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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 June 30, 2019

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)

(866777-2673

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

Title of Each Class

Trading Symbol

Name of each exchange on which registered

Common Stock, $0.01 par value per share

COR

New York Stock Exchange

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 every Interactive Data File required to be submitted 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 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.

Large Accelerated Filer

Accelerated filer

Non-accelerated filer

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 July 24, 2019, was 36,890,854.

Table of Contents

CORESITE REALTY CORPORATION

FORM 10-Q

FOR THE QUARTER ENDED June 30, 2019

TABLE OF CONTENTS

year

 

    

PAGE

 

NO.

PART I. FINANCIAL INFORMATION

3

ITEM 1. Financial Statements

3

Condensed Consolidated Balance Sheets as of June 30, 2019, and December 31, 2018 (unaudited)

3

Condensed Consolidated Statements of Operations for the three and six months ended June 30 2019, and 2018 (unaudited)

4

Condensed Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2019, and 2018 (unaudited)

5

Condensed Consolidated Statements of Equity for the three and six months ended June 30, 2019, and 2018 (unaudited)

6

Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2019, and 2018 (unaudited)

7

Notes to Condensed Consolidated Financial Statements (unaudited)

8

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

26

ITEM 3. Quantitative and Qualitative Disclosures About Market Risk

42

ITEM 4. Controls and Procedures

42

PART II. OTHER INFORMATION

43

ITEM 1. Legal Proceedings

43

ITEM 1A. Risk Factors

43

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

43

ITEM 3. Defaults Upon Senior Securities

43

ITEM 4. Mine Safety Disclosures

43

ITEM 5. Other Information

43

ITEM 6. Exhibits

44

Signatures

45

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 and per share data)

June 30,

December 31,

    

2019

    

2018

ASSETS

Investments in real estate:

Land

$

87,765

$

86,955

Buildings and improvements

1,822,252

1,730,329

1,910,017

1,817,284

Less: Accumulated depreciation and amortization

(653,177)

(590,784)

Net investment in operating properties

1,256,840

1,226,500

Construction in progress

386,226

265,921

Net investments in real estate

1,643,066

1,492,421

Operating lease right-of-use assets, net

181,270

190,304

Cash and cash equivalents

2,836

2,599

Accounts and other receivables, net of allowance for doubtful accounts of $392 and $417 as of June 30, 2019, and December 31, 2018, respectively

29,758

18,464

Lease intangibles, net of accumulated amortization of $9,005 and $7,756 as of June 30, 2019, and December 31, 2018, respectively

5,694

6,943

Goodwill

40,646

40,646

Other assets, net

98,174

102,290

Total assets

$

2,001,444

$

1,853,667

LIABILITIES AND EQUITY

Liabilities:

Debt, net of unamortized deferred financing costs of $7,136 and $5,677 as of June 30, 2019, and December 31, 2018, respectively

$

1,310,114

$

1,130,823

Operating lease liabilities

194,893

202,699

Accounts payable and accrued expenses

122,251

89,315

Accrued dividends and distributions

61,332

55,679

Acquired below-market lease contracts, net of accumulated amortization of $4,056 and $3,840 as of June 30, 2019, and December 31, 2018, respectively

2,629

2,846

Unearned revenue, prepaid rent and other liabilities

34,102

37,672

Total liabilities

1,725,321

1,519,034

Stockholders' equity:

Common Stock, par value $0.01, 100,000,000 shares authorized and 36,890,371 and 36,708,691 shares issued and outstanding at June 30, 2019, and December 31, 2018, respectively

364

363

Additional paid-in capital

498,828

491,314

Accumulated other comprehensive loss

(6,235)

(2,193)

Distributions in excess of net income

(293,209)

(246,929)

Total stockholders' equity

199,748

242,555

Noncontrolling interests

76,375

92,078

Total equity

276,123

334,633

Total liabilities and equity

$

2,001,444

$

1,853,667

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 June 30,

Six Months Ended June 30,

    

2019

    

2018

    

2019

    

2018

    

Operating revenues:

Data center revenue:

Rental, power, and related revenue

$

121,083

$

116,147

$

238,936

$

226,155

Interconnection revenue

18,776

17,422

37,192

33,982

Office, light-industrial and other revenue

3,047

2,878

5,673

5,929

Total operating revenues

142,906

136,447

281,801

266,066

Operating expenses:

Property operating and maintenance

38,067

37,861

76,177

71,709

Real estate taxes and insurance

5,988

4,693

12,184

9,630

Depreciation and amortization

36,996

35,558

72,642

69,334

Sales and marketing

5,784

5,369

11,436

10,449

General and administrative

12,282

10,297

22,452

19,482

Rent

7,733

6,547

15,421

12,947

Transaction costs

19

75

Total operating expenses

106,850

100,344

210,312

193,626

Operating income

36,056

36,103

71,489

72,440

Interest expense

(10,311)

(8,907)

(19,809)

(16,645)

Income before income taxes

25,745

27,196

51,680

55,795

Income tax (expense) benefit

(2)

83

(32)

50

Net income

$

25,743

$

27,279

$

51,648

$

55,845

Net income attributable to noncontrolling interests

6,208

7,890

12,452

16,154

Net income attributable to common shares

$

19,535

$

19,389

$

39,196

$

39,691

Net income per share attributable to common shares:

Basic

$

0.54

$

0.57

$

1.08

$

1.17

Diluted

$

0.53

$

0.57

$

1.07

$

1.16

Weighted average common shares outstanding

Basic

36,463,421

34,049,391

36,405,921

33,992,792

Diluted

36,618,533

34,220,321

36,580,547

34,183,408

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 June 30,

Six Months Ended June 30,

 

2019

 

2018

 

2019

 

2018

 

Net income

$

25,743

$

27,279

$

51,648

$

55,845

Other comprehensive income (loss):

Unrealized gain (loss) on derivative contracts

(679)

224

(5,145)

833

Reclassification of other comprehensive income (loss) to interest expense

17

(44)

(181)

(76)

Comprehensive income

25,081

27,459

46,322

56,602

Comprehensive income attributable to noncontrolling interests

6,048

7,942

11,168

16,373

Comprehensive income attributable to common shares

$

19,033

$

19,517

$

35,154

$

40,229

See accompanying notes to condensed consolidated financial statements.

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CORESITE REALTY CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF EQUITY

(unaudited and in thousands except share data)

   

   

   

Accumulated

   

   

   

   

   

   

Additional

   

Other

   

Distributions

   

Total

   

   

   

Common Shares

   

Paid-in

   

Comprehensive

   

in Excess of

   

Stockholders'

   

Noncontrolling

   

Total

   

Number

    

Amount

   

Capital

   

Income (Loss)

   

Net Income

   

Equity

   

Interests

   

Equity

Balance at January 1, 2019

36,708,691

$

363

$

491,314

$

(2,193)

$

(246,929)

$

242,555

$

92,078

$

334,633

Issuance of stock awards, net of forfeitures

192,009

Exercise of stock options

1,129

17

17

17

Share-based compensation

1

3,592

3,593

3,593

Dividends and distributions

(40,581)

(40,581)

(12,733)

(53,314)

Net income

19,661

19,661

6,244

25,905

Other comprehensive loss

(3,540)

(3,540)

(1,124)

(4,664)

Balance at March 31, 2019

36,901,829

$

364

$

494,923

$

(5,733)

$

(267,849)

$

221,705

$

84,465

$

306,170

Redemption of noncontrolling interests

2,770

20

20

(20)

Issuance of stock awards, net of forfeitures

(15,567)

Exercise of stock options

1,339

21

21

21

Share-based compensation

3,864

3,864

3,864

Dividends and distributions

(44,895)

(44,895)

(14,118)

(59,013)

Net income

19,535

19,535

6,208

25,743

Other comprehensive loss

(502)

(502)

(160)

(662)

Balance at June 30, 2019

36,890,371

$

364

$

498,828

$

(6,235)

$

(293,209)

$

199,748

$

76,375

$

276,123

   

   

   

Accumulated

   

   

   

   

   

   

Additional

   

Other

   

Distributions

   

Total

   

   

   

Common Shares

   

Paid-in

   

Comprehensive

   

in Excess of

   

Stockholders'

   

Noncontrolling

   

Total

   

Number

    

Amount

   

Capital

   

Income (Loss)

   

Net Income

   

Equity

   

Interests

   

Equity

Balance at January 1, 2018

34,240,815

$

338

$

457,495

$

753

$

(177,566)

$

281,020

$

137,624

$

418,644

Redemption of noncontrolling interests

7,056

70

70

(70)

Issuance of stock awards, net of forfeitures

201,181

Exercise of stock options

5,161

100

100

100

Share-based compensation

2

2,739

2,741

2,741

Dividends and distributions

(33,749)

(33,749)

(13,553)

(47,302)

Net income

20,302

20,302

8,264

28,566

Other comprehensive income

410

410

167

577

Balance at March 31, 2018

34,454,213

$

340

$

460,404

$

1,163

$

(191,013)

$

270,894

$

132,432

$

403,326

Issuance of stock awards, net of forfeitures

(2,205)

Exercise of stock options

7,720

119

119

119

Share-based compensation

3,364

3,364

3,364

Dividends and distributions

(35,424)

(35,424)

(14,244)

(49,668)

Net income

19,389

19,389

7,890

27,279

Other comprehensive income

128

128

52

180

Balance at June 30, 2018

34,459,728

$

340

$

463,887

$

1,291

$

(207,048)

$

258,470

$

126,130

$

384,600

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)

Six Months Ended June 30,

  

2019

  

2018

CASH FLOWS FROM OPERATING ACTIVITIES

Net income

$

51,648

$

55,845

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

Depreciation and amortization

72,642

69,334

Amortization of above/below market leases

(172)

(339)

Amortization of deferred financing costs and hedge amortization

1,467

1,119

Share-based compensation

7,049

5,812

Bad debt expense

195

(88)

Changes in operating assets and liabilities:

Accounts receivable

(11,489)

4,183

Deferred rent receivable

2,548

(2,667)

Deferred leasing costs

(6,983)

(5,976)

Other assets

(1,121)

(2,211)

Accounts payable and accrued expenses

6,946

(341)

Unearned revenue, prepaid rent and other liabilities

(8,819)

(746)

Operating leases

1,466

442

Net cash provided by operating activities

115,377

124,367

CASH FLOWS FROM INVESTING ACTIVITIES

Tenant improvements

(2,144)

(2,667)

Real estate improvements

(158,745)

(107,093)

Business combinations and asset acquisitions

(26,060)

(10,681)

Net cash used in investing activities

(186,949)

(120,441)

CASH FLOWS FROM FINANCING ACTIVITIES

Proceeds from exercise of stock options

38

219

Proceeds from revolving credit facility

199,250

122,500

Payments on revolving credit facility

(343,500)

(180,036)

Proceeds from unsecured debt

325,000

150,000

Payments of loan fees and costs

(2,305)

(4,837)

Dividends and distributions

(106,674)

(94,185)

Net cash provided by (used in) financing activities

71,809

(6,339)

Net change in cash and cash equivalents

237

(2,413)

Cash and cash equivalents, beginning of period

2,599

5,247

Cash and cash equivalents, end of period

$

2,836

$

2,834

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

Cash paid for interest, net of capitalized amounts

$

16,811

$

15,419

Cash paid for operating lease liabilities

$

12,159

$

10,628

NON-CASH INVESTING AND FINANCING ACTIVITY

Construction costs payable capitalized to real estate

$

66,925

$

26,868

Accrual of dividends and distributions

$

61,332

$

51,760

NON-CASH OPERATING ACTIVITY

Lease liabilities arising from obtaining right-of-use assets

$

$

96,790

See accompanying notes to condensed consolidated financial statements.

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CORESITE REALTY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2019

(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 June 30, 2019, the Company owned a 75.9% common interest in our Operating Partnership, and affiliates of The Carlyle Group and others owned a 24.1% interest in our Operating Partnership. See additional discussion in Note 10, Noncontrolling Interests — Operating Partnership.

2. Summary of Significant Accounting Policies

Principles of Consolidation and Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared by our management in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and in compliance with the rules and regulations of the U.S. Securities and Exchange Commission. Accordingly, these unaudited condensed consolidated financial statements do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of our management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. The results of operations for the three and six months ended June 30, 2019, are not necessarily indicative of the expected results for the year ending December 31, 2019. 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, 2018.

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

Recent Accounting Pronouncements Not Yet Adopted

Fair Value Measurement

In August 2018, the Financial Accounting Standards Board (“FASB”) issued guidance codified in Accounting Standards Update (“ASU”) 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement. ASU 2018-13 improves the overall usefulness of disclosures to financial statement users and reduces unnecessary costs in preparing fair value measurement disclosures. The standard will be effective for interim and annual reporting periods beginning after December 15, 2019, with early adoption permitted. We do not expect the provisions of ASU 2018-13 to have a material impact on our condensed consolidated financial statements.

Intangibles – Goodwill and Other – Internal-Use Software

In August 2018, the FASB issued guidance codified in ASU 2018-15, Intangibles – Goodwill and Other – Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract. ASU 2018-15 clarifies that implementation costs incurred by customers in cloud computing arrangements are deferred if they would be capitalized by customers in software licensing arrangements under the internal-use software guidance. Additionally, ASU 2018-15 clarifies that all capitalized costs must be presented in the same financial statement line item as the cloud computing arrangement. The standard will be effective, on either a prospective or retrospective basis, for interim and annual reporting periods beginning after

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December 15, 2019, with early adoption permitted. We are currently evaluating the provisions of ASU 2018-15 and whether the provisions will have a material impact on our condensed consolidated financial statements.

We determined that all other recently issued accounting pronouncements will not have a material impact on our consolidated financial statements or do not apply to our operations.

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 our standalone selling prices, performance-based equity compensation plans and the carrying values of our real estate properties, goodwill, and accrued liabilities. 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 project 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 $3.6 million and $1.1 million for the three months ended June 30, 2019, and 2018, respectively. Capitalized interest costs were $6.2 million and $2.2 million for the six months ended June 30, 2019, and 2018, respectively.

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

Buildings

    

27 to 40 years

Building improvements

1 to 10 years

Leasehold improvements

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

Depreciation expense was $32.8 million and $30.8 million for the three months ended June 30, 2019, and 2018, respectively. Depreciation expense was $65.0 million and $59.9 million for the six months ended June 30, 2019, and 2018, 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 primary difference between business combinations and asset acquisitions is that asset acquisitions require cost accumulation and allocation at a relative fair value. Acquisition costs are capitalized for asset acquisitions and are expensed for business combinations.

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.

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

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

The carrying value of intangible assets is reviewed for impairment in connection with its respective asset group whenever events or changes in circumstances indicate that the asset group may not be recoverable. An impairment loss is recognized if the carrying amount of the asset group is not recoverable and its carrying amount exceeds its estimated fair value. No impairment loss related to these intangible assets was recognized for the three or six months ended June 30, 2019, or 2018.

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 June 30, 2019, and December 31, 2018, we had $40.6 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 or six months ended June 30, 2019, or 2018.

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.

Initial Direct Costs

Initial direct 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. Initial direct costs are incremental costs that would not have been incurred if the lease agreement had not been executed. These initial direct costs are capitalized and generally 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 initial direct costs related to the lease are written off to amortization expense. Amortization of initial direct costs was $3.4 million and $3.9 million for the three months ended June 30, 2019, and 2018, respectively. Amortization of initial direct costs was $6.9 million and $7.8 million for the six months ended June 30, 2019, and 2018, respectively. Initial direct costs are included within other assets in the condensed consolidated balance sheets and consisted of the following, net of amortization, as of June 30, 2019, and December 31, 2018 (in thousands):

June 30,

December 31,

    

2019

    

2018

 

Internal sales commissions

$

15,002

$

14,199

Third party commissions

10,120

9,855

Other

517

597

Total

$

25,639

$

24,651

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Deferred Financing Costs

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 indebtedness 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 and six months ended June 30, 2019, and 2018, no impairment of long-lived assets was recognized in the condensed consolidated financial statements.

Derivative Instruments and Hedging Activities

We reflect all derivative instruments at fair value as either assets or liabilities on the condensed consolidated balance sheets. For those derivative instruments that are designated and qualify as hedging instruments, we record the gain or loss on the hedging instruments as a component of accumulated other comprehensive income or loss. 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 8, 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 of internal-use software was recognized in the condensed consolidated financial statements for the three and six months ended June 30, 2019, and 2018.

Revenue Recognition

Rental, Power, and Related Revenue

We derive our revenues from leases with customers for data center and office and light-industrial space. Our leases include rental revenue lease components and nonlease revenue components, such as power and tenant reimbursements. We have elected to combine all of our nonlease revenue components that have the same pattern of transfer as the related operating lease component into a single combined lease component.

Our leases with customers are classified as operating leases and rental revenue is recognized on a straight-line basis over the customer lease term. Occasionally, our customer leases include options to extend or terminate the lease agreements. We do not include any of these extension or termination options in a customer’s lease term for lease classification purposes or for recognizing rental revenue unless we are reasonably certain the customer will exercise these extension or termination options. The excess of rents recognized over amounts contractually due pursuant to the underlying leases is recorded as deferred rent receivable within other assets on our condensed consolidated balance sheets.

In general, we provide two power products for our data center leased space, consisting of a fixed (breakered-amperage) and a variable (sub-metered) model. Customer power arrangements are coterminous with the customer’s underlying

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lease and have the same pattern of transfer over the lease term and are therefore combined with lease revenue within our condensed consolidated statements of operations. For fixed power arrangements, a customer pays us a fixed monthly fee for a committed available amount of power. We recognize the fixed power revenue each month over the term of the lease. For variable power arrangements, a customer pays us variable monthly fees for the specific amount of power utilized at the current utility rates. We recognize variable power revenue each month as the uncertainty related to the consideration is resolved, as power is provided to our customers, and as our customers utilize the power.

Some of our leases contain provisions under which our customers reimburse us for common area maintenance and other executory costs. These customer reimbursements are variable and are recognized in the period that the expenses are recognized. These services have the same pattern of transfer over the lease term and are also combined with lease revenue within our condensed consolidated statements of operations.

Interconnection Revenue

We also derive revenue from interconnection services, which are generally contracted on a month-to-month basis cancellable by us or the customer at any time. Interconnection services are accounted for as separate contracts and are not combined with lease and power arrangements. We recognize interconnection revenue each month as these services are delivered to, and utilized by, our customers.

Allowance for Doubtful Accounts

A provision for uncollectible accounts is recorded if a receivable balance relating to contractual rent, rental revenue recorded on a straight-line basis, tenant reimbursements or other billed amounts is considered by management to be uncollectible. At June 30, 2019, and December 31, 2018, the allowance for doubtful accounts totaled $0.4 million on the condensed consolidated balance sheets at each date.

Lessee Accounting

We determine if an arrangement is a lease at inception. Our operating lease agreements are primarily for real estate space and are included within operating lease ROU assets and operating lease liabilities on the condensed consolidated balance sheets. We elected the practical expedient to combine our lease and related nonlease components for our lessee building leases.

ROU assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease. ROU assets and lease liabilities are recognized at the commencement date based on the present value of lease payments over the lease term. Our variable lease payments consist of nonlease services related to the lease. Variable lease payments are excluded from the ROU assets and lease liabilities and are recognized in the period in which the obligation for those payments is incurred. As most of our leases do not provide an implicit rate, we use our incremental borrowing rate based on the information available at commencement date in determining the present value of lease payments. ROU assets also include any lease payments made and exclude lease incentives. Many of our lessee agreements include options to extend the lease, which we do not include in our minimum lease terms unless they are reasonably certain to be exercised. Rental expense for lease payments related to operating leases is recognized on a straight-line basis over the lease term.

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. We have elected to account for forfeitures as they occur.

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 June 30, 2019, and December 31, 2018, the amount

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included in unearned revenue, prepaid rent and other liabilities on the condensed consolidated balance sheets was approximately $1.6 million at each date.

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.

To maintain REIT status, we must distribute a minimum of 90% of our taxable income. However, it is our policy and intent, subject to change, to distribute 100% of our taxable income and therefore, no provision is required in the accompanying condensed consolidated financial statements for federal income taxes with regard to our activities and our subsidiary pass-through entities. The allocable share of taxable income is included in the income tax returns of its stockholders. We are subject to the statutory requirements of the locations in which we conduct 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 June 30, 2019, and December 31, 2018, 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 2016.

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.

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3. Investment in Real Estate

The following is a summary of the properties owned or leased by market at June 30, 2019 (in thousands):

Buildings and

Construction in

Market

    

Land

    

Improvements

    

Progress

    

Total Cost

 

Boston

$

5,154

$

110,094

$

2,148

$

117,396

Chicago

5,493

114,767

43,148

163,408

Denver

32,046

419

32,465

Los Angeles

18,672

366,346

46,955

431,973

Miami

728

14,198

200

15,126

New York

2,729

154,425

34,938

192,092

Northern Virginia

23,603

400,609

90,767

514,979

San Francisco Bay(1)

31,386

629,767

167,651

828,804

Total

$

87,765

$

1,822,252