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WASHINGTON, D.C. 20549
For the quarterly period ended June 30, 2012.
For the transition period from to .
Commission file number: 001-34877
CoreSite Realty Corporation
(Exact name of registrant as specified in its charter)
(Registrants telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o.
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
The number of shares of common stock outstanding at July 25, 2012 was 21,126,390
CORESITE REALTY CORPORATION
FOR THE QUARTER ENDED JUNE 30, 2012
CORESITE REALTY CORPORATION
(unaudited and in thousands except share data)
See accompanying notes to condensed consolidated financial statements.
CORESITE REALTY CORPORATION
(unaudited and in thousands except share and per share data)
See accompanying notes to condensed consolidated financial statements.
CORESITE REALTY CORPORATION
(unaudited and in thousands)
See accompanying notes to condensed consolidated financial statements.
CORESITE REALTY CORPORATION
(unaudited and in thousands except share data)
See accompanying notes to condensed consolidated financial statements.
CORESITE REALTY CORPORATION
(unaudited and in thousands)
See accompanying notes to condensed consolidated financial statements.
CORESITE REALTY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2012
1. Organization and Description of Business
CoreSite Realty Corporation, through its controlling interest in CoreSite, L.P. (the Operating Partnership) and the subsidiaries of the Operating Partnership (collectively, the Company, we, or our), is a fully integrated, self-administered, and self-managed real estate investment trust (REIT). The Company was organized in the state of Maryland on February 17, 2010, completed its initial public offering of common stock (the IPO) on September 28, 2010, and is the sole general partner of the Operating Partnership.
We are engaged in the business of owning, acquiring, constructing and managing technology-related real estate and as of June 30, 2012, our property portfolio included 14 operating data center facilities and one development site located in some of the largest and fastest growing data center markets in the United States, including Los Angeles, the San Francisco Bay and Northern Virginia areas, Chicago, Boston, New York City, Miami and Denver.
2. Summary of Significant Accounting Policies
Principles of Consolidation and Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have been prepared by management in accordance with U.S. generally accepted accounting principles (GAAP) for interim financial information and in compliance with the rules and regulations of the United States Securities and Exchange Commission. Accordingly, these condensed consolidated financial statements do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of 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, 2012 are not necessarily indicative of the expected results for the year ending December 31, 2012. These 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, 2011. Intercompany balances and transactions have been eliminated.
Use of Estimates
The preparation of the condensed consolidated financial statements in conformity with accounting principles generally accepted in the U.S. requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingencies at the date of the condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. We evaluate our estimates, including those related to assessing the carrying values of our real estate properties, accrued liabilities, performance-based equity compensation plans, and qualification as a REIT based on estimates of historical experience, current market conditions, and various other assumptions that are believed 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 the 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 the development of the properties, the capitalization of costs, which include interest, real estate taxes and other direct and indirect costs, begins upon commencement of development efforts and ceases when the property is ready for its intended use. 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 $0.5 million and $0.3 million for the three months ended June 30, 2012 and 2011, respectively, and $1.2 million and $0.4 million for the six months ended June 30, 2012 and 2011, respectively.
Depreciation and amortization are calculated using the straight-line method over the following useful lives of the assets:
Depreciation expense was $9.9 million and $7.8 million for the three months ended June 30, 2012, and 2011, respectively, and $19.3 million and $16.4 million for the six months ended June 30, 2012, and 2011, respectively.
Acquisition of Investment in Real Estate
Purchase accounting is applied to the assets and liabilities related to all real estate investments acquired. The fair value of the real estate acquired is allocated to the acquired tangible assets, consisting primarily of land, building and 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 value is then allocated to land and building based on managements 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) managements estimate of fair market lease rates for the corresponding in-place leases, measured over a period equal to the remaining non-cancelable term of the lease and, for below-market leases, over a period equal to the initial term plus any below-market fixed rate renewal periods. Lease origination costs include estimates of costs avoided associated with leasing the property, including tenant allowances and improvements and leasing commissions. Customer relationship intangibles relate to the additional revenue opportunities expected to be generated through interconnection services and utility services to be provided to the in-place lease tenants. During the three and six months ended June 30, 2012, the Company recorded a net of $2.7 million in intangible assets and liabilities due to the acquisition of Comfluent, a Denver, Colorado based data center operator, consisting of two leased locations, 910 15th Street Denver, Colorado and 639 E. 18th Avenue Denver, Colorado.
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 an increase to or a reduction of rental income, amortization related to above-market and below-market leases where the Company is the lessee is recorded as either an increase to or a reduction of rent expense and amortization for lease origination costs and customer relationships are recorded as amortization expense. If a lease is terminated prior to its stated expiration, all unamortized amounts relating to that lease are written off. The carrying value of intangible assets is reviewed for impairment in connection with its respective asset group whenever events or changes in circumstances indicate that the asset group may not be recoverable. An impairment loss is recognized if the carrying amount of the asset group is not recoverable and its carrying amount exceeds its estimated fair value.
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, 2012, and December 31, 2011 we had approximately $41.2 million of goodwill. The Companys 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.
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.
The Company is required to maintain certain minimum cash balances in escrow by loan agreements to cover various building improvements. The Company is legally restricted by these agreements from using this cash other than for the purposes specified therein.
Deferred leasing costs include commissions and other direct and incremental costs incurred to obtain new customer leases, which are capitalized and amortized over the terms of the related leases using the straight-line method. If a lease terminates prior to the expiration of its initial term, any unamortized costs related to the lease are written off to amortization expense.
Deferred financing costs include costs incurred in connection with obtaining debt and extending existing debt. These financing costs are capitalized and amortized on a straight-line basis, which approximates the effective-interest method, over the term of the loan and are included as a component of interest expense.
Impairment of Long-Lived Assets
The Company reviews its 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 assets. To the extent that an impairment has occurred, the excess of the carrying amount of long-lived assets over its estimated fair value would be charged to income. For the three and six months ended June 30, 2012, and 2011, no impairment was recognized.
Derivative Instruments and Hedging Activities
We reflect all derivative instruments at fair value as either assets or liabilities on the condensed consolidated balance sheets. For those derivative instruments that are designated, and qualify, as hedging instruments, we record the effective portion of the gain or loss on the hedge instruments as a component of accumulated other comprehensive income (loss). Any ineffective portion of a derivatives change in fair value is immediately recognized in earnings. For derivatives that do not meet the criteria for hedge accounting, changes in fair value are immediately recognized in earnings.
All leases are classified as operating leases and minimum rents are recognized on a straight-line basis over the non-cancellable term of the agreements. The excess of rents recognized over amounts contractually due pursuant to the underlying leases are included in deferred rent receivable. If a lease terminates prior to its stated expiration, the deferred rent receivable relating to that lease is written off to rental revenue.
When arrangements include both lease and nonlease elements, the revenues associated with separate elements are allocated based on their relative fair values. The revenue associated with each element is then recognized as earned. Interconnection, utility and power 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 in which the services are performed. Utility and power services are included in power revenue in the accompanying statements of operations. Interconnection services are included in other revenue in the accompanying statements of operations. Set-up charges and utility installation fees are initially deferred and recognized over the term of the arrangement as other revenue or the expected period of performance unless management determines a separate earnings process exists related to an installation charge.
Tenant reimbursements for real estate taxes, common area maintenance, and other recoverable costs are recognized in the period in which the expenses are incurred.
Above-market and below-market lease intangibles that were acquired are amortized on a straight-line basis as decreases and increases, respectively, to rental revenue over the remaining non-cancellable term of the underlying leases. For the three months ended June 30, 2012, and 2011, the net effect of amortization of acquired above-market and below-market leases resulted in an increase to rental income of $0.4 million and $0.4 million, respectively. For the six months ended June 30, 2012, and 2011, the net effect of amortization of acquired above-market and below-market leases resulted in an increase to rental income of $0.8 million and $0.8 million, respectively. Balances, net of accumulated amortization, at June 30, 2012, and December 31, 2011, are as follows (in thousands):
A provision for uncollectible accounts is recorded if a receivable balance relating to contractual rent, rent recorded on a straight-line basis, or tenant reimbursements is considered by management to be uncollectible. At June 30, 2012, and December 31, 2011, the allowance for doubtful accounts totaled $0.4 million and $0.5 million, respectively.
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 being amortized on a straight-line basis over the vesting period of the stock options. The fair value of restricted share-based and Operating Partnership unit compensation is based on the market value of our common stock on the date of the grant and is amortized on a straight-line basis over the vesting period.
Asset Retirement Obligations
We record accruals for estimated retirement obligations. The asset retirement obligations relate primarily to the removal of asbestos and contaminated soil during development or redevelopment of the properties as well as the estimated equipment removal costs upon termination of a certain lease under which the Company is the lessee. At June 30, 2012, and December 31, 2011, the amount included in other liabilities on the condensed consolidated balance sheets was approximately $1.8 million and $1.9 million, respectively.
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 are generally 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 will distribute a minimum of 90% of our taxable income. However, it is our policy and intent, subject to change, to distribute 100% of our taxable income and therefore no provision is required in the accompanying financial statements for federal income taxes with regards to activities of the REIT and its subsidiary pass-through entities. Any taxable income prior to the completion of the IPO is the responsibility of the Companys prior member. The allocable share of income is included in the income tax returns of the members. 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 one of our subsidiaries as a taxable REIT subsidiary (TRS). Certain activities that we undertake must be conducted by a TRS, such as services for our tenants that would otherwise be 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. Relative deferred tax assets and liabilities arising from temporary differences in financial reporting versus tax reporting are also established as determined by management.
Deferred income taxes are recognized in certain taxable entities. Deferred income tax is generally a function of the periods 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 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, 2012, the deferred income taxes were not material.
We currently have no liabilities for uncertain tax positions. The earliest tax year for which we are subject to examination is 2010. Prior to their contribution to our Operating Partnership, our subsidiaries were treated as pass-through entities for tax purposes and the earliest year for which our subsidiaries are subject to examination is 2008.
Concentration of Credit Risks
The Companys cash and cash equivalents are maintained in various financial institutions, which, at times, may exceed federally insured limits. The Company has not experienced any losses in such accounts, and management believes that the Company is not exposed to any significant credit risk in this area. The Company has no off-balance-sheet concentrations of credit risk, such as foreign exchange contracts, option contracts, or foreign currency hedging arrangements.
For the three months ended June 30, 2012, and 2011, and the six months ended June 30, 2012, and 2011, one customer accounted for 8.3%, 11.7%, 9.3%, and 11.9%, respectively, of total operating revenues.
The Company manages its business as one reportable segment consisting of investments in data centers located in the United States. Although the Company provides 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.
Recent Accounting Pronouncements
In June 2011, the FASB issued ASU 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income, which amends current comprehensive income guidance. This accounting update eliminates the option to present the components of other comprehensive income as part of the statement of stockholders equity. Instead, the Company must report comprehensive income in either a single continuous statement of comprehensive income which contains two sections, net income and other comprehensive income, or in two separate but consecutive statements. This new guidance is effective for fiscal years and interim periods beginning after December 15, 2011. The Company adopted the provisions of this standard effective January 1, 2012, by presenting a separate Condensed Consolidated Statement of Comprehensive Income.
3. Investment in Real Estate
In April 2012, the Company acquired a leasehold interest in two additional locations, 910 15th Street Denver, Colorado and 639 E. 18th Avenue Denver, Colorado, through the acquisition of Comfluent, a Denver, Colorado based data center operator. The following is a summary of the properties owned and leased at June 30, 2012 (in thousands):
4. Other Assets
Our other assets consisted of the following, net of amortization and depreciation, if applicable, as of June 30, 2012, and December 31, 2011 (in thousands):
A summary of outstanding indebtedness as of June 30, 2012, and December 31, 2011 is as follows (in thousands):
(1) At the Companys election, borrowings under the credit facility bear interest at a rate per annum equal to either (i) LIBOR plus 225 basis points to 300 basis points, or (ii) a base rate plus 125 basis points to 200 basis points, depending on our leverage ratio. As of June 30, 2012, the weighted average interest rate on outstanding borrowings under the senior secured credit facility was 2.49%.
(2) In October 2010, we entered into an interest rate swap agreement with respect to the indebtedness on 55 S. Market and an interest rate cap agreement with respect to the indebtedness on 12100 Sunrise Valley, each as a cash flow hedge for interest incurred on these LIBOR based loans.
(3) The mortgage contains a two-year extension option subject to our Company meeting certain financial and other customary conditions and the payment of an extension fee equal to 60 basis points.
Senior Secured Credit Facility
On December 15, 2011, our Operating Partnership and certain subsidiary co-borrowers entered into an amended and restated senior secured revolving credit facility (the Amended Credit Agreement) with a group of lenders for which KeyBank National Association acts as the administrative agent. The Amended Credit Agreement amended our Operating Partnerships then-existing senior secured revolving credit facility, dated September 28, 2010 (the Prior Facility), and is unconditionally guaranteed on a senior unsecured basis by us. Our Operating Partnership acts as the parent borrower, and our subsidiaries that own 1656 McCarthy, 70 Innerbelt, 2901 Coronado and 900 N. Alameda are co-borrowers under the Amended Credit Agreement, with borrowings under the facility secured by a lien on these properties on a senior secured basis. In addition, the obligations of each of our Operating Partnership and the co-borrowers under the Amended Credit Agreement are joint and several.
On February 7, 2012, we repaid the senior mortgage loan of $25.0 million secured by the 427 S. LaSalle property and subsequently added the subsidiary that owns 427 S. LaSalle as a co-borrower under the Amended Credit Agreement, with borrowings under the facility secured by a lien on such real estate property on a senior secured basis.
The Amended Credit Agreement increased the commitment from the Prior Facility of $110.0 million to $225.0 million, and extended the initial maturity date of the Prior Facility from September 28, 2013, to December 15, 2014, with a one-time extension option, which, if exercised, would extend the maturity date to December 15, 2015. An exercise of the extension option is subject to the payment of an extension fee equal to 25 basis points of the total commitment under the Amended Credit Agreement at initial maturity and certain other customary conditions. The Amended Credit Agreement also contains an accordion feature to allow our Operating Partnership to increase the total commitment by $175.0 million, to $400.0 million, under specified circumstances. As of June 30, 2012, and December 31, 2011, $54.8 million and $5.0 million, respectively, was outstanding under the facility.
Under the Amended Credit Agreement, our Operating Partnership may elect to have borrowings bear interest at a rate per annum equal to (i) LIBOR plus 225 basis points to 300 basis points, or (ii) a base rate plus 125 basis points to 200 basis points, each depending on our Operating Partnerships leverage ratio.
The total amount available for borrowings under the Amended Credit Agreement will be subject to the lesser of a percentage of the appraised value of our Operating Partnerships properties that form the designated borrowing base properties of the facility, a minimum borrowing base debt service coverage ratio and a minimum borrowing base debt yield. As of June 30, 2012, $139.1 million was available for us to borrow under the facility.
Our ability to borrow under the Amended Credit Agreement is subject to ongoing compliance with a number of financial covenants and other customary restrictive covenants, including:
· a maximum leverage ratio (defined as consolidated total indebtedness to total gross asset value) of 60%;
· a minimum fixed charge coverage ratio (defined as adjusted consolidated earnings before interest, taxes, depreciation and amortization to consolidated fixed charges) of 1.75 to 1.0;
· a maximum unhedged variable rate debt ratio (defined as unhedged variable rate indebtedness to gross asset value) of 30%;
· a maximum recourse debt ratio (defined as recourse indebtedness other than indebtedness under the revolving credit facility to gross asset value) of 30%; and
· a minimum tangible net worth equal to at least $468.8 million plus 80% of the net proceeds of any additional equity issuances.
As of June 30, 2012, we were in compliance with the covenants under our Amended Credit Agreement.
Financing costs of $2.3 million and $1.8 million, which were incurred in connection with the execution of the Prior Facility and the Amended Credit Agreement, respectively, have been capitalized and are included in deferred financing costs. Amortization of these deferred financing costs for the three months ended June 30, 2012, and 2011 totaled $0.3 million and $0.2 million, respectively, and for the six months ended June 30, 2012 and 2011 totaled $0.5 million and $0.4 million, respectively, and have been included in interest expense.
55 S. Market
As of June 30, 2012, the 55 S. Market property had a $60.0 million mortgage loan, which matures on October 9, 2012. The mortgage payable contains a two-year extension option provided we meet certain financial and other customary conditions and subject to the payment of an extension fee equal to 60 basis points. The Company has the ability and intent to extend the mortgage loan. The loan bears interest at LIBOR plus 350 basis points and requires the payment of interest only until maturity. The mortgage requires ongoing compliance by us with various covenants including liquidity and net operating income covenants. As of June 30, 2012, we were in compliance with the covenants.
On October 7, 2010, we entered into a $60.0 million interest rate swap agreement to protect against adverse fluctuations in interest rates by reducing our exposure to variability in cash flows relating to interest payments on the $60.0 million 55 S. Market mortgage. The interest rate swap matures on October 9, 2012, and effectively fixes the interest rate at 4.01%.
12100 Sunrise Valley
As of June 30, 2012, the 12100 Sunrise Valley property had a mortgage loan payable of $31.7 million. The loan is secured by the 12100 Sunrise Valley property and required payments of interest only until the amortization commencement date on July 1, 2011. The loan matures on June 1, 2013 and we may exercise the remaining one-year extension option provided we meet certain financial and other customary conditions and subject to the payment of an extension fee equal to 50 basis points. The mortgage loan payable contains certain financial and nonfinancial covenants. As of June 30, 2012, we were in compliance with the covenants.
On October 8, 2010, we purchased an interest rate cap to hedge $25.0 million of the indebtedness secured by our 12100 Sunrise Valley property. The interest rate cap matures on October 1, 2012, and hedges against LIBOR interest rate increases above 2.0%.
427 S. LaSalle
On February 7, 2012, we repaid the $25.0 million senior mortgage loan on the 427 S. LaSalle property.
The following table summarizes our debt maturities as of June 30, 2012 (in thousands):
(1) The 55 S. Market mortgage, which is scheduled to mature on October 9, 2012, contains a two-year extension option subject to the Company meeting certain financial and other customary conditions and the payment of an extension fee equal to 60 basis points.
6. Derivatives and Hedging Activities
Risk Management Objective of Using Derivatives
The Company is exposed to certain risk arising from both its business operations and economic conditions. The Company principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. The Company manages economic risks, including interest rate, liquidity, and credit risk primarily by managing the amount, sources, and duration of its debt funding and the use of derivative financial instruments. Specifically, the Company enters into derivative financial instruments to manage exposures that arise from business activities that result in the receipt or payment of future known and uncertain cash amounts, the value of which are determined by interest rates. The Companys derivative financial instruments are used to manage differences in the amount, timing, and duration of the Companys known or expected cash receipts and its known or expected cash payments principally related to the Companys investments and borrowings.
Cash Flow Hedges of Interest Rate Risk
The Companys objectives in using interest rate derivatives are to add stability to interest expense and to manage its exposure to interest rate movements. To accomplish this objective, the Company primarily uses interest rate swaps and caps as part of its 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. Interest rate caps designated as cash flow hedges involve the receipt of variable amounts from a counterparty if interest rates rise above the strike rate on the contract in exchange for an up-front premium.
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 (loss) on the condensed consolidated balance sheets and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. The amount recorded in accumulated other comprehensive income (loss) is not considered material for any period. Such derivatives were used to hedge the variable cash flows associated with existing variable-rate debt. The amount reclassified to interest expense on the condensed consolidated statements of operations was less than $0.1 million for the three and six months ended June 30, 2012 and 2011. The ineffective portion of the change in fair value of the derivatives is recognized directly in earnings. During the three and six months ended June 30, 2012, and 2011, the Company did not record any amount in earnings related to derivatives due to hedge ineffectiveness.
Amounts reported in accumulated other comprehensive income (loss) related to derivatives will be reclassified to interest expense as interest payments are made on the Companys variable-rate debt. During 2012, the Company estimates that $0.1 million will be reclassified as an increase to interest expense.
As of June 30, 2012, the Company had the following outstanding interest rate derivatives that were designated as cash flow hedges of interest rate risk:
Cash Flow Hedge Derivative Summary
All derivatives are recognized at fair value in our condensed consolidated balance sheets in other assets and other liabilities, as applicable. We do not net our derivative position by counterparty for purposes of balance sheet presentation and disclosure. The Company had less than $0.1 million accrued in other liabilities in our condensed consolidated balance sheet relating to these outstanding derivatives at June 30, 2012, and December 31, 2011.
Credit-Risk-Related Contingent Features
The Company has agreements with each of its derivative counterparties that each contain a provision whereas if the Company defaults on any of its indebtedness, including default when repayment of the indebtedness has not been accelerated by the lender, the Company could also be declared in default on its derivative obligations. Such a default may require the Company to settle any outstanding derivatives at their then current fair value. As of June 30, 2012, the derivative instruments with fair values in a net liability position were not material and the Company has not posted any cash collateral related to these agreements.
7. Noncontrolling Interests Operating Partnership
Noncontrolling interests represent the limited partnership interests in the Operating Partnership held by individuals and entities other than CoreSite Realty Corporation. Since September 28, 2011, the current holders of Operating Partnership units have been eligible to have the Operating Partnership units redeemed for cash or, at our option, exchangeable into our common stock on a one-for-one basis. We have evaluated whether we control the actions or events necessary to issue the maximum number of shares that could be required to be delivered under the share settlement of the Operating Partnership units. Based on the results of this analysis, we concluded that the Operating Partnership units met the criteria to be classified within equity at June 30, 2012.
The following table shows the ownership interest in the Operating Partnership as of June 30, 2012 and December 31, 2011:
For each share of common stock issued, the Operating Partnership issues an equivalent Operating Partnership unit to the Company. During the six months ended June 30, 2012, the Company issued 119,211 shares of common stock related to employee compensation arrangements and therefore an equivalent number of Operating Partnership units were issued. Additionally, during the six months ended June 30, 2012, 1,490 Operating Partnership units were issued to employees upon their vesting in the incentive unit awards.
The redemption value of the noncontrolling interests at June 30, 2012, was $654.4 million based on the closing price of the Companys stock of $25.82 on June 29, 2012, the last trading day of the quarter.
8. Stockholders Equity
On March 13, 2012, we declared a regular cash dividend for the first quarter of 2012 of $0.18 per common share payable to stockholders of record as of March 30, 2012. In addition, holders of Operating Partnership units also received a distribution of $0.18 per unit. The dividend and distribution were paid on April 16, 2012.
On June 15, 2012, we declared a regular cash dividend for the second quarter of 2012 of $0.18 per common share payable to stockholders of record as of June 29, 2012. In addition, holders of Operating Partnership units also received a distribution of $0.18 per unit. The dividend and distribution were paid on July 16, 2012.
9. Equity Incentive Plan
In connection with our IPO, the Companys Board of Directors adopted the 2010 Equity Incentive Plan (the 2010 Plan). The 2010 Plan is administered by the Board of Directors, or the plan administrator. Awards issuable under the 2010 Plan include common stock, stock options, restricted stock, stock appreciation rights, dividend equivalents and other incentive awards. We have reserved a total of 3,000,000 shares of our common stock for issuance pursuant to the 2010 Plan, which may be adjusted for changes in our capitalization and certain corporate transactions. To the extent that an award expires, terminates or lapses, or an award is settled in cash without the delivery of shares of common stock to the participant, then any unexercised shares subject to the award will be available for future grant or sale under the 2010 Plan. Shares of restricted stock which are forfeited or repurchased by us pursuant to the 2010 Plan may again be optioned, granted or awarded under the 2010 Plan. The payment of dividend equivalents in cash in conjunction with any outstanding awards will not be counted against the shares available for issuance under the 2010 Plan.
As of June 30, 2012, 992,698 shares of our common stock remained available for issuance pursuant to the 2010 Plan.
Stock option awards are granted with an exercise price equal to the closing market price of the Companys common stock at the date of grant. The fair value of each option granted under the 2010 Plan is estimated on the date of the grant using the Black-Scholes option-pricing model. For the six months ended June 30, 2012, options to purchase 227,121 shares of common stock were granted. The fair values are being expensed on a straight-line basis over the vesting periods.
The following table sets forth the stock option activity under the 2010 Plan for the six months ended June 30, 2012:
The following table sets forth the number of shares subject to option that are unvested as of June 30, 2012, and the fair value of these options at the grant date:
As of June 30, 2012, total unearned compensation on options was approximately $4.0 million, and the weighted-average vesting period was 2.9 years.
During the six months ended June 30, 2012, the Company granted 360,202 shares of restricted stock. Additionally, the Company granted 6,812 restricted stock units, or RSUs. The principal difference between these instruments is that RSUs are not outstanding shares of the Companys 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 one share of common stock for each RSU. The restricted awards are amortized on a straight-line basis to expense over the vesting period. The following table sets forth the number of unvested restricted awards and the weighted average fair value of these awards at the date of grant:
As of June 30, 2012, total unearned compensation on restricted awards was approximately $10.4 million, and the weighted-average vesting period was 3.0 years.
Operating Partnership Units
In connection with the Companys IPO, we granted 25,883 Operating Partnership units, which had a grant date fair value of $15.98 per unit or $0.4 million in total. The Operating Partnership units are amortized on a straight-line basis to expense over the vesting period. As of June 30, 2012, 10,117 Operating Partnership units have vested and 14,275 Operating Partnership units were unvested. As of June 30, 2012, total unearned compensation on Operating Partnership units was approximately $0.2 million, and the weighted-average vesting period was 1.3 years.
10. Earnings Per Share
The following is a summary of basic and diluted income (loss) per share (in thousands, except share and per share amounts):
We have excluded the following potentially dilutive securities in the calculations above as their effect would have been antidilutive:
11. Estimated Fair Value of Financial Instruments
Authoritative guidance issued by the Financial Accounting Standards Board (FASB) establishes a hierarchy of valuation techniques based on the observability of inputs utilized in measuring assets and liabilities at fair values. This hierarchy establishes market-based or observable inputs as the preferred source of values, followed by valuation models using management assumptions in the absence of market inputs. The three levels of the hierarchy under the authoritative guidance are as follows:
Level 1 Inputs are quoted prices in active markets for identical assets or liabilities.
Level 2 Inputs are quoted prices for similar assets or liabilities in an active market, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable, and market-corroborated inputs which are derived principally from or corroborated by observable market data.
Level 3 Inputs are derived from valuation techniques in which one or more significant inputs or value drivers are unobservable.
Our financial instruments consist of cash and cash equivalents, restricted cash, accounts and other receivables, interest rate caps, interest rate swaps, senior secured credit facility, mortgage loans payable, interest payable and accounts payable. The carrying values of cash and cash equivalents, restricted cash, accounts and other receivables, interest payable and accounts payable approximate fair values due to the short-term nature of these accounts. The interest rate caps and interest rate swap are carried at fair value.
The combined balance of our mortgage loans payable was $91.7 million and $116.9 million as of June 30, 2012, and December 31, 2011, respectively, with a fair value of $91.1 million and $116.1 million, respectively, based on Level 3 inputs from the fair value hierarchy. The carrying value of the senior secured credit facility approximated fair value at June 30, 2012, based on Level 3 inputs from the fair value hierarchy. The fair values of mortgage notes payable and the senior secured credit facility are based on the Companys assumptions of interest rates and terms available incorporating the Companys credit risk.
Derivative financial instruments
Currently, the Company uses interest rate derivative instruments to manage interest rate risk. The fair values of interest rate swaps are determined using the market standard methodology of netting the discounted future fixed cash receipts (or payments) and the discounted expected variable cash payments (or receipts). The variable cash payments (or receipts) are based on the expectation of future interest rates (forward curves) derived from observed market interest rate curves. In addition, to comply with the provisions of FASB Accounting Standards Codification (ASC) 820, credit valuation adjustments, which consider the impact of any credit risk to the contracts, are incorporated in the fair values to account for potential nonperformance risk. In adjusting the fair value of its derivative contracts for the effect of nonperformance risk, the Company has considered any applicable credit enhancements such as collateral postings, thresholds, mutual puts, and guarantees.
Although the Company has determined that the majority of the inputs used to value its derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with its derivatives utilize Level 3 inputs, such as estimates of current credit spreads, to evaluate the likelihood of default by the Company and its counterparties. However, as of June 30, 2012, the Company has assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions and has determined that the credit valuation adjustment is not significant to the overall valuation of its derivative portfolios. As a result, the Company classifies its derivative valuations in Level 2 of the fair value hierarchy.
The table below presents the Companys assets and liabilities measured at fair value on a recurring basis as of June 30, 2012, and December 31, 2011, aggregated by the level in the fair value hierarchy within which those measurements fall.
12. Related Party Transactions
We lease 1,515 net rentable square feet of space at our 12100 Sunrise Valley property to an affiliate of The Carlyle Group. The lease commenced on July 1, 2008, and expires on June 30, 2013. Rental revenue was less than $0.1 million for the three and six months ended June 30, 2012 and 2011, respectively.
13. Commitments and Contingencies
As of June 30, 2012, the Company currently leases the data center space under noncancelable operating lease agreements at 32 Avenue of the Americas, One Wilshire, 1275 K Street, 910 15th Street, and 639 E. 18th Avenue, and the Company leases its headquarters located in Denver, Colorado under a noncancelable operating lease agreement. The lease agreements provide for base rental rate increases at defined intervals during the term of the leases. In addition, the Company has negotiated rent abatement periods to better match the phased build-out of the data center space. The Company accounts for such abatements and increasing base rentals using the straight-line method over the noncancelable term of the lease. The difference between the straight-line expense and the cash payment is recorded as deferred rent payable.
Additionally, the Company has commitments related to telecommunications capacity used to connect data centers located within the same market or geographical area and power usage.
The following table summarizes our contractual obligations as of June 30, 2012 (in thousands):
(1) Obligations for tenant improvement work at 55 S. Market Street, power contracts, telecommunications leases and insurance premiums.
Rent expense for the three months ended June 30, 2012, and 2011 was $4.7 million and $4.6 million, respectively, and for the six months ended June 30, 2012, and 2011 rent expense was $9.3 million and $9.2 million, respectively.
Our properties require periodic investments of capital for general capital improvements and for tenant related capital expenditures. Additionally, the Company enters into various construction contracts with third parties for the development and redevelopment of our properties. At June 30, 2012, we had open commitments related to construction contracts of approximately $13.3 million.
From time to time, the Company may have certain contingent liabilities that arise in the ordinary course of its business activities. Management believes that the resolution of such matters will not have a material adverse effect on the financial position, results of operations or cash flows of the Company.
As previously disclosed, the Company is involved in litigation in Colorado District Court in Denver with Ari Brumer, the former general counsel of its affiliate, CoreSite, LLC, arising out of the termination of Mr. Brumers employment. The allegations made by Mr. Brumer in his complaint against the Company, certain of our affiliates, and certain affiliates of The Carlyle Group also have been previously reported, as have been the counterclaims asserted against Mr. Brumer by the Company and certain of our affiliates. The case remains in the discovery stage and various discovery matters require resolution by the court. As previously disclosed, the case initially was set for a nine-day trial to commence on October 1, 2012. The parties now have agreed to set the case for a ten-day trial to commence on June 17, 2013. We intend to vigorously defend the case and pursue our counterclaims against Mr. Brumer. Based on the information currently available, the Company continues to believe that this litigation will not have a material adverse effect on its business, financial position or liquidity.
One of our former customers, Add2Net, Inc., brought an action against us in April 2009 before the American Arbitration Association in California asserting claims of breach of contract, unfair business practices, negligent misrepresentation and fraudulent inducement. Add2Net alleged that it suffered damages of approximately $3.5 million, consisting of license and service fees paid to us, loss of business income and equipment damage, and sought attorneys fees and punitive damages. We counterclaimed for breach of contract and bad faith dealing. On April 6, 2012, we agreed to pay Add2Net $1.5 million to settle the action in its entirety and recorded the expense in general and administrative expense for the six months ended June 30, 2012.
This Quarterly Report on Form 10-Q (this Quarterly Report), together with other statements and information publicly disseminated by our company, contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the Securities Act), and Section 21E of the Securities Exchange Act of 1934, as amended (the Exchange Act). We intend such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995 and include this statement for purposes of complying with these safe harbor provisions.
In particular, statements pertaining to our capital resources, portfolio performance and results of operations contain certain forward-looking statements. You can identify forward-looking statements by the use of forward-looking terminology such as believes, expects, may, will, should, seeks, intends, plans, pro forma or anticipates or the negative of these words and phrases or similar words or phrases that are predictions of or indicate future events or trends and that do not relate solely to historical matters. You can also identify forward-looking statements by discussions of strategy, plans or intentions. Such statements are subject to risks, uncertainties and assumptions and are not guarantees of future performance, which may be affected by known and unknown risks, trends, uncertainties and factors that are beyond our control. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, estimated or projected. The following factors, among others, could cause actual results and future events to differ materially from those set forth or contemplated in the forward-looking statements: (i) the geographic concentration of our data centers in certain markets and any adverse developments in local economic conditions or the demand for data center space in these markets; (ii) fluctuations in interest rates and increased operating costs; (iii) difficulties in identifying properties to acquire and completing acquisitions; (iv) the significant competition in our industry and an inability to lease vacant space, renew existing leases or release space as leases expire; (v) lack of sufficient customer demand to realize expected returns on our investments to expand our property portfolio; (vi) decreased revenue from costs and disruptions associated with any failure of our physical infrastructure or services; (vii) our ability to lease available space to existing or new customers; (viii) our failure to obtain necessary outside financing; (ix) our failure to qualify or maintain our status as a REIT; (x) financial market fluctuations; (xi) changes in real estate and zoning laws and increases in real property tax rates; (xii) delays or disruptions in third-party network connectivity; (xiii) service failures or price increases by third party power suppliers; (xiv) inability to renew net leases on the data center properties we lease; and (xv) other factors affecting the real estate industry generally.
While forward-looking statements reflect our good faith beliefs, they are not guarantees of future performance. We disclaim any obligation to publicly update or revise any forward-looking statement to reflect changes in underlying assumptions or factors, of new information, data or methods, future events or other changes. The risks included here are not exhaustive, and additional factors could adversely affect our business and financial performance, including factors and risks included in other sections of this Quarterly Report. Additional information concerning these and other risks and uncertainties is contained in our other periodic filings with the United States Securities and Exchange Commission, or SEC, pursuant to the Exchange Act. We discussed a number of material risks in Item 1A. Risk Factors of our Annual Report on Form 10-K for the year ended December 31, 2011. Those risks continue to be relevant to our performance and financial condition. Given these risks and uncertainties, investors should not place undue reliance on forward-looking statements as a prediction of actual results.
Unless the context requires otherwise, references in this Quarterly Report to we, our, us and our company refer to CoreSite Realty Corporation, a Maryland corporation, together with its consolidated subsidiaries, including CoreSite, L.P., a Delaware limited partnership of which CoreSite Realty Corporation is the sole general partner and which we refer to in this Quarterly Report as our Operating Partnership and CoreSite Services, Inc., a Delaware corporation, our taxable REIT subsidiary, or TRS.
We formed CoreSite Realty Corporation as a Maryland corporation on February 17, 2010. We completed our IPO of common stock on September 28, 2010 and through our controlling interest in our Operating Partnership, we are engaged in the business of ownership, acquisition, construction and management of strategically located data centers in some of the largest and fastest growing data center markets in the United States, including Los Angeles, the San Francisco Bay and Northern Virginia areas, Chicago, Boston, New York City, Miami and Denver. Our high-quality data centers feature ample and redundant power, advanced cooling and security systems and many are points of dense network interconnection. We have 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.
As of June 30, 2012, our property portfolio included 14 operating data center facilities and one development site, which collectively comprise over 2.0 million net rentable square feet of space (NRSF), of which approximately 1.2 million NRSF is existing data center space. These properties include 399,226 NRSF of space readily available for lease, of which 304,033 NRSF is available for lease as data center space. Including the space currently under construction or in preconstruction at June 30, 2012, and including currently operating space targeted for future redevelopment, we own land and buildings sufficient to develop or redevelop 810,036 square feet of data center space, comprised of (1) 70,841 NRSF of data center space currently under construction, (2) 393,945 NRSF of office and industrial space currently available for redevelopment, and (3) 345,250 NRSF of new data center space that can be developed on land that we currently own at our Coronado-Stender Business Park. We expect that this redevelopment and development potential
plus any potential expansion into new markets will enable us to accommodate existing and future customer demand and position us to significantly increase our cash flows. We intend to pursue redevelopment and development projects and expansion into new markets when we believe those opportunities support the additional supply in those markets.
The following table provides an overview of our new and expansion data center leasing activity (in NRSF):
The following table provides an overview of our properties as of June 30, 2012: