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 March 31, 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 April 26, 2017,  was 34,195,567.

 

 

 


 

Table of Contents

CORESITE REALTY CORPORATION

FORM 10-Q

FOR THE QUARTER ENDED March 31, 2017

TABLE OF CONTENTS

 

 

 

 

 

    

PAGE

 

 

NO.

 

 

 

PART I. FINANCIAL INFORMATION 

 

3

 

 

 

ITEM 1. Financial Statements 

 

3

 

 

 

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

 

3

 

 

 

Condensed Consolidated Statements of Operations for the three months ended March 31, 2017, and 2016 (unaudited) 

 

4

 

 

 

Condensed Consolidated Statements of Comprehensive Income for the three months ended March 31, 2017, and 2016 (unaudited) 

 

5

 

 

 

Condensed Consolidated Statement of Equity for the three months ended March 31, 2017 (unaudited) 

 

6

 

 

 

Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 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 

 

24

 

 

 

ITEM 3. Quantitative and Qualitative Disclosures About Market Risk 

 

35

 

 

 

ITEM 4. Controls and Procedures 

 

36

 

 

 

PART II. OTHER INFORMATION 

 

36

 

 

 

ITEM 1. Legal Proceedings 

 

36

 

 

 

ITEM 1A. Risk Factors 

 

37

 

 

 

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

 

37

 

 

 

ITEM 3. Defaults Upon Senior Securities 

 

37

 

 

 

ITEM 4. Mine Safety Disclosures 

 

37

 

 

 

ITEM 5. Other Information 

 

37

 

 

 

ITEM 6. Exhibits 

 

37

 

 

 

Signatures 

 

39

 

 

 

Exhibit 10.1

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

 

 

 

 

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PART I — FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

 

CORESITE REALTY CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(unaudited and in thousands except share data)

 

 

 

 

 

 

 

 

 

 

 

March 31,

 

December 31,

 

 

    

2017

    

2016

 

ASSETS

 

 

 

 

 

 

 

Investments in real estate:

 

 

 

 

 

 

 

Land

 

$

97,258

 

$

100,258

 

Buildings and improvements

 

 

1,475,029

 

 

1,472,580

 

 

 

 

1,572,287

 

 

1,572,838

 

Less: Accumulated depreciation and amortization

 

 

(395,039)

 

 

(369,303)

 

Net investment in operating properties

 

 

1,177,248

 

 

1,203,535

 

Construction in progress

 

 

98,695

 

 

70,738

 

Net investments in real estate

 

 

1,275,943

 

 

1,274,273

 

Cash and cash equivalents

 

 

2,386

 

 

4,429

 

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

 

 

21,369

 

 

25,125

 

Lease intangibles, net of accumulated amortization of $13,555 and $12,385 as of March 31, 2017, and December 31, 2016, respectively

 

 

8,743

 

 

9,913

 

Goodwill

 

 

41,191

 

 

41,191

 

Other assets, net

 

 

102,957

 

 

96,372

 

Total assets

 

$

1,452,589

 

$

1,451,303

 

 

 

 

 

 

 

 

 

LIABILITIES AND EQUITY

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

 

 

Debt, net of unamortized deferred financing costs of $3,343 and $3,550 as of March 31, 2017, and December 31, 2016, respectively

 

$

719,657

 

$

690,450

 

Accounts payable and accrued expenses

 

 

55,164

 

 

72,519

 

Accrued dividends and distributions

 

 

41,097

 

 

41,849

 

Deferred rent payable

 

 

9,099

 

 

7,694

 

Acquired below-market lease contracts, net of accumulated amortization of $5,645 and $5,439 as of March 31, 2017, and December 31, 2016, respectively

 

 

4,086

 

 

4,292

 

Unearned revenue, prepaid rent and other liabilities

 

 

34,820

 

 

37,413

 

Total liabilities

 

 

863,923

 

 

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 March 31, 2017, and December 31, 2016

 

 

115,000

 

 

115,000

 

Common Stock, par value $0.01,  100,000,000 shares authorized and 34,193,619 and 33,896,771 shares issued and outstanding at March 31, 2017, and December 31, 2016, respectively

 

 

338

 

 

334

 

Additional paid-in capital

 

 

444,653

 

 

438,531

 

Accumulated other comprehensive income (loss)

 

 

332

 

 

(101)

 

Distributions in excess of net income

 

 

(128,797)

 

 

(118,038)

 

Total stockholders' equity

 

 

431,526

 

 

435,726

 

Noncontrolling interests

 

 

157,140

 

 

161,360

 

Total equity

 

 

588,666

 

 

597,086

 

Total liabilities and equity

 

$

1,452,589

 

$

1,451,303

 

 

See accompanying notes to condensed consolidated financial statements.

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CORESITE REALTY CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

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

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended March 31,

 

 

    

2017

    

2016

    

Operating revenues:

 

 

 

 

 

 

 

Data center revenue:

 

 

 

 

 

 

 

Rental revenue

 

$

64,251

 

$

50,371

 

Power revenue

 

 

30,861

 

 

25,574

 

Interconnection revenue

 

 

14,512

 

 

12,742

 

Tenant reimbursement and other

 

 

2,276

 

 

1,830

 

Office, light-industrial and other revenue

 

 

3,021

 

 

1,963

 

Total operating revenues

 

 

114,921

 

 

92,480

 

Operating expenses:

 

 

 

 

 

 

 

Property operating and maintenance

 

 

29,226

 

 

24,663

 

Real estate taxes and insurance

 

 

4,504

 

 

3,065

 

Depreciation and amortization

 

 

32,338

 

 

24,770

 

Sales and marketing

 

 

4,503

 

 

4,221

 

General and administrative

 

 

8,124

 

 

8,720

 

Rent 

 

 

5,962

 

 

5,417

 

Transaction costs

 

 

 —

 

 

 3

 

Total operating expenses

 

 

84,657

 

 

70,859

 

Operating income

 

 

30,264

 

 

21,621

 

Interest income

 

 

 —

 

 

 1

 

Interest expense

 

 

(5,107)

 

 

(2,012)

 

Income before income taxes

 

 

25,157

 

 

19,610

 

Income tax expense

 

 

(97)

 

 

(4)

 

Net income

 

$

25,060

 

$

19,606

 

Net income attributable to noncontrolling interests

 

 

6,684

 

 

6,261

 

Net income attributable to CoreSite Realty Corporation

 

$

18,376

 

$

13,345

 

Preferred stock dividends

 

 

(2,084)

 

 

(2,084)

 

Net income attributable to common shares

 

$

16,292

 

$

11,261

 

Net income per share attributable to common shares:

 

 

 

 

 

 

 

Basic

 

$

0.49

 

$

0.37

 

Diluted

 

$

0.48

 

$

0.37

 

Weighted average common shares outstanding

 

 

 

 

 

 

 

Basic

 

 

33,558,787

 

 

30,252,693

 

Diluted

 

 

33,981,776

 

 

30,694,747

 

 

See accompanying notes to condensed consolidated financial statements.

 

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CORESITE REALTY CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(unaudited and in thousands)

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended March 31,

 

 

    

2017

    

2016

    

Net income

 

$

25,060

 

$

19,606

 

Other comprehensive income (loss):

 

 

 

 

 

 

 

Unrealized gain (loss) on derivative contracts

 

 

313

 

 

(3,198)

 

Reclassification of other comprehensive income to interest expense

 

 

297

 

 

456

 

Comprehensive income

 

 

25,670

 

 

16,864

 

Comprehensive income attributable to noncontrolling interests

 

 

6,861

 

 

5,281

 

Comprehensive income attributable to CoreSite Realty Corporation

 

$

18,809

 

$

11,583

 

 

 

 

 

 

 

 

 

 

See accompanying notes to condensed consolidated financial statements.

 

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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

 

Issuance of stock awards, net of forfeitures

 

 

 —

 

133,149

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

Exercise of stock options

 

 

 —

 

163,699

 

 

 2

 

 

4,172

 

 

 —

 

 

 —

 

 

4,174

 

 

 —

 

 

4,174

 

Share-based compensation

 

 

 —

 

 —

 

 

 2

 

 

1,950

 

 

 —

 

 

 —

 

 

1,952

 

 

 —

 

 

1,952

 

Dividends declared on preferred stock

 

 

 —

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(2,084)

 

 

(2,084)

 

 

 —

 

 

(2,084)

 

Dividends and distributions

 

 

 —

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(27,051)

 

 

(27,051)

 

 

(11,081)

 

 

(38,132)

 

Net income

 

 

 —

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

18,376

 

 

18,376

 

 

6,684

 

 

25,060

 

Other comprehensive income

 

 

 —

 

 —

 

 

 —

 

 

 —

 

 

433

 

 

 —

 

 

433

 

 

177

 

 

610

 

Balance at March 31, 2017

 

$

115,000

 

34,193,619

 

$

338

 

$

444,653

 

$

332

 

$

(128,797)

 

$

431,526

 

$

157,140

 

$

588,666

 

 

See accompanying notes to condensed consolidated financial statements.

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CORESITE REALTY CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited and in thousands)

 

 

 

 

 

 

 

 

 

 

Three Months Ended March 31,

 

  

2017

  

2016

CASH FLOWS FROM OPERATING ACTIVITIES

 

 

 

 

 

 

Net income

 

$

25,060

 

$

19,606

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

 

 

 

 

 

 

Depreciation and amortization

 

 

32,338

 

 

24,770

Amortization of above/below market leases

 

 

(124)

 

 

(133)

Amortization of deferred financing costs

 

 

369

 

 

283

Share-based compensation

 

 

1,802

 

 

2,093

Bad debt expense

 

 

(96)

 

 

142

Changes in operating assets and liabilities:

 

 

 

 

 

 

Accounts receivable

 

 

3,853

 

 

(4,011)

Deferred rent receivable

 

 

(1,350)

 

 

(1,047)

Deferred leasing costs

 

 

(3,660)

 

 

(3,541)

Other assets

 

 

(7,243)

 

 

(6,102)

Accounts payable and accrued expenses

 

 

846

 

 

(5,533)

Unearned revenue, prepaid rent and other liabilities

 

 

(2,255)

 

 

129

Deferred rent payable

 

 

1,405

 

 

(320)

Net cash provided by operating activities

 

 

50,945

 

 

26,336

CASH FLOWS FROM INVESTING ACTIVITIES

 

 

 

 

 

 

Tenant improvements

 

 

(2,608)

 

 

(777)

Real estate improvements

 

 

(42,586)

 

 

(70,601)

Net cash used in investing activities

 

 

(45,194)

 

 

(71,378)

CASH FLOWS FROM FINANCING ACTIVITIES

 

 

 

 

 

 

Proceeds from exercise of stock options

 

 

4,174

 

 

1,009

Proceeds from revolving credit facility

 

 

38,000

 

 

60,750

Payments on revolving credit facility

 

 

(9,000)

 

 

(92,000)

Proceeds from unsecured debt

 

 

 —

 

 

100,000

Payments of loan fees and costs

 

 

 —

 

 

(1,035)

Dividends and distributions

 

 

(40,968)

 

 

(27,336)

Net cash provided by (used in) financing activities

 

 

(7,794)

 

 

41,388

Net change in cash and cash equivalents

 

 

(2,043)

 

 

(3,654)

Cash and cash equivalents, beginning of period

 

 

4,429

 

 

6,854

Cash and cash equivalents, end of period

 

$

2,386

 

$

3,200

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

 

 

 

 

 

 

Cash paid for interest, net of capitalized amounts

 

$

3,302

 

$

1,748

NON-CASH INVESTING AND FINANCING ACTIVITY

 

 

 

 

 

 

Construction costs payable capitalized to real estate

 

$

9,461

 

$

33,931

Accrual of dividends and distributions

 

$

41,097

 

$

28,158

 

See accompanying notes to condensed consolidated financial statements.

 

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CORESITE REALTY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 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 March 31, 2017, the Company owns a 70.9% common interest in our Operating Partnership and affiliates of The Carlyle Group and others own a 29.1% 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 months ended March 31, 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. 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 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 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 840, Leases. 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. As a lessee we do not anticipate the classification of our leases to change, 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 will evaluate 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 leases. If we determine that we are reasonably certain to exercise all renewal options for each lease, we estimate the

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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 $1.3 million and $1.2 million within our consolidated statement of operations for the three months ended March 31, 2017, and 2016, respectively.  

In accordance with ASC Topic 842, lessor accounting for our leases remains largely unchanged, apart from the narrower scope of initial direct costs that can be capitalized. The new standard defines initial direct costs as only 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 statement of operations upon adoption of ASC Topic 842. We estimate sales and marketing expense could increase up to $0.5 million for both the three months ended March 31, 2017, and 2016. We are currently evaluating the other impacts of ASC Topic 842 and ASC Topic 606 on our significant accounting policies and consolidated financial statements.

In August 2016, the FASB issued guidance codified in Accounting Standards Update (“ASU”) Topic 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 ASC 2016-15 to have a material impact on our consolidated financial statements.

In January 2017, the FASB issued guidance codified in ASU Topic 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 ASC 2017-04 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 believe to be reasonable under the circumstances. Actual results may vary from those estimates and those estimates could vary under different assumptions or conditions.

 

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 $0.6 million and $1.1 million for the three months ended March 31, 2017, and 2016, respectively.

 

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

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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  $26.8 million and $20.1 million for the three months ended March 31, 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 fair 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.

 

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 months ended March 31, 2017, or 2016.

 

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 March 31, 2017, and December 31, 2016, 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 months ended March 31, 2017, or 2016.

 

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.

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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 March 31, 2017, and December 31, 2016 (in thousands):

 

 

 

 

 

 

 

 

 

 

 

March 31,

 

December 31,

 

 

    

2017

    

2016

 

Internal sales commissions

 

$

18,493

 

$

18,748

 

Third party commissions

 

 

12,883

 

 

13,643

 

External legal counsel

 

 

742

 

 

730

 

Total

 

$

32,118

 

$

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 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 months ended March 31, 2017, and 2016, no impairment of long-lived assets 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 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 months ended March 31, 2017, and 2016.

 

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Revenue Recognition

 

All customer leases are classified as operating leases and minimum rents are 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 are included in deferred rent receivable and included in other assets in the condensed consolidated balance sheets.  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 lease 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 noncancelable term of the underlying leases. For both the three months ended March 31, 2017, and 2016, the net effect of amortization of acquired above-market and below-market leases resulted in an increase to rental revenue of $0.1 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 March 31, 2017, and December 31, 2016, the allowance for doubtful accounts totaled less than $0.1 million and $0.2 million, respectively.

 

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 March 31, 2017, and December 31, 2016, the amount included in unearned revenue, prepaid rent and other liabilities on the condensed consolidated balance sheets was approximately $1.4  million.

 

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

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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 March 31, 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 2013.

 

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.

 

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 March 31, 2017 (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Buildings and

 

Construction in

 

 

 

 

Market

    

Land

    

Improvements

    

Progress

    

Total Cost

 

Boston

 

$

5,154

 

$

96,604

 

$

377

 

$

102,135

 

Chicago

 

 

5,493

 

 

99,661

 

 

8,439

 

 

113,593

 

Denver

 

 

 —

 

 

5,413

 

 

8,546

 

 

13,959

 

Los Angeles

 

 

28,467

 

 

240,475

 

 

12,268

 

 

281,210

 

Miami

 

 

728

 

 

10,516

 

 

152

 

 

11,396

 

New York

 

 

2,388

 

 

128,638

 

 

39,786

 

 

170,812

 

Northern Virginia(1)

 

 

23,642

 

 

284,442

 

 

26,341

 

 

334,425

 

San Francisco Bay

 

 

31,386

 

 

609,280

 

 

2,786

 

 

643,452

 

Total

 

$

97,258

 

$

1,475,029

 

$

98,695

 

$

1,670,982

 


(1)

On February 23, 2017, we executed a ten-year lease for 25,000 square feet at a new property, referred to as DC2, to further expand our data center presence in Washington D.C., which is under construction as of March 31, 2017.

 

 

 

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4. Other Assets

 

Our other assets consisted of the following, net of amortization and depreciation, if applicable, as of March 31, 2017, and December 31, 2016 (in thousands):

 

 

 

 

 

 

 

 

 

 

 

March 31,

 

December 31,

 

 

    

2017

    

2016

 

Deferred leasing costs

 

$

32,118

 

$

33,121

 

Deferred rent receivable

 

 

37,743

 

 

36,393

 

Internal-use software

 

 

15,254

 

 

14,440

 

Prepaid expenses

 

 

8,746

 

 

4,390

 

Corporate furniture, fixtures and equipment

 

 

6,196

 

 

5,356

 

Deferred financing costs - revolving credit facility

 

 

1,442

 

 

1,604

 

Other

 

 

1,458

 

 

1,068

 

Total

 

$

102,957

 

$

96,372

 

 

 

 

5. Debt

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Maturity

 

March 31,

 

December 31,

 

 

    

Interest Rate

    

Date

    

2017

    

2016

 

Revolving credit facility

 

2.53% and 2.32% at March 31, 2017, and December 31, 2016, respectively

 

June 24, 2019

 

$

223,000

 

$

194,000

 

2019 Senior unsecured term loan(1)

 

3.23% at March 31, 2017, and December 31, 2016

 

January 31, 2019

 

 

100,000

 

 

100,000

 

2020 Senior unsecured term loan(2)

 

2.71% and 2.60% at March 31, 2017, and December 31, 2016

 

June 24, 2020

 

 

150,000

 

 

150,000

 

2021 Senior unsecured term loan

 

2.48% and 2.27% at March 31, 2017, and December 31, 2016

 

February 2, 2021

 

 

100,000

 

 

100,000

 

2023 Senior unsecured notes

 

4.19% at March 31, 2017, and December 31, 2016

 

June 15, 2023

 

 

150,000

 

 

150,000

 

Total principal outstanding

 

 

 

 

 

 

723,000

 

 

694,000

 

Unamortized deferred financing costs

 

 

 

 

 

 

(3,343)

 

 

(3,550)

 

Total debt

 

 

 

 

 

$

719,657

 

$

690,450

 


(1)

Our Operating Partnership entered into a swap agreement with respect to the 2019 Term Loan (as defined below) to swap the variable interest rate associated with $100 million, or 100%, of the 2019 Term Loan to a fixed rate of approximately 3.23% per annum at our current leverage ratio. See Note 6 – Derivatives and Hedging Activities.

(2)

Our Operating Partnership entered into 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 March 31, 2017, is 2.48%. See Note 6 – Derivatives and Hedging Activities.

 

Subsequent Debt Financing

 

On April 19, 2017, and April 20, 2017, our Operating Partnership executed two separate financing transactions resulting in additional liquidity of $275 million, which will be used to refinance existing debt and for general corporate purposes. The new debt is comprised of a $100 million increase to the current 2019 Term Loan with a new five-year term maturing in April 2022 and the issuance of $175 million of 3.91% senior notes due April 2024. See “2019 Senior Unsecured Term Loan” and “2024 Senior Unsecured Notes” below for additional discussion.

 

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,

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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 March 31, 2017, our Operating Partnership’s leverage ratio was 22.4% and the interest rate was LIBOR plus 155 basis points.

 

The total amount available for borrowing under the revolving credit facility, which is part of the Credit Agreement, is equal to the lesser of $350.0 million or the availability calculated based on our unencumbered asset pool. As of March 31, 2017, the borrowing capacity was $350.0 million. As of March 31, 2017,  $223.0 million was borrowed and outstanding, $4.5 million was outstanding under letters of credit and therefore $122.5 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 March 31, 2017, was 22.4%

·

a maximum secured debt ratio (defined as total consolidated secured debt to total gross asset value) of 40%,  which, as of March 31, 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 March 31, 2017, was 8.6 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 March 31, 2017, our unhedged variable rate debt ratio was 12.2%.

 

As of March 31, 2017, we were in compliance with all of the financial covenants under the Credit Agreement.

 

2019 Senior Unsecured Term Loan

 

On January 31, 2014, our Operating Partnership and certain subsidiaries entered into a $100 million senior unsecured term loan (the “2019 Term Loan”). The 2019 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, including securing capital from new or existing lenders. The 2019 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 of March 31, 2017, we were in compliance with all of the financial covenants under the 2019 Term Loan.

 

The borrowings under the 2019 Term Loan bear interest at a variable rate per annum equal to either (i) LIBOR plus 175 basis points to 265 basis points, or (ii) a base rate plus 75 basis points to 165 basis points, each depending on our Operating Partnership's leverage ratio. At March 31, 2017, our Operating Partnership’s leverage ratio was 22.4% and the interest rate was LIBOR plus 175 basis points. 

 

On April 19, 2017, our Operating Partnership and certain subsidiaries amended the 2019 Term Loan to (i) exercise the accordion feature to increase the total commitments to $200 million, (ii) extend the maturity of the facility 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, and (iv) explicitly permit the issuance of the 2024 Notes defined below. All other terms of the 2019 Term Loan remain materially unchanged.

 

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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 2019 Term Loan, the 2021 Term Loan, the 2023 Notes and the 2024 Notes and contains the same financial covenants and other customary restrictive covenants. As of March 31, 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 March 31, 2017, the Operating Partnership’s leverage ratio was 22.4% 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 2019 Term Loan, the 2020 Term Loan, the 2023 Notes, the 2024 Notes and the Credit Agreement and contains the same financial covenants and other customary restrictive covenants. As of March 31, 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 March 31, 2017, our Operating Partnership’s leverage ratio was 22.4% 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 named therein.

 

Interest is payable semiannually, on the 15th day of June and December in 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 will have the right to require our Operating Partnership to purchase 100% of such holder’s 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 2019 Term Loan, the 2020 Term Loan, the 2021 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, certain 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. The aforementioned covenants are subject to a number of exceptions and qualifications set forth in the 2023 Note Purchase Agreement. As of March 31, 2017, we were in compliance with all of the financial covenants under the 2023 Note Purchase Agreement. 

 

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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 named therein.

 

Interest is payable semiannually, on the 15th day of June and December in 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 our Operating Partnership’s subsidiaries that guarantees indebtedness under our 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 holder’s 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 2019 Term Loan, the 2020 Term Loan, the 2021 Term Loan, the 2023 Notes and the Credit Agreement. The 2024 Note Purchase Agreement contains the same financial covenants as the Credit 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. The aforementioned covenants are subject to a number of exceptions and qualifications set forth in the 2024 Note Purchase Agreement.

 

Debt Maturities

 

The following table summarizes when our debt currently becomes due, adjusted for the April 2017 debt financing transactions,  which includes the amended 2019 Term Loan, the 2024 Notes, and the repayment of the revolving credit facility (in thousands):

 

 

 

 

 

 

Year Ending December 31,

    

 

 

 

2017

 

$

 —

 

2018

 

 

 —

 

2019

 

 

 —

 

2020

 

 

150,000

 

2021

 

 

100,000

 

Thereafter

 

 

473,000

 

Total principal outstanding

 

 

723,000

 

Unamortized deferred financing costs

 

 

(3,343)

 

Total debt, net

 

$

719,657

 

 

 

 

6. Derivatives and Hedging Activities

 

On April 9, 2015, we entered into a $75 million forward starting five-year interest rate swap agreement, effective May 5, 2015, 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 effectively fixes the interest rate on $100 million of outstanding debt at approximately 3.23% per annum. Both interest rate swap agreements were designated for hedge accounting. 

 

On April 21, 2017, we terminated $50 million of our $100 million five-year interest rate swap.

 

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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. The amounts recorded in other comprehensive income related to the unrealized loss or gain on derivative contracts were a gain of $0.3 million and a loss of $3.2 million for the three months ended March 31, 2017, and 2016, respectively. The amounts reclassified from other comprehensive income to interest expense on the condensed consolidated statements of operations were $0.3 million and $0.5 million for the three months ended March 31, 2017, and 2016. Any ineffective portion of the change in fair value of the derivatives is recognized directly in net income. During the three months ended March 31, 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 April 1, 2017, we estimate that $0.4 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 $0.1 million and $0.4 million in derivative liabilities recognized in unearned revenue, prepaid rent and other liabilities in our condensed consolidated balance sheets as of March 31, 2017, and December 31, 2016, respectively. We also had a $0.6 million and $0.3 million derivative asset recognized in other assets in our consolidated balance sheets as of March 31, 2017, and December 31, 2016, respectively.

 

7. Stockholders’ Equity

 

We declared the following dividends per share on our Series A cumulative preferred stock and common stock during the three months ended March 31, 2017:

 

 

 

 

 

 

 

 

 

 

 

 

 

Declaration Date

    

Record Date

    

Payment Date

    

Preferred Stock

 

Common Stock

    

March 9, 2017

 

March 31, 2017

 

April 17, 2017

 

$

0.4531

(1)

$

0.80

 


(1)

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

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In connection with the issuance of our 7.25% Series A cumulative redeemable 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.

 

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

 

 

 

 

 

 

 

 

 

 

 

 

March 31, 2017

 

December 31, 2016

 

 

    

Number of Units

    

Percentage of Total

 

Number of Units

    

Percentage of Total

 

CoreSite Realty Corporation

 

33,764,350

 

70.9

%  

33,376,568

 

70.7

%

Noncontrolling interests

 

13,851,347

 

29.1

 

13,851,347

 

29.3

 

Total

 

47,615,697

 

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 three months ended March 31, 2017, we issued 387,782 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 March 31, 2017, received quarterly distributions of $0.80 per unit, payable in correlation with declared dividends on common stock.

 

The redemption value of the noncontrolling interests at March 31, 2017, was $1.2 billion based on the closing price of the Company’s common stock of $90.05 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 the 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 which 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 March 31, 2017,  3,054,224 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.

 

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The following table sets forth stock option activity under the 2010 Plan for the three months ended March 31, 2017:

 

 

 

 

 

 

 

 

 

 

Number of

 

 

 

 

 

Shares

 

Weighted-

 

 

 

Subject to

 

Average

 

 

 

Option

 

Exercise Price

 

Options outstanding, December 31, 2016

    

265,550

    

$

22.96

 

Granted

 

 —

 

 

 —

 

Exercised

 

(163,699)

 

 

25.50

 

Forfeited

 

 —

 

 

 —

 

Expired

 

 —

 

 

 —

 

Options outstanding, March 31, 2017

 

101,851

 

$

19.07

 

 

The following table sets forth the number of shares subject to options that are unvested as of March 31, 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, March 31, 2017

 

 —

 

$

 —

 

 

Restricted 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:

 

 

 

 

 

 

 

 

 

 

 

Weighted-

 

 

 

Restricted

 

Average Fair

 

 

 

Awards and

 

Value at Grant

 

 

    

Units

    

Date

 

Unvested balance, December 31, 2016

 

323,641

 

$

53.84

 

Granted

 

126,846

 

 

85.51

 

Forfeited

 

(26,321)

 

 

62.23

 

Vested

 

(117,242)

 

 

41.33

 

Unvested balance, March 31, 2017

 

306,924

 

$

69.48

 

 

As of March 31, 2017, total unearned compensation on restricted awards was approximately $20.0 million, and the weighted-average vesting period was 3.0 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 0% and 150% of a target number of shares for PSAs granted in 2014 and 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 achieve maximum relative TSR versus the MSCI US REIT Index. The PSAs are

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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 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 will be accrued and paid in cash at the end of the three-year performance period.

 

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

 

7,143

 

49,999

 

28,571

 

 

105.30

 

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, March 31, 2017

 

38,627

 

130,370

 

84,499

 

$

84.49

 


(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 March 31, 2017, total unearned compensation on PSAs was approximately $5.1 million, and the weighted-average vesting period was 2.5 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 three months ended March 31, 2017, and 2016.

 

 

 

 

 

 

 

 

Three Months Ended March 31,

 

 

    

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):

 

 

 

 

&nb