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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, 2020

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 29, 2020, was 42,532,858.

Table of Contents

CORESITE REALTY CORPORATION

FORM 10-Q

FOR THE QUARTER ENDED June 30, 2020

TABLE OF CONTENTS

six

 

    

PAGE

 

NO.

PART I. FINANCIAL INFORMATION

3

ITEM 1. Financial Statements

3

Condensed Consolidated Balance Sheets as of June 30, 2020, and December 31, 2019 (unaudited)

3

Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2020, and 2019 (unaudited)

4

Condensed Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2020, and 2019 (unaudited)

5

Condensed Consolidated Statements of Equity for the three months ended March 31, and June 30, 2020, and 2019 (unaudited)

6

Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2020, and 2019 (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

40

ITEM 4. Controls and Procedures

40

PART II. OTHER INFORMATION

41

ITEM 1. Legal Proceedings

41

ITEM 1A. Risk Factors

41

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

42

ITEM 3. Defaults Upon Senior Securities

42

ITEM 4. Mine Safety Disclosures

42

ITEM 5. Other Information

42

ITEM 6. Exhibits

43

Signatures

44

Exhibit 31.1

Exhibit 31.2

Exhibit 32.1

Exhibit 32.2

EX-101 INSTANCE DOCUMENT

EX-101 SCHEMA DOCUMENT

EX-101 CALCULATION LINKBASE DOCUMENT

EX-101 LABELS LINKBASE DOCUMENT

EX-101 PRESENTATION LINKBASE DOCUMENT

EX-101 DEFINITION LINKBASE DOCUMENT

2

Table of Contents

PART I — FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

CORESITE REALTY CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

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

June 30,

December 31,

    

2020

    

2019

ASSETS

Investments in real estate:

Land

$

100,432

$

94,593

Buildings and improvements

2,140,529

1,989,731

2,240,961

2,084,324

Less: Accumulated depreciation and amortization

(792,281)

(720,498)

Net investment in operating properties

1,448,680

1,363,826

Construction in progress

381,145

394,474

Net investments in real estate

1,829,825

1,758,300

Operating lease right-of-use assets, net

171,576

172,976

Cash and cash equivalents

2,686

3,048

Accounts and other receivables, net of allowance for doubtful accounts of $1,140 and $371 as of June 30, 2020, and December 31, 2019, respectively

22,059

21,008

Lease intangibles, net of accumulated amortization of $4,220 and $4,022 as of June 30, 2020, and December 31, 2019, respectively

3,275

3,939

Goodwill

40,646

40,646

Other assets, net

98,823

101,082

Total assets

$

2,168,890

$

2,100,999

LIABILITIES AND EQUITY

Liabilities:

Debt, net of unamortized deferred financing costs of $8,759 and $9,098 as of June 30, 2020, and December 31, 2019, respectively

$

1,615,241

$

1,478,402

Operating lease liabilities

186,636

187,443

Accounts payable and accrued expenses

116,580

123,304

Accrued dividends and distributions

62,227

62,332

Acquired below-market lease contracts, net of accumulated amortization of $1,585 and $1,511 as of June 30, 2020, and December 31, 2019, respectively

2,412

2,511

Unearned revenue, prepaid rent and other liabilities

54,212

33,119

Total liabilities

2,037,308

1,887,111

Stockholders' equity:

Common Stock, par value $0.01, 100,000,000 shares authorized and 42,533,420 and 37,701,042 shares issued and outstanding at June 30, 2020, and December 31, 2019, respectively

420

373

Additional paid-in capital

545,814

512,324

Accumulated other comprehensive loss

(23,840)

(6,026)

Distributions in excess of net income

(408,021)

(348,509)

Total stockholders' equity

114,373

158,162

Noncontrolling interests

17,209

55,726

Total equity

131,582

213,888

Total liabilities and equity

$

2,168,890

$

2,100,999

See accompanying notes to condensed consolidated financial statements.

3

Table of Contents

CORESITE REALTY CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

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

Three Months Ended June 30,

Six Months Ended June 30,

    

2020

    

2019

    

2020

    

2019

    

Operating revenues:

Data center revenue:

Rental, power, and related revenue

$

127,108

$

121,083

$

251,613

$

238,936

Interconnection revenue

20,897

18,776

40,982

37,192

Office, light-industrial and other revenue

2,538

3,047

5,310

5,673

Total operating revenues

150,543

142,906

297,905

281,801

Operating expenses:

Property operating and maintenance

41,037

38,067

81,220

76,177

Real estate taxes and insurance

5,599

5,988

11,789

12,184

Depreciation and amortization

41,779

36,996

82,770

72,642

Sales and marketing

5,837

5,784

11,981

11,436

General and administrative

11,603

12,282

22,870

22,452

Rent

8,995

7,733

17,394

15,421

Total operating expenses

114,850

106,850

228,024

210,312

Operating income

35,693

36,056

69,881

71,489

Interest expense

(10,586)

(10,311)

(21,769)

(19,809)

Income before income taxes

25,107

25,745

48,112

51,680

Income tax expense

(19)

(2)

(36)

(32)

Net income

$

25,088

$

25,743

$

48,076

$

51,648

Net income attributable to noncontrolling interests

4,417

6,208

9,557

12,452

Net income attributable to common shares

$

20,671

$

19,535

$

38,519

$

39,196

Net income per share attributable to common shares:

Basic

$

0.52

$

0.54

$

1.00

$

1.08

Diluted

$

0.52

$

0.53

$

0.99

$

1.07

Weighted average common shares outstanding

Basic

39,873,260

36,463,421

38,604,576

36,405,921

Diluted

39,993,011

36,618,533

38,759,072

36,580,547

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,

 

2020

 

2019

 

2020

 

2019

 

Net income

$

25,088

$

25,743

$

48,076

$

51,648

Other comprehensive (loss) income:

Unrealized (loss) gain on derivative contracts

(4,369)

(679)

(21,397)

(5,145)

Reclassification of other comprehensive income (loss) to interest expense

1,198

17

1,312

(181)

Comprehensive income

21,917

25,081

27,991

46,322

Comprehensive income attributable to noncontrolling interests

3,334

6,048

4,692

11,168

Comprehensive income attributable to CoreSite Realty Corporation

$

18,583

$

19,033

$

23,299

$

35,154

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, 2020

37,701,042

$

373

$

512,324

$

(6,026)

$

(348,509)

$

158,162

$

55,726

$

213,888

Redemption of noncontrolling interests

2,140

11

11

(11)

Issuance of stock awards, net of forfeitures

199,541

Exercise of stock options

3,210

73

73

73

Share-based compensation

1

3,725

3,726

3,726

Dividends and distributions

(46,174)

(46,174)

(13,139)

(59,313)

Net income

17,848

17,848

5,140

22,988

Other comprehensive loss

(13,132)

(13,132)

(3,782)

(16,914)

Balance at March 31, 2020

37,905,933

$

374

$

516,133

$

(19,158)

$

(376,835)

$

120,514

$

43,934

$

164,448

Redemption of noncontrolling interests

4,620,000

46

25,105

(2,594)

22,557

(22,557)

Issuance of stock awards, net of forfeitures

(1,185)

Exercise of stock options

8,672

99

99

99

Share-based compensation

4,477

4,477

4,477

Dividends and distributions

(51,857)

(51,857)

(7,502)

(59,359)

Net income

20,671

20,671

4,417

25,088

Other comprehensive loss

(2,088)

(2,088)

(1,083)

(3,171)

Balance at June 30, 2020

42,533,420

$

420

$

545,814

$

(23,840)

$

(408,021)

$

114,373

$

17,209

$

131,582

   

   

   

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 income

(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

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,

  

2020

  

2019

 

CASH FLOWS FROM OPERATING ACTIVITIES

Net income

$

48,076

$

51,648

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

Depreciation and amortization

82,770

72,642

Amortization of above/below market leases

(68)

(172)

Amortization of deferred financing costs and hedge amortization

2,072

1,467

Share-based compensation

7,654

7,049

Bad debt expense

993

195

Changes in operating assets and liabilities:

Accounts receivable

(2,045)

(11,489)

Deferred rent receivable

(760)

2,548

Initial direct costs

(9,349)

(6,983)

Other assets

1,153

(1,121)

Accounts payable and accrued expenses

5,643

6,946

Unearned revenue, prepaid rent and other liabilities

766

(8,819)

Operating leases

599

1,466

Net cash provided by operating activities

137,504

115,377

CASH FLOWS FROM INVESTING ACTIVITIES

Tenant improvements

(3,351)

(2,144)

Real estate improvements

(151,331)

(158,745)

Business combinations and asset acquisitions

(26,060)

Net cash used in investing activities

(154,682)

(186,949)

CASH FLOWS FROM FINANCING ACTIVITIES

Proceeds from exercise of stock options

172

38

Proceeds from revolving credit facility

166,000

199,250

Payments on revolving credit facility

(129,500)

(343,500)

Proceeds from unsecured debt

100,000

325,000

Payments of loan fees and costs

(1,078)

(2,305)

Dividends and distributions

(118,778)

(106,674)

Net cash provided by financing activities

16,816

71,809

Net change in cash and cash equivalents

(362)

237

Cash and cash equivalents, beginning of period

3,048

2,599

Cash and cash equivalents, end of period

$

2,686

$

2,836

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

Cash paid for interest, net of capitalized amounts

$

23,586

$

16,811

Cash paid for operating lease liabilities

$

13,318

$

12,159

NON-CASH INVESTING AND FINANCING ACTIVITY

Construction costs payable capitalized to real estate

$

53,125

$

66,925

Accrual of dividends and distributions

$

62,227

$

61,332

NON-CASH OPERATING ACTIVITY

Lease liabilities arising from obtaining right-of-use assets

$

7,935

$

See accompanying notes to condensed consolidated financial statements.

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CORESITE REALTY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2020

(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, 2020, the Company owned an 87.2% common interest in our Operating Partnership, and affiliates of The Carlyle Group and others owned a 12.8% 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, 2020, are not necessarily indicative of the expected results for the year ending December 31, 2020, or any other future period. 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, 2019.

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.

Recently Adopted Accounting Pronouncements

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 became effective for interim and annual reporting periods beginning after December 15, 2019, with early adoption permitted. We adopted the standard effective January 1, 2020, and the provisions of ASU 2018-13 did not 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. We adopted the standard effective January 1, 2020, on a prospective basis, and the provisions of ASU 2018-15 did not have a material impact on our condensed consolidated financial statements.

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Financial Instruments – Credit Losses

In June 2016, the FASB issued guidance codified in ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. ASU 2016-13 introduced the “current expected credit losses” model, which requires companies to estimate credit losses immediately upon exposure. The guidance applies to financial assets measured at amortized cost, including financing receivables and trade receivables. In November 2018, the FASB issued ASU 2018-19, Codification Improvements to Topic 326, Financial Instruments – Credit Losses, which clarified that operating leases are outside the scope of Topic 326, and instead should be accounted for under ASC 842. The standard became effective, for interim and annual reporting periods beginning after December 15, 2019, with early adoption permitted. We adopted the standard effective January 1, 2020, on a prospective basis, and the provisions of ASU 2016-13 and ASU 2018-19 did not have a material impact on our condensed consolidated financial statements.

Recent Accounting Pronouncements Not Yet Adopted

Reference Rate Reform

In March 2020, the FASB issued guidance codified in ASU 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting. ASU 2020-04 provides optional expedients for a limited period of time to ease the potential burden in accounting for (or recognizing the effects of) reference rate reform on financial reporting. ASU 2020-04 provides optional expedients and exceptions for applying GAAP to contracts, hedging relationships, and other transactions affected by reference rate reform if certain criteria are met. The standard is effective for all entities as of March 12, 2020 through December 31, 2022. An entity can elect to apply the amendments as of any date from the beginning of an interim period that includes or is subsequent to March 12, 2020, or prospectively from a date within an interim period that includes or is subsequent to March 12, 2020, up to that date that the financial statements are available to be issued. We are currently evaluating the optional expedients and exceptions provided by ASU 2020-04 to determine the impact on our condensed consolidated financial statements.

We determined that all other recently issued accounting pronouncements will not have a material impact on our condensed 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 $3.3 million and $3.6 million for the three months ended June 30, 2020, and 2019, respectively. Capitalized interest costs were $6.7 million and $6.2 million for the six months ended June 30, 2020, and 2019, respectively.

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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 $37.7 million and $32.8 million for the three months ended June 30, 2020, and 2019, respectively. Depreciation expense was $74.6 million and $65.0 million for the six months ended June 30, 2020, and 2019, 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.

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 rental services, 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, 2020, or 2019.

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, 2020, and December 31, 2019, 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, 2020, or 2019.

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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 customer 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 $3.6 million and $3.4 million for the three months ended June 30, 2020, and 2019, respectively. Amortization of initial direct costs was $6.9 million for both the six months ended June 30, 2020, and 2019. 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, 2020, and December 31, 2019 (in thousands):

June 30,

December 31,

    

2020

    

2019

 

Internal sales commissions

$

15,009

$

15,064

Third party commissions

12,442

10,845

Other

409

462

Total

$

27,860

$

26,371

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 their estimated fair value would be recognized as an impairment loss charged to net income. For the three and six months ended June 30, 2020, and 2019, 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.

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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, 2020, and 2019.

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 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 the collectability of 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 not be probable. At June 30, 2020, and December 31, 2019, the allowance for doubtful accounts totaled $1.1 million and $0.4 million, respectively, on the condensed consolidated balance sheets.

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Table of Contents

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 right-of-use (“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, 2020, and December 31, 2019, the amount included in unearned revenue, prepaid rent and other liabilities on the condensed consolidated balance sheets was approximately $1.7 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.

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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, 2020, and December 31, 2019, 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 2017.

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.

Risks and Uncertainties

The full extent of the operational and financial impact of the novel coronavirus (“COVID-19”) outbreak on our business has yet to be determined. The impact of the outbreak of COVID-19 is dependent on future developments, including, among other factors, the duration and spread of the outbreak, along with related government-mandated business shutdowns, travel advisories and restrictions on movement, the recovery time of general employment levels, disrupted supply chains, potentially material staffing shortages, construction and development delays, and uncertainty with respect to accessibility of additional funding sources. In addition, some of our customers and prospective customers are dependent on areas of the economy that have been significantly impacted by the outbreak of COVID-19, which may impact their ability to comply with their rent obligations or their demand for additional space and power from us. As of June 30, 2020, we have not recognized a material loss, impairment, or contingency within our condensed consolidated financial statements as a result of the COVID-19 pandemic.

3. Investment in Real Estate

The following is a summary of the properties owned or leased by market at June 30, 2020 (in thousands):

Buildings and

Construction in

Market

    

Land

    

Improvements

    

Progress

    

Total Cost

 

Boston

$

5,154

$

119,958

$

6,451

$

131,563

Chicago

7,059

177,793

59,625

244,477

Denver