Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

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

 

For the quarterly period ended September 30, 2014

 

o         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
(State or other jurisdiction
of incorporation or organization)

 

27-1925611
(I.R.S. Employer
Identification No.)

 

 

 

1001 17th Street, Suite 500
Denver, CO

(Address of principal executive offices)

 

80202
(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 x  No o.

 

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 x  No o

 

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

 

Large accelerated filer o

 

Accelerated filer x

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

(Do not check if a smaller reporting company)

 

 

 

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

 

The number of shares of common stock outstanding at October 29, 2014, was 21,711,368.

 

 

 



Table of Contents

 

CORESITE REALTY CORPORATION

FORM 10-Q

FOR THE QUARTER ENDED SEPTEMBER 30, 2014

TABLE OF CONTENTS

 

 

PAGE

 

NO.

 

 

PART I. FINANCIAL INFORMATION

3

 

 

ITEM 1. Financial Statements

3

 

 

Condensed Consolidated Balance Sheets as of September 30, 2014, and December 31, 2013 (unaudited)

3

 

 

Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2014, and 2013 (unaudited)

4

 

 

Condensed Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2014, and 2013 (unaudited)

5

 

 

Condensed Consolidated Statement of Equity for the nine months ended September 30, 2014 (unaudited)

6

 

 

Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2014, and 2013 (unaudited)

7

 

 

Notes to Condensed Consolidated Financial Statements (unaudited)

8

 

 

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

19

 

 

ITEM 3. Quantitative and Qualitative Disclosures About Market Risk

29

 

 

ITEM 4. Controls and Procedures

30

 

 

PART II. OTHER INFORMATION

30

 

 

ITEM 1. Legal Proceedings

30

 

 

ITEM 1A. Risk Factors

30

 

 

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

30

 

 

ITEM 3. Defaults Upon Senior Securities

31

 

 

ITEM 4. Mine Safety Disclosures

31

 

 

ITEM 5. Other Information

31

 

 

ITEM 6. Exhibits

31

 

 

Signatures

32

 

 

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 data)

 

 

 

September 30,

 

December 31,

 

 

 

2014

 

2013

 

ASSETS

 

 

 

 

 

Investments in real estate:

 

 

 

 

 

Land

 

$

79,929

 

$

78,983

 

Building and building improvements

 

772,791

 

717,007

 

Leasehold improvements

 

102,267

 

95,218

 

 

 

954,987

 

891,208

 

Less: Accumulated depreciation and amortization

 

(200,588

)

(155,704

)

Net investment in operating properties

 

754,399

 

735,504

 

Construction in progress

 

171,476

 

157,317

 

Net investments in real estate

 

925,875

 

892,821

 

Cash and cash equivalents

 

9,268

 

5,313

 

Accounts and other receivables, net of allowance for doubtful accounts of $436 and $159 as of September 30, 2014, and December 31, 2013, respectively

 

11,279

 

10,339

 

Lease intangibles, net of accumulated amortization of $14,100 and $17,646 as of September 30, 2014, and December 31, 2013, respectively

 

7,940

 

11,028

 

Goodwill

 

41,191

 

41,191

 

Other assets

 

67,145

 

55,802

 

Total assets

 

$

1,062,698

 

$

1,016,494

 

 

 

 

 

 

 

LIABILITIES AND EQUITY

 

 

 

 

 

Liabilities:

 

 

 

 

 

Revolving credit facility

 

$

205,250

 

$

174,250

 

Senior unsecured term loan

 

100,000

 

 

Mortgage loan payable

 

 

58,250

 

Accounts payable and accrued expenses

 

38,979

 

48,978

 

Accrued dividends and distributions

 

18,968

 

18,804

 

Deferred rent payable

 

9,196

 

9,646

 

Acquired below-market lease contracts, net of accumulated amortization of $4,456 and $4,361 as of September 30, 2014, and December 31, 2013, respectively

 

5,808

 

6,681

 

Prepaid rent and other liabilities

 

18,161

 

11,578

 

Total liabilities

 

396,362

 

328,187

 

 

 

 

 

 

 

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, 2014, and December 31, 2013

 

115,000

 

115,000

 

Common Stock, par value $0.01, 100,000,000 shares authorized and 21,721,807 and 21,387,152 shares issued and outstanding at September 30, 2014, and December 31, 2013, respectively

 

212

 

209

 

Additional paid-in capital

 

272,771

 

267,465

 

Accumulated other comprehensive income

 

200

 

 

Distributions in excess of net income

 

(63,084

)

(50,264

)

Total stockholders’ equity

 

325,099

 

332,410

 

Noncontrolling interests

 

341,237

 

355,897

 

Total equity

 

666,336

 

688,307

 

Total liabilities and equity

 

$

1,062,698

 

$

1,016,494

 

 

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,

 

 

 

2014

 

2013

 

2014

 

2013

 

Operating revenues:

 

 

 

 

 

 

 

 

 

Data center revenue:

 

 

 

 

 

 

 

 

 

Rental revenue

 

$

38,315

 

$

33,428

 

$

110,152

 

$

97,092

 

Power revenue

 

18,687

 

15,979

 

51,264

 

43,994

 

Interconnection revenue

 

9,169

 

7,441

 

25,819

 

21,066

 

Tenant reimbursement and other

 

2,328

 

1,873

 

6,711

 

5,432

 

Office, light industrial and other revenue

 

2,016

 

1,914

 

5,982

 

5,809

 

Total operating revenues

 

70,515

 

60,635

 

199,928

 

173,393

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Property operating and maintenance

 

20,043

 

17,368

 

54,866

 

47,013

 

Real estate taxes and insurance

 

3,073

 

2,226

 

5,059

 

6,750

 

Depreciation and amortization

 

20,914

 

16,424

 

58,300

 

48,634

 

Sales and marketing

 

3,806

 

3,206

 

11,141

 

10,931

 

General and administrative

 

7,145

 

7,045

 

21,582

 

20,225

 

Rent

 

5,113

 

5,082

 

15,249

 

14,631

 

Impairment of internal-use software

 

 

 

1,959

 

 

Transaction costs

 

49

 

25

 

62

 

279

 

Total operating expenses

 

60,143

 

51,376

 

168,218

 

148,463

 

Operating income

 

10,372

 

9,259

 

31,710

 

24,930

 

Interest income

 

1

 

14

 

5

 

18

 

Interest expense

 

(1,361

)

(708

)

(3,949

)

(1,930

)

Income before income taxes

 

9,012

 

8,565

 

27,766

 

23,018

 

Income tax expense

 

(22

)

(56

)

(20

)

(435

)

Net income

 

$

8,990

 

$

8,509

 

$

27,746

 

$

22,583

 

Net income attributable to noncontrolling interests

 

3,759

 

3,524

 

11,730

 

8,962

 

Net income attributable to CoreSite Realty Corporation

 

$

5,231

 

$

4,985

 

$

16,016

 

$

13,621

 

Preferred stock dividends

 

(2,084

)

(2,084

)

(6,253

)

(6,253

)

Net income attributable to common shares

 

$

3,147

 

$

2,901

 

$

9,763

 

$

7,368

 

Net income per share attributable to common shares:

 

 

 

 

 

 

 

 

 

Basic

 

$

0.15

 

$

0.14

 

$

0.46

 

$

0.35

 

Diluted

 

$

0.14

 

$

0.14

 

$

0.45

 

$

0.34

 

Weighted average common shares outstanding

 

 

 

 

 

 

 

 

 

Basic

 

21,214,825

 

20,871,504

 

21,113,700

 

20,793,596

 

Diluted

 

21,708,759

 

21,479,971

 

21,679,931

 

21,465,710

 

 

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,

 

 

 

2014

 

2013

 

2014

 

2013

 

Net income

 

$

8,990

 

$

8,509

 

$

27,746

 

$

22,583

 

Other comprehensive income (loss):

 

 

 

 

 

 

 

 

 

Unrealized gain (loss) on derivative contracts

 

397

 

 

(357

)

 

Reclassification of other comprehensive income to interest expense

 

340

 

 

795

 

 

Comprehensive income

 

9,727

 

8,509

 

28,184

 

22,583

 

Comprehensive income attributable to noncontrolling interests

 

4,160

 

3,524

 

11,968

 

8,962

 

Comprehensive income attributable to CoreSite Realty Corporation

 

$

5,567

 

$

4,985

 

$

16,216

 

$

13,621

 

 

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

 

Net Income

 

Equity

 

Interests

 

Equity

 

Balance at January 1, 2014

 

$

115,000

 

21,387,152

 

$

209

 

$

267,465

 

$

 

$

(50,264

)

$

332,410

 

$

355,897

 

$

688,307

 

Issuance of stock awards, net of forfeitures

 

 

192,982

 

 

 

 

 

 

 

 

Exercise of stock options

 

 

141,673

 

1

 

144

 

 

 

145

 

 

145

 

Share-based compensation

 

 

 

2

 

5,162

 

 

 

5,164

 

 

5,164

 

Dividends declared on preferred stock

 

 

 

 

 

 

(6,253

)

(6,253

)

 

(6,253

)

Dividends and distributions

 

 

 

 

 

 

(22,583

)

(22,583

)

(26,628

)

(49,211

)

Net income

 

 

 

 

 

 

16,016

 

16,016

 

11,730

 

27,746

 

Other comprehensive income

 

 

 

 

 

200

 

 

200

 

238

 

438

 

Balance at September 30, 2014

 

$

115,000

 

21,721,807

 

$

212

 

$

272,771

 

$

200

 

$

(63,084

)

$

325,099

 

$

341,237

 

$

666,336

 

 

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,

 

 

 

2014

 

2013

 

CASH FLOWS FROM OPERATING ACTIVITIES

 

 

 

 

 

Net income

 

$

27,746

 

$

22,583

 

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

 

 

 

 

 

Depreciation and amortization

 

58,300

 

48,634

 

Amortization of above/below market leases

 

(438

)

(672

)

Amortization of deferred financing costs

 

1,477

 

1,293

 

Share-based compensation

 

4,766

 

5,337

 

Bad debt expense

 

826

 

241

 

Changes in operating assets and liabilities:

 

 

 

 

 

Accounts receivable

 

(1,766

)

(1,435

)

Deferred rent receivable

 

(2,728

)

(1,660

)

Deferred leasing costs

 

(15,540

)

(5,373

)

Other assets

 

35

 

(2,713

)

Accounts payable and accrued expenses

 

(4,264

)

3,361

 

Prepaid rent and other liabilities

 

6,582

 

380

 

Deferred rent payable

 

(450

)

5,250

 

Net cash provided by operating activities

 

74,546

 

75,226

 

CASH FLOWS FROM INVESTING ACTIVITIES

 

 

 

 

 

Tenant improvements

 

(5,040

)

(5,214

)

Real estate improvements

 

(82,118

)

(117,964

)

Acquisition of NY2

 

 

(21,889

)

Net cash used in investing activities

 

(87,158

)

(145,067

)

CASH FLOWS FROM FINANCING ACTIVITIES

 

 

 

 

 

Proceeds from exercise of stock options

 

1,555

 

630

 

Offering costs

 

(24

)

(27

)

Proceeds from revolving credit facility

 

72,000

 

108,000

 

Payments on revolving credit facility

 

(41,000

)

 

Proceeds from senior unsecured term loan

 

100,000

 

 

Repayments of mortgage loans payable

 

(58,250

)

(1,125

)

Payments of loan fees and costs

 

(1,000

)

(2,621

)

Payments to net settle equity awards

 

(1,410

)

 

Dividends and distributions

 

(55,304

)

(42,444

)

Net cash provided by financing activities

 

16,567

 

62,413

 

Net change in cash and cash equivalents

 

3,955

 

(7,428

)

Cash and cash equivalents, beginning of period

 

5,313

 

8,130

 

Cash and cash equivalents, end of period

 

$

9,268

 

$

702

 

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

 

 

 

 

 

Cash paid for interest, net of capitalized amounts

 

$

2,958

 

$

1,250

 

NON-CASH INVESTING AND FINANCING ACTIVITY

 

 

 

 

 

Construction costs payable capitalized to real estate

 

$

13,086

 

$

32,291

 

Accrual of dividends and distributions

 

$

18,968

 

$

15,051

 

 

See accompanying notes to condensed consolidated financial statements.

 

7



Table of Contents

 

CORESITE REALTY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2014

(unaudited)

 

1. Organization and Description of Business

 

CoreSite Realty Corporation (the “Company,” “we,” 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 managing data centers. As of September 30, 2014, the Company owns a 45.6% common interest in our Operating Partnership and affiliates of The Carlyle Group and others own a 54.4% interest in our Operating Partnership. See additional discussion in Note 8.

 

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 United States 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 nine months ended September 30, 2014, are not necessarily indicative of the expected results for the year ending December 31, 2014. 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, 2013. Intercompany balances and transactions have been eliminated.

 

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

 

Adjustments and Reclassifications

 

Office, light industrial and other revenue, included within the condensed consolidated statements of operations for the three and nine months ended September 30, 2013, and accrued dividends and distributions, included with the condensed consolidated balance sheet as December 31, 2013, have been reclassified to conform to the 2014 financial statement presentation. In addition, certain other immaterial amounts included in the condensed consolidated financial statements for 2013 have been reclassified to conform to the 2014 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 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 $1.2 million and $1.1 million for the three months ended September 30, 2014, and 2013, respectively, and $3.4 million and $3.0 million for the nine months ended September 30, 2014, and 2013, 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

 

 

8



Table of Contents

 

Depreciation expense was $16.8 million and $13.7 million for the three months ended September 30, 2014, and 2013, respectively, and $47.7 million and $38.9 million for the nine months ended September 30, 2014, and 2013, respectively.

 

Acquisition of Investment in Real Estate

 

Purchase accounting is applied to the assets and liabilities related to all real estate investments acquired. 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 fair market lease rates for the corresponding in-place leases, measured over a period equal to the remaining non-cancelable term of the lease and, for below-market leases, over a 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.

 

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 income, 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 and amortization for lease origination costs and customer relationships are recorded as amortization 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 and nine months ended September 30, 2014, and 2013.

 

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, 2014, and December 31, 2013, we had approximately $41.2 million of goodwill at each date. 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 and nine months ended September 30, 2014, and 2013.

 

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 leasing 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 terms of the related leases using the straight-line method. If a 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 sheet and consisted of the following, net of amortization, as of September 30, 2014, and December 31, 2013 (in thousands):

 

 

 

September 30,

 

December 31,

 

 

 

2014

 

2013

 

Internal sales commissions

 

$

10,518

 

$

7,530

 

Third party commissions

 

12,969

 

6,328

 

External legal counsel

 

335

 

301

 

 

 

$

23,822

 

$

14,159

 

 

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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 are included as a component of interest expense.

 

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 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, 2014, and 2013, no real estate impairment was recognized.

 

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 hedge 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.

 

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.

 

During the three and nine months ended September 30, 2014, we recognized $0 and $2.0 million related to an impairment of internal use software, respectively, in the condensed consolidated statements of operations. The impairment is a result of internal-use software previously under development that was discontinued during the period and will not be placed into service. No impairment was recognized during the three and nine months ended September 30, 2013.

 

During the nine months ended September 30, 2014, we revised the remaining useful life of certain internal-use software from six years to one year. As of September 30, 2014, the remaining net book value of this internal-use software was $2.6 million and it will be fully amortized as of June 30, 2015.

 

Revenue Recognition

 

All customer leases are classified as operating leases and minimum rents are recognized on a straight-line basis over the non-cancellable term of the agreements. The excess of rents recognized over amounts contractually due pursuant to the underlying leases are included in deferred rent receivable. If a lease terminates prior to its stated expiration, the deferred rent receivable relating to that lease is written off as a reduction of rental revenue.

 

When arrangements include multiple elements, the revenue associated with separate elements is allocated based on the relative fair values of those elements. The revenue associated with each element is then recognized as earned. Interconnection services and additional space services are considered as separate earnings processes that are provided and completed on a month-to-month basis and revenue is recognized in the period that services are performed. Customer set-up charges and utility installation fees are initially deferred and recognized over the term of the arrangement as revenue.

 

Tenant reimbursements for real estate taxes, common area maintenance, and other recoverable costs are recognized as revenue in the period that the related expenses are incurred.

 

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 non-cancellable term of the underlying leases. For the three months ended September 30, 2014, and 2013, the net effect of amortization of acquired above-market and below-market leases resulted in an increase to rental revenue of $0.3 million and $0.2 million, respectively. For the nine months ended September 30, 2014, and 2013, the net effect of amortization of acquired above-market and below-market leases resulted in an increase to rental income of $0.4 million and $0.7 million, respectively.

 

A provision for uncollectible accounts is recorded if a receivable balance relating to contractual rent, rent recorded on a straight-line basis, or

 

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tenant reimbursements is considered by management to be uncollectible. At September 30, 2014, and December 31, 2013, the allowance for doubtful accounts totaled $0.4 million and $0.2 million, respectively.

 

In May 2014, the FASB issued guidance codified in Accounting Standards Codification (“ASC”) 606, Revenue Recognition — Revenue from Contracts with Customers, which amends the guidance in former ASC 605, Revenue Recognition. The standard is effective for interim and annual reporting periods beginning after December 15, 2016. The standard permits the use of either the retrospective or cumulative effect transition method. We are currently evaluating the impact of the provisions of ASC 606 on our revenue recognition policies.

 

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 Black-Scholes option-pricing model. The fair value of restricted share-based and Operating Partnership unit compensation is based on the market 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 retirement and environmental remediation obligations. The obligations relate primarily to the removal of asbestos and contaminated soil 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, 2014, and December 31, 2013, the amount included in prepaid rent and other liabilities on the condensed consolidated balance sheets was approximately $2.3 million and $2.2 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 financial statements for federal income taxes with regards to activities of the REIT and its subsidiary pass-through entities. The allocable share of 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 not 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, 2014, and December 31, 2013, 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 2010. Prior to their contribution to our Operating Partnership, our subsidiaries were treated as pass-through entities for tax purposes and 2010 also is the earliest year subject to examination with respect to our subsidiaries.

 

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 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.

 

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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 at September 30, 2014 (in thousands):

 

 

 

 

 

 

 

Buildings and

 

Leasehold

 

Construction

 

 

 

Property Name

 

Location

 

Land

 

Improvements

 

Improvements

 

in Progress

 

Total Cost

 

SV1

 

San Jose, CA

 

$

6,863

 

$

124,759

 

$

 

$

1,223

 

$

132,845

 

SV2

 

Milpitas, CA

 

5,086

 

24,885

 

 

1,124

 

31,095

 

SV3

 

Santa Clara, CA

 

3,972

 

46,903

 

 

192

 

51,067

 

SV4

 

Santa Clara, CA

 

4,442

 

88,082

 

 

228

 

92,752

 

SV5

 

Santa Clara, CA

 

2,544

 

20,428

 

 

 

22,972

 

Santa Clara Campus(1)

 

Santa Clara, CA

 

8,173

 

8,221

 

 

13,661

 

30,055

 

BO1

 

Somerville, MA

 

6,100

 

79,136

 

 

2,500

 

87,736

 

NY1

 

New York, NY

 

 

 

33,216

 

313

 

33,529

 

NY2

 

Secaucus, NJ

 

1,158

 

43,638

 

 

65,657

 

110,453

 

VA1

 

Reston, VA

 

6,903

 

108,554

 

 

6,798

 

122,255

 

VA2

 

Reston, VA

 

 

 

 

74,931

 

74,931

 

DC1

 

Washington, DC

 

 

 

7,782

 

243

 

8,025

 

CH1

 

Chicago, IL

 

5,493

 

83,531

 

 

434

 

89,458

 

LA1

 

Los Angeles, CA

 

 

 

59,192

 

3,125

 

62,317

 

LA2

 

Los Angeles, CA

 

28,467

 

134,591

 

 

769

 

163,827

 

MI1

 

Miami, FL

 

728

 

10,063

 

 

86

 

10,877

 

DE1

 

Denver, CO

 

 

 

1,201

 

115

 

1,316

 

DE2

 

Denver, CO

 

 

 

876

 

77

 

953

 

Total

 

 

 

$

79,929

 

$

772,791

 

$

102,267

 

$

171,476

 

$

1,126,463

 

 


(1)                   This campus includes office and light-industrial buildings and land held for development in Santa Clara, CA.

 

4. Other Assets

 

Our other assets consisted of the following, net of amortization and depreciation, if applicable, as of September 30, 2014, and December 31, 2013 (in thousands):

 

 

 

September 30,

 

December 31,

 

 

 

2014

 

2013

 

Deferred leasing costs

 

$

23,822

 

$

14,159

 

Deferred rent receivable

 

19,993

 

17,265

 

Corporate furniture, fixtures and equipment

 

7,930

 

7,346

 

Internal-use software

 

8,604

 

8,525

 

Deferred financing costs

 

2,841

 

3,312

 

Other

 

3,955

 

5,195

 

Total

 

$

67,145

 

$

55,802

 

 

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5.           Debt

 

A summary of outstanding indebtedness as of September 30, 2014, and December 31, 2013, is as follows (in thousands):

 

 

 

 

 

Maturity

 

September 30,

 

December 31,

 

 

 

Interest Rate

 

Date

 

2014

 

2013

 

Revolving credit facility

 

2.16% and 2.17% at September 30, 2014, and December 31, 2013, respectively

 

January 3, 2017

 

$

205,250

 

$

174,250

 

Senior unsecured term loan

 

3.23% at September 30, 2014

 

January 31, 2019

 

100,000

 

 

SV1 - Mortgage loan

 

Repaid on January 31, 2014, and 3.67% at December 31, 2013

 

N/A

 

 

58,250

 

Total principal outstanding

 

 

 

 

 

$

305,250

 

$

232,500

 

 

Revolving Credit Facility

 

On January 3, 2013, our Operating Partnership and certain subsidiary co-borrowers entered into a second amended and restated senior unsecured revolving credit facility (the “Credit Agreement”) with a group of lenders for which KeyBank National Association acts as the administrative agent. The Credit Agreement maturity date is January 3, 2017, with a one-time extension option, which, if exercised, would extend the maturity date to January 3, 2018. The exercise of the extension option is subject to the payment of an extension fee equal to 25 basis points of the total commitment under the Credit Agreement at initial maturity and certain other customary conditions. The Credit Agreement contains an accordion feature, which allows our Operating Partnership to increase the total commitment from $405 million to $500 million, under specified circumstances.

 

Under the Credit Agreement, our Operating Partnership may elect to have borrowings bear interest at a rate per annum equal to (i) LIBOR plus 200 basis points to 275 basis points, or (ii) a base rate plus 100 basis points to 175 basis points, each depending on our Operating Partnership’s leverage ratio. At September 30, 2014, the Operating Partnership’s leverage ratio was 17.5% and the interest rate was LIBOR plus 200 basis points.

 

The total amount available for borrowings under the Credit Agreement is subject to the lesser of the facility amount or the availability calculated based on our unencumbered asset pool. As of September 30, 2014, the borrowing capacity was $405 million. As of September 30, 2014, $205.3 million was borrowed and outstanding, $7.3 million was outstanding letters of credit and $192.4 million remained available for us to borrow under the Credit Agreement.

 

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, 2014, was 17.5%;

·                  a maximum secured debt ratio (defined as total consolidated secured debt to total gross asset value) of 40%, which, as of September 30, 2014, was 0%;

·                  a minimum fixed charge coverage ratio (defined as adjusted consolidated earnings before interest, taxes, depreciation and amortization to consolidated fixed charges) of 1.75 to 1.00, which, as of September 30, 2014, was 7.68% to 1.00; 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, 2014, was 11.5%.

 

As of September 30, 2014, we were in compliance with all of the covenants under the Credit Agreement.

 

Senior Unsecured Term Loan

 

On January 31, 2014, our Operating Partnership and certain subsidiaries entered into a $100 million senior unsecured term loan (the “Term Loan”). The Term Loan has a five-year term and contains an accordion feature, which allows our Operating Partnership to increase the total commitments by $100 million, to $200 million, under specified circumstances. The Term Loan ranks pari passu with our Credit Agreement and contains the same financial covenants and other customary restrictive covenants. As of September 30, 2014, we were in compliance with the covenants under the Term Loan.

 

The borrowings under the Term Loan bear interest at a rate per annum equal to (i) LIBOR plus 175 basis points to 265 basis points, or (ii) a base rate plus 75 basis points to 165 points, each depending on our Operating Partnership’s leverage ratio. At September 30, 2014, the Operating Partnership’s leverage ratio was 17.5% and the interest rate was LIBOR plus 175 basis points.

 

On February 3, 2014, we entered into a $100 million interest rate swap agreement to hedge one-month LIBOR variable rate debt, which includes the Term Loan and, if the Term Loan is repaid prior to maturity, the revolving credit facility under the Credit Agreement. The interest rate swap

 

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has a five-year term and, at our current leverage ratio, effectively fixes the Term Loan interest rate at 3.23%. See additional discussion in Note 6.

 

On January 31, 2014, we repaid the SV1 Mortgage loan in its entirety using the proceeds from the Term Loan.

 

Debt Maturities

 

The following table summarizes the amount of our outstanding debt as of September 30, 2014, when such debt currently becomes due (in thousands):

 

Year Ending December 31,

 

 

 

Remainder of 2014

 

$

 

2015

 

 

2016

 

 

2017

 

205,250

 

2018

 

 

2019

 

100,000

 

Total

 

$

305,250

 

 

6.           Derivatives and Hedging Activities

 

On February 3, 2014, we entered into a $100 million interest rate swap agreement to protect against adverse fluctuations in interest rates by reducing our exposure to variability in cash flows relating to interest payments on $100 million of one-month LIBOR variable rate debt. The interest rate swap was designated for hedge accounting. This interest rate swap is our only derivative outstanding as of September 30, 2014, and there were none outstanding as of December 31, 2013.

 

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.

 

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. During the nine months ended September 30, 2014, the amount recorded in accumulated other comprehensive income was a gain of $0.4 million. The amount reclassified to interest expense on the condensed consolidated statements of operations was $0.3 million and none for the three months ended September 30, 2014, and 2013, respectively, and was $0.8 million and none for the nine months ended September 30, 2014, and 2013, respectively. The ineffective portion of the change in fair value of the derivatives is recognized directly in earnings. During the three and nine months ended September 30, 2014, and 2013, we did not record any amount in earnings 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, we estimate that $1.2 million will be reclassified as an increase to interest expense.

 

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Derivatives are recorded at fair value in our condensed consolidated balance sheets in other assets and other liabilities, as applicable. We do not net our derivative position by counterparty for purposes of balance sheet presentation and disclosure. We had a $0.4 million derivative asset recognized in other assets in our condensed consolidated balance sheet as of September 30, 2014.

 

7.           Stockholders’ Equity

 

We have paid the following dividends per share on our Series A Cumulative Preferred Stock and common shares during the nine months ended September 30, 2014:

 

Declaration Date

 

Record Date

 

Payment Date

 

Preferred Stock

 

Common Shares

 

March 6, 2014

 

March 31, 2014

 

April 15, 2014

 

$

0.4531

(1)

$

0.35

 

May 30, 2014

 

June 30, 2014

 

July 15, 2014

 

0.4531

(2)

0.35

 

August 29, 2014

 

September 30, 2014

 

October 15, 2014

 

0.4531

(3)

0.35

 

 

 

 

 

 

 

$

1.3593

 

$

1.05

 

 


(1)  Dividend covers the period from January 15, 2014, to April 14, 2014.

(2)  Dividend covers the period from April 15, 2014, to July 14, 2014.

(3)  Dividend covers the period from July 15, 2014, to October 14, 2014.

 

8.           Noncontrolling Interests — Operating Partnership

 

Noncontrolling interests represent the limited partnership interests in the Operating Partnership held by individuals and entities other than CoreSite Realty Corporation. Since September 28, 2011, the current holders of Common Operating Partnership units have been eligible to have the Common Operating Partnership units redeemed for common stock on a one-for-one basis or cash, at our option. Preferred Operating Partnership units rank senior to the Common Operating Partnership units held by both the Company and noncontrolling interests.

 

The following table shows the ownership interests in the Operating Partnership as of September 30, 2014, and December 31, 2013:

 

 

 

September 30, 2014

 

December 31, 2013

 

 

 

Number of Units

 

Percentage of Total

 

Number of Units

 

Percentage of Total

 

The Company

 

21,235,555

 

45.6

%

20,896,685

 

45.2

%

Noncontrolling interests

 

25,360,847

 

54.4

%

25,360,847

 

54.8

%

Total

 

46,596,402

 

100.0

%

46,257,532

 

100.0

%

 

For each share of common stock issued by the Company, the Operating Partnership issues an equivalent Common Operating Partnership unit to the Company. During the nine months ended September 30, 2014, the Company issued 338,870 shares of common stock related to employee compensation arrangements and therefore an equivalent number of Common Operating Partnership units were issued to the Company by the Operating Partnership.

 

Holders of Common Operating Partnership units of record as of September 30, 2014, will receive quarterly distributions of $0.35 per unit, which correlates to dividends paid on common shares.

 

The redemption value of the noncontrolling interests at September 30, 2014, was $833.6 million based on the closing price of the Company’s common stock of $32.87 on that date.

 

9.           Equity Incentive Plan

 

The Company’s Board of Directors has adopted and, with the consent of the Company’s stockholders, amended the 2010 Equity Incentive Plan (as amended, the “2010 Plan”). The 2010 Plan is administered by the Compensation Committee of the Board of Directors. Awards issuable under the 2010 Plan include common stock, stock options, restricted stock, stock appreciation rights, dividend equivalents 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 unexercised shares subject to the award will be available for future grant or sale under the 2010 Plan. Shares of restricted stock which are forfeited or repurchased by us pursuant to the 2010 Plan may again be optioned, granted or 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.

 

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As of September 30, 2014, 3,550,688 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 at 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.

 

The following table sets forth stock option activity under the 2010 Plan for the nine months ended September 30, 2014:

 

 

 

Number of

 

Weighted

 

 

 

Shares Subject

 

Average Exercise

 

 

 

to Options

 

Price

 

Options outstanding, December 31, 2013

 

1,133,915

 

$

19.89

 

Granted

 

 

 

Exercised

 

(259,605

)

15.98

 

Forfeited

 

(64,148

)

25.95

 

Expired

 

(3,947

)

15.80

 

Options outstanding, September 30, 2014

 

806,215

 

$

20.68

 

 

The following table sets forth the number of shares subject to options that are unvested as of September 30, 2014, and the fair value of these options at the grant date:

 

 

 

Number of

 

Weighted

 

 

 

Shares Subject

 

Average Fair

 

 

 

to Options

 

Value at Grant

 

Unvested balance, December 31, 2013

 

635,739

 

$

7.10

 

Granted

 

 

 

Forfeited

 

(64,148

)

8.07

 

Vested

 

(284,257

)

6.25

 

Unvested balance, September 30, 2014

 

287,334

 

$

7.72

 

 

As of September 30, 2014, total unearned compensation on options was approximately $1.6 million, and the weighted-average vesting period was 1.5 years.

 

Restricted Awards and Units

 

During the nine months ended September 30, 2014, the Company granted 204,686 shares of restricted stock which had a value of $6.5 million on the grant date. Also during the nine months ended September 30, 2014, the Company issued 10,668 restricted stock units, or RSUs. The principal difference between these instruments is that RSUs are not shares of the Company’s 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 awards will be amortized on a straight-line basis to expense over the vesting period. The following table sets forth the number of unvested restricted awards and RSUs and the weighted average fair value of these awards at the date of grant:

 

 

 

 

 

Weighted

 

 

 

Restricted

 

Average Fair

 

 

 

Awards

 

Value at Grant

 

Unvested balance, December 31, 2013

 

495,151

 

$

25.08

 

Granted

 

215,354

 

31.56

 

Forfeited

 

(97,555

)

27.28

 

Vested

 

(202,953

)

22.80

 

Unvested balance, September 30, 2014

 

409,997

 

$

29.08

 

 

As of September 30, 2014, total unearned compensation on restricted awards was approximately $9.5 million, and the weighted-average vesting period was 2.3 years.

 

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Performance Stock Awards

 

On March 4, 2014, the Company granted long-term incentives to the Company’s executive officers in the form of performance-based restricted stock awards (“PSAs”) under the 2010 Plan. The number of PSAs earned is based on the Company’s achievement of relative total shareholder return (“TSR”) measured versus the MSCI US REIT Index over a three-year performance period, and the number of shares earned under the PSAs may range from 0% to 150%. The PSAs are earned as follows: (i) 20% of the PSAs are eligible to be earned upon TSR achievement in year one of the performance period, (ii) 20% of the PSAs are eligible to be earned upon TSR achievement in year two of the performance period, (iii) 20% of the PSAs are earned upon TSR achievement in year three of the performance period, and (iv) 40% of the PSAs are eligible to be earned upon a cumulative TSR achievement over the three-year performance period. The PSAs have a service condition and will be released at the end of the three-year performance period provided that the executive continues to be employed by the Company at the end of the three-year performance period. Holders of the PSAs are entitled to dividends on the PSAs, which will be accrued and paid in cash at the end of the performance period. The PSAs initially are granted and issued at 150% of the target amount and thereafter are forfeited to the extent vesting conditions are not met.

 

The Company granted 91,335 PSAs equal to 150% of the target amount, with an aggregate value of $1.6 million on the grant date. The PSAs, in addition to a service condition, are subject to the Company’s performance versus the MSCI US REIT Index which is a market condition and impacts the number of shares that ultimately vests. Upon evaluating the results of the market condition, the final number of shares is determined and such shares vest based on satisfaction of the service conditions. The PSAs have graded vesting terms and will be amortized on a straight-line basis over the vesting period. During the nine months ended September 30, 2014, 5,484 PSAs were forfeited. As of September 30, 2014, total unearned compensation on performance stock awards was approximately $1.2 million, and the weighted-average vesting period was 2.3 years.

 

10.           Earnings Per Share

 

Basic 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 income per share adjusts basic income per share for the effects of potentially dilutive common shares, if the effect is not antidilutive. Potentially dilutive common shares consist of shares issuable under the 2010 plan. The following is a summary of basic and diluted income per share (in thousands, except share and per share amounts):

 

 

 

Three Months Ended September 30,

 

Nine Months Ended September 30,

 

 

 

2014

 

2013

 

2014

 

2013

 

Net income attributable to common shares

 

$

3,147

 

$

2,901

 

$

9,763

 

$

7,368

 

Weighted average common shares outstanding - basic

 

21,214,825

 

20,871,504

 

21,113,700

 

20,793,596

 

Effect of potentially dilutive common shares:

 

 

 

 

 

 

 

 

 

Stock options

 

338,674

 

391,398

 

360,707

 

388,889

 

Unvested awards

 

155,260

 

217,069

 

205,524

 

283,225

 

Weighted average common shares outstanding - diluted

 

21,708,759

 

21,479,971

 

21,679,931

 

21,465,710

 

Net income per share attributable to common shares

 

 

 

 

 

 

 

 

 

Basic

 

$

0.15

 

$

0.14

 

$

0.46

 

$

0.35

 

Diluted

 

$

0.14

 

$

0.14

 

$

0.45

 

$

0.34

 

 

In the calculations above, we have excluded weighted-average potentially dilutive securities of 146,216 and 211,721 for the three months ended September 30, 2014, and 2013, respectively, and 187,404 and 166,732 for the nine months ended September 30, 2014, and 2013, respectively, as their effect would have been antidilutive.

 

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, restricted cash, accounts and other receivables, the interest rate swap, the revolving credit facility, the senior unsecured term loan, interest payable and accounts payable. The carrying values of cash and cash equivalents, restricted cash, 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 swap is carried at fair value.

 

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The Company has determined that the majority of the inputs used to value its derivative fall within Level 2 of the fair value hierarchy; however, the credit valuation adjustments associated with its derivative utilize Level 3 inputs, such as estimates of current credit spreads, to evaluate the likelihood of default by the Operating Partnership and its counterparties. As of September 30, 2014, the Company has assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions and has determined that the credit valuation adjustment is not significant to the overall valuation of its derivative portfolio. As a result, the Company classifies its derivative valuation in Level 2 of the fair value hierarchy.

 

The total balance of our revolving credit facility and senior unsecured term loan was $305.3 million as of September 30, 2014, with a fair value that approximated book value, based on Level 3 inputs from the fair value hierarchy. Under the discounted cash flow method, the fair values are based on the Company’s assumptions of market interest rates and terms available incorporating the Company’s credit risk.

 

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. In addition, we enter into contracts for company-wide improvements that are ancillary to revenue generation. At September 30, 2014, we had open commitments related to these contracts of approximately $19.2 million.

 

Additionally, we have commitments related to telecommunications capacity used to connect data centers located within the same market or geographical area and power usage. At September 30, 2014, we had open commitments related to these contracts of approximately $12.4 million.

 

As part of our 2012 acquisition of Comfluent, a Denver, Colorado based data center operator, the former Comfluent owner was employed by us and was entitled to a payment based upon successfully renewing and increasing revenues from the customer base that existed at the date of acquisition. During the three months ended September 30, 2014, the payment calculation date was accelerated from January 1, 2015 to September 1, 2014 and we paid $9.3 million in full satisfaction of our payment obligation.

 

From time to time, we are party to a variety of legal proceedings arising in the ordinary course of business. We believe that, with respect to any such matter to which we currently are a party, the ultimate disposition of any such matter will not result in a material adverse effect on our business, financial condition, cash flows or results of operations.

 

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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 lease available space to existing or new customers; (viii) our failure to obtain necessary outside financing; (ix) our failure to qualify or maintain our status as a REIT; (x) financial market fluctuations; (xi) changes in real estate and zoning laws and increases in real property tax rates; (xii) delays or disruptions in third-party network connectivity; (xiii) service failures or price increases by third party power suppliers; (xiv) inability to renew net leases on the data center properties we lease; and (xv) other factors affecting the real estate industry 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. 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, or SEC, pursuant to the Exchange Act. We discussed a number of material risks in Item 1A. “Risk Factor” of our Annual Report on Form 10-K for the year ended December 31, 2013. 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 which we refer to in this Quarterly Report as our “Operating Partnership.”

 

We deliver secure and reliable data center solutions across eight key North American markets. We connect, protect and deliver a reliable performance environment and continued operation of mission-critical data and information technology infrastructure for more than 800 of the world’s leading enterprise and Internet, private networking, mobility, and cloud service providers. Across 16 high-performance data centers, we support the operation and growth of our customers’ businesses by providing products and services aimed toward helping them establish connections with networks, cloud-service providers, and other technology-services providers, operate performance-sensitive applications, and secure their mission-critical information and communications technology equipment.

 

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

 

Our Portfolio

 

As of September 30, 2014, our property portfolio included 16 operating data center facilities and multiple development projects which collectively comprise over 2.7 million net rentable square feet of space (“NRSF”), of which approximately 1.5 million NRSF is existing data center space, including pre-stabilized NRSF. Pre-stabilized NRSF includes projects and facilities that recently have been developed and are in the initial lease-up phase until they become stabilized operating NRSF, defined as 85% occupied or in service for 24 months. The development

 

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projects include land and space available for development and construction of new facilities in the San Francisco Bay, Northern Virginia and New York areas. Our stabilized operating portfolio includes approximately 261,000 NRSF of space readily available for lease, of which 182,000 NRSF is available for lease as data center space. Including the space currently under construction at September 30, 2014, undeveloped space and land targeted for future development, we own land and buildings sufficient to develop approximately 0.9 million NRSF of data center space. We expect that this development potential plus any potential expansion into new markets will enable us to accommodate existing and future customer demand and position us to continue to increase our operating cash flows. We intend to pursue development projects and expansion into new markets when we believe customer demand supports the additional supply in those markets. The following table provides an overview of our properties as of September 30, 2014:

 

 

 

Stabilized Operating NRSF

 

 

 

 

 

 

 

 

 

 

 

 

 

Office and Light-

 

 

 

 

 

Pre-Stabilized

 

Development

 

 

 

 

 

 

 

Data Center(1)

 

Industrial(2)

 

Total

 

NRSF(5)

 

NRSF(6)

 

Total

 

 

 

Annualized

 

 

 

Percent

 

 

 

Percent

 

 

 

Percent

 

 

 

 

 

Portfolio

 

Market/Facilities

 

Rent ($000)(3)

 

Total

 

Occupied(4)

 

Total

 

Occupied(4)

 

Total

 

Occupied(4)

 

Total

 

Total

 

NRSF

 

San Francisco Bay

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

SV1

 

$

11,070

 

84,045

 

83.0

%

206,255

 

79.4

%

290,300

 

80.4

%

 

 

290,300

 

SV2

 

7,251

 

76,676

 

78.7

 

 

 

76,676

 

78.7

 

 

 

76,676

 

Santa Clara Campus

 

26,609

 

237,316

 

95.4

 

71,308

 

91.7

 

308,624

 

94.6

 

14,857

 

173,240

 

496,721

 

San Francisco Bay Total

 

44,930

 

398,037

 

89.6

 

277,563

 

82.5

 

675,600

 

86.7

 

14,857

 

173,240

 

863,697

 

Los Angeles

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

One Wilshire Campus

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

LA1*

 

24,071

 

139,053

 

81.5

 

4,373

 

82.8

 

143,426

 

81.5

 

 

 

143,426

 

LA2

 

15,676

 

161,911

 

83.6

 

7,029

 

68.4

 

168,940

 

83.0

 

63,002

 

199,978

 

431,920

 

Los Angeles Total

 

39,747

 

300,964

 

82.6

 

11,402

 

73.9

 

312,366

 

82.3

 

63,002

 

199,978

 

575,346

 

Northern Virginia

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

VA1

 

24,482

 

201,719

 

80.4

 

61,050

 

80.6

 

262,769

 

80.5

 

 

 

262,769

 

VA2

 

 

 

 

 

 

 

 

 

198,000

 

198,000

 

DC1*

 

2,906

 

22,137

 

88.8

 

 

 

22,137

 

88.8

 

 

 

22,137

 

Northern Virginia Total

 

27,388

 

223,856

 

81.3

 

61,050

 

80.6

 

284,906

 

81.1

 

 

198,000

 

482,906

 

Boston

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

BO1

 

14,078

 

166,026

 

98.2

 

19,495

 

64.1

 

185,521

 

94.6

 

 

87,650

 

273,171

 

Chicago

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

CH1

 

11,730

 

158,167

 

86.2

 

4,946

 

65.8

 

163,113

 

85.5

 

20,240

 

 

183,353

 

New York

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

NY1*

 

5,501

 

48,404

 

73.3

 

209

 

100.0

 

48,613

 

73.5

 

 

 

48,613

 

NY2

 

24

 

 

 

7,281

 

16.5

 

7,281

 

16.5

 

52,692

 

195,086

 

255,059

 

New York Total

 

5,525

 

48,404

 

73.3

 

7,490

 

18.9

 

55,894

 

66.0

 

52,692

 

195,086

 

303,672

 

Miami

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

MI1

 

1,767

 

30,176

 

79.3

 

1,934

 

38.6

 

32,110

 

76.8

 

 

13,154

 

45,264

 

Denver

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

DE1*

 

733

 

4,144

 

100.0

 

 

 

4,144

 

100.0

 

 

 

4,144

 

DE2*

 

301

 

5,140

 

65.3

 

 

 

5,140

 

65.3

 

 

 

5,140

 

Denver Total

 

1,034

 

9,284

 

80.8

 

 

 

9,284

 

80.8

 

 

 

9,284

 

Total Facilities

 

$

146,199

 

1,334,914

 

86.4

%

383,880

 

79.4

%

1,718,794

 

84.8

%

150,791

 

867,108

 

2,736,693

 

 


* Indicates properties in which we hold a leasehold interest.

 

(1)             Represents the NRSF at each operating facility that is currently occupied or readily available for lease as data center space. Both occupied and available data center NRSF includes a factor 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.

(2)             Represents the NRSF at each operating facility that is currently occupied or readily available for lease as space other than data center space, which is typically space offered for office or light industrial uses.

(3)             Represents the monthly contractual rent on stabilized operating NRSF under existing commenced customer leases as of September 30, 2014, 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 annualized rent was approximately $152.5 million as of September 30, 2014, which reflects the addition of $6.3 million in operating expense reimbursements to contractual net rent under modified gross and triple-net leases.

(4)             Includes customer leases that have commenced and are occupied as of September 30, 2014. The percent occupied is determined based on leased square feet as a proportion of total operating NRSF.  The percent occupied for data center space, office and light industrial space, and space in total would have been 88.9%, 79.7%, and 86.9%, respectively, if all leases signed in current and prior periods had commenced.

(5)             Represents pre-stabilized NRSF of projects/facilities which recently have been developed and are in the initial lease-up phase. Pre-stabilized projects/facilities become stabilized operating properties at the earlier of achievement of 85% occupancy or 24 months after development completion. Annualized rent and percent occupied for pre-stabilized NRSF is $5.1 million and 35.1%, respectively, as of September 30, 2014. The percent occupied for total data center space including stabilized and pre-stabilized data center space was 81.2%

(6)             Represents vacant space and entitled land in our portfolio that requires significant capital investment in order to develop into data center facilities as of September 30, 2014. Includes NRSF under construction for which substantial activities are ongoing to prepare the property for its intended use following development. In addition to the amounts above, we may develop an additional 138,000 NRSF at the Santa Clara Campus and 100,000 NRSF at NY2 upon our receipt of the necessary entitlements.

 

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The following table shows the September 30, 2014, “same store” operating statistics for space within each data center facility that was leased or available to be leased as of December 31, 2012, and excludes space for which development was completed and became available to be leased after December 31, 2012. The Company tracks same store space leased or available to be leased at the computer room level within each data center facility. For comparison purposes, the operating activity totals as of December 31, 2013, and 2012, for this space are provided at the bottom of this table.

 

 

 

Same Store Property Portfolio (in NRSF)

 

 

 

 

 

 

 

 

 

Office and Light-

 

 

 

 

 

 

 

 

 

Data Center

 

Industrial

 

Total

 

 

 

Annualized

 

 

 

Percent

 

 

 

Percent

 

 

 

Percent

 

Market/Facilities

 

Rent ($000)(1)

 

Total

 

Occupied(2)

 

Total

 

Occupied(2)

 

Total

 

Occupied(2)

 

San Francisco Bay

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

SV1

 

$

11,070

 

84,045

 

83.0

%

206,255

 

79.4

%

290,300

 

80.4

%

SV2

 

7,251

 

76,676

 

78.7

 

 

 

76,676

 

78.7

 

Santa Clara Campus

 

21,541

 

118,955

 

90.9

 

71,308

 

91.7

 

190,263

 

91.2

 

San Francisco Bay Total

 

39,862

 

279,676

 

85.2

 

277,563

 

82.5

 

557,239

 

83.9

 

Los Angeles

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

One Wilshire Campus

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

LA1*

 

24,071

 

139,053

 

81.5

 

4,373

 

82.8

 

143,426

 

81.5

 

LA2

 

15,568

 

159,617

 

83.4

 

5,147

 

93.4

 

164,764

 

83.7

 

Los Angeles Total

 

39,639

 

298,670

 

82.5

 

9,520

 

88.6

 

308,190

 

82.7

 

Northern Virginia

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

VA1

 

24,482

 

201,719

 

80.4

 

61,050

 

80.6

 

262,769

 

80.5

 

DC1*

 

2,906

 

22,137

 

88.8

 

 

 

22,137

 

88.8

 

Northern Virginia Total

 

27,388

 

223,856

 

81.3

 

61,050

 

80.6

 

284,906

 

81.1

 

Boston

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

BO1

 

11,697

 

148,795

 

98.0

 

13,063

 

46.5

 

161,858

 

93.8

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Chicago

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

CH1

 

11,730

 

158,167

 

86.2

 

4,946

 

65.8

 

163,113

 

85.5

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

New York

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

NY1*

 

5,488

 

48,404

 

73.3

 

 

 

48,404

 

73.3

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Miami

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

MI1

 

1,767

 

30,176

 

79.3

 

1,934

 

38.6

 

32,110

 

76.8

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Denver

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

DE1*

 

733

 

4,144

 

100.0

 

 

 

4,144

 

100.0

 

DE2*

 

301

 

5,140

 

65.3

 

 

 

5,140

 

65.3

 

Denver Total

 

1,034

 

9,284