cor_Current_Folio_10Q

Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the quarterly period ended September 30, 2017

 

Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the transition period from                      to                     .

 

Commission file number: 001-34877

 

CoreSite Realty Corporation

(Exact name of registrant as specified in its charter)

 

Maryland

 

27-1925611

(State or other jurisdiction
of incorporation or organization)

 

(I.R.S. Employer
Identification No.)

 

 

 

1001 17th Street, Suite 500
Denver, CO

 

80202

(Address of principal executive offices)

 

(Zip Code)

 

(866) 777-2673

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes ☒  No ☐.

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes ☒  No ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer ☒

 

Accelerated filer ☐

Non-accelerated filer ☐
(Do not check if a smaller reporting
company)

 

Smaller reporting company ☐

Emerging growth company ☐

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ☐

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes ☐  No ☒

 

The number of shares of common stock outstanding at October 25, 2017, was 34,241,504.

 

 

 


 

Table of Contents

CORESITE REALTY CORPORATION

FORM 10-Q

FOR THE QUARTER ENDED September 30, 2017

TABLE OF CONTENTS

 

 

 

 

 

    

PAGE

 

 

NO.

 

 

 

PART I. FINANCIAL INFORMATION 

 

3

 

 

 

ITEM 1. Financial Statements 

 

3

 

 

 

Condensed Consolidated Balance Sheets as of September 30, 2017, and December 31, 2016 (unaudited) 

 

3

 

 

 

Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2017, and 2016 (unaudited) 

 

4

 

 

 

Condensed Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2017, and 2016 (unaudited) 

 

5

 

 

 

Condensed Consolidated Statement of Equity for the nine months ended September 30, 2017 (unaudited) 

 

6

 

 

 

Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2017, and 2016 (unaudited) 

 

7

 

 

 

Notes to Condensed Consolidated Financial Statements (unaudited) 

 

8

 

 

 

ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 

 

25

 

 

 

ITEM 3. Quantitative and Qualitative Disclosures About Market Risk 

 

39

 

 

 

ITEM 4. Controls and Procedures 

 

40

 

 

 

PART II. OTHER INFORMATION 

 

40

 

 

 

ITEM 1. Legal Proceedings 

 

40

 

 

 

ITEM 1A. Risk Factors 

 

41

 

 

 

ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds 

 

41

 

 

 

ITEM 3. Defaults Upon Senior Securities 

 

41

 

 

 

ITEM 4. Mine Safety Disclosures 

 

41

 

 

 

ITEM 5. Other Information 

 

41

 

 

 

ITEM 6. Exhibits 

 

42

 

 

 

Signatures 

 

44

 

 

 

Exhibit 31.1

 

 

Exhibit 31.2

 

 

Exhibit 32.1

 

 

Exhibit 32.2

 

 

EX-101 INSTANCE DOCUMENT

 

 

EX-101 SCHEMA DOCUMENT

 

 

EX-101 CALCULATION LINKBASE DOCUMENT

 

 

EX-101 LABELS LINKBASE DOCUMENT

 

 

EX-101 PRESENTATION LINKBASE DOCUMENT

 

 

EX-101 DEFINITION LINKBASE DOCUMENT

 

 

 

 

2


 

Table of Contents

PART I — FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

 

CORESITE REALTY CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(unaudited and in thousands except share and per share data)

 

 

 

 

 

 

 

 

 

 

 

September 30,

 

December 31,

 

 

    

2017

    

2016

 

ASSETS

 

 

 

 

 

 

 

Investments in real estate:

 

 

 

 

 

 

 

Land

 

$

97,258

 

$

100,258

 

Buildings and improvements

 

 

1,512,015

 

 

1,472,580

 

 

 

 

1,609,273

 

 

1,572,838

 

Less: Accumulated depreciation and amortization

 

 

(446,742)

 

 

(369,303)

 

Net investment in operating properties

 

 

1,162,531

 

 

1,203,535

 

Construction in progress

 

 

153,079

 

 

70,738

 

Net investments in real estate

 

 

1,315,610

 

 

1,274,273

 

Cash and cash equivalents

 

 

4,682

 

 

4,429

 

Accounts and other receivables, net of allowance for doubtful accounts of $1,020 and $209 as of September 30, 2017, and December 31, 2016, respectively

 

 

27,990

 

 

25,125

 

Lease intangibles, net of accumulated amortization of $7,910 and $12,385 as of September 30, 2017, and December 31, 2016, respectively

 

 

6,989

 

 

9,913

 

Goodwill

 

 

40,646

 

 

41,191

 

Other assets, net

 

 

104,039

 

 

96,372

 

Total assets

 

$

1,499,956

 

$

1,451,303

 

 

 

 

 

 

 

 

 

LIABILITIES AND EQUITY

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

 

 

Debt, net of unamortized deferred financing costs of $5,213 and $3,550 as of September 30, 2017, and December 31, 2016, respectively

 

$

788,787

 

$

690,450

 

Accounts payable and accrued expenses

 

 

67,798

 

 

72,519

 

Accrued dividends and distributions

 

 

46,523

 

 

41,849

 

Deferred rent payable

 

 

9,674

 

 

7,694

 

Acquired below-market lease contracts, net of accumulated amortization of $5,424 and $5,439 as of September 30, 2017, and December 31, 2016, respectively

 

 

3,688

 

 

4,292

 

Unearned revenue, prepaid rent and other liabilities

 

 

31,260

 

 

37,413

 

Total liabilities

 

 

947,730

 

 

854,217

 

Stockholders' equity:

 

 

 

 

 

 

 

Series A Cumulative Preferred Stock 7.25%, $115,000 liquidation preference ($25.00 per share, $0.01 par value), 4,600,000 shares issued and outstanding as of September 30, 2017, and December 31, 2016

 

 

115,000

 

 

115,000

 

Common Stock, par value $0.01, 100,000,000 shares authorized and 34,241,504 and 33,896,771 shares issued and outstanding at September 30, 2017, and December 31, 2016, respectively

 

 

338

 

 

334

 

Additional paid-in capital

 

 

450,594

 

 

438,531

 

Accumulated other comprehensive income (loss)

 

 

314

 

 

(101)

 

Distributions in excess of net income

 

 

(158,926)

 

 

(118,038)

 

Total stockholders' equity

 

 

407,320

 

 

435,726

 

Noncontrolling interests

 

 

144,906

 

 

161,360

 

Total equity

 

 

552,226

 

 

597,086

 

Total liabilities and equity

 

$

1,499,956

 

$

1,451,303

 

 

See accompanying notes to condensed consolidated financial statements.

 

3


 

Table of Contents

CORESITE REALTY CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited and in thousands except share and per share data)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended September 30,

 

Nine Months Ended September 30,

 

 

    

2017

    

2016

    

2017

    

2016

    

Operating revenues:

 

 

 

 

 

 

 

 

 

 

 

 

 

Data center revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

Rental revenue

 

$

66,657

 

$

54,219

 

$

195,761

 

$

156,954

 

Power revenue

 

 

35,110

 

 

28,844

 

 

98,381

 

 

80,819

 

Interconnection revenue

 

 

16,201

 

 

13,374

 

 

46,038

 

 

39,093

 

Tenant reimbursement and other

 

 

2,185

 

 

2,826

 

 

6,790

 

 

6,982

 

Office, light-industrial and other revenue

 

 

2,915

 

 

2,011

 

 

8,905

 

 

5,996

 

Total operating revenues

 

 

123,068

 

 

101,274

 

 

355,875

 

 

289,844

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

Property operating and maintenance

 

 

37,091

 

 

28,283

 

 

98,098

 

 

78,522

 

Real estate taxes and insurance

 

 

2,622

 

 

3,524

 

 

10,950

 

 

9,659

 

Depreciation and amortization

 

 

32,077

 

 

26,981

 

 

96,622

 

 

77,978

 

Sales and marketing

 

 

4,643

 

 

4,465

 

 

13,560

 

 

13,187

 

General and administrative

 

 

9,759

 

 

9,432

 

 

27,391

 

 

26,970

 

Rent 

 

 

6,077

 

 

5,967

 

 

17,970

 

 

16,718

 

Transaction costs

 

 

 —

 

 

117

 

 

139

 

 

126

 

Total operating expenses

 

 

92,269

 

 

78,769

 

 

264,730

 

 

223,160

 

Operating income

 

 

30,799

 

 

22,505

 

 

91,145

 

 

66,684

 

Interest expense

 

 

(6,447)

 

 

(3,188)

 

 

(17,512)

 

 

(7,879)

 

Income before income taxes

 

 

24,352

 

 

19,317

 

 

73,633

 

 

58,805

 

Income tax benefit (expense)

 

 

(64)

 

 

 2

 

 

(150)

 

 

(45)

 

Net income

 

$

24,288

 

$

19,319

 

$

73,483

 

$

58,760

 

Net income attributable to noncontrolling interests

 

 

6,446

 

 

5,055

 

 

19,537

 

 

17,031

 

Net income attributable to CoreSite Realty Corporation

 

$

17,842

 

$

14,264

 

$

53,946

 

$

41,729

 

Preferred stock dividends

 

 

(2,084)

 

 

(2,084)

 

 

(6,253)

 

 

(6,253)

 

Net income attributable to common shares

 

$

15,758

 

$

12,180

 

$

47,693

 

$

35,476

 

Net income per share attributable to common shares:

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

0.47

 

$

0.36

 

$

1.41

 

$

1.11

 

Diluted

 

$

0.46

 

$

0.36

 

$

1.40

 

$

1.10

 

Weighted average common shares outstanding

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

33,878,881

 

 

33,425,762

 

 

33,758,971

 

 

31,906,000

 

Diluted

 

 

34,114,169

 

 

33,912,155

 

 

34,033,842

 

 

32,361,367

 

 

See accompanying notes to condensed consolidated financial statements.

 

4


 

Table of Contents

CORESITE REALTY CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(unaudited and in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended September 30,

 

Nine Months Ended September 30,

 

 

 

2017

 

2016

  

2017

 

2016

 

Net income

 

$

24,288

 

$

19,319

 

$

73,483

 

$

58,760

 

Other comprehensive income (loss):

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized gain (loss) on derivative contracts

 

 

41

 

 

824

 

 

31

 

 

(3,597)

 

Reclassification of other comprehensive income to interest expense

 

 

87

 

 

432

 

 

554

 

 

1,338

 

Comprehensive income

 

 

24,416

 

 

20,575

 

 

74,068

 

 

56,501

 

Comprehensive income attributable to noncontrolling interests

 

 

6,483

 

 

5,423

 

 

19,707

 

 

16,214

 

Comprehensive income attributable to CoreSite Realty Corporation

 

$

17,933

 

$

15,152

 

$

54,361

 

$

40,287

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

See accompanying notes to condensed consolidated financial statements.

 

5


 

Table of Contents

CORESITE REALTY CORPORATION

CONDENSED CONSOLIDATED STATEMENT OF EQUITY

(unaudited and in thousands except share data)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

   

 

 

   

 

 

 

 

   

 

 

   

Accumulated

   

 

 

   

 

 

   

 

 

   

 

 

   

 

   

 

 

   

 

 

 

 

   

Additional

   

Other

   

Distributions

   

Total

   

 

   

 

 

   

 

   

Preferred

   

Common Shares

   

Paid-in

   

Comprehensive

   

in Excess of

   

Stockholders'

   

Noncontrolling

   

Total

   

 

   

Stock

   

Number

    

Amount

   

Capital

   

Income (Loss)

   

Net Income

   

Equity

   

Interests

   

Equity

   

Balance at January 1, 2017

 

$

115,000

 

33,896,771

 

$

334

 

$

438,531

 

$

(101)

 

$

(118,038)

 

$

435,726

 

$

161,360

 

$

597,086

 

Redemption of noncontrolling interests

 

 

 —

 

15,011

 

 

 —

 

 

167

 

 

 —

 

 

 —

 

 

167

 

 

(167)

 

 

 —

 

Issuance of stock awards, net of forfeitures

 

 

 —

 

131,961

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

Exercise of stock options

 

 

 —

 

197,761

 

 

 2

 

 

4,818

 

 

 —

 

 

 —

 

 

4,820

 

 

 —

 

 

4,820

 

Share-based compensation

 

 

 —

 

 —

 

 

 2

 

 

7,078

 

 

 —

 

 

 —

 

 

7,080

 

 

 —

 

 

7,080

 

Dividends declared on preferred stock

 

 

 —

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(6,253)

 

 

(6,253)

 

 

 —

 

 

(6,253)

 

Dividends and distributions

 

 

 —

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(88,581)

 

 

(88,581)

 

 

(35,994)

 

 

(124,575)

 

Net income

 

 

 —

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

53,946

 

 

53,946

 

 

19,537

 

 

73,483

 

Other comprehensive income

 

 

 —

 

 —

 

 

 —

 

 

 —

 

 

415

 

 

 —

 

 

415

 

 

170

 

 

585

 

Balance at September 30, 2017

 

$

115,000

 

34,241,504

 

$

338

 

$

450,594

 

$

314

 

$

(158,926)

 

$

407,320

 

$

144,906

 

$

552,226

 

 

See accompanying notes to condensed consolidated financial statements.

 

6


 

Table of Contents

CORESITE REALTY CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited and in thousands)

 

 

 

 

 

 

 

 

 

 

Nine Months Ended September 30,

 

  

2017

  

2016

CASH FLOWS FROM OPERATING ACTIVITIES

 

 

 

 

 

 

Net income

 

$

73,483

 

$

58,760

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

 

Depreciation and amortization

 

 

96,622

 

 

77,978

Amortization of above/below market leases

 

 

(428)

 

 

(417)

Amortization of deferred financing costs

 

 

1,231

 

 

964

Share-based compensation

 

 

6,545

 

 

6,874

Bad debt expense

 

 

1,003

 

 

272

Changes in operating assets and liabilities:

 

 

 

 

 

 

Accounts receivable

 

 

(3,867)

 

 

(4,140)

Deferred rent receivable

 

 

(3,161)

 

 

(1,906)

Deferred leasing costs

 

 

(9,956)

 

 

(10,534)

Other assets

 

 

(10,385)

 

 

(8,499)

Accounts payable and accrued expenses

 

 

3,758

 

 

1,413

Unearned revenue, prepaid rent and other liabilities

 

 

(5,841)

 

 

2,480

Deferred rent payable

 

 

1,980

 

 

(356)

Net cash provided by operating activities

 

 

150,984

 

 

122,889

CASH FLOWS FROM INVESTING ACTIVITIES

 

 

 

 

 

 

Tenant improvements

 

 

(6,281)

 

 

(3,487)

Real estate improvements

 

 

(108,548)

 

 

(234,963)

Acquisition of SV8 land

 

 

(12,158)

 

 

 —

Escrow deposits

 

 

 —

 

 

(4,075)

Net cash used in investing activities

 

 

(126,987)

 

 

(242,525)

CASH FLOWS FROM FINANCING ACTIVITIES

 

 

 

 

 

 

Proceeds from exercise of stock options

 

 

4,820

 

 

1,243

Proceeds from revolving credit facility

 

 

107,000

 

 

200,250

Payments on revolving credit facility

 

 

(282,000)

 

 

(247,750)

Proceeds from unsecured debt

 

 

275,000

 

 

250,000

Payments of loan fees and costs

 

 

(2,410)

 

 

(2,981)

Dividends and distributions

 

 

(126,154)

 

 

(81,684)

Net cash provided by (used in) financing activities

 

 

(23,744)

 

 

119,078

Net change in cash and cash equivalents

 

 

253

 

 

(558)

Cash and cash equivalents, beginning of period

 

 

4,429

 

 

6,854

Cash and cash equivalents, end of period

 

$

4,682

 

$

6,296

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

 

 

 

 

 

 

Cash paid for interest, net of capitalized amounts

 

$

12,310

 

$

5,912

NON-CASH INVESTING AND FINANCING ACTIVITY

 

 

 

 

 

 

Construction costs payable capitalized to real estate

 

$

17,303

 

$

46,048

Accrual of dividends and distributions

 

$

46,523

 

$

28,630

 

See accompanying notes to condensed consolidated financial statements.

 

7


 

Table of Contents

CORESITE REALTY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2017

(unaudited)

 

1. Organization and Description of Business

 

CoreSite Realty Corporation (the “Company,” “we,”  “us,” or “our”) was organized in the state of Maryland on February 17, 2010, and is a fully-integrated, self-administered, and self-managed real estate investment trust (“REIT”). Through our controlling interest in CoreSite, L.P. (our “Operating Partnership”), we are engaged in the business of owning, acquiring, constructing and operating data centers. As of September 30, 2017, the Company owns a 71.0% common interest in our Operating Partnership, and affiliates of The Carlyle Group and others own a 29.0% interest in our Operating Partnership. See additional discussion in Note 8, Noncontrolling Interests — Operating Partnership.

 

2. Summary of Significant Accounting Policies

 

Principles of Consolidation and Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statements have been prepared by our management in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and in compliance with the rules and regulations of the U.S. Securities and Exchange Commission. Accordingly, these unaudited condensed consolidated financial statements do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of our management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. The results of operations for the three and nine months ended September 30, 2017, are not necessarily indicative of the expected results for the year ending December 31, 2017. These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2016.

 

Our Operating Partnership meets the definition and criteria of a variable interest entity (“VIE”) and we are the primary beneficiary of the VIE. Our sole significant asset is the investment in our Operating Partnership, and consequently, substantially all of our assets and liabilities represent those assets and liabilities of our Operating Partnership. Our debt is an obligation of our Operating Partnership where the creditors also have recourse against the credit of the Company. Intercompany balances and transactions have been eliminated upon consolidation.

 

Recent Accounting Pronouncements

 

In May 2014, the Financial Accounting Standards Board (“FASB”) issued guidance codified in Accounting Standards Codification (“ASC”) Topic 606, Revenue Recognition — Revenue from Contracts with Customers, which amends the guidance in former ASC Topic 605, Revenue Recognition. The standard establishes a five-step model framework which recognizes revenue as an entity transfers control of goods or services to the customer and requires enhanced disclosures. This standard does not apply to leases, which will be accounted for under ASC Topic 842, Leases. The revenue standard is effective for interim and annual reporting periods beginning after December 15, 2017. The standard permits the use of either the retrospective or cumulative effect transition method. As ASC Topic 606 does not impact lessor accounting, we do not believe this standard will significantly impact our accounting for rental revenue. In addition, we do not anticipate a significant impact to our accounting for nonlease components, including power, interconnection, tenant reimbursement and other revenue.

 

In February 2016, the FASB issued guidance codified in ASC Topic 842, Leases, which amends the guidance in former ASC Topic 840, Leases. We are party to leases as both a lessor and lessee. The main principle of ASC 842 requires lessees to recognize the assets and liabilities that arise from nearly all leases on the consolidated balance sheet. Lessor accounting remains mainly consistent with current guidance, with the majority of changes allowing for better alignment with the new lessee model and ASC Topic 606. The standard is effective for interim and annual reporting periods beginning after December 15, 2018, with early adoption permitted. The standard requires a modified retrospective transition approach. We plan to adopt ASC Topic 842 and ASC Topic 606 effective January 1, 2018, which will result in a transition date of January 1, 2016.

 

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As a lessee we do not anticipate any change in the classification of our leases, but we will be required to recognize a lease liability and corresponding right-of-use asset on our consolidated balance sheets for all of our operating leases. Using the fixed noncancellable term of all existing data center leases, excluding renewal options, we estimate the initial lease liability and right-of-use asset will be approximately $100 million on our consolidated balance sheet as of the transition date. As we continue to evaluate the provisions of ASC Topic 842, we are evaluating our existing renewal options within our data center leases and ultimately conclude as to whether we are, or are not, reasonably certain, based on relevant factors that may create an economic incentive for us, to exercise renewal options for each of our data center operating leases. If we determine that we are reasonably certain to exercise all renewal options for each lease, we estimate the initial lease liability and right-of-use asset will be approximately $300 million on our consolidated balance sheet as of the transition date. Subject to our evaluation of whether we are reasonably certain to exercise renewal options for each of our data center leases as well as resolution of other implementation items, we estimate our straight-line rental expense could increase up to $4.0 million within our consolidated statements of operations for each year ended December 31, 2016, 2017, and on a prospective basis for 2018.

In accordance with ASC Topic 842, lessor accounting for our leases remains largely unchanged, apart from the narrower definition of initial direct costs that can be capitalized. The new standard defines initial direct costs as only the incremental costs of signing a lease. Internal sales employees’ compensation, payroll-related fringe benefits and certain external legal fees related to the execution of successful lease agreements will not meet the definition of initial direct costs under the new standard and will be accounted for as a sales and marketing expense in the consolidated statements of operations upon adoption of ASC Topic 842. On a prospective basis, we estimate that the sales and marketing expense in our consolidated statement of operations will increase by approximately $1.5 million for the year ending December 31, 2018, as a result of the narrower definition of initial direct costs.

We are currently evaluating the other impacts of ASC Topic 842 and ASC Topic 606 on our significant accounting policies and consolidated financial statements, such as the adoption of practical expedients and transition methods.

In August 2016, the FASB issued guidance codified in Accounting Standards Update (“ASU”) 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. The standard provides guidance on eight specific cash flow classification issues including debt prepayment or debt extinguishment costs, contingent consideration payments made after a business combination, and separately identifiable cash flows and application of the predominance principle. The standard will be effective for the fiscal year beginning January 1, 2018, and subsequent interim periods. We do not expect the provisions of ASU 2016-15 to have a material impact on our consolidated financial statements.

In January 2017, the FASB issued guidance codified in ASU 2017-04, Intangibles – Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. ASU 2017-04 simplifies the accounting for goodwill impairment by eliminating the process of measuring the implied value of goodwill, known as step two, from the goodwill impairment test. Instead, if the carrying amount of a reporting unit exceeds its fair value, an impairment loss shall be recognized in an amount equal to that excess, limited to the total amount of goodwill allocated to that reporting unit. The standard will be effective for interim and annual reporting periods beginning after December 15, 2019, with early adoption permitted. We do not expect the provisions of ASU 2017-04 to have a material impact on our consolidated financial statements.

In August 2017, the FASB issued guidance codified in ASU 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities. ASU 2017-12 simplifies the accounting for hedge accounting by eliminating the requirement to separately measure and report hedge ineffectiveness and presenting all items that affect earnings in the same income statement line item as the hedged item. The standard will be effective for interim and annual reporting periods beginning after December 15, 2018, with early adoption permitted. We do not expect the provisions of ASU 2017-12 to have a material impact on our consolidated financial statements.

Use of Estimates

 

The preparation of these unaudited condensed consolidated financial statements in conformity with GAAP requires our management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingencies at the date of the unaudited condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. We evaluate our estimates, including those related to assessing the carrying values of our real estate properties, goodwill, accrued liabilities and performance-based equity compensation plans. We base our estimates on historical experience, current market conditions, and various other assumptions that we

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believe to be reasonable under the circumstances. Actual results may vary from those estimates and those estimates could vary under different assumptions or conditions.

 

Reclassifications

 

Certain immaterial amounts included in the condensed consolidated financial statements for 2016 have been reclassified to conform to the 2017 financial statement presentation.

 

Investments in Real Estate

 

Real estate investments are carried at cost less accumulated depreciation and amortization. The cost of real estate includes the purchase price of property and leasehold improvements. Expenditures for maintenance and repairs are expensed as incurred. Significant renovations and betterments that extend the economic useful lives of assets are capitalized. During land development and construction periods, we capitalize construction costs, legal fees, financing costs, real estate taxes and insurance, rent expense and internal costs of personnel performing development, if such costs are incremental and identifiable to a specific development project. Capitalization of costs begins upon commencement of development efforts and ceases when the property is ready for its intended use and held available for occupancy. Interest is capitalized during the period of development based upon applying the weighted-average borrowing rate to the actual development costs expended. Capitalized interest costs were $0.8 million and $1.6 million for the three months ended September 30, 2017, and 2016, respectively, and $2.2 million and $3.5 million for the nine months ended September 30, 2017, and 2016, respectively.

 

Depreciation and amortization are calculated using the straight-line method over the following useful lives of the assets:

 

 

 

 

Buildings

    

27 to 40 years

Building improvements

 

1 to 10 years

Leasehold improvements

 

The shorter of the lease term or useful life of the asset

 

Depreciation expense was $27.0 million and $22.3 million for the three months ended September 30, 2017, and 2016, respectively, and $80.5 million and $63.9 million for the nine months ended September 30, 2017, and 2016, respectively.

 

Acquisition of Investment in Real Estate

 

When accounting for business combinations and asset acquisitions, the fair value of the real estate acquired is allocated to the acquired tangible assets, consisting primarily of land, building and building improvements, and identified intangible assets and liabilities, consisting of the value of above-market and below-market leases, value of in-place leases and the value of customer relationships.

 

The fair value of the land and building of an acquired property is determined by valuing the property as if it were vacant, and the “as-if-vacant” fair value is then allocated to land and building based on management's determination of the fair values of these assets. Management determines the as-if-vacant fair value of a property using methods similar to those used by independent appraisers. Factors considered by management in performing these analyses include an estimate of carrying costs during the expected lease-up periods considering current market conditions and costs to execute similar leases.

 

The fair value of intangibles related to in-place leases includes the value of lease intangibles for above-market and below-market leases, lease origination costs, and customer relationships, determined on a lease-by-lease basis. Above-market and below-market leases are valued based on the present value (using an interest rate which reflects the risks associated with the leases acquired) of the difference between (i) the contractual amounts to be paid pursuant to the in-place leases and (ii) management's estimate of market lease rates for the corresponding in-place leases, measured over a period equal to the remaining noncancelable term of the lease and, for below-market leases, over a time period equal to the initial term plus any below-market fixed rate renewal periods. Lease origination costs include estimates of costs avoided associated with leasing the property, including tenant allowances and improvements and leasing commissions. Customer relationship intangibles relate to the additional revenue opportunities expected to be generated through interconnection services and utility services to be provided to the in-place lease tenants.

 

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The capitalized values for above and below-market lease intangibles, lease origination costs, and customer relationships are amortized over the term of the underlying leases or the expected customer relationship. Amortization related to above-market and below-market leases where the Company is the lessor is recorded as either a reduction of or an increase to rental revenue, amortization related to above-market and below-market leases where the Company is the lessee is recorded as either a reduction of or an increase to rent expense. If a lease is terminated prior to its stated expiration, all unamortized amounts relating to that lease are written off.

 

The carrying value of intangible assets is reviewed for impairment in connection with its respective asset group whenever events or changes in circumstances indicate that the asset group may not be recoverable. An impairment loss is recognized if the carrying amount of the asset group is not recoverable and its carrying amount exceeds its estimated fair value. No impairment loss related to these intangible assets was recognized for the three or nine months ended September 30, 2017, or 2016, in the condensed consolidated financial statements.

 

The excess of the cost of an acquired business over the net of the amounts assigned to assets acquired (including identified intangible assets) and liabilities assumed is recorded as goodwill. As of September 30, 2017, and December 31, 2016, we had $40.6 million and $41.2 million of goodwill, respectively. The Company’s goodwill has an indeterminate life and is not amortized, but is tested for impairment on an annual basis, or more frequently if events or changes in circumstances indicate that the asset might be impaired. No impairment loss was recognized for the three or nine months ended September 30, 2017, or 2016. During the nine months ended September 30, 2017, goodwill was reduced by $0.5 million due to the receipt of cash from an escrow account associated with an entity acquired at the time of the Company’s initial public offering.

 

Cash and Cash Equivalents

 

Cash and cash equivalents include all non-restricted cash held in financial institutions and other non-restricted highly liquid short-term investments with original maturities at acquisition of three months or less.

 

Deferred Costs

 

Deferred leasing costs include commissions paid to third parties, including brokers, leasing and referral agents, and internal sales commissions paid to employees for successful execution of lease agreements. These commissions and other direct and incremental costs incurred to obtain new customer leases are capitalized and amortized over the term of the related leases using the straight-line method. If a customer lease terminates prior to the expiration of its initial term, any unamortized deferred costs related to the lease are written off to amortization expense. Deferred leasing costs are included within other assets in the condensed consolidated balance sheets and consisted of the following, net of amortization, as of September 30, 2017, and December 31, 2016 (in thousands):

 

 

 

 

 

 

 

 

 

 

 

September 30,

 

December 31,

 

 

    

2017

    

2016

 

Internal sales commissions

 

$

17,352

 

$

18,748

 

Third party commissions

 

 

12,104

 

 

13,643

 

External legal counsel

 

 

776

 

 

730

 

Total

 

$

30,232

 

$

33,121

 

 

Deferred financing costs include costs incurred in connection with obtaining debt and extending existing debt. These financing costs are capitalized and amortized on a straight-line basis, which approximates the effective-interest method, over the term of the loan and the amortization is included as a component of interest expense. Depending on the type of debt instrument, deferred financing costs are reported either in other assets or as a direct deduction from the carrying amount of the related debt liabilities in our condensed consolidated balance sheets.

 

Recoverability of Long-Lived Assets

 

We review our long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Impairment is recognized when estimated expected future cash flows (undiscounted and without interest charges) are less than the carrying amount of the assets. The estimation of expected future net cash flows is inherently uncertain and relies, to a considerable extent, on assumptions regarding current and future economics and market conditions and the availability of capital. If, in future periods, there are changes in the

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estimates or assumptions incorporated into the impairment review analysis, the changes could result in an adjustment to the carrying amount of the long-lived assets. To the extent that impairment has occurred, the excess of the carrying amount of long-lived assets over its estimated fair value would be recognized as an impairment loss charged to net income. For the three and nine months ended September 30, 2017, and 2016, no impairment of long-lived assets was recognized in the condensed consolidated financial statements.

 

Derivative Instruments and Hedging Activities

 

We reflect all derivative instruments at fair value as either assets or liabilities on the condensed consolidated balance sheets. For those derivative instruments that are designated and qualify as hedging instruments, we record the effective portion of the gain or loss on the hedging instruments as a component of accumulated other comprehensive income or loss. Any ineffective portion of a derivative's change in fair value is immediately recognized within net income. For derivatives that do not meet the criteria for hedge accounting, changes in fair value are immediately recognized within net income. See additional discussion in Note 6, Derivatives and Hedging Activities.

 

Internal-Use Software

 

We recognize internal-use software development costs based on the development stage of the project and nature of the cost. Internal and external costs incurred during the preliminary project stage are expensed as they are incurred. Internal and external costs incurred to develop internal-use software during the application development stage are capitalized. Internal and external training costs and maintenance costs during the post-implementation-operation stage are expensed as incurred. Completed projects are placed into service and amortized over the estimated useful life of the software. No impairment was recognized related to internal-use software in the condensed consolidated statements of operations for the three and nine months ended September 30, 2017, and 2016.

 

Revenue Recognition

 

Our customer arrangements contain lease and nonlease elements. Consideration called for by the arrangement is separated at the inception of the arrangement into the lease and nonlease elements based on the relative fair value of each element. For the lease elements, rental revenue is recognized on a straight‑line basis over the customer’s lease term.  The excess of rents recognized over amounts contractually due pursuant to the underlying leases is recorded as deferred rent receivable within our condensed consolidated balance sheets.

 

Nonlease elements include power and interconnection services. Power revenue is recognized each month as the power services are delivered to and utilized by our customers. Power services may include non‑recurring customer set‑up charges and installation fees that are initially deferred and recognized over the expected performance period. Interconnection services are contracted on a month-to-month basis and revenue is recognized each month as these services are delivered to and utilized by our customers.

 

Some of our data center leases contain provisions under which our customers reimburse us for a portion of real estate taxes, insurance, common area maintenance, and other recoverable costs.  Such customer reimbursements are recognized in the period that the expenses are recognized.

 

Above-market and below-market lease intangibles that were acquired are amortized on a straight-line basis as decreases and increases, respectively, to rental revenue over the remaining noncancelable term of the underlying leases. For the three months ended September 30, 2017, and 2016, the net effect of amortization of acquired above-market and below-market leases resulted in an increase to rental revenue of $0.2 million and $0.1 million, respectively. For both the nine months ended September 30, 2017, and 2016, the net effect of amortization of acquired above-market and below-market leases resulted in an increase to rental revenue of $0.4 million.

 

A provision for uncollectible accounts is recorded if a receivable balance relating to contractual rent, rent recorded on a straight-line basis, tenant reimbursements or other billed amounts is considered by management to be uncollectible. At September 30, 2017, and December 31, 2016, the allowance for doubtful accounts totaled $1.0 million and $0.2 million, respectively, on the condensed consolidated balance sheets.

 

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Share-Based Compensation

 

We account for share-based compensation using the fair value method of accounting. The estimated fair value of the stock options granted by us is calculated based on the Black-Scholes option-pricing model. The fair value of restricted share-based and Operating Partnership unit compensation is based on the fair value of our common stock on the date of the grant. The fair value of performance share awards, which have a market condition, is based on a Monte Carlo simulation. The fair value for all share-based compensation is amortized on a straight-line basis over the vesting period.

 

Asset Retirement and Environmental Remediation Obligations

 

We record accruals for estimated asset retirement and environmental remediation obligations. The obligations relate primarily to the removal of asbestos during development of properties as well as the estimated equipment removal costs upon termination of a certain lease where we are the lessee. At September 30, 2017, and December 31, 2016, the amount included in unearned revenue, prepaid rent and other liabilities on the condensed consolidated balance sheets was approximately $1.5 million and $1.4 million, respectively.

 

Income Taxes

 

We elected to be taxed as a REIT under the Internal Revenue Code of 1986, as amended (the “Code”), commencing with our taxable year ended December 31, 2010. To qualify as a REIT, we are required to distribute at least 90% of our taxable income to our stockholders and meet various other requirements imposed by the Code relating to such matters as operating results, asset holdings, distribution levels and diversity of stock ownership. Provided we qualify for taxation as a REIT, we generally are not subject to corporate level federal income tax on the earnings distributed currently to our stockholders. If we fail to qualify as a REIT in any taxable year, and are unable to avail ourselves of certain savings provisions set forth in the Code, all of our taxable income would be subject to federal income tax at regular corporate rates, including any applicable alternative minimum tax.

 

To maintain REIT status, we must distribute a minimum of 90% of our taxable income. However, it is our policy and intent, subject to change, to distribute 100% of our taxable income and therefore, no provision is required in the accompanying condensed consolidated financial statements for federal income taxes with regards to activities of the REIT and its subsidiary pass-through entities. The allocable share of taxable income is included in the income tax returns of its stockholders. The Company is subject to the statutory requirements of the locations in which it conducts business. State and local income taxes are accrued as deemed required in the best judgment of management based on analysis and interpretation of respective tax laws.

 

We have elected to treat certain subsidiaries as taxable REIT subsidiaries (“TRS”). Certain activities that we undertake must be conducted by a TRS, such as services for our tenants that could be considered otherwise impermissible for us to perform and holding assets that we cannot hold directly. A TRS is subject to corporate level federal and state income taxes.

 

Deferred income taxes are recognized in certain taxable entities. Deferred income tax generally is a function of the period's temporary differences (items that are treated differently for tax purposes than for financial reporting purposes), the utilization of tax net operating losses generated in prior years that previously had been recognized as deferred income tax assets and the reversal of any previously recorded deferred income tax liabilities. A valuation allowance for deferred income tax assets is provided if we believe all or some portion of the deferred income tax asset may more likely than not be realized. Any increase or decrease in the valuation allowance resulting from a change in circumstances that causes a change in the estimated realizability of the related deferred income tax asset is included in deferred tax expense. As of September 30, 2017, and December 31, 2016, the gross deferred income taxes were not material.

 

We currently have no liabilities for uncertain income tax positions. The earliest tax year for which we are subject to examination is 2014.

 

Concentration of Credit Risks

 

Our cash and cash equivalents are maintained in various financial institutions, which, at times, may exceed federally insured limits. We have not experienced any losses in such accounts, and management believes that the Company is not

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exposed to any significant credit risk in this area. We have no off-balance sheet concentrations of credit risk, such as foreign exchange contracts, option contracts, or foreign currency hedging arrangements.

 

Segment Information

 

We manage our business as one reportable segment consisting of investments in data centers located in the United States. Although we provide services in several markets, these operations have been aggregated into one reportable segment based on the similar economic characteristics amongst all markets, including the nature of the services provided and the type of customers purchasing these services.

 

3. Investment in Real Estate

 

The following is a summary of the properties owned or leased by market at September 30, 2017 (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Buildings and

 

Construction in

 

 

 

 

Market

    

Land

    

Improvements

    

Progress

    

Total Cost

 

Boston

 

$

5,154

 

$

97,991

 

$

5,807

 

$

108,952

 

Chicago

 

 

5,493

 

 

100,469

 

 

11,321

 

 

117,283

 

Denver

 

 

 —

 

 

16,730

 

 

379

 

 

17,109

 

Los Angeles

 

 

28,467

 

 

245,734

 

 

38,906

 

 

313,107

 

Miami

 

 

728

 

 

11,435

 

 

 2

 

 

12,165

 

New York

 

 

2,388

 

 

131,095

 

 

40,188

 

 

173,671

 

Northern Virginia(1)

 

 

23,642

 

 

297,633

 

 

39,910

 

 

361,185

 

San Francisco Bay(2)

 

 

31,386

 

 

610,928

 

 

16,566

 

 

658,880

 

Total

 

$

97,258

 

$

1,512,015

 

$

153,079

 

$

1,762,352

 


(1)

On February 23, 2017, we executed a ten-year lease for 25,000 square feet at a new property, which we refer to as DC2, to further expand our data center presence in Washington D.C, within our Northern Virginia market. DC2 is under construction as of September 30, 2017.

(2)

On August 29, 2017, we acquired a two-acre land parcel adjacent to our existing Santa Clara campus, with a total real estate cost of $12.2 million. In accordance with the purchase and sale agreement, the seller has committed to pay us $0.3 million over six months to assist them to vacate the property. We will account for the $0.3 million of cash receipts as ancillary operations which will reduce the basis of the land parcel. We plan to build a turn-key data center on the acquired land parcel, which we refer to as SV8, upon the receipt of necessary entitlements.

 

 

4. Other Assets

 

Other assets consisted of the following, net of amortization and depreciation, if applicable for each line item, as of September 30, 2017, and December 31, 2016 (in thousands):

 

 

 

 

 

 

 

 

 

 

 

September 30,

 

December 31,

 

 

    

2017

    

2016

 

Deferred leasing costs

 

$

30,232

 

$

33,121

 

Deferred rent receivable

 

 

39,555

 

 

36,393

 

Internal-use software

 

 

17,248

 

 

14,440

 

Prepaid expenses

 

 

8,396

 

 

4,390

 

Corporate furniture, fixtures and equipment

 

 

6,377

 

 

5,356

 

Deferred financing costs - revolving credit facility

 

 

1,119

 

 

1,604

 

Other

 

 

1,112

 

 

1,068

 

Total

 

$

104,039

 

$

96,372

 

 

 

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5. Debt

 

A summary of outstanding indebtedness as of September 30, 2017, and December 31, 2016, is as follows (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Maturity

 

September 30,

 

December 31,

 

 

    

Interest Rate

    

Date

    

2017

    

2016

 

Revolving credit facility

 

2.78% and 2.32% at September 30, 2017, and December 31, 2016, respectively

 

June 24, 2019

 

$

19,000

 

$

194,000

 

2020 Senior unsecured term loan(1)

 

2.83% and 2.60% at September 30, 2017, and December 31, 2016, respectively

 

June 24, 2020

 

 

150,000

 

 

150,000

 

2021 Senior unsecured term loan

 

2.73% and 2.27% at September 30, 2017, and December 31, 2016, respectively

 

February 2, 2021

 

 

100,000

 

 

100,000

 

2022 Senior unsecured term loan(2)

 

2.79% and 3.23% at September 30, 2017, and December 31, 2016, respectively

 

April 19, 2022

 

 

200,000

 

 

100,000

 

2023 Senior unsecured notes

 

4.19% at September 30, 2017, and December 31, 2016, respectively

 

June 15, 2023

 

 

150,000

 

 

150,000

 

2024 Senior unsecured notes

 

3.91% at September 30, 2017

 

April 20, 2024

 

 

175,000

 

 

 —

 

Total principal outstanding

 

 

 

`

 

 

794,000

 

 

694,000

 

Unamortized deferred financing costs

 

 

 

 

 

 

(5,213)

 

 

(3,550)

 

Total debt

 

 

 

 

 

$

788,787

 

$

690,450

 


(1)

Our Operating Partnership has in place a swap agreement with respect to the 2020 Term Loan (as defined below) to swap the variable interest rate associated with $75 million, or 50% of the principal amount, of the 2020 Term Loan to a fixed rate of approximately 2.93% per annum at our current leverage ratio. The interest rate on the remaining $75 million of the 2020 Term Loan is based on LIBOR plus the applicable spread. The effective interest rate as of September 30, 2017, is 2.83%. See Note 6 – Derivatives and Hedging Activities.

(2)

Our Operating Partnership has in place a swap agreement with respect to the 2022 Term Loan (as defined below) to swap the variable interest rate associated with $50 million, or 25% of the principal amount of the 2022 Term Loan to a fixed rate of approximately 2.98% at our current leverage ratio as of September 30, 2017. The interest rate on the remaining $150 million of the 2022 Term Loan is based on LIBOR plus the applicable spread. The effective interest rate as of September 30, 2017, is 2.79%. See Note 6 – Derivatives and Hedging Activities.

 

Revolving Credit Facility

 

On February 2, 2016, our Operating Partnership and certain subsidiary co-borrowers entered into the first amendment to the third amended and restated credit agreement (as amended, the “Credit Agreement”) with a group of lenders for which KeyBank National Association acts as the administrative agent. The Credit Agreement maturity date is June 24, 2019, with a one-time extension option, which, if exercised, would extend the maturity date to June 24, 2020. The exercise of the extension option is subject to the payment of an extension fee equal to 10 basis points of the total commitment under the Credit Agreement at initial maturity and certain other customary conditions. The Credit Agreement includes a total commitment of $600 million, providing for a $350 million revolving credit facility, a $150 million unsecured term loan scheduled to mature on June 24, 2020, and a $100 million unsecured term loan scheduled to mature on February 2, 2021. See “2020 Senior Unsecured Term Loan” and “2021 Senior Unsecured Term Loan” below for a discussion of the $150 million and $100 million term loans. The Credit Agreement contains an accordion feature, which allows our Operating Partnership to increase the total commitment from $600 million to $800 million, under specified circumstances, including securing capital from new or existing lenders.

 

Borrowings under the revolving credit facility bear interest at a variable rate per annum equal to either (i) LIBOR plus 155 basis points to 225 basis points, or (ii) a base rate plus 55 basis points to 125 basis points, each depending on our Operating Partnership’s leverage ratio. At September 30, 2017, our Operating Partnership’s leverage ratio was 23.8% and the interest rate was LIBOR plus 155 basis points.

 

The total amount available for borrowing under the revolving credit facility is equal to the lesser of $350.0 million or the availability calculated based on our unencumbered asset pool. As of September 30, 2017, the borrowing capacity was $350.0 million. As of September 30, 2017, there were $19.0 million of borrowings outstanding, $3.5 million was

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outstanding under letters of credit, and therefore, $327.5 million remained available for us to borrow under the revolving credit facility.

 

Our ability to borrow under the Credit Agreement is subject to ongoing compliance with a number of financial covenants and other customary restrictive covenants, including, among others:

 

·

a maximum leverage ratio (defined as total consolidated indebtedness to total gross asset value) of 60%, which, as of September 30, 2017, was 23.8%

·

a maximum secured debt ratio (defined as total consolidated secured debt to total gross asset value) of 40%, which, as of September 30, 2017, was 0.0%

·

a minimum fixed charge coverage ratio (defined as adjusted consolidated earnings before interest, taxes, depreciation and amortization to consolidated fixed charges) of 1.7 to 1.0, which, as of September 30, 2017, was 7.4 to 1.0; and

·

a maximum unhedged variable rate debt ratio (defined as unhedged variable rate indebtedness to gross asset value) of 30%, which, as of September 30, 2017, was 10.3%.

 

The Credit Agreement ranks pari passu with the 2020 Term Loan, the 2021 Term Loan, the 2022 Term Loan, the 2023 Notes, and the 2024 Notes and contains the same financial covenants and other customary restrictive covenants as those debt instruments. As of September 30, 2017, we were in compliance with all of the financial covenants under the Credit Agreement.

 

2020 Senior Unsecured Term Loan

 

On June 24, 2015, in connection with, and pursuant to the terms of, the Credit Agreement, our Operating Partnership and certain subsidiaries entered into a $150 million senior unsecured term loan (the “2020 Term Loan”). The 2020 Term Loan has a five-year term maturing on June 24, 2020. The 2020 Term Loan ranks pari passu with the 2021 Term Loan, the 2022 Term Loan, the 2023 Notes, the 2024 Notes and the Credit Agreement and contains the same financial covenants and other customary restrictive covenants as those debt instruments. As of September 30, 2017, we were in compliance with all of the financial covenants under the 2020 Term Loan.

 

The borrowings under the 2020 Term Loan bear interest at a variable rate per annum equal to either (i) LIBOR plus 150 basis points to 220 basis points, or (ii) a base rate plus 50 basis points to 120 basis points, each depending on our Operating Partnership's leverage ratio. At September 30, 2017, the Operating Partnership’s leverage ratio was 23.8% and the interest rate was LIBOR plus 150 basis points.

 

2021 Senior Unsecured Term Loan

 

On February 2, 2016, pursuant to the terms of the Credit Agreement, we partially exercised the accordion feature and entered into a $100 million senior unsecured term loan (the “2021 Term Loan”). The 2021 Term Loan has a five-year term maturing on February 2, 2021. The 2021 Term Loan ranks pari passu with the 2020 Term Loan, the 2022 Term Loan, the 2023 Notes, the 2024 Notes and the Credit Agreement and contains the same financial covenants and other customary restrictive covenants as those debt instruments. As of September 30, 2017, we were in compliance with all of the financial covenants under the 2021 Term Loan.

 

The borrowings under the 2021 Term Loan bear interest at a variable rate per annum equal to either (i) LIBOR plus 150 basis points to 220 basis points, or (ii) a base rate plus 50 basis points to 120 basis points, each depending on our Operating Partnership’s leverage ratio. At September 30, 2017, our Operating Partnership’s leverage ratio was 23.8% and the interest rate was LIBOR plus 150 basis points.

 

2022 Senior Unsecured Term Loan

 

On April 19, 2017, our Operating Partnership and certain subsidiaries amended and restated the $100 million senior unsecured term loan, originally entered into on January 31, 2014, to (i) exercise the accordion feature to increase the total commitments to $200 million, (ii) extend the maturity of the term loan from January 31, 2019, to April 19, 2022, (iii) amend the accordion feature to allow an increase in total commitments from $200 million to $300 million, under specified circumstances, including securing capital from new or existing lenders, and (iv) explicitly permit the issuance of the 2024 Notes defined below (the “2022 Term Loan”).

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The 2022 Term Loan ranks pari passu with the 2020 Term Loan, the 2021 Term Loan, the 2023 Notes, the 2024 Notes and the Credit Agreement and contains the same financial covenants and other customary restrictive covenants as those debt instruments. As of September 30, 2017, we were in compliance with all of the financial covenants under the 2022 Term Loan.

 

The borrowings under the 2022 Term Loan bear interest at a variable rate per annum equal to either (i) LIBOR plus 150 basis points to 210 basis points, or (ii) a base rate plus 50 basis points to 110 basis points, each depending on our Operating Partnership's leverage ratio. At September 30, 2017, our Operating Partnership’s leverage ratio was 23.8% and the interest rate was LIBOR plus 150 basis points. 

 

2023 Senior Unsecured Notes

 

On June 15, 2016, our Operating Partnership issued an aggregate principal amount of $150 million, 4.19% senior unsecured notes due June 15, 2023 (the “2023 Notes”), in a private placement to certain accredited investors. The terms of the 2023 Notes are governed by a note purchase agreement, dated June 15, 2016 (the “2023 Note Purchase Agreement”), by and among our Operating Partnership, the Company and the purchasers of the 2023 Notes.

 

Interest is payable semiannually, on the 15th day of June and December of each year, commencing on December 15, 2016. The 2023 Notes are senior unsecured obligations of our Operating Partnership and are jointly and severally guaranteed by the Company and each of our Operating Partnership’s subsidiaries that guarantees indebtedness under our Operating Partnership’s Credit Agreement (the “Subsidiary Guarantors”).

 

Our Operating Partnership may prepay all or a portion of the 2023 Notes upon notice to the holders for 100% of the principal amount so prepaid plus a make-whole premium as set forth in the 2023 Note Purchase Agreement. Upon the occurrence of certain change of control events, holders of the 2023 Notes have the right to require our Operating Partnership to purchase 100% of such holders’ 2023 Notes in cash at a purchase price equal to 100% of the principal amount thereof plus accrued and unpaid interest, if any, to the date of repurchase.

 

The 2023 Notes rank pari passu with the 2020 Term Loan, the 2021 Term Loan, the 2022 Term Loan, the 2024 Notes and the Credit Agreement. The 2023 Note Purchase Agreement contains the same financial covenants as the Credit Agreement, as described above. In addition, additional financial covenants in the Credit Agreement were automatically incorporated into the 2023 Note Purchase Agreement, and, subject to certain conditions, these additional financial covenants will be deleted, removed, amended or otherwise modified to be more or less restrictive if the analogous covenant in the Credit Agreement is so deleted, removed, amended or otherwise modified. These covenants are subject to a number of exceptions and qualifications set forth in the 2023 Note Purchase Agreement. As of September 30, 2017, we were in compliance with all of the financial covenants under the 2023 Note Purchase Agreement. 

 

2024 Senior Unsecured Notes

 

On April 20, 2017, our Operating Partnership issued an aggregate principal amount of $175 million, 3.91% senior unsecured notes due April 20, 2024 (the “2024 Notes”), in a private placement to certain accredited investors. The terms of the 2024 Notes are governed by a note purchase agreement, dated April 20, 2017 (the “2024 Note Purchase Agreement”), by and among our Operating Partnership, the Company and the purchasers of the 2024 Notes.

 

Interest is payable semiannually, on the 15th day of June and December of each year, commencing on December 15, 2017. The 2024 Notes are senior unsecured obligations of our Operating Partnership and are jointly and severally guaranteed by the Company and each of the Subsidiary Guarantors.

 

Our Operating Partnership may prepay all or a portion of the 2024 Notes upon notice to the holders for 100% of the principal amount so prepaid plus a make-whole premium as set forth in the 2024 Note Purchase Agreement. Upon the occurrence of certain change of control events, holders of the 2024 Notes will have the right to require our Operating Partnership to purchase 100% of such holders’ 2024 Notes in cash at a purchase price equal to 100% of the principal amount thereof plus accrued and unpaid interest, if any, to the date of repurchase.

 

The 2024 Notes rank pari passu with the 2020 Term Loan, the 2021 Term Loan, the 2022 Term Loan, the 2023 Notes and the Credit Agreement. The 2024 Note Purchase Agreement contains the same financial covenants as the Credit

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Agreement, as described above. In addition, certain additional financial covenants in the Credit Agreement were automatically incorporated into the 2024 Note Purchase Agreement, and, subject to certain conditions, these additional financial covenants will be deleted, removed, amended or otherwise modified to be more or less restrictive if the analogous covenant in the Credit Agreement is so deleted, removed, amended or otherwise modified. These covenants are subject to a number of exceptions and qualifications set forth in the 2024 Note Purchase Agreement. As of September 30, 2017, we were in compliance with all of the financial covenants under the 2024 Note Purchase Agreement.

 

Debt Maturities

 

The following table summarizes the amount of our outstanding debt as of September 30, 2017, based on when such debt currently becomes due (in thousands):

 

 

 

 

 

 

Year Ending December 31,

    

 

 

 

2017

 

$

 —

 

2018

 

 

 —

 

2019

 

 

19,000

 

2020

 

 

150,000

 

2021

 

 

100,000

 

Thereafter

 

 

525,000

 

Total principal outstanding

 

 

794,000

 

Unamortized deferred financing costs

 

 

(5,213)

 

Total debt, net

 

$

788,787

 

 

 

6. Derivatives and Hedging Activities

 

On April 9, 2015, we entered into a $75 million forward starting five-year interest rate swap agreement to protect against adverse fluctuation in interest rates. The swap reduces our exposure to variability in cash flows relating to interest payments on $75 million of one-month LIBOR variable rate debt and effectively fixes the interest rate at approximately 2.93% per annum. Also, on February 3, 2014, we entered into a five-year interest rate swap agreement that reduces our exposure to variability in cash flows relating to interest payments on $100 million of outstanding one-month LIBOR variable rate debt and effectively fixes the interest rate at approximately 3.23% per annum. On April 21, 2017, we terminated $50 million of this $100 million five-year interest rate swap, resulting in a remaining $50 million interest rate swap effective through February 2, 2019, at approximately 2.98% per annum. Both interest rate swap agreements were designated for hedge accounting.

 

Risk Management Objective of Using Derivatives

 

We are exposed to certain risks arising from both our business operations and economic conditions. We principally manage our exposures to a wide variety of business and operational risks through management of our core business activities. We manage economic risks, including interest rate, liquidity, and credit risk primarily by managing the amount, sources, and duration of our debt funding and the use of derivative financial instruments. Specifically, we enter into derivative financial instruments to manage exposures that arise from business activities that result in the receipt or payment of future known or uncertain cash amounts, the value of which are determined by interest rates. Our derivative financial instruments are used to manage differences in the amount, timing, and duration of our known or expected cash receipts and our known or expected cash payments principally related to our investments and borrowings.

 

Cash Flow Hedges of Interest Rate Risk

 

Our objectives in using interest rate derivatives are to reduce variability in interest expense and to manage our exposure to adverse interest rate movements. To accomplish this objective, we primarily use interest rate swaps as part of our interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involve the receipt of variable amounts from a counterparty in exchange for the Company making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount.

 

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The effective portion of changes in the fair value of derivatives designated and that qualify as cash flow hedges is recorded in accumulated other comprehensive income or loss on the condensed consolidated balance sheets and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. The amounts recorded in other comprehensive income or loss related to the unrealized gain or loss on derivative contracts were gains of less than $0.1 million and $0.8 million for the three months ended September 30, 2017, and 2016, respectively, and were a gain of less than $0.1 million and a loss of $3.6 million for the nine months ended September 30, 2017, and 2016, respectively. The amounts reclassified from other comprehensive income or loss to interest expense on the condensed consolidated statements of operations were $0.1 million and $0.4 million for the three months ended September 30, 2017, and 2016, respectively, and were $0.6 million and $1.3 million for the nine months ended September 30, 2017, and 2016, respectively. Any ineffective portion of the change in fair value of the derivatives is recognized directly in net income. During the three and nine months ended September 30, 2017, and 2016, we did not record any amount in net income related to derivatives as there was no hedge ineffectiveness.

 

Amounts reported in accumulated other comprehensive loss related to derivatives will be reclassified to interest expense as interest payments are made on our variable-rate debt. During the subsequent twelve months, beginning October 1, 2017, we estimate that $0.1 million will be reclassified as an increase to interest expense.

 

Derivatives are recorded at fair value in our condensed consolidated balance sheets in other assets or unearned revenue, prepaid rent and other liabilities, as applicable. We do not net our derivative position by counterparty for purposes of balance sheet presentation and disclosure. We had zero and $0.4 million in derivative liabilities recognized in unearned revenue, prepaid rent and other liabilities in our condensed consolidated balance sheets as of September 30, 2017, and December 31, 2016, respectively. We also had $0.5 million and $0.3 million in derivative assets recognized in other assets in our condensed consolidated balance sheets as of September 30, 2017, and December 31, 2016, respectively.

 

7. Stockholders’ Equity

 

On October 16, 2017, we announced that we intend to redeem all 4,600,000 shares of our outstanding 7.25% Series A cumulative redeemable preferred stock (“Series A Preferred Stock”) on December 12, 2017. The Series A Preferred Stock will be redeemed for $25.00 per share, plus all accrued and unpaid dividends in an amount equal to $0.292014 per share, for a total payment of $25.292014 per share.

 

We declared the following dividends per share on our Series A Preferred Stock and common stock during the nine months ended September 30, 2017:

 

 

 

 

 

 

 

 

 

 

 

 

 

Declaration Date

    

Record Date

    

Payment Date

    

Series A
Preferred Stock

 

Common Stock

    

March 9, 2017

 

March 31, 2017

 

April 17, 2017

 

$

0.4531

(1)

$

0.80

 

May 30, 2017

 

June 30, 2017

 

July 17, 2017

 

 

0.4531

(2)

 

0.90

 

September 1, 2017

 

September 29, 2017

 

October 16, 2017

 

 

0.4531

(3)

 

0.90

 

 

 

 

 

 

 

$

1.3593

 

$

2.60

 


(1)

Dividend covers the period from January 15, 2017, to April 14, 2017.

(2)

Dividend covers the period from April 15, 2017, to July 14, 2017.

(3)

Dividend covers the period from July 15, 2017, to October 14, 2017.

 

8. Noncontrolling Interests — Operating Partnership

 

Noncontrolling interests represent the limited partnership interests in our Operating Partnership held by individuals and entities other than CoreSite Realty Corporation. The current holders of common Operating Partnership units are eligible to have the common Operating Partnership units redeemed for cash or common stock on a one-for-one basis, at our option.

 

In connection with the issuance of our Series A Preferred Stock on December 12, 2012, our Operating Partnership issued 4,600,000 7.25% Series A cumulative redeemable preferred Operating Partnership units to us. Preferred Operating Partnership units rank senior to the common Operating Partnership units held by both us and noncontrolling interests, and will no longer be outstanding following the redemption of our Series A Preferred Stock.

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The following table shows the common ownership interests in our Operating Partnership as of September 30, 2017, and December 31, 2016:

 

 

 

 

 

 

 

 

 

 

 

 

September 30, 2017

 

December 31, 2016

 

 

    

Number of Units

    

Percentage of Total

 

Number of Units

    

Percentage of Total

 

CoreSite Realty Corporation

 

33,824,829

 

71.0

%  

33,376,568

 

70.7

%

Noncontrolling interests

 

13,836,336

 

29.0

 

13,851,347

 

29.3

 

Total

 

47,661,165

 

100.0

%  

47,227,915

 

100.0

%

 

For each share of common stock issued by us, our Operating Partnership issues to us an equivalent common Operating Partnership unit. During the nine months ended September 30, 2017, we issued 448,261 shares of common stock related to employee compensation arrangements and therefore an equivalent number of common Operating Partnership units were issued to us by our Operating Partnership.

 

Holders of common Operating Partnership units of record as of September 30, 2017, received quarterly distributions of $0.90 per unit, payable in correlation with declared dividends on common stock.

 

The redemption value of the noncontrolling interests at September 30, 2017, was $1.5 billion based on the closing price of the Company’s common stock of $111.90 per share on that date.

 

9. Equity Incentive Plan

 

Our Board of Directors adopted and, with the approval of our stockholders, amended the 2010 Equity Award Incentive Plan (as amended, the “2010 Plan”). The 2010 Plan is administered by the Compensation Committee of our Board of Directors. Awards issuable under the 2010 Plan include common stock, stock options, restricted stock, stock appreciation rights, dividend equivalents, Operating Partnership units and other incentive awards. We have reserved a total of 6,000,000 shares of our common stock for issuance pursuant to the 2010 Plan, which may be adjusted for changes in our capitalization and certain corporate transactions. To the extent that an award expires, terminates or lapses, or an award is settled in cash without the delivery of shares of common stock to the participant, then any unvested shares subject to the award will be available for future grant or sale under the 2010 Plan. Shares of restricted stock that are forfeited or repurchased by us pursuant to the 2010 Plan may again be awarded under the 2010 Plan. The payment of dividend equivalents in cash in conjunction with any outstanding awards will not be counted against the shares available for issuance under the 2010 Plan.

 

As of September 30, 2017, 3,048,337 shares of our common stock were available for issuance pursuant to the 2010 Plan.

 

Stock Options

 

Stock option awards are granted with an exercise price equal to the closing market price of the Company’s common stock on the date of grant. The fair value of each option granted under the 2010 Plan is estimated on the date of grant using the Black-Scholes option-pricing model. The fair values are amortized on a straight-line basis over the vesting periods. Stock options have not been granted since the year ending December 31, 2013.

 

The following table sets forth stock option activity under the 2010 Plan for the nine months ended September 30, 2017:

 

 

 

 

 

 

 

 

 

 

Number of

 

 

 

 

 

Shares

 

Weighted-

 

 

 

Subject to

 

Average

 

 

 

Option

 

Exercise Price

 

Options outstanding, December 31, 2016

    

265,550

    

$

22.96

 

Granted

 

 —

 

 

 —

 

Exercised

 

(197,761)

 

 

24.37

 

Forfeited

 

 —

 

 

 —

 

Expired

 

 —

 

 

 —

 

Options outstanding, September 30, 2017

 

67,789

 

$

19.12

 

 

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The following table sets forth the number of shares subject to options that are unvested as of September 30, 2017, and the fair value of these options at the grant date:

 

 

 

 

 

 

 

 

 

 

Number of

 

Weighted-

 

 

 

Shares

 

Average Fair

 

 

 

Subject to

 

Value at Grant

 

 

    

Option

    

Date

 

Unvested balance, December 31, 2016

 

16,323

 

$

9.99

 

Granted

 

 —

 

 

 —

 

Forfeited

 

 —

 

 

 —

 

Vested

 

(16,323)

 

 

9.99

 

Unvested balance, September 30, 2017

 

 —

 

$

 —

 

 

Restricted Stock Awards and Units

 

Restricted stock awards and restricted stock units, or RSUs, are granted with a fair value equal to the closing market price of the Company’s common stock on the date of grant. The principal difference between restricted stock awards and RSUs is that RSUs are not shares of our common stock and do not have any of the rights or privileges thereof, including voting rights. On the applicable vesting date, the holder of an RSU becomes entitled to a share of common stock. The restricted stock awards and RSUs are amortized on a straight-line basis to expense over the vesting period. The following table sets forth the number of unvested restricted stock awards and RSUs and the weighted-average fair value of these awards at the date of grant:

 

 

 

 

 

 

 

 

 

Restricted

 

Weighted-

 

 

 

Stock

 

Average Fair

 

 

 

Awards and

 

Value at Grant

 

 

    

Units

    

Date

 

Unvested balance, December 31, 2016

 

323,641

 

$

53.84

 

Granted

 

139,134

 

 

86.08

 

Forfeited

 

(33,195)

 

 

63.86

 

Vested

 

(137,663)

 

 

44.34

 

Unvested balance, September 30, 2017

 

291,917

 

$

70.62

 

 

As of September 30, 2017, total unearned compensation on restricted stock awards and RSUs was approximately $16.5 million, and the weighted-average vesting period was 2.5 years.

 

Performance Stock Awards

 

We grant long-term incentives to members of management in the form of performance-based restricted stock awards (“PSAs”) under the 2010 Plan. The number of PSAs earned is based on our achievement of relative total shareholder return (“TSR”) measured versus the MSCI US REIT Index over a three-year performance period and ranges between 25% and 175% of the target number of shares for PSAs granted in 2015, 2016, and 2017. The PSAs are granted at the maximum percentage of target and are retired annually to the extent we do not meet the maximum relative TSR performance threshold versus the MSCI US REIT Index. The PSAs are earned upon TSR achievement measured both annually and over the full three-year performance period. The PSAs have a service condition and will be released at the end of the three-year performance period, to the extent earned, provided that the holder continues to be employed by or otherwise in service of the Company at the end of the three-year performance period. The PSAs are amortized on a straight-line basis to expense over the vesting period. Holders of the PSAs are entitled to dividends on the PSAs, which are accrued and paid in cash at the end of the three-year performance period.

 

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The following table sets forth the number of unvested PSAs and the weighted-average fair value of these awards at the date of grant:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted-

 

 

 

 

 

 

 

Average Fair

 

 

 

Performance-Based Restricted Stock Awards

 

Value at Grant

 

 

    

Minimum

 

Maximum

    

Target

    

Date

 

Unvested balance, December 31, 2016

 

44,835

 

167,725

 

113,976

 

$

54.24

 

Granted

 

7,210

 

50,472

 

28,841

 

 

105.50

 

Performance adjustment (1)

 

62,841

 

 —

 

23,725

 

 

 —

 

Forfeited

 

(5,674)

 

(16,836)

 

(11,255)

 

 

79.09

 

Vested

 

(70,518)

 

(70,518)

 

(70,518)

 

 

25.89

 

Unvested balance, September 30, 2017

 

38,694

 

130,843

 

84,769

 

$

84.63

 


(1)

Includes the annual adjustment for the number of PSAs earned based on our achievement of relative TSR measured versus the MSCI US REIT Index for the applicable performance periods.

 

As of September 30, 2017, total unearned compensation on PSAs was approximately $3.9 million, and the weighted-average vesting period was 2.0 years. The fair value of each PSA award is estimated on the date of grant using a Monte Carlo simulation. The simulation requires assumptions for expected volatility, risk-free rate of return, and dividend yield. The following table summarizes the assumptions used to value the PSAs granted during the nine months ended September 30, 2017, and 2016.

 

 

 

 

 

 

 

 

Nine Months Ended September 30,

 

 

    

2017

 

2016

 

Expected term (in years)

 

2.81

 

2.83

 

Expected volatility

 

23.33

%

25.29

%

Expected annual dividend(1)

 

 —

 

 —

 

Risk-free rate

 

1.60

%

0.97

%


(1)

The fair value of the PSAs assumes reinvestment of dividends.

 

10. Earnings Per Share

 

Basic net income per share is calculated by dividing the net income attributable to common shares by the weighted-average number of common shares outstanding during the period. Diluted net income per share adjusts basic net income per share for the effects of potentially dilutive common shares, if the effect is not antidilutive. Potentially dilutive common stock consists of shares issuable under the 2010 Plan. The following is a summary of basic and diluted net income per share (in thousands, except share and per share amounts):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended September 30,

 

Nine Months Ended September 30,

 

 

  

2017

  

2016

  

2017

  

2016

 

Net income attributable to common shares

 

$

15,758

 

$

12,180

 

$

47,693

 

$

35,476

 

Weighted-average common shares outstanding - basic

 

 

33,878,881

 

 

33,425,762

 

 

33,758,971

 

 

31,906,000

 

Effect of potentially dilutive common shares:

 

 

 

 

 

 

 

 

 

 

 

 

 

Stock options

 

 

59,201

 

 

192,272

 

 

98,660

 

 

197,166

 

Unvested awards

 

 

176,087

 

 

294,121

 

 

176,211

 

 

258,201

 

Weighted-average common shares outstanding - diluted

 

 

34,114,169

 

 

33,912,155

 

 

34,033,842

 

 

32,361,367

 

Net income per share attributable to common shares

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

0.47

 

$

0.36

 

$

1.41

 

$

1.11

 

Diluted

 

$

0.46

 

$

0.36

 

$

1.40

 

$

1.10

 

 

In the calculations above, we have excluded weighted-average potentially dilutive securities of 1,205 and 7,757 for the three months ended September 30, 2017, and 2016, respectively, and 109,953 and 113,920 for the nine months ended September 30, 2017, and 2016, respectively, as their effect would have been antidilutive.

 

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11. Estimated Fair Value of Financial Instruments

 

Authoritative guidance issued by FASB establishes a hierarchy of valuation techniques based on the observability of inputs utilized in measuring assets and liabilities at fair values. This hierarchy establishes market-based or observable inputs as the preferred source of values, followed by valuation models using management assumptions in the absence of market inputs. The three levels of the hierarchy under the authoritative guidance are as follows:

 

Level 1 — Quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity can access at the assessment date.

 

Level 2 — Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly.

 

Level 3 — Unobservable inputs for the asset or liability.

 

Our financial instruments consist of cash and cash equivalents, accounts and other receivables, interest rate swaps, the revolving credit facility, the senior unsecured term loans, senior unsecured notes, interest payable and accounts payable. The carrying values of cash and cash equivalents, accounts and other receivables, interest payable and accounts payable approximate fair values due to the short-term nature of these financial instruments. The interest rate swaps are recorded at fair value.

 

The valuation of our derivatives is determined using widely accepted valuation techniques including discounted cash flow analysis on the expected cash flows of each derivative, which reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs, including interest rate curves. We have determined that the majority of the inputs used to value our derivatives fall within Level 2 of the fair value hierarchy; however, the credit valuation adjustments associated with our derivatives utilize Level 3 inputs, such as estimates of current credit spreads, to evaluate the likelihood of default by our Operating Partnership and its counterparties. As of September 30, 2017, we have assessed the significance of the impact of the credit valuation adjustments on the overall valuation of our derivative positions and have determined that the credit valuation adjustment is not significant to the overall valuation of our derivative portfolio. As a result we classify our derivative valuation in Level 2 of the fair value hierarchy.

 

The total principal balance of our revolving credit facility, senior unsecured term loans, and senior unsecured notes was $794.0 million and $694.0 million as of September 30, 2017, and December 31, 2016, respectively, with a fair value of $796.2 million and $673.0 million, respectively, based on Level 3 inputs from the fair value hierarchy. Under the discounted cash flow method, the fair values of the revolving credit facility and the senior unsecured term loans are based on our assumptions of market interest rates and terms available incorporating our credit risk for similar loan maturities.

 

12. Commitments and Contingencies

 

Our properties require periodic investments of capital for general capital improvements and for tenant-related capital expenditures. We enter into various construction and equipment contracts with third parties for the development of our properties. At September 30, 2017, we had open commitments related to construction contracts of approximately $38.4 million.

 

Additionally, we have commitments related to telecommunications capacity used to connect data centers located within the same market or geographical area, power usage, and company-wide improvements that are ancillary to revenue generation. At September 30, 2017, we had open commitments related to these contracts of approximately $5.0 million.

 

We entered into a Memorandum of Understanding with the Virginia Economic Development Partnership Authority (the “Virginia Memorandum of Understanding”) pursuant to which we are afforded the opportunity to benefit from an exemption from sales and use tax for certain qualifying data center related purchases and equipment leases. This exemption also extends to our customers who execute a Landlord-Tenant Participation Agreement under the Virginia Memorandum of Understanding. The Virginia Memorandum of Understanding establishes thresholds relating to the level of capital investment and qualifying new jobs created within the Commonwealth of Virginia by us and our customers who have agreed to sign participation agreements. In the event those thresholds were not met as of the agreed upon performance date of June 1, 2017, we would have been required to repay the sales and use tax benefit we received,

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as well as any tax benefit received by our customers who default on their obligation to repay the tax benefit they received under the exemption program. On October 4, 2017, we received a satisfaction letter from the Virginia Economic Development Partnership Authority certifying that we have met the performance thresholds as of the performance date of June 1, 2017.

 

In the ordinary course of business, we are subject to claims and administrative proceedings. Except as described below, we are not presently party to any proceeding, which we believe to be material or which we would expect to have, individually or in the aggregate, a material adverse effect on our business, financial condition, cash flows or results of operations. 

 

On February 4, 2014, U.S. Colo, LLC (“U.S. Colo”), a current customer, filed a complaint against us in the United States District Court for the Central District of California. In the complaint, U.S. Colo alleged that it should not have been charged for the use of various interconnection services under the terms of an existing agreement between the parties.

 

On July 23, 2015, after amendments to the complaint, dismissal of several of U.S. Colo’s claims, and a remand of the case to the Superior Court of the State of California, County of Los Angeles (the “Superior Court”), U.S. Colo filed an amended complaint alleging breach of contract and breach of the covenant of good faith and fair dealing. The amended complaint seeks $802,564 in damages for charges paid to us for interconnection services; $70,080,000 in damages for alleged losses of revenue and profits; attorney’s fees, interest, and costs of the suit; and declaratory and injunctive relief. 

 

On February 4, 2016, the Superior Court granted our motion for summary adjudication, finding that U.S. Colo had contractually waived all claims for lost revenue or profits or other consequential damages.

 

The case was set to start trial on July 24, 2017 (after being rescheduled previously), but upon unopposed application by U.S. Colo, the Superior Court vacated the July 24, 2017, trial date, continued the trial date to April 9, 2018, set a final status conference for March 29, 2018, and reset other procedural deadlines in the action. We intend to vigorously defend this legal proceeding.

 

On July 9, 2015, a purported class action lawsuit was filed in the Superior Court of the State of California, County of Los Angeles, against us, alleging various employment law violations related to overtime, meal and break periods, minimum wage, timely payment of wages, wage statements, payroll records and business expenses. On March 15, 2016, we filed a responsive pleading generally denying the allegations. On July 27, 2016, the parties agreed upon class-wide settlement terms, subject to court approval. On June 26, 2017, the Superior Court granted preliminary approval of the parties’ settlement, which resolves the matter on a class-wide basis, on behalf of all non-exempt employees in California. The proposed settlement also resolves a related class action lawsuit filed on July 22, 2016, alleging similar claims. As part of the settlement, we agreed to pay $600,000. The Superior Court set a hearing for November 28, 2017, to determine whether final approval of the settlement will be granted. In the meantime, notice of the proposed settlement has been sent to class members who will then have an opportunity to object or opt out of the settlement. There can be no assurance that the settlement will be finally approved by the Superior Court. We intend to vigorously defend this legal proceeding if the settlement is not approved.

 

While it is not feasible to predict or determine the outcome of these legal proceedings, as of September 30, 2017, we estimate that the ultimate resolution of these litigation matters and other disputes could result in a loss that is reasonably possible between $0.6 million and $3.1 million in the aggregate, of which $2.9 million has been accrued in accounts payable and accrued expenses in our condensed consolidated balance sheet as of September 30, 2017.

 

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Forward-Looking Statements

 

This Quarterly Report on Form 10-Q (this “Quarterly Report”), together with other statements and information publicly disseminated by our company, contains certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 (“PSLRA”), namely Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). We intend such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the PSLRA and include this statement for purposes of complying with these safe harbor provisions.

 

In particular, statements pertaining to our capital resources, portfolio performance, business strategies and results of operations contain forward-looking statements. You can identify forward-looking statements by the use of forward-looking terminology such as “believes,”  “expects,” “may,” “will,” “should,” “seeks,” “intends,” “plans,” “pro forma” or “anticipates” or the negative of these words and phrases or similar words or phrases that are predictions of or indicate future events or trends and that do not relate solely to historical matters. You can also identify forward-looking statements by discussions of strategy, plans or intentions. Such statements are subject to risks, uncertainties and assumptions and are not guarantees of future performance, which may be affected by known and unknown risks, trends, uncertainties and factors that are beyond our control. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, estimated or projected. The following factors, among others, could cause actual results and future events to differ materially from those set forth or contemplated in the forward-looking statements: (i) the geographic concentration of our data centers in certain markets and any adverse developments in local economic conditions or the demand for data center space in these markets; (ii) fluctuations in interest rates and increased operating costs; (iii) difficulties in identifying properties to acquire and completing acquisitions; (iv) the significant competition in our industry and an inability to lease vacant space, renew existing leases or release space as leases expire; (v) lack of sufficient customer demand to realize expected returns on our investments to expand our property portfolio; (vi) decreased revenue from costs and disruptions associated with any failure of our physical infrastructure or services; (vii) our ability to develop and lease available space to existing or new customers; (viii) our failure to obtain necessary outside financing; (ix) our ability to service existing debt; (x) our failure to qualify or maintain our status as a REIT; (xi) financial market fluctuations; (xii) changes in real estate and zoning laws and increases in real estate taxes; (xiii) delays or disruptions in third-party network connectivity; (xiv) service failures or price increases by third party power suppliers; (xv) inability to renew net leases on the data center properties we lease; and (xvi) other factors affecting the real estate or technology industries generally.

 

While forward-looking statements reflect our good faith beliefs, they are not guarantees of future performance. We disclaim any obligation to publicly update or revise any forward-looking statement to reflect changes in underlying assumptions or factors, of new information, data or methods, future events or other changes, except as required by applicable law. The risks included here are not exhaustive, and additional factors could adversely affect our business and financial performance, including factors and risks included in other sections of this Quarterly Report. Additional information concerning these and other risks and uncertainties is contained in our other periodic filings with the United States Securities and Exchange Commission (“SEC”) pursuant to the Exchange Act. We discussed a number of material risks in Item 1A. “Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2016. Those risks continue to be relevant to our performance and financial condition. Given these risks and uncertainties, investors should not place undue reliance on forward-looking statements as a prediction of actual results.

 

Overview

 

Unless the context requires otherwise, references in this Quarterly Report to “we,” “our,” “us” and “our company” refer to CoreSite Realty Corporation, a Maryland corporation, together with our consolidated subsidiaries, including CoreSite, L.P., a Delaware limited partnership of which we are the sole general partner and to which we refer in this Quarterly Report as our “Operating Partnership.”

 

We are engaged in the business of ownership, acquisition, construction and operation of strategically located data centers in some of the largest and fastest growing data center markets in the United States, including the Northern Virginia (including Washington D.C.), New York and San Francisco Bay areas, Chicago, Los Angeles, Boston, Miami, and Denver.

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We deliver secure, reliable, high-performance data center and interconnection solutions to a growing customer ecosystem across eight key North American markets. More than 1,200 of the world’s leading enterprises, network operators, cloud providers, and supporting service providers choose us to connect, protect and optimize their performance-sensitive data, applications and computing workloads.

 

Our focus is to bring together a network and cloud community to support the needs of enterprises, and create a diverse customer ecosystem. Our growth strategy includes (i) increasing cash flow from in-place data center space, (ii) capitalizing on embedded expansion opportunities within existing data centers, (iii) selectively pursuing acquisition and development opportunities in existing and new markets, (iv) expanding existing customer relationships, and (v) attracting new customers.

 

Our Portfolio

 

As of September 30, 2017, our property portfolio included 20 operating data center facilities, office and light-industrial space and multiple potential development projects that collectively comprise over 3.9 million net rentable square feet (“NRSF”), of which over 2.2 million NRSF is existing data center space. The approximately 1.3 million NRSF of development projects includes space available for development and construction of new data center facilities. We expect that this development potential plus any incremental investment into existing or new markets will enable us to accommodate existing and future customer demand and position us to continue to increase our operating cash flows. The following table provides an overview of our property portfolio as of September 30, 2017:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Data Center Operating NRSF (1)

 

Development

 

 

 

 

 

 

 

 

Stabilized

 

Pre-Stabilized (2)

 

Total

 

NRSF (3)

 

Total NRSF

 

 

 

Annualized

 

 

 

Percent

 

 

 

Percent

 

 

 

Percent

 

 

 

Total

 

Market/Facilities

 

Rent ($000)(4)

    

Total

    

Occupied(5)

    

Total

    

Occupied(5)

    

Total

    

Occupied(5)

    

Total

    

Portfolio

 

San Francisco Bay

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

SV1

 

$

6,023

 

85,932

 

78.1

%

 —

 

 —

%

85,932

 

78.1

%

 —

 

85,932

 

SV2

 

 

8,493

 

76,676

 

88.2

 

 —

 

 —

 

76,676

 

88.2

 

 —

 

76,676

 

Santa Clara campus

 

 

64,743

 

538,615

 

99.2

 

76,885

 

32.9

 

615,500

 

90.9

 

160,000

 

775,500

 

San Francisco Bay Total

 

 

79,259

 

701,223

 

95.4

 

76,885

 

32.9

 

778,108

 

89.2

 

160,000

 

938,108

 

Los Angeles

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

One Wilshire campus

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

LA1*

 

 

29,819

 

139,053

 

92.5

 

 —

 

 —

 

139,053

 

92.5

 

10,352

 

149,405

 

LA2

 

 

36,073

 

264,512

 

91.7

 

43,345

 

45.5

 

307,857

 

85.2

 

117,033

 

424,890

 

LA3

 

 

 —

 

 —

 

 —

 

 —

 

 —

 

 —

 

 —

 

180,000

 

180,000

 

Los Angeles Total

 

 

65,892

 

403,565

 

92.0

 

43,345

 

45.5

 

446,910

 

87.4

 

307,385

 

754,295

 

Northern Virginia

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

VA1

 

 

29,306

 

198,632

 

92.9

 

 —

 

 —

 

198,632

 

92.9

 

3,087

 

201,719

 

VA2

 

 

16,336

 

115,336

 

100.0

 

73,111

 

34.1

 

188,447

 

74.4

 

 —

 

188,447

 

DC1*

 

 

3,278

 

22,137

 

80.5

 

 —

 

 —

 

22,137

 

80.5

 

 —

 

22,137

 

DC2*

 

 

 —

 

 —

 

 —

 

 —

 

 —

 

 —

 

 —

 

24,563

 

24,563

 

Reston Campus Expansion(6)

 

 

1,136

 

48,928

 

100.0

 

 —

 

 —

 

48,928

 

100.0

 

611,072

 

660,000

 

Northern Virginia Total

 

 

50,056

 

385,033

 

95.2

 

73,111

 

34.1

 

458,144

 

85.4

 

638,722

 

1,096,866

 

New York

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

NY1*

 

 

6,036

 

48,404

 

84.9

 

 —

 

 —

 

48,404

 

84.9

 

 —

 

48,404

 

NY2

 

 

12,677

 

101,742

 

85.8

 

 —

 

 —

 

101,742

 

85.8

 

134,508

 

236,250

 

New York Total

 

 

18,713

 

150,146

 

85.5

 

 —

 

 —

 

150,146

 

85.5

 

134,508

 

284,654

 

Chicago

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

CH1

 

 

18,692

 

178,407

 

92.0

 

 —

 

 —

 

178,407

 

92.0

 

 —

 

178,407

 

Boston

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

BO1

 

 

17,867

 

166,026

 

98.0

 

14,031

 

79.5

 

180,057

 

96.5

 

73,619

 

253,676

 

Denver

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

DE1*

 

 

2,248

 

5,878

 

98.9

 

8,276

 

35.2

 

14,154

 

61.7

 

15,630

 

29,784

 

DE2*

 

 

455

 

5,140

 

87.5

 

 —

 

 —

 

5,140

 

87.5

 

 —

 

5,140

 

Denver Total

 

 

2,703

 

11,018

 

93.6

 

8,276

 

 —

 

19,294

 

68.5

 

15,630

 

34,924

 

Miami

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

MI1

 

 

1,399

 

30,176

 

62.3

 

 —

 

 —

 

30,176

 

62.3

 

13,154

 

43,330

 

Total Data Center Facilities

 

$

254,581

 

2,025,594

 

93.4

%  

215,648

 

38.9

%  

2,241,242

 

88.1

%  

1,343,018

 

3,584,260

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Office and Light-Industrial(7)

 

 

7,927

 

354,721

 

79.0

 

 —

 

 —

 

354,721

 

79.0

 

 —

 

354,721

 

Reston Office and Light-Industrial(6)

 

 

2,087

 

150,375

 

100.0

 

 —

 

 —

 

150,375

 

100.0

 

(150,375)

 

 —

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Portfolio

 

$

264,595

 

2,530,690

 

91.7

%  

215,648

 

38.9

%  

2,746,338

 

87.6

%  

1,192,643

 

3,938,981

 


*Indicates properties in which we hold a leasehold interest.

(1)

Represents NRSF at each operating facility that is currently occupied or readily available for lease as data center space and pre-stabilized data center space. Both occupied and available data center NRSF includes a factor based on

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management’s estimate to account for a customer’s proportionate share of the required data center support space (such as the mechanical, telecommunications and utility rooms) and building common areas, which may be updated on a periodic basis to reflect the most current build-out of our properties. Operating data center NRSF may require investment of Deferred Expansion Capital (see definition on page 30).

(2)

Pre-stabilized NRSF represents projects or facilities that recently have been developed and are in the initial lease-up phase. Pre-stabilized projects or facilities become stabilized operating properties at the earlier of achievement of 85% occupancy or 24 months after development completion.

(3)

Represents incremental data center capacity currently vacant in existing facilities in our portfolio that requires significant capital investment in order to develop into data center facilities. Includes NRSF under construction for which substantial activities are ongoing to prepare the property for its intended use following development. The NRSF reflects management’s estimate of engineering drawings and required support space and is subject to change based on final demising of space.

(4)

Represents the monthly contractual rent under existing commenced customer leases as of September 30, 2017, multiplied by 12. This amount reflects total annualized base rent before any one-time or non-recurring rent abatements and excludes power revenue, interconnection revenue and operating expense reimbursement. On a gross basis, our total portfolio annualized rent was approximately $270.3 million as of September 30, 2017, which includes $5.7 million in operating expense reimbursements under modified gross and triple-net leases.

(5)

Includes customer leases that have commenced and are occupied as of September 30, 2017. The percent occupied is determined based on occupied square feet as a proportion of total operating NRSF as of September 30, 2017. The percent occupied for stabilized data center space would have been 93.6%, rather than 93.4%, if all leases signed in the current and prior periods had commenced. The percent occupied for our total portfolio, including stabilized data center space, pre-stabilized space and office and light-industrial space, would have been 89.1%, rather than 87.6%, if all leases signed in current and prior periods had commenced.

(6)

Included within our Reston Campus Expansion held for development space is 150,375 NRSF which is currently operating as office and light-industrial space.

(7)

Represents space that is currently occupied or readily available for lease as space other than data center space, which typically is offered for office or light-industrial uses.

 

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“Same-Store” statistics are based on space within each data center facility that was leased or available to be leased as of December 31, 2015, excluding space for which development was completed and became available to be leased after December 31, 2015. We track Same-Store space leased or available to be leased at the computer room level within each data center facility. The following table shows the September 30, 2017, Same-Store operating statistics. For comparison purposes, the operating activity totals as of December 31, 2016, and 2015, for this space are provided at the bottom of this table.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Same-Store Property Portfolio (in NRSF)

 

 

 

 

 

 

Data Center

 

Office and Light-Industrial

 

Total

 

 

 

Annualized

 

 

 

Percent

 

 

 

Percent

 

 

 

Percent

 

Market/Facilities

    

Rent ($000)(1)

    

Total

    

Occupied(2)

    

Total

    

Occupied(2)

    

Total

    

Occupied(2)

 

San Francisco Bay

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

SV1

 

$

11,750

 

85,932

 

78.1

%  

234,238

 

81.2

%  

320,170

 

80.4

%

SV2

 

 

8,493

 

76,676

 

88.2

 

 —

 

 —

 

76,676

 

88.2

 

Santa Clara campus

 

 

30,184

 

252,009

 

98.3

 

712

 

84.3

 

252,721

 

98.3

 

San Francisco Bay Total

 

 

50,427

 

414,617

 

92.3

 

234,950

 

81.2

 

649,567

 

88.3

 

Los Angeles

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

One Wilshire campus

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

LA1*

 

 

29,996

 

139,053

 

92.5

 

4,373

 

79.4

 

143,426

 

92.1

 

LA2

 

 

29,486

 

259,786

 

91.5

 

7,029

 

73.8

 

266,815

 

91.1

 

Los Angeles Total

 

 

59,482

 

398,839

 

91.9

 

11,402

 

75.9

 

410,241

 

91.4

 

Northern Virginia

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

VA1

 

 

30,423

 

198,632

 

92.9

 

61,050

 

91.2

 

259,682

 

92.5

 

VA2

 

 

10,230

 

92,173

 

100.0

 

 —

 

 —

 

92,173

 

100.0

 

DC1*

 

 

3,278

 

22,137

 

80.5

 

 —

 

 —

 

22,137

 

80.5

 

Northern Virginia Total

 

 

43,931

 

312,942

 

94.1

 

61,050

 

91.2

 

373,992

 

93.6

 

New York

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

NY1*

 

 

6,050

 

48,404

 

84.9

 

209

 

100.0

 

48,613

 

84.9

 

NY2

 

 

12,936

 

101,742

 

85.8

 

20,735

 

24.6

 

122,477

 

75.4

 

New York Total

 

 

18,986

 

150,146

 

85.5

 

20,944

 

25.4

 

171,090

 

78.1

 

Chicago

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

CH1

 

 

18,786

 

178,407

 

92.0

 

4,946

 

76.0

 

183,353

 

91.6

 

Boston

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

BO1

 

 

16,159

 

166,026

 

98.0

 

19,495

 

76.6

 

185,521

 

95.7

 

Denver

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

DE1*

 

 

1,465

 

5,878

 

98.9

 

 —

 

 —

 

5,878

 

98.9

 

DE2*

 

 

455

 

5,140

 

87.5

 

 —

 

 —

 

5,140

 

87.5

 

Denver Total

 

 

1,920

 

11,018

 

93.6

 

 —

 

 —

 

11,018

 

93.6

 

Miami

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

MI1

 

 

1,423

 

30,176

 

62.3

 

1,934

 

55.7

 

32,110

 

61.9

 

Total Facilities at September 30, 2017(3)

 

$

211,114

 

1,662,171

 

91.9

%  

354,721

 

79.0

%  

2,016,892

 

89.6

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Facilities at December 31, 2016

 

$

206,038

 

 

 

92.3

%  

 

 

76.2

%  

 

 

89.5

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Facilities at December 31, 2015

 

$

191,088

 

 

 

89.8

%  

 

 

72.6

%  

 

 

86.8

%


*Indicates properties in which we hold a leasehold interest.

(1)

Represents the monthly contractual rent under existing commenced customer leases as of each respective period, multiplied by 12. This amount reflects total annualized base rent before any one-time or non-recurring rent abatements and excludes power revenue, interconnection revenue and operating expense reimbursement.

(2)

Includes customer leases that have commenced and are occupied as of each respective period. The percent occupied is determined based on occupied square feet as a proportion of total operating NRSF.

(3)

The percent occupied for data center space, office and light-industrial space, and total space would have been 92.2%, 80.8% and 90.2%, respectively, if all leases signed in the current and prior periods had commenced.

 

Same-Store annualized rent increased to $211.1 million at September 30, 2017, compared to $206.0 million at December 31, 2016. The increase of $5.1 million is due primarily to the increase of $3.9 million, $2.8 million, and $1.8 million in Same-Store annualized rent at our New York, Northern Virginia (including Washington D.C.), and Los Angeles markets, respectively. This increase was partially offset by the expiration of $4.1 million in annualized rent associated with a restructured lease agreement at our Santa Clara campus.

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Development space is unoccupied space or land that requires significant capital investment in order to develop data center facilities that are ready for use. The following table summarizes the NRSF under construction and NRSF held for development throughout our portfolio, each as of September 30, 2017:

 

 

 

 

 

 

 

 

 

 

 

Development Opportunities (in NRSF)

 

 

 

Under

 

Held for

 

 

 

Facilities

 

Construction(1)

 

Development(2)

 

Total

 

Santa Clara campus

 

 

 

 

 

 

 

SV8(3)

 

 —

 

160,000

 

160,000

 

San Francisco Bay Total

 

 —

 

160,000

 

160,000

 

One Wilshire campus

 

 

 

 

 

 

 

LA1

 

 —

 

10,352

 

10,352

 

LA2

 

87,263

 

29,770

 

117,033

 

LA3(3)

 

 —

 

180,000

 

180,000

 

Los Angeles Total

 

87,263

 

220,122

 

307,385

 

Northern Virginia

 

 

 

 

 

 

 

VA1

 

3,087

 

 —

 

3,087

 

DC2

 

24,563

 

 —

 

24,563

 

Reston Campus Expansion(4)

 

74,759

 

536,313

 

611,072

 

Northern Virginia Total

 

102,409

 

536,313

 

638,722

 

New York

 

 

 

 

 

 

 

NY2

 

 —

 

134,508

 

134,508

 

Boston

 

 

 

 

 

 

 

BO1

 

13,735

 

59,884

 

73,619

 

Denver

 

 

 

 

 

 

 

DE1

 

15,630

 

 —

 

15,630

 

Miami

 

 

 

 

 

 

 

MI1

 

 —

 

13,154

 

13,154

 

Total Facilities(5)

 

219,037

 

1,123,981

 

1,343,018

 


(1)

Represents NRSF for which substantial construction activities are ongoing to prepare the property for its intended use following development. The NRSF reflects management’s estimate of engineering drawings and required support space and is subject to change based on final demising of space.

(2)

Represents estimated incremental data center capacity currently vacant in existing facilities or on vacant land in our portfolio that requires significant capital investment in order to develop into data center facilities.

(3)

The NRSF for these facilities reflect management’s estimates based on our current construction plans and expectations regarding entitlements. These estimates are subject to change based on current economic conditions, final zoning approvals, and the supply and demand dynamics of the market.

(4)

Based upon our current design plans for the Reston Campus Expansion, we estimate that we can build approximately 611,000 NRSF of incremental data center capacity (of which 74,759 NRSF is under construction) across multiple phases with new buildings and as existing light-industrial / flex office leases expire and customers vacate. Based on our entitlement application, we believe we may be able to build an additional 286,000 NRSF for a total of 897,000 NRSF of incremental data center capacity. These estimates are subject to change based on current economic conditions, final zoning approvals, and the supply and demand dynamics of the market. The chart assumes the minimum expected zoning entitlement.

(5)

In addition to our development opportunities disclosed within this table, we have land adjacent to our NY2 facility, in the form of an existing parking lot. By utilizing this land, we believe that we could develop 100,000 NRSF on our available acreage in New York, upon receipt of necessary entitlements.

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Table of Contents

Capital Expenditures

 

The following table sets forth information regarding capital expenditures during the nine months ended September 30, 2017 (in thousands):

 

 

 

 

 

 

 

 

Nine Months Ended

 

 

    

September 30, 2017

 

Data center expansion

 

$

98,892

 

Non-recurring investments

 

 

8,985

 

Tenant improvements

 

 

5,298

 

Recurring capital expenditures

 

 

12,776

 

Total capital expenditures

 

$

125,951

 

 

During the nine months ended September 30, 2017, we incurred approximately $126.0 million of capital expenditures, of which approximately $98.9 million related to data center expansion activities, including new data center construction, the development of capacity within existing data centers and other revenue generating investments. As we construct data center capacity, we work to optimize both the amount of capital we deploy on power and cooling infrastructure and the timing of that capital deployment; as such, we generally construct our power and cooling infrastructure supporting our data center NRSF based on our estimate of customer utilization. This practice can result in our investment at a later time in “Deferred Expansion Capital”. We define Deferred Expansion Capital as our estimate of the incremental capital we may invest in the future to add power or cooling infrastructure to support existing or anticipated future customer utilization of NRSF within our operating data centers.

 

During the nine months ended September 30, 2017, we completed development of one computer room at LA2 and two computer rooms at DE1. The following table sets forth capital expenditures spent on data center NRSF placed into service during the nine months ended September 30, 2017, or under construction as of September 30, 2017:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

NRSF

 

 

 

Data Center

 

Placed into

 

Under

 

Property

    

Expansion

    

Service

    

Construction

 

LA2

 

$

35,225

 

4,726

 

87,263

 

Reston Expansion

 

 

19,662

 

 —

 

74,759

 

SV8(1)

 

 

12,307

 

 —

 

 —

 

BO1

 

 

6,220

 

 —

 

13,735

 

DE1

 

 

5,248

 

8,276

 

15,630

 

DC2

 

 

3,758

 

 —

 

24,563

 

Other

 

 

16,472

 

 —

 

3,087

 

Total

 

$

98,892

 

13,002

 

219,037

 


(1)

On August 29, 2017, we acquired a two-acre land parcel adjacent to our existing Santa Clara campus, with a total real estate value of $12.2 million. We plan to build a turn-key data center on the acquired land parcel, which we refer to as SV8, upon the receipt of necessary entitlements.

 

During the nine months ended September 30, 2017, we incurred approximately $9.0 million in non-recurring investments, of which $5.9 million is a result of internal IT software development projects and the remaining $3.1 million is a result of other non-recurring investments, such as remodel or upgrade projects.

 

During the nine months ended September 30, 2017, we incurred approximately $5.3 million in tenant improvements, which relates to numerous small tenant improvement projects at various properties.

 

During the nine months ended September 30, 2017, we incurred approximately $12.8 million of recurring capital expenditures within our portfolio, of which $3.3 million relates to the replacement and upgrade of an existing chiller system and the remaining $9.5 million is for other required equipment upgrades that have a future economic benefit.

 

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Table of Contents

Factors that May Influence our Results of Operations

 

A complete discussion of factors that may influence our results of operations can be found in our Annual Report on Form 10-K for the year ended December 31, 2016, filed with the SEC on February 10, 2017, which is accessible on the SEC’s website at www.sec.gov.

 

Our ability to re-lease or renew expiring space at rental rates equal to or in excess of current rental rates will impact our results of operations. In addition to approximately 341,000 NRSF of data center and office and light-industrial space currently unoccupied in our total portfolio, 273 and 1,108 data center leases representing approximately 5.4% and 17.6% of the NRSF in our operating data center portfolio with current average annualized rental rates of $164 per NRSF and $157 per NRSF are scheduled to expire during the remainder of 2017 and the year ending December 31, 2018, respectively.

 

The amount of revenue generated by the properties in our portfolio depends on several factors, including our ability to lease available unoccupied and under construction space. As of September 30, 2017, we had approximately 568,000 NRSF of unoccupied or under construction data center space of which approximately 71,000 NRSF is leased with a future commencement date. The loss of one or more significant customers could have a material adverse effect on our results of operations. During the nine months ended September 30, 2017, we entered into new and expansion leases totaling approximately 139,000 NRSF. The following table summarizes our leasing activity during the nine months ended September 30, 2017:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

GAAP

 

Total

 

 

 

 

 

 

 

 

 

 

Number of

 

Annualized

 

Leased

 

GAAP Rental

 

GAAP Rent

 

 

 

Three Months Ended

 

Leases(1)

 

Rent

 

NRSF(2)

 

Rates(3)

 

Growth(4)

 

New/expansion leases commenced

    

September 30, 2017

    

122

    

$

8,855

    

21,617

    

$

410

 

 

 

 

 

June 30, 2017

    

129

    

 

6,580

    

25,712

    

 

256

(5)

 

 

 

 

March 31, 2017

    

118

    

 

9,121

    

37,352

    

 

244

    

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

New/expansion leases signed(6)

 

September 30, 2017

 

103

 

$

10,099

 

40,842

 

$

247

 

 

 

 

 

June 30, 2017

 

119

 

 

11,918

 

51,568

 

 

208

(5)

 

 

 

 

March 31, 2017

 

128

 

 

9,701

 

46,484

 

 

209

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Renewal leases signed

 

September 30, 2017

 

280

 

$

14,370

 

80,818

 

$

178

 

10.9

%

 

 

June 30, 2017

 

172

 

 

12,934

 

83,097

 

 

156

 

6.5

 

 

 

March 31, 2017

 

178

 

 

13,885

 

95,108

 

 

146

 

5.5

 


(1)

Number of leases represents each agreement with a customer; a lease agreement could include multiple spaces and a customer could have multiple leases.

(2)

Total leased NRSF is determined based on contractually leased square feet, including required data center support space (such as the mechanical, telecommunications and utility rooms) and building common areas.

(3)

GAAP rental rates represent annual contractual rent per NRSF adjusted for straight-line rents in accordance with GAAP.

(4)

GAAP rent growth represents the increase in rental rates on renewed leases commencing during the period, as compared with the previous period’s rental rates for the same space.

(5)

GAAP annualized rent includes contractual payments related to reserved dedicated expansion space, which is excluded from the GAAP annualized rent per leased NRSF rate.

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Table of Contents

Results of Operations

 

Three Months Ended September 30, 2017, Compared to the Three Months Ended September 30, 2016

 

The discussion below relates to our financial condition and results of operations for the three months ended September 30, 2017, and 2016. A summary of our operating results for the three months ended September 30, 2017, and 2016, is as follows (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended September 30,

 

 

 

 

 

 

 

    

2017

    

2016

    

$ Change

    

% Change

 

Operating revenue

 

$

123,068

 

$

101,274

 

$

21,794

 

21.5

%

Operating expense

 

 

92,269

 

 

78,769

 

 

13,500

 

17.1

 

Operating income

 

 

30,799

 

 

22,505

 

 

8,294

 

36.9

 

Interest expense

 

 

6,447

 

 

3,188

 

 

3,259

 

102.2

 

Net income

 

 

24,288

 

 

19,319

 

 

4,969

 

25.7

 

 

Operating Revenue

 

Operating revenue during the three months ended September 30, 2017, and 2016, was as follows (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended September 30,

 

 

 

 

 

 

 

    

2017

    

2016

    

$ Change

    

% Change

 

Data center revenue:

 

 

 

 

 

 

 

 

 

 

 

 

Rental revenue

 

$

66,657

 

$

54,219

 

$

12,438

 

22.9

%

Power revenue

 

 

35,110

 

 

28,844

 

 

6,266

 

21.7

 

Interconnection revenue

 

 

16,201

 

 

13,374

 

 

2,827

 

21.1

 

Tenant reimbursement and other

 

 

2,185

 

 

2,826

 

 

(641)

 

(22.7)

 

Total data center revenue

 

 

120,153

 

 

99,263

 

 

20,890

 

21.0

 

Office, light-industrial and other revenue

 

 

2,915

 

 

2,011

 

 

904

 

45.0

 

Total operating revenues

 

$

123,068

 

$

101,274

 

$

21,794

 

21.5

%

 

 

A majority of the increase in operating revenues was due to an $18.7 million increase in data center rental and power revenue during the three months ended September 30, 2017, compared to the 2016 period. The increase in data center rental and power revenue is due primarily to the commencement of new and expansion leases of approximately 274,000 NRSF at an average rental rate of $217 per NRSF during the twelve months ended September 30, 2017. The increase in operating revenues was also attributable to the lease renewals of approximately 311,000 NRSF at a rent growth rate of 7.2% and assumed in-place leases of 199,000 NRSF in connection with the acquisition of the Reston Campus Expansion during the twelve months ended September 30, 2017. This increase was partially offset by the move-out of customer leases totaling approximately 84,000 NRSF at an average rental rate of $142 per NRSF during the twelve months ended September 30, 2017, and the expiration of $4.1 million of annualized rent associated with a restructured lease agreement at our Santa Clara campus.

 

In addition, interconnection revenue increased $2.8 million, or 21.1%, during the three months ended September 30, 2017, compared to the 2016 period. The increase is primarily a result of an 12.8% increase in the volume of cross connects from new and existing customers during the twelve months ended September 30, 2017, and revenue increases resulting from customers migrating to our higher priced fiber product.

 

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Table of Contents

Operating Expenses

 

Operating expenses during the three months ended September 30, 2017, and 2016, were as follows (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended September 30,

 

 

 

 

 

 

 

    

2017

    

2016

    

$ Change

    

% Change

 

Property operating and maintenance

 

$

37,091

 

$

28,283

 

$

8,808

 

31.1

%

Real estate taxes and insurance

 

 

2,622

 

 

3,524

 

 

(902)

 

(25.6)

 

Depreciation and amortization

 

 

32,077

 

 

26,981

 

 

5,096

 

18.9

 

Sales and marketing

 

 

4,643

 

 

4,465

 

 

178

 

4.0

 

General and administrative

 

 

9,759

 

 

9,432

 

 

327

 

3.5

 

Rent

 

 

6,077

 

 

5,967

 

 

110

 

1.8

 

Transaction costs

 

 

 —

 

 

117

 

 

(117)

 

(100.0)

 

Total operating expenses

 

$

92,269

 

$

78,769

 

$

13,500

 

17.1

%

 

Property operating and maintenance expense increased $8.8 million, or 31.1%, primarily as a result of an increase in power expense due to increased customer consumption related to the commencement of new and expansion leases during the twelve months ended September 30, 2017, which resulted in a 15.6% increase in occupied data center NRSF. In addition, maintenance expense increased due to 240,000 data center NRSF being placed into service during the twelve months ended September 30, 2017, and payroll and benefits expense increased due to an increase in facilities and operations headcount associated with the increased occupied data center NRSF.

 

Real estate taxes and insurance decreased $0.9 million, or 25.6%, during the three months ended September 30, 2017, compared to the 2016 period, primarily as a result of real estate tax accrual true-ups related to the receipt of supplemental real estate tax assessments which reflect the assessed taxable values of our newly constructed SV6 and SV7 data centers within our Santa Clara campus. This decrease was partially offset by a decrease in capitalized real estate taxes resulting from the completion of SV7 in the fourth of 2016 and increased real estate tax expense related to our Reston Campus Expansion, which we did not own during the three months ended September 30, 2016.

 

Depreciation and amortization expense increased $5.1 million, or 18.9%, during the three months ended September 30, 2017, compared to the 2016 period, as a result of an increase in depreciation expense from approximately 240,000 NRSF of new data center expansion projects placed into service with a cost basis of approximately $245.6 million.

 

Interest Expense

 

Interest expense increased $3.3 million during the three months ended September 30, 2017, compared to the 2016 period, primarily as a result of the increase in overall debt outstanding, increased interest rates, and a reduction in capitalized interest resulting from the completion of SV7 in the fourth quarter of 2016. The total principal debt outstanding was $794.0 million and $594.8 million as of September 30, 2017, and 2016, respectively. Our daily weighted average interest rate increased from 2.92% during the three months ended September 30, 2016, to 3.28% during the three months ended September 30, 2017. A summary of interest expense for the three months ended September 30, 2017, and 2016, is as follows (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended September 30,

 

 

 

 

 

 

 

    

2017

    

2016

    

$ Change

    

% Change

 

Interest expense and fees

 

$

6,840

 

$

4,398

 

$

2,442

 

55.5

%

Amortization of deferred financing costs

 

 

445

 

 

370

 

 

75

 

20.3

 

Capitalized interest

 

 

(838)

 

 

(1,580)

 

 

742

 

(47.0)

 

Total interest expense

 

$

6,447

 

$

3,188

 

$

3,259

 

102.2

%

Percent capitalized

 

 

11.5

%  

 

33.1

%  

 

 

 

 

 

 

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Table of Contents

Nine Months Ended September 30, 2017, Compared to the Nine Months Ended September 30, 2016

 

The discussion below relates to our financial condition and results of operations for the nine months ended September 30, 2017, and 2016. A summary of our operating results for the nine months ended September 30, 2017, and 2016, is as follows (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine Months Ended September 30,

 

 

 

 

 

 

 

    

2017

    

2016

    

$ Change

    

% Change

 

Operating revenue

 

$

355,875

 

$

289,844

 

$

66,031

 

22.8

%

Operating expense

 

 

264,730

 

 

223,160

 

 

41,570

 

18.6

 

Operating income

 

 

91,145

 

 

66,684

 

 

24,461

 

36.7

 

Interest expense

 

 

17,512

 

 

7,879

 

 

9,633

 

122.3

 

Net income

 

 

73,483

 

 

58,760

 

 

14,723

 

25.1

 

 

Operating Revenue

 

Operating revenue during the nine months ended September 30, 2017, and 2016, was as follows (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine Months Ended September 30,

 

 

 

 

 

 

 

    

2017

    

2016

    

$ Change

    

% Change

 

Data center revenue:

 

 

 

 

 

 

 

 

 

 

 

 

Rental revenue

 

$

195,761

 

$

156,954

 

$

38,807

 

24.7

%

Power revenue

 

 

98,381

 

 

80,819

 

 

17,562

 

21.7

 

Interconnection revenue

 

 

46,038

 

 

39,093

 

 

6,945

 

17.8

 

Tenant reimbursement and other

 

 

6,790

 

 

6,982

 

 

(192)

 

(2.7)

 

Total data center revenue

 

 

346,970

 

 

283,848

 

 

63,122

 

22.2

 

Office, light-industrial and other revenue

 

 

8,905

 

 

5,996

 

 

2,909

 

48.5

 

Total operating revenues

 

$

355,875

 

$

289,844

 

$

66,031

 

22.8

%

 

A majority of the increase in operating revenues was due to a $56.4 million increase in data center rental and power revenue during the nine months ended September 30, 2017, compared to the 2016 period. The increase in data center rental and power revenue is due primarily to the commencement of new and expansion leases of approximately 274,000 NRSF at an average rental rate of $217 per NRSF during the twelve months ended September 30, 2017. The increase in operating revenues was also attributable to the lease renewals of approximately 311,000 NRSF at a rent growth rate of 7.2% and assumed in-place leases of 199,000 NRSF in connection with the acquisition of the Reston Campus Expansion during the twelve months ended September 30, 2017. This increase was partially offset by the move-out of customer leases totaling approximately 84,000 NRSF at an average rental rate of $142 per NRSF during the twelve months ended September 30, 2017, and the expiration of $4.1 million of annualized rent associated with a restructured lease agreement at our Santa Clara campus.

 

In addition, interconnection revenue increased $6.9 million, or 17.8%, during the nine months ended September 30, 2017, compared to the 2016 period. The increase is primarily a result of an 12.8% increase in the volume of cross connects from new and existing customers during the twelve months ended September 30, 2017, and revenue increases resulting from customers migrating to our higher priced fiber product.

 

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Table of Contents

Operating Expenses

 

Operating expenses during the nine months ended September 30, 2017, and 2016, were as follows (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine Months Ended September 30,

 

 

 

 

 

 

 

    

2017

    

2016

    

$ Change

    

% Change

 

Property operating and maintenance

 

$

98,098

 

$

78,522

 

$

19,576

 

24.9

%

Real estate taxes and insurance

 

 

10,950

 

 

9,659

 

 

1,291

 

13.4

 

Depreciation and amortization

 

 

96,622

 

 

77,978

 

 

18,644

 

23.9

 

Sales and marketing

 

 

13,560

 

 

13,187

 

 

373

 

2.8

 

General and administrative

 

 

27,391

 

 

26,970

 

 

421

 

1.6

 

Rent

 

 

17,970

 

 

16,718

 

 

1,252

 

7.5

 

Transaction costs

 

 

139

 

 

126

 

 

13

 

10.3

 

Total operating expenses

 

$

264,730

 

$

223,160

 

$

41,570

 

18.6

%

 

Property operating and maintenance expense increased $19.6 million, or 24.9%, primarily as a result of an increase in power expense due to increased customer consumption related to the commencement of new and expansion leases during the twelve months ended September 30, 2017, which resulted in a 15.6% increase in occupied data center NRSF. In addition, maintenance expense increased due to 240,000 data center NRSF being placed into service during the twelve months ended September 30, 2017, and payroll and benefits expense increased due to an increase in facilities and operations headcount associated with increased occupied data center NRSF.

 

Real estate taxes and insurance increased $1.3 million, or 13.4%, during the nine months ended September 30, 2017, compared to the 2016 period, primarily as a result of increased tax assessments and decreased capitalized real estate taxes resulting from the completion of SV7 in the fourth quarter of 2016. We also recognized real estate tax expense related to our Reston Campus Expansion, which we did not own during the nine months ended September 30, 2016. These increases were partially offset by real estate tax accrual true-ups related to the receipt of supplemental real estate tax assessments which reflect the assessed taxable values of our newly constructed SV6 and SV7 data centers in our Santa Clara campus.

 

Depreciation and amortization expense increased $18.6 million, or 23.9%, during the nine months ended September 30, 2017, compared to the 2016 period, as a result of an increase in depreciation expense from approximately 240,000 NRSF of new data center expansion projects placed into service with a cost basis of approximately $245.6 million.

 

Interest Expense

 

Interest expense increased $9.6 million during the nine months ended September 30, 2017, compared to the 2016 period, primarily as a result of the increase in overall debt outstanding, increased interest rates, and a reduction in capitalized interest resulting from the completion of SV7 in the fourth quarter 2016. The total principal debt outstanding was $794.0 million and $594.8 million as of September 30, 2017, and 2016, respectively. Our daily weighted average interest rate increased from 2.60% during the nine months September 30, 2016, to 3.12% during the nine months ended September 30, 2017. A summary of interest expense for the nine months ended September 30, 2017, and 2016, is as follows (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine Months Ended September 30,

 

 

 

 

 

 

 

    

2017

    

2016

    

$ Change

    

% Change

 

Interest expense and fees

 

$

18,511

 

$

10,456

 

$

8,055

 

77.0

%

Amortization of deferred financing costs

 

 

1,231

 

 

964

 

 

267

 

27.7

 

Capitalized interest

 

 

(2,230)

 

 

(3,541)

 

 

1,311

 

(37.0)

 

Total interest expense

 

$

17,512

 

$

7,879

 

$

9,633

 

122.3

%

Percent capitalized

 

 

11.3

%  

 

31.0

%  

 

 

 

 

 

 

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Table of Contents

Liquidity and Capital Resources

 

Discussion of Cash Flows

 

Nine Months Ended September 30, 2017, Compared to Nine Months Ended September 30, 2016

 

Operating Activities

 

Net cash provided by operating activities was $151.0 million for the nine months ended September 30, 2017, compared to $122.9 million for the nine months ended September 30, 2016. The increase of $28.1 million, or 23%, was primarily due to the commencement of new and expansion leases of approximately 274,000 NRSF at an average rental rate of $217 per NRSF, the lease renewals of approximately 311,000 NRSF at a rent growth rate of 7.2%, which were partially offset by a decrease in prepaid rent from our customers.

 

Investing Activities

 

Net cash used in investing activities decreased by $115.5 million, or 48%, to $127.0 million for the nine months ended September 30, 2017, compared to $242.5 million for the nine months ended September 30, 2016. This decrease was due primarily to higher construction spend on our SV6 and SV7 properties at our Santa Clara campus during the nine months ended September 30, 2016, compared to construction spend on active development projects and the acquisition of SV8 during the nine months ended September 30, 2017.

 

Financing Activities

 

During the nine months ended September 30, 2017, we received cash proceeds from the 2022 Term Loan, as defined below, and 2024 Notes, as defined below, of $275.0 million and paid down the revolving credit facility by a net amount of $175.0 million.

 

During the nine months ended September 30, 2016, we received cash proceeds from the 2021 senior unsecured term loan and 2023 senior unsecured notes, as defined below, of $250.0 million and paid down the revolving credit facility by a net amount of $47.5 million.

 

We paid $126.2 million in dividends and distributions on our common stock and Operating Partnership units during the nine months ended September 30, 2017, compared to $81.7 million during the nine months ended September 30, 2016, as a result of an increase in the quarterly dividend from $0.53 per share or unit paid during the nine months ended September 30, 2016, to $0.80 per share and unit paid during the six months ended June 30, 2017 and $0.90 per share and unit paid during the three months ended September 30, 2017.

 

Analysis of Liquidity and Capital Resources

 

We have an effective shelf registration statement that allows us to offer for sale various unspecified classes of equity and debt securities. As circumstances warrant, we may issue debt and/or equity securities from time to time on an opportunistic basis, dependent upon market conditions and available pricing. We make no assurance that we can issue and sell such securities on acceptable terms or at all.

 

Our short-term liquidity requirements primarily consist of funds needed for interest expense, operating costs, including utilities, site maintenance costs, real estate and personal property taxes, insurance, rental expenses, sales and marketing and general and administrative expenses, certain capital expenditures, including for the development of data center space and future distributions to common and preferred stockholders and holders of our common Operating Partnership units during the next twelve months. On October 16, 2017, we announced that we intend to redeem all 4,600,000 shares of our outstanding 7.25% Series A cumulative redeemable preferred stock (“Series A Preferred Stock”) on December 12, 2017. The Series A Preferred Stock will be redeemed for $25.00 per share, plus all accrued and unpaid dividends in an amount

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equal to $0.292014 per share, for a total payment of $25.292014 per share, which will be paid from our revolving credit facility.

 

As of September 30, 2017, we had $4.7 million of cash and cash equivalents. Subject to our ability to obtain capital upon favorable terms, we estimate our anticipated development activity over the next twelve months will require approximately $310 million to $330 million of capital investment to expand our operating data center portfolio.

 

Our anticipated capital investment over the next twelve months includes the remaining estimated capital required on our current expansion projects under construction as of September 30, 2017, shown in the table below, as well as commencement of the first phases of development at SV8 and LA3:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Costs

 

 

 

 

 

Metropolitan

 

Estimated

 

 

 

Incurred to-

 

Estimated

 

Per

 

Percent

 

Projects/Facilities

    

Market

    

Completion

    

NRSF

    

Date

    

Total

    

NRSF

    

Leased

 

TKD(1)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

VA1

 

Northern Virginia

 

Q4 2017

 

3,087

 

$

878

 

$

1,700

 

$

551

 

 -

%

BO1

 

Boston

 

Q4 2017

 

13,735

 

 

5,418

 

 

7,800

 

 

568

 

 -

 

VA3 Phase 1A

 

Northern Virginia

 

Q4 2017

 

24,922

 

 

13,929

 

 

22,300

 

 

895

 

 -

 

LA2(2)

 

Los Angeles

 

Q1 2018

 

47,338

 

 

31,154

 

 

45,200

 

 

955

 

78.6

 

LA2

 

Los Angeles

 

Q1 2018

 

39,925

 

 

277

 

 

15,000

 

 

376

 

 -

 

DC2

 

Northern Virginia

 

Q2 2018

 

24,563

 

 

3,758

 

 

17,400

 

 

708

 

 -

 

DE1

 

Denver

 

Q3 2018

 

15,630

 

 

 5

 

 

7,500

 

 

480

 

 -

 

VA3 Phase 1B(2)

 

Northern Virginia

 

Q4 2018

 

49,837

 

 

6,921

 

 

100,200

 

 

2,011

 

 -

 

Total TKD

 

 

 

 

 

219,037

 

$

62,340

 

$

217,100

 

 

 

 

16.4

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deferred Expansion Capital

 

 

 

 

 

 —

 

 

12,478

 

 

18,700

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

 

 

 

 

219,037

 

$

74,818

 

$

235,800

 

 

 

 

 

 


(1)

Turn-Key Data Center (“TKD”) estimated development costs includes two components: (1) general construction to ready the NRSF as data center space and (2) power, cooling and other infrastructure to provide the designed amount of power capacity for the project. Following development completion, incremental capital, referred to as Deferred Expansion Capital, may be invested to support existing or anticipated future customer utilization of NRSF within our operating data centers.

(2)

Includes a portion of the cost of infrastructure to support later phases of the development.

 

We expect to meet our short-term liquidity requirements, including our anticipated development activity over the next twelve months and Series A Preferred Stock redemption, through net cash on hand, cash provided by operations and by incurring additional indebtedness.

 

On February 2, 2016, our Operating Partnership and certain subsidiary co-borrowers entered into the first amendment to the third amended and restated credit agreement (the “Credit Agreement”), which provides a total commitment of $600.0 million, including a $350.0 million revolving credit facility and $250.0 million of term loans. The total amount available for borrowing under our revolving credit facility is equal to the lesser of $350.0 million or the availability calculated on our unencumbered asset pool. As of September 30, 2017, there were $19.0 million of borrowings outstanding, $3.5 million was outstanding under letters of credit, and therefore, $327.5 million remained available for us to borrow under our revolving credit facility. Our Credit Agreement contains an accordion feature which allows our Operating Partnership to increase the total commitment by $200.0 million under specified circumstances, including securing capital from new or existing lenders. Our indebtedness maturity schedule is summarized below.

 

On April 19, 2017, our Operating Partnership and certain subsidiaries amended and restated our $100 million senior unsecured term loan entered into in January 2014 to (i) exercise the accordion feature to increase the total commitments to $200 million and (ii) extend the maturity of the facility from January 31, 2019, to April 19, 2022 (the “2022 Term Loan”). Additionally, on April 20, 2017, our Operating Partnership issued an aggregate principal amount of $175 million, 3.91% senior unsecured notes due April 20, 2024 (the “2024 Notes”) in a private placement to certain accredited investors. The proceeds from these two transactions were used to pay down the revolving credit facility and increase our short-term liquidity. Refer to Item 1. Financial Statements — Note 5 — Debt for additional information.

 

Our long-term liquidity requirements primarily consist of the costs to fund the Reston Campus Expansion, the SV8 and LA3 expansions, Deferred Expansion Capital, additional phases of our current projects under construction, future

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development of other space in our portfolio not currently scheduled, property acquisitions, future distributions to common stockholders and holders of our common Operating Partnership units, scheduled debt maturities and other capital expenditures. We expect to meet our long-term liquidity requirements through net cash provided by operations, after payment of dividends, and by incurring long-term indebtedness, such as drawing on our revolving credit facility, exercising our senior unsecured term loan accordion features or entering into new debt agreements with our bank group or existing and new accredited investors. We also may raise capital in the future through the issuance of additional equity or debt securities, subject to prevailing market conditions, and/or through the issuance of common Operating Partnership units. However, there is no assurance that we will be able to successfully raise additional capital on acceptable terms or at all.

 

Indebtedness

 

A summary of outstanding indebtedness as of September 30, 2017, and December 31, 2016, is as follows (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Maturity

 

September 30,

 

December 31,

 

 

 

Interest Rate

 

Date

 

2017

 

2016

 

Revolving credit facility

    

2.78% and 2.32% at September 30, 2017, and December 31, 2016, respectively

    

June 24, 2019

    

$

19,000

    

$

194,000

 

2020 Senior unsecured term loan

 

2.83% and 2.60% at September 30, 2017, and December 31, 2016, respectively

 

June 24, 2020

 

 

150,000

 

 

150,000

 

2021 Senior unsecured term loan

 

2.73% and 2.27% at September 30, 2017, and December 31, 2016, respectively

 

February 2, 2021

 

 

100,000

 

 

100,000

 

2022 Senior unsecured term loan

 

2.79% and 3.23% at September 30, 2017, and December 31, 2016, respectively

 

April 19, 2022

 

 

200,000

 

 

100,000

 

2023 Senior unsecured notes

 

4.19% at September 30, 2017, and December 31, 2016, respectively

 

June 15, 2023

 

 

150,000

 

 

150,000

 

2024 Senior unsecured notes

 

3.91% at September 30, 2017

 

April 20, 2024

 

 

175,000

 

 

 —

 

Total principal outstanding

 

 

 

 

 

 

794,000

 

 

694,000

 

Unamortized deferred financing costs

 

 

 

 

 

 

(5,213)

 

 

(3,550)

 

Total debt

 

 

 

 

 

$

788,787

 

$

690,450

 

 

As of September 30, 2017, we were in compliance with the financial covenants under our revolving credit facility, senior unsecured term loans and senior unsecured notes. For additional information with respect to our outstanding indebtedness as of September 30, 2017, and December 31, 2016, as well as the available borrowing capacity under our existing revolving credit facility, debt covenant requirements, subsequent debt financing, and future debt maturities, refer to Item 1. Financial Statements — Note 5 — Debt.

 

Funds From Operations

 

We consider funds from operations (“FFO”), a non-GAAP measure, to be a supplemental measure of our performance which should be considered along with, but not as an alternative to, net income and cash provided by operating activities as a measure of operating performance and liquidity. We calculate FFO in accordance with the standards established by the National Association of Real Estate Investment Trusts (“NAREIT”). NAREIT defined FFO represents net income (computed in accordance with GAAP), excluding gains (or losses) from sales of property and undepreciated land and impairment write-downs of depreciable real estate, plus real estate related depreciation and amortization (excluding amortization of deferred financing costs) and after adjustments for unconsolidated partnerships and joint ventures. FFO attributable to common shares and units represents FFO less preferred stock dividends declared during the period.

 

Our management uses FFO as a supplemental performance measure because, in excluding real estate related depreciation and amortization and gains and losses from property dispositions, it provides a performance measure that, when compared year over year, captures trends in occupancy rates, rental rates and operating costs.

 

We offer this measure because we recognize that FFO will be used by investors as a basis to compare our operating performance with that of other REITs. However, because FFO excludes real estate related depreciation and amortization and captures neither the changes in the value of our properties that result from use or market conditions, nor the level of

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capital expenditures and capitalized leasing commissions necessary to maintain the operating performance of our properties, all of which have real economic effect and could materially impact our financial condition and results from operations, the utility of FFO as a measure of our performance is limited. FFO is a non-GAAP measure and should not be considered a measure of liquidity, an alternative to net income, cash provided by operating activities or any other performance measure determined in accordance with GAAP, nor is it indicative of funds available to fund our cash needs, including our ability to pay dividends or make distributions. In addition, our calculations of FFO are not necessarily comparable to FFO as calculated by other REITs that do not use the same definition or implementation guidelines or interpret the NAREIT standards differently from us. Investors in our securities should not rely on these measures as a substitute for any GAAP measure, including net income. The following table provides a reconciliation of our net income to FFO:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended September 30,

 

Nine Months Ended September 30,

 

(in thousands)

    

2017

    

2016

    

2017

    

2016

 

Net income

 

$

24,288

 

$

19,319

 

$

73,483

 

$

58,760

 

Real estate depreciation and amortization

 

 

30,727

 

 

25,533

 

 

92,635

 

 

73,782

 

FFO

 

 

55,015

 

 

44,852

 

 

166,118

 

 

132,542

 

Preferred stock dividends

 

 

(2,084)

 

 

(2,084)

 

 

(6,253)

 

 

(6,253)

 

FFO attributable to common shares and units

 

$

52,931

 

$

42,768

 

$

159,865

 

$

126,289

 

FFO per common share and OP unit - diluted

 

$

1.10

 

$

0.90

 

$

3.34

 

$

 2.65

 

 

Distribution Policy

 

In order to comply with the REIT requirements of the Internal Revenue Code of 1986, as amended (the “Code”), we are generally required to make annual distributions to our stockholders of at least 90% of our net taxable income. Our common share distribution policy is to distribute a percentage of our cash flow to ensure that we will, at a minimum, meet the distribution requirements of the Code while considering other cash requirements, such as capital improvements, investment activities and other capital needs.

 

We have made distributions every quarter since our initial public offering. During the three months ended September 30, 2017, we declared a dividend of $0.90 per common share and Operating Partnership Unit as of September 30, 2017. While we plan to continue to make quarterly distributions, no assurances can be made as to the frequency or amounts of any future distributions. The payment of common share distributions is dependent upon our financial condition, operating results and REIT distribution requirements and may be adjusted at the discretion of our Board of Directors during the year.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Market risk refers to the risk of loss from adverse changes in market prices and interest rates. The primary market risk to which we believe we are exposed is interest rate risk. Our future income, cash flows and fair values relevant to financial instruments are dependent upon prevalent market interest rates. Many factors, including governmental monetary and tax policies, domestic and international economic and political considerations and other factors that are beyond our control contribute to interest rate risk.

 

As of September 30, 2017, we had $469.0 million in aggregate principal amount of consolidated debt outstanding that bore variable interest based on one-month LIBOR. As of September 30, 2017, we have two interest rate swap agreements in place to fix the interest rate on $125.0 million of our one-month LIBOR variable rate debt. Our interest rate risk not covered by an interest rate swap agreement is $344.0 million of variable rate debt outstanding as of September 30, 2017. See additional discussion in Item 1. Financial Statements — Note 6 — Derivatives and Hedging Activities.

 

We monitor our market interest rate risk exposures using a sensitivity analysis. Our sensitivity analysis estimates the exposure to market interest rate risk sensitive instruments assuming a hypothetical 1% change in interest rates on our $344.0 million unhedged variable rate debt. If interest rates were to increase or decrease by 1%, the corresponding increase or decrease, as applicable, in interest expense on our variable rate debt would increase or decrease, as applicable, future earnings and cash flows by approximately $3.4 million per year.

 

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These analyses do not consider the effect of any change in overall economic activity that could impact interest rates. Further, in the event of an increase in interest rates of significant magnitude, we may take actions to further mitigate our exposure to the change. However, due to the uncertainty of the specific actions that would be taken and their possible effects, these analyses assume no changes in our financial structure.

 

ITEM 4. CONTROLS AND PROCEDURES 

 

Evaluation of Disclosure Controls and Procedures

 

We maintain disclosure controls and procedures (as such term is defined in Rule 13a-15(e) and 15d-15(e) under the Exchange Act) that are designed to ensure that information required to be disclosed in our reports under the Exchange Act is processed, recorded, summarized and reported within the time periods specified in the SEC’s rules and regulations and that such information is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

 

As of September 30, 2017, we carried out an evaluation, under the supervision and with the participation of management, including our Chief Executive Officer and our Chief Financial Officer, regarding the effectiveness of our disclosure controls and procedures. Based on the foregoing, our Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures were effective as of September 30, 2017.

 

Changes in Internal Control over Financial Reporting

 

Effective September 5, 2017, we implemented the billing and accounts receivable components of our new accounting and reporting information technology system. Except as noted above, there were no changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15(d)-15(f) under the Exchange Act) that occurred during the three months ended September 30, 2017, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

PART II - OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

 

In the ordinary course of our business, we are subject to claims and administrative proceedings. Except as described below, we are not presently party to any proceeding which we believe to be material or which we would expect to have, individually or in the aggregate, a material adverse effect on our business, financial condition, cash flows or results of operations.

 

On February 4, 2014, U.S. Colo, LLC (“U.S. Colo”), a current customer, filed a complaint against us in the United States District Court for the Central District of California. In the complaint, U.S. Colo alleged that it should not have been charged for the use of various interconnection services under the terms of an existing agreement between the parties.

 

On July 23, 2015, after amendments to the complaint, dismissal of several of U.S. Colo’s claims, and a remand of the case to the Superior Court of the State of California, County of Los Angeles (the “Superior Court”), U.S. Colo filed an amended complaint alleging breach of contract and breach of the covenant of good faith and fair dealing. The amended complaint seeks $802,564 in damages for charges paid to us for interconnection services; $70,080,000 in damages for alleged losses of revenue and profits; attorney’s fees, interest, and costs of the suit; and declaratory and injunctive relief. 

 

On February 4, 2016, the Superior Court granted our motion for summary adjudication, finding that U.S. Colo had contractually waived all claims for lost revenue or profits or other consequential damages.

 

The case was set to start trial on July 24, 2017 (after being rescheduled previously), but upon unopposed application by U.S. Colo, the Superior Court vacated the July 24, 2017, trial date, continued the trial date to April 9, 2018, set a final status conference for March 29, 2018, and reset other procedural deadlines in the action. We intend to vigorously defend this legal proceeding.

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On July 9, 2015, a purported class action lawsuit was filed in the Superior Court of the State of California, County of Los Angeles, against us, alleging various employment law violations related to overtime, meal and break periods, minimum wage, timely payment of wages, wage statements, payroll records and business expenses. On March 15, 2016, we filed a responsive pleading generally denying the allegations. On July 27, 2016, the parties agreed upon class-wide settlement terms, subject to court approval. On June 26, 2017, the Superior Court granted preliminary approval of the parties’ settlement, which resolves the matter on a class-wide basis, on behalf of all non-exempt employees in California. The proposed settlement also resolves a related class action lawsuit filed on July 22, 2016, alleging similar claims. As part of the settlement, we agreed to pay $600,000. The Superior Court set a hearing for November 28, 2017, to determine whether final approval of the settlement will be granted. In the meantime, notice of the proposed settlement has been sent to class members who will then have an opportunity to object or opt out of the settlement. There can be no assurance that the settlement will be finally approved by the Superior Court. We intend to vigorously defend this legal proceeding if the settlement is not approved.

 

ITEM 1A. RISK FACTORS

 

There have been no material changes to the risk factors included in the section entitled “Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2016, filed with the SEC on February 10, 2017, which is accessible on the SEC’s website at www.sec.gov.

 

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 

SALES OF UNREGISTERED EQUITY SECURITIES

 

None.

 

REPURCHASES OF EQUITY SECURITIES

 

None.

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

 

None.

 

ITEM 4. MINE SAFETY DISCLOSURES

 

Not applicable.

 

ITEM 5. OTHER INFORMATION

 

None.

 

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ITEM 6. EXHIBITS

 

 

 

 

Exhibit
Number

    

Description

3.1

 

Articles of Amendment and Restatement of CoreSite Realty Corporation.(1)

 

 

 

3.2

 

Articles Supplementary of CoreSite Realty Corporation — 7.25% Series A Cumulative Redeemable Preferred Stock.(2)

 

 

 

3.3

 

Amended and Restated Bylaws of CoreSite Realty Corporation.(4)

 

 

 

4.1

 

Specimen certificate representing the Common Stock of CoreSite Realty Corporation.(3)

 

 

 

31.1

 

Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

 

 

31.2

 

Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

 

 

32.1

 

Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

 

 

32.2

 

Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

 

 

101.INS

 

XBRL Instance Document.

 

 

 

101.SCH

 

XBRL Taxonomy Extension Schema Document.

 

 

 

101.CAL

 

XBRL Taxonomy Extension Calculation Linkbase Document.

 

 

 

101.LAB

 

XBRL Taxonomy Extension Labels Linkbase Document.

 

 

 

101.PRE

 

XBRL Taxonomy Extension Presentation Linkbase Document.

 

 

 

101.DEF

 

XBRL Taxonomy Extension Definition Linkbase Document.


(1)

Incorporated by reference to our Registration Statement (Amendment No. 7) on Form S-11 (Registration No. 333-166810) filed on September 22, 2010.

(2)

Incorporated by reference to Exhibit 3.1 to our Current Report on Form 8-K filed on December 18, 2012.

(3)

Incorporated by reference to our Post-Effective Amendment to our Registration Statement on Form S-11 (Registration No. 333-166810) filed on September 22, 2010.

(4)

Incorporated by reference to our Current Report on Form 8-K filed on March 9, 2017.

 

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Exhibit Index

 

 

 

 

Exhibit
Number

    

Description

3.1

 

Articles of Amendment and Restatement of CoreSite Realty Corporation.(1)

 

 

 

3.2

 

Articles Supplementary of CoreSite Realty Corporation — 7.25% Series A Cumulative Redeemable Preferred Stock.(2)

 

 

 

3.3

 

Amended and Restated Bylaws of CoreSite Realty Corporation.(4)

 

 

 

4.1

 

Specimen certificate representing the Common Stock of CoreSite Realty Corporation.(3)

 

 

 

31.1

 

Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

 

 

31.2

 

Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

 

 

32.1

 

Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

 

 

32.2

 

Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

 

 

101.INS

 

XBRL Instance Document.

 

 

 

101.SCH

 

XBRL Taxonomy Extension Schema Document.

 

 

 

101.CAL

 

XBRL Taxonomy Extension Calculation Linkbase Document.

 

 

 

101.LAB

 

XBRL Taxonomy Extension Labels Linkbase Document.

 

 

 

101.PRE

 

XBRL Taxonomy Extension Presentation Linkbase Document.

 

 

 

101.DEF

 

XBRL Taxonomy Extension Definition Linkbase Document.


(1)

Incorporated by reference to our Registration Statement (Amendment No. 7) on Form S-11 (Registration No. 333-166810) filed on September 22, 2010.

(2)

Incorporated by reference to Exhibit 3.1 to our Current Report on Form 8-K filed on December 18, 2012.

(3)

Incorporated by reference to our Post-Effective Amendment to our Registration Statement on Form S-11 (Registration No. 333-166810) filed on September 22, 2010.

(4)

Incorporated by reference to our Current Report on Form 8-K filed on March 9, 2017.

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

 

 

 

 

 

    

CORESITE REALTY CORPORATION

 

 

 

 

 

 

Date: October 27, 2017

 

By:

/s/ Jeffrey S. Finnin

 

 

 

Jeffrey S. Finnin

 

 

 

Chief Financial Officer

 

 

 

(Principal Financial Officer)

 

 

 

44