4 million and $5 million. For 2016, we anticipate capital expenditures of between $300 million and $350 million. As we've discussed during last quarter's call, when undertaking any customer migration exercise, it is typical to potentially experience some incremental costs, downgrades and/or higher levels of churn.

We discussed that it was our expectation that churn in 2016 could potentially come in above our historical range as a result of our customer migration efforts. Based on our initial conversations with customers, we now expect to be more successful than previously anticipated in customer retention, and as such, our expectation for churn for 2016 remains at our normal historical range of 5% to 8%. However, as a function of consenting customers to migrate, we do expect to see modest impact to revenue in the form of downgrades, which we define as negative change in price for our customer exists -- for a customer's existing contracted space. This expected downgrade activity will show up in our reported net leasing metrics. We are expecting core organic revenue growth for 2016 in the mid-teens. In general, we expect revenue growth to be more back-end loaded and ramping during the year.

Given our expectation of success, executing on our migration initiatives and our progress to-date we also now expect to achieve operational savings in synergies coming from the Carpathia acquisition above prior expectations. As a result, we expect to achieve approximately 300 basis points of adjusted EBITDA margin expansion over the next few years, which is an increase from the previous expectation of 200 basis points.

We continue to expect the operational savings from our migration efforts to offset the one-time revenue impacts in 2016 related to downgrades, and then to drive incremental value creation in 2017 and beyond. We remain enthusiastic and confident that this customer migration effort will generate substantial value for QTS shareholders.

Finally, we are declaring dividend of $0.36 per share for the first quarter of 2016. On an annualized basis, this represents a $1.44 per share or an increase of 12.5% compared to our previous rate of $0.32 per quarter for 2015, or a $1.28 per share on an annualized basis. We plan to maintain this rate through 2016 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 are supported by our significant backlog. And finally, we are pleased with our balance sheet and liquidity, supporting strong expectations for future performance.

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

Chad Williams

Thanks, Bill. Looking back over 2015, we are pleased with the strong performance and momentum that we have experienced. We are also excited with the capital investments that we have made, and look forward to executing on our core strategy of providing a fully-integrated, highly compliant technology services platform on top of our world-class portfolio of mega data center real-estate. I want to thank our customers and shareholders for their continued trust and confidence in QTS.

In addition, at QTS, we're powered by our people. And I want to recognize our employees for their significant accomplishments that made 2015 possible, delivering premium customer service to our 1000-plus customers, and continuing to differentiate QTS in the market.

Now, I'd like to open you the call to questions. Operator?

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. [Operator Instructions] And our first question today comes from Richard Cho of JPMorgan. Please go ahead.

Richard Cho

Great, thank you. I wanted to ask, a little clarification on the churn, the 5% to 8%, is that including Carpathia, and what would have it been without any migration there? And then also, what drove the 2.2% in the fourth quarter?

Chad Williams

Hey, Richard. Thanks. This is Chad. Dan, do you want to take that?

Dan Bennewitz

Yes. The answer to the question is, yes, it does. And what we've guided, you saw that our churn performance in 2015, which we're very excited about, and very pleased with the results. And what we're guiding is churn in 2016 to be between 5% and 8%, and includes Carpathia.

Richard Cho

And then on the Dallas expansion, a lot of space being built up there, what gives you the confidence in building up that space, and what's driving the success there?

Chad Williams

Richard, this is Chad. We've had a tremendous opportunity and momentum in Dallas since we opened, right. I mean, we opened with -- we don't plan on opening with pre-leasing, but we love when that happens. And we got off to a strong start in Dallas. I think it's a testament to the market depth in Dallas. Our facility is at unique scale with unique infrastructure with our 150 megawatt substation and hundreds of thousands of square feet of facility and grounds are operational in our product offering. It's just differentiated, and has had a big impact, and we've just had tremendous momentum, and continue to balance the investment in new space with the lease up of the existing space. And Dan and his team have done a fantastic job at keeping the momentum, but not just in large co-sale deals, which we've had great success, but we've had tremendous uptick in driving our engine of our business, which is our Colocation C2 product, and our Cloud and Services product. So, Dan, anything to add to that?

Dan Bennewitz

I'd just add that we're very excited about the success we've had in Dallas thus far. We continue to see strong demand continuing into 2016, and we're very optimistic as we continue to pull ahead capital and build out the Dallas to meet the demand in the market.

Jeff Berson

Hey, Richard, this is Jeff. Just a little bit clarification, I think one of the questions was did that churn include impact from migration. It does. If you remember, last quarter we talked about it and we thought churn might be higher than our normalized 5% to 8%, and we're actually still with 5% to 8% for '16. And the reason for that is as we had some early conversations with customers about migration, our expectation in terms of losing customers has actually improved. We think that we will be able to retain higher level of customers. So, churn will not be as high as we had once thought. However, as we keep those customers, you will see some impact in downgrades because you still have to incentivize customers to move. So that's where you should see some of that migration impacting the numbers.

Richard Cho

Great, thank you.

Operator

And our next question comes from Jonathan Schildkraut of Evercore ISI. Please go ahead.

Robert Gutman

Hi, this is Rob for Jonathan. I was wondering if you could discuss a little bit the impact of Carpathia on C2, C3 discussions, for example, what are you seeing in terms of dedicated customers' views towards utilizing shared infrastructure, are you seeing cross-selling opportunities running in both directions, and are you seeing any change in demand from enterprise on the back of strong SaaS deployments?

Chad Williams

Yes, I think -- again, this is Chad. I think we have seen just tremendous opportunity to have a solutions conversation. The acquisition of Carpathia has just enhanced that opportunity to have conversations. So what I continue to be excited about within the business, and I'll have Dan maybe drive a little deeper on this. But we can start conversations around Colocation. And with Carpathia strengthening our cloud and services platform, very easily migrate in connecting them to public cloud, driving a dedicated environment, talking to them about a FedRAMP environment if they have a federal interest or an acquisition of high compliance and security. Those types of conversations are just allowing us to be in a very different solution phase of our business, and our customers are appreciating the flexibility, the scalability, and the breadth of the product offering, which is differentiating us.

And I think all of those conversations are happening. And it's because of really the product set, and the scale and flexibility we have. Dan?

Dan Bennewitz

Just to add to that. It's obvious, and the buzzword now is around a hybrid IT environment. And when we talk to customers, we're talking to customers who are living in that environment. So our ability to have strengthened our C3 portfolio with the addition of Carpathia, we can now have a discussion with customers on their IT needs. We can do dedicated posting. We can do shared infrastructure. We can do self-service, we can do managed. And so former Carpathia customers, the discussions we're having with them is how do we help them scale and grow, which is our data centers allow the ability to scale and grow.

To the QTS customers, we have the additional services portfolio that Carpathia brings to add to be able to solution more and more of their needs. So yes, we see a lot of co-selling. We see a lot of ability to address a greater portion of our customers' IT needs with this integration and the expanded portfolio.

Chad Williams

And other thing I might highlight is, you think about Carpathia's additional servicing capability and depth within the cloud and services area being a great cross-sell for QTS. And it has been, and will continue to be. One area that's been really exciting is that Carpathia did not own a major infrastructure and have footprint of our scale. So what's been kind of rewarding is the opportunity for their customers to feel like the breadth of their ability to go into a Colo environment, and not really have the limitations that they once had of being in a facility that usually had some form of limitation on power and space, where they can really come and grow with us. It's a core product, and that's something we welcome, versus -- previously Carpathia had to be fairly focused on the utilization of their space because they were using partners to provide that. And so I think that is something that the sales organization, that's existing now shared with QTS, is excited about going the direction of Carpathia and QTS coming together as an operating platform.

Dan Bennewitz

And Rob, this is Dan. Just one more point on your question on enterprise. I think the third example that Chad referenced is the clinical lab, who is now a C1 customer with ours. The discussion we had with them was how can they take advantage of this new expanded portfolio of cloud and managed services? And that absolutely was a differentiator, along with the compliance and security that we're able to offer. So that discussion we had with that client was different in the fourth quarter than we had before we integrated with Carpathia.

Robert Gutman

Great, thank you very much.

Operator

And our next question comes from Vincent Chao of Deutsche Bank. Please go ahead.

Vincent Chao

Hi, good morning everyone. Just curious, once we get past the migration impacts from Carpathia get past the downgrades. Just curious as you think about the mid to upper teens revenue growth that you previously had mostly talked about, do you see that accelerating in light of some of the cross-selling opportunities you just talked about? And is that the driver for the increase in the EBITDA margin expansion expectations?

Chad Williams

Yes, I think we remain confident that our mid-to-high teens growth, once we get through this migration phase will be a consistent ability for us to drive our growth. But certainly as we think about the opportunity that really is in front of us is because we've substantially completed this integration about six months ahead of what we had planned. And what has opened up the opportunity for, is us to have a really unique set of conversations around taking this migration phase to the next level. And we are excited. As I said earlier, Carpathia relied upon great partners to provide data center space. Some of those relationships will continue, and are valuable for us as a combined company.

Some of them, where we have facility overlap, are not as valuable, and are very much in our interest that we want to control that client within a QTS facility so that we can offer all of those services that QTS offers, with our people delivering those services at a high value. And Vincent, to your point, our margin expansion is something that we feel it's a good trade for this year to take some revenue, mid-teens growth, but focus on the profitability and the margin expansion of having those customers come into a QTS-owned facility, where that full breadth of product is available to them. And it's one of the reasons we felt comfortable to talk about the margin expansion over the next years being a 100 basis points. And we're excited about that.

We feel that QTS customers being able to be in a QTS facility is a great trade for us as we move the company forward, and continue to try to deliver to the customer the highest value solution that we can.

And Jeff, do you have any further comment on that?

Jeff Berson

No, I mean I think the only other thing I'd add to that, Vince, is as you think about the timing and the migration, this is not something that's going to be happening over the next two to three months, and then we move on. This is going to be something –- we're excited about the upside, but you also have to be very deliberate, and very delicate with how you work with your customers and maintain those relationships. And so the migration opportunity can be very significant from a value-creation standpoint, but can happen over the course of the next couple of years.

Vincent Chao

Okay, thanks for that. And just another question on Chicago, so I think in your prepared comments you said that the return on capital will dip below the 15% range as Chicago comes online. So I guess that that assumes that there's a zero pre-leasing at open. Is that correct?

Jeff Berson

Yes, I think, Vin, typically -- I mean, we had the same expectation in Dallas. We think there'll be great demand in Chicago. We saw a great demand in Dallas. But we don't anticipate, we don't build into any of our models the ability to pre-lease. It's very difficult to get customers to make a commitment pre-leasing on a new build facility, because effectively they don't want to take the risk on timing of construction, and so that tends to put some limitation. So that was our expectation.

Now, in Dallas, we were thrilled that we ultimately wound up pre-leasing the entire first pod that come from largely existing QTS customers that had worked with us, and were willing to commit that we would be good on our word and timing. But it's difficult to predict, and it's not anticipated in our model.

We don't expect that a lack of pre-leasing should drive any expectations in terms of the success of Chicago. From conversations we have, we think that there is a tremendous need. We think there's a supply-demand imbalance. And we think that this kind of purpose-built space in the location we have it, with the products and solutions we offer will be very well-received, but we expect that to ramp once the facility is open.

Dan Bennewitz

And even once you do the facility, you're brining basically the entire capital into the mix at that point in time. And the revenues will kind of ramp over the months as those new customers deploy their equipment.

Vincent Chao

Right, okay. And just one last quick question just on the comment about fixing or looking out for opportunities to fix your debt, is there any fixed rate debt assumed in the guidance?

Dan Bennewitz

Well, yes, we've assumed a certain level of that, probably more toward the middle of the year, and so forth. But again, we look –- we'll continue to monitor the markets and act accordingly, and maintaining our balance sheet in a strong position.

Vincent Chao

Okay. Thanks a lot guys.

Operator

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

Lisa Lam

Hi, this is Lisa for Simon. Thanks for taking the question. Maybe a quick question on the current data centers that are being sold be telecom companies out in the market today. What are your thoughts on just the M&A activity in the market? And would you be interested in some of these properties? Thanks.

Chad Williams

Yes, it does seem like the telecoms have all kind of thought about that at the same time. So it has been interesting. I would tell you that we continue to focus the opportunity for us to deploy capital is substantial within our current footprint. So when you think about being able to double our operational square feet in our key markets, we're pretty focused on our ability to return capital with our consistency and reliability of our product and our facilities. And don't feel that a lot of other facilities are needed to enhance the operation. So I'm not sure we'd be a great one to ask about those type of transactions.

Typically, those facilities are more of a legacy type facility versus kind of our scale and operating efficiency of the facilities that we own and operate today. So it will be interesting to see how that plays out in the market. But at QTS we're continue to focus on what drives our engine. We're focused on launch in Chicago this year, and really focused on our infrastructure, mega data center type assets that really drive our business.

Lisa Lam

All right. Thank you.

Operator

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

Jordan Sadler

Thank you, and good morning. First question is regarding the downgrade laid out in your prepared remarks in the press release that sort of reduce the overall leasing in the quarter by the $2 million. Can you -- what was the nature of that customer's decision, and is that commonplace? Has it happened before, and should we expect that trend -- for that to become a potential trend?

Chad Williams

Hi, Jordan, Chad. Thanks for the question. Yes, it's -- when we acquired Carpathia, they had a portion of their business within a dedicated cloud environment business, which is something that we bought, and will remain in our product portfolio. It actually plays into -- there's a number of customers in the marketplace that have dedicated needs, whether it could be proprietary apps or software, or security or compliance. And so that is a product that continues to be something that we will continue to go forward with and value. And when those customer contracts, they're similar to our Colocation contracts, two to three-year contracts. And from time to time, when those customer contracts come up, if the infrastructure is existing and reliable, and stable, and there's no big plan for change of what's operating on those systems, it's very customary for a customer to have a conversation around the decision whether they want to keep the existing infrastructure operating for another year or two, or migrate to new infrastructure.

Since we make customers carry that burden of equipment in our dedicated business, meaning that we would buy that and put a return against that, and capitalize that into our services deal, it is something that we can have a price conversation about. And if they want to stick with the existing gear, and go forward with that, then that would be something that we would do. And you saw it reflective in this quarter. And I think we're focused on the ability for our customers to kind of getting paid for what services we're providing to them, and making our returns. And if that dedicated business continues to perform at that level, then we'll see this from time to time. It's not a large area of our business. If you think about our total, kind of server refresh capital, is less than $10 million a year, it's not a significant portion of our business, even with the Carpathia acquisition. But we'll continue to go.

Dan, do you have any further comments on that?

Dan Bennewitz

I would just add that when to go through these types of relationships we fully burden the technology to get our returns and fully burden with the depreciation. So when that term comes up, that our profit margin has been maintained. As we move forward here we make sure that the margin actually is maintained or increases in the -- as we go through that renewal. So in this case, while we lose some revenue, we actually maintain the margin here, which is what our key focus is.

Jordan Sadler

The only other question I would have there is -- and I don't know if you have this order of magnitude. What percent of rent, if you will, comes from capitalized equipment? So if C3 is 22% of rent, I would imagine that's the only spot where you'd have the capitalized cost of equipment? Some percent of that, right?

Bill Schafer

Yes. Less than 5% of our revenue is coming from this equipment side of dedicated servers.

Jordan Sadler

Okay, that's helpful. Thank you. And then, as it relates to the revenue mix, what's embedded in guidance in terms of revenue mix these days? I mean what are you anticipating relative to the current mix of the portfolio?

Bill Schafer

Yes, Jordan, as we've said in the past, we don't manage our business to try to hit a certain split between C1, C2, C3, but the mix we have right now feels pretty comfortable for us largely because all three of those product verticals are growing pretty equally.

You may see over the course of the next year a little bit of an increase in C1, partially because a lot of this booked-not-billed is still more C1 focused just because have a couple of large contracts coming through. And as we launch Chicago off in early and a launch of a new facility we will lean in on some C1 because it can be larger revenue and get an early return on that asset, but once we bring in that C1, you then see the C2 and C3 start to fill up and sort of catch up. So I would say over a longer-term perspective, you'll see the mix stay pretty constant. You may see a little bit more C1 over the next year.

Jordan Sadler

Okay. And then regarding Carpathia, you previously guided toward $2 million of synergies and operational savings in 2016, and now you are saying it's better. Do you have a number?

Chad Williams

Well, I will think -- Jordan, this is Chad. When we talked about the synergies of $2 million realized in '16, you can know that $2 million of those synergies are realized in our budget, one, for 2016 forward. So, we feel good that that's built in and something that we have visibility and clarity on the execution of that. And then to your point about migration, we will -- now that we are able to take on that migration, quite frankly sooner than what we had anticipated because we thought the integration of the companies might be six months longer. It's now at a phase where we can turn to that. There's opportunity for us. I think it's kind of why we are comfortable to talk about the 100 points of margin expansion over the next few years really kind as a direct result of the ability for us to take on this migration conversation and drive the business to be more profitable in that regard by putting customers in the QTS-owned data centers.

And I think the 2 million that we talked about last year and after the acquisition is something that's built into our '16 budget and we have great visibility. And now, we'll start the migration phase which -- it's been something that people talk to us about over time. But to just point earlier, we want to do the right customer and the solution the customer is trusting us to provide, and we value the sensitivity around that. But now we are able to turn and focus on that, we think we are having conversations that are productively moving the right now. And now that we can focus on it more, we'll continue to drive that in 2016, and really see the results of that late half of '16 and '17 and beyond. And -- but, Jordan, mathematically if you go from 200 basis point margin improvement over the next few years, which is where we have been to 300 basis points improvement over the next few years, which is where we are today off of our current anticipated revenue base, you're talking about incremental profitability there of about $4 million over the next few years.

Jordan Sadler

Okay, on top of the first 2 million, that makes sense. And then lastly -- sorry, and I'll hop off. Can you give us sources and uses per for 16, Bill? I get the -- you gave us the 5.3 times EBITDA -- debt to EBITDA number on the 4Q annualized number. I know it's going to ramp a little bit. But just to may be how you expect to fund the 300+ million of spend and what your leverage will look like end of the year?

Bill Schafer

Yes, Jordan. And again, we -- right now if you look at the end of 2015, we had almost $400 million of available liquidity. That plus the retained cash flow that we will continue to generate gives us more than capital to fund all of our needs throughout that. That been said, we will continue to look at opportunities in the capital markets to enhance liquidity. And again, we'll look to maintain a solid balance sheet going forward from a debt to EBITDA.

We talked -- we just -- as we have said that we on a stabilized basis that we will hope it will be about five times on a debt to EBITDA. And we look to kind of manage that over the period. And again, we are comfortable with it being above that five times given the significance of our booked-not-billed backlog. And again, we'll do what we need to kind of manage the strength of our balance sheet.

Jordan Sadler

Okay, that's helpful. Thank you.

Operator

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

Jonathan Atkin

Yes, I was wondering if you could talk a little bit about decision cycles. And any sense that they have elongated or stayed same or maybe even compressed a bit on the part of customers for C1 and C2 type deals?

And then, thinking about also C1 and C2 with regards to pipeline as well as just weakened business, how much of that would you characterize as being compliance driven versus non-compliance driven? I think you've been putting your business in both segments, but maybe a rough breakup will be interesting to hear.

Chad Williams

Thanks, Jonathan. This is Chad. Dan, this is great question for you. Why don't you take the cycle question first?

Dan Bennewitz

Yes. Yes, hi, this is Dan. So, I think what we have seen on a longer-term basis is decision cycles are changing in a couple ways. One is they are going from single decision makers to more of a committee and higher level approvals as IT continues to become strategic with customers. And so, we -- while that has not added a dramatic impact on decision cycles, we've seen decision cycles frankly maintained over the last year or so. I think they are longer than they were 2 or 3 years ago. But over the last year or so, they've maintained. And what we are seeing is that while the decision cycle is the same and our sales cycles relatively the same, within the sales cycles we have to deal with committees approving capital spend or OpEx spending in those type of environments.

As it relates to the pipeline, let me just take that and send it back to Chad, is even the examples that Chad talked about in the prepared remarks with the clinical lab company, our software as a service company, and the car provider who is big in the federal space, all of those have a compliance and security aspect even if they are in the commercial space.

And so, we see compliance and security both physical and data security coming up more and more. Even if it's not a regulatory requirement, there are customers and enterprises looking for that to satisfy their audit, their compliance requirement. So, we think that is a great differentiator for QTS because we continue to invest in compliance and in security and to be able to deliver much higher level of expertise to customers around the compliance and security market.

Jonathan Atkin

Great. Thank you very much.

Operator

And our next question comes from Matthew Heinz of Stifel. Please go ahead.

Matthew Heinz

Hi, good morning. Just a question on the macro backdrop, I am wondering if your conversations with customers indicate any pause in corporate decision making in terms of migrating IT infrastructure particularly for first time outsourcers, which certainly doesn't seem to be reflected in 4Q results? But I am curious if there has been any change in sentiment year-to-date.

Chad Williams

Matt, from my perspective, Dan and the team continue to have good things happen for us in the field. And sometimes, it's partly because we have the right solution at the right time and the right infrastructure and that always helps in the conversations. But I haven't -- we haven't noticed and maybe Dan can give a little more clarity, market seems consistent and reliable. And I think that's been demonstrating in kind of the broader sector.

Dan Bennewitz

This is Dan. I will just add as we see a continued relentless drive for IT continues to grow. You've got the hybrid angle these days. You've got the internet of things. You have digitalization; all that is driving continued demand. And so, we see a positive macro environment for demand in our space across all of our three C products and markets that we target.

Matthew Heinz

Okay. That's helpful. And then a couple of follow-ups for Bill, I was hoping you could give us some sense of how much of your CapEX guide is allocated to maintenance? And also, what percentage of your interest expense you expect to capitalize in 2016?

Bill Schafer

My sense on the capitalization of interest will probably be consistent with where we were in 2015. As far as the maintenance CapEx, again that's probably in a 5 to $6 million range where I would estimate that.

Matthew Heinz

Okay. Thanks very much guys.

Chad Williams

Thank you.

Operator

And ladies and gentlemen, 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 participating in the call and thanks for a great year. 2015 had a lot of things happen for QTS and we are so appreciate of our people around the country that make this happen every quarter and every year. We thank you for the shareholder support and the continued confidence in QTS. We're excited about 2016. The opportunities in front of us with our infrastructure, our facility, Chicago, opening, our progress, and are terrific, powered by people, QTS serves the deliver of unbelievable value, solutions, and premium customer service every day is what's differentiating QTS. And we thank you for your support. Look forward to next quarter's call. And thank you for the support you all have given us. Thank you.

Operator

And ladies and gentlemen, the conference is now concluded. Thank you for attending today's presentation. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!