ITEM 1. BUSINESS
The Company
DuPont Fabros Technology, Inc. (the “Company”) was incorporated in March 2007 under the laws of the State of Maryland and is headquartered in Washington, D.C. DuPont Fabros Technology, Inc. is the sole general partner of DuPont Fabros Technology, L.P. (“Operating Partnership” or “OP”), and as of December 31, 2008, owned approximately 53% of the partnership interests in the Operating Partnership. We are organized so as to qualify, and have elected to be taxed, as a real estate investment trust, or REIT, under the Internal Revenue Code of 1986, as amended (the “Code”).
Through our operating subsidiaries, we own, develop, operate and manage wholesale data centers that are highly specialized, secure facilities used primarily by national and international technology companies to house, power and cool the computer servers that support many of their most critical business processes. We also conduct certain activities through our taxable REIT subsidiary (“TRS”), DF Technical Services LLC, which is wholly-owned by the Operating Partnership.
For the year ended December 31, 2008, we generated $173.7 million of total revenues and $19.1 million in net income. As of December 31, 2008, we had total assets of $1.86 billion.
Our common stock trades on the New York Stock Exchange, or NYSE, under the symbol “DFT.”
Unless the context otherwise requires, references to the “Company,” “we,” “us” and “our” mean DuPont Fabros Technology, Inc. and its subsidiaries.
Our Initial Public Offering and Formation
On October 24, 2007, we completed the initial public offering of our common stock (the “IPO”), which yielded the sale of 35,075,000 shares of common stock and resulted in proceeds to our Company, net of underwriting discounts, commissions, financial advisory fees and other offering costs, of $676.9 million. We had no significant operations prior to October 24, 2007, when we completed the IPO and a number of formation transactions.
We contributed the proceeds of our IPO to the Operating Partnership in exchange for a number of units of limited partnership interest of the Operating Partnership (“OP units”) equal to the number of common shares sold in the IPO.
In connection with the IPO, we completed a series of formation transactions with entities affiliated with our Executive Chairman and President and Chief Executive Officer and certain of our directors. As part of these formation transactions, we issued an aggregate of 31,162,272 OP units and paid $378.6 million in cash (which included $274.0 million of cash used to retire the debt and fund other obligations) in exchange for the following:
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four stabilized data centers located in Northern Virginia;
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two data centers under development, one in Northern Virginia (which was completed in October 2007) and one in suburban Chicago (which was completed in August 2008);
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undeveloped land in Northern Virginia and Piscataway, New Jersey; and
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a contract to acquire land in Santa Clara, California, which we acquired in December 2007.
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management, development, leasing, asset management and technical services agreements and arrangements for these properties.
Our Business
We are a leading owner, developer, operator and manager of large-scale data center facilities leased to tenants under long-term leases-commonly referred to as “wholesale data centers.” Our data centers are highly specialized, secure facilities used by our tenants-primarily national and international technology companies, including Microsoft, Yahoo!, Facebook and Google-to house, power and cool the computer servers that support many of their most critical business processes. We lease the raised square footage and available power of each of our facilities to our tenants under long-term triple-net leases, which contain annual rental increases.
We believe our data centers are engineered to the highest specifications commercially available and provide sufficient power to meet the needs of the world’s largest technology companies. Our data center located in Northern Virginia and known as ACC4 is our prototype for future ground-up developments due to its enhanced power capacity and flexible design, which enables us to accommodate both smaller and larger tenants in a single facility. ACC4 is capable of providing tenants with a total of 36.4 megawatts, or MW, of power, which we refer to as critical load, or IT load. Critical load is that portion of each facility’s total power capacity that is made available for the exclusive use by our tenants to operate their computer servers. Because we believe that critical load is the primary factor that tenants evaluate in choosing a data center, we generally establish our rents based on the amount of power that we make available to our tenants, rather than the amount of space that they occupy. Accordingly, where we discuss our operations in terms of raised square footage, which we consider to be the net rentable square footage of each of our facilities, we generally also provide a corresponding discussion of critical load, which is one of the primary metrics that we use to manage our business.
We provide property management, development, asset management and technical services to the tenants of our operating properties. By combining our properties with these core operating functions, we believe we are well positioned as a fully-integrated wholesale data center provider, capable of developing, leasing, operating and managing our growing portfolio.
We intend to continue our focus on the performance of our six operating properties, as well as our pursuit of growth through the build-out and lease-up of our development properties. Our current operating properties are located in Northern Virginia and suburban Chicago, Illinois, and as we complete the build-out of planned data centers in Piscataway, New Jersey and Santa Clara, California, our portfolio of data centers will become more geographically diverse in the future.
Our Business and Growth Strategies
Our primary business objectives are to maximize cash flow per share and returns to our stockholders through the prudent management of a balanced portfolio of operating and development properties. Our business strategies to achieve these objectives are:
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Maximize cash flow from existing properties. We derive substantially all of our revenue from rents received from tenants under existing leases at each of our operating properties. We maximize our cash flows under these leases by including a monthly base rent obligation, a property management fee to compensate us for the management of our properties, and a “triple net” structure, which obligates our tenants to reimburse us for the costs that we incur to operate the data center, including the cost of electricity used by tenants to power their computer equipment and the pro rata share of most other operating expenses, such as real estate taxes and insurance. Our leases include annual increases of base rent-either based on the consumer price index or a flat rate of about 3.0%.
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Build-out our current development pipeline. Development of new data center properties is the primary means by which we plan to increase our revenues and cash flows from operations. In 2008, we commenced development of data centers at three locations-Phase I of our ACC5 data center in Northern Virginia, Phase I of our NJ1 data center in Piscataway, New Jersey and Phase I of our SC1 data center in Santa Clara, California. When completed, each of these initial phases will have available
critical load of 18.2 megawatts (“MW”) for a total of 54.6 MW of critical load. In the fourth quarter of 2008, we suspended development at each of these properties, as we were not able to obtain adequate financing to complete their construction. In the first quarter of 2009, we obtained sufficient financing to allow us to complete construction of ACC5 Phase I. We have resumed development at that site, and expect to complete construction in the third quarter 2009. We continue to seek pre-leasing and additional financing to resume development at NJ1 and SC1, but there can be no assurance that we can obtain financing on satisfactory terms, or at all.
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Expand and diversify tenant base. Our existing tenant base consists primarily of large technology companies, and three of our stabilized data center properties are leased by our two largest tenants under long-term leases. We seek to expand and diversify our tenant base by marketing our remaining available vacancy at our existing properties and new space at our development properties to other Internet companies, enterprise companies, large financial services companies and government agencies, which demand data center space in smaller quantities-generally 10 MW or less-than large technology companies. We believe that our wholesale data center model offers such enterprise companies a number of important advantages compared to a typical collocation facility, including the ability to realize economies of scale (such as bulk-priced power contracts) by sharing the facility with larger users, while at the same time enjoying tightly controlled access to their own dedicated computer room. Our triple-net lease terms also enable enterprise tenants to control costs during any ramp-up phase (the period before they are utilizing all of the power they have contracted for). We have attracted these types of companies to our ACC4 and CH1 data center properties, as well as to our ACC5 data property currently under development. We will continue to market our properties to both large technology and enterprise companies.
Our Properties
Stabilized Operating Properties
The following table presents a summary of our five stabilized operating properties as of December 31, 2008:
Stabilized Operating Properties
As of December 31, 2008
(1) Stabilized operating properties are either 85% or more leased or are in service for 24 months or greater.
(2) Gross building area is the entire building area, including raised square footage (the portion of gross building area where our tenants’ computer servers are located), tenant common areas, areas controlled by us (such as the mechanical, telecommunications and utility rooms) and, in some facilities, individual office and storage space leased on an as available basis to our tenants.
(3) Raised square footage is that portion of gross building area where our tenants locate their computer servers. We consider raised square footage to be the net rentable square footage in each of our facilities.
(4) Critical load (also referred to as IT load or load used by tenants’ servers or related equipment) is the power available for exclusive use by our tenants expressed in terms of megawatt, or MW, or kilowatt, or kW (1 MW is equal to 1,000 kW).
(5) Percentage leased is expressed as a percentage of critical load that is subject to an executed lease. As of February 11, 2009, we have executed one additional lease at ACC4, increasing the percentage leased for ACC4 to 93.8% and percentage leased for the stabilized operating properties to 97.3%.
(6) Annualized base rent on a straight-lined basis for leases executed and/or amended as of January 1, 2009 over the non-cancellable terms of the respective leases and excludes approximately $7.0 million net amortization increase in revenue of above and below market leases. Annualized base rent on a cash basis for the 2009 calendar year is $89.5 million assuming no additional leasing or changes to existing leases.
Tenant Diversification
As of January 1, 2009, our portfolio was leased to thirteen data center tenants, many of which are nationally recognized firms in the technology industry. As of January 1, 2009, our two largest tenants, Microsoft and Yahoo!, accounted for 67.2% of our annualized base rent.
Lease Expirations
The following table sets forth a summary schedule of lease expirations of our stabilized operating properties for each of the ten full calendar years beginning January 1, 2009. The information set forth in the table assumes that tenants exercise no renewal options.
(1) The stabilized operating properties have 13 tenants with 16 separate leases and 26 different lease expiration dates.
(2) Raised square footage is that portion of gross building area where our tenants locate their computer servers. We consider raised square footage to be the net rentable square footage in each of our facilities.
(3) One megawatt is equal to 1,000 kW.
Lease Distribution
The following table sets forth information relating to the distribution of leases of each of our stabilized operating properties based on critical load, in terms of kilowatts or kW, under lease as of December 31, 2008:
(1) Critical load is that portion of each facility’s total load that is made available for the exclusive use by our tenants to operate their computer servers. In addition to critical load, each of our data centers is designed to provide sufficient additional power to cool our tenant’s servers, which we refer to as essential load.
(2) Annualized base rent on a straight-lined basis for leases executed and/or amended as of January 1, 2009 over the non-cancellable terms of the respective leases and excludes approximately $7.0 million net amortization increase in revenue of above and below market leases. Annualized base rent on a cash basis for the 2009 calendar year is $89.5 million assuming no additional leasing or changes to existing leases.
Development Projects
We own fee simple title to all land at our development projects. Our development projects include one complete data center-Phase I of CH1 in Elk Grove Village, Illinois-that is not stabilized, three data center projects under development-Phase I of ACC5 in Ashburn, Virginia; Phase I of NJ1 in Piscataway, New Jersey; and Phase I of SC1 in Santa Clara, California-and undeveloped land sufficient for the development of other data center facilities.
We completed construction of Phase I of CH1 in August 2008. As of February 11, 2009, Phase I of CH1 is 9.5% leased.
In late 2008, we temporarily suspended development of ACC5, NJ1 and SC1 to conserve our liquidity. Since December 31, 2008, we have resumed construction at ACC5 and expect Phase I of ACC5 to be completed in the third quarter 2009. As of February 11, 2009, Phase I of ACC5 is 57.3% pre-leased. We do not plan to resume development at NJ1 or SC1 until we obtain sufficient funds to complete the projects.
The following table presents a summary of our development properties as of December 31, 2008:
Development Projects
As of December 31, 2008
($ in thousands)
* Development costs have not yet been estimated.
(1) Gross building area is the entire building area, including raised square footage (the portion of gross building area where our tenants’ computer servers are located), tenant common areas, areas controlled by us (such as the mechanical, telecommunications and utility rooms) and, in some facilities, individual office and storage space leased on an as available basis to our tenants.
(2) Raised square footage is that portion of gross building area where our tenants locate their computer servers. We consider raised square footage to be the net rentable square footage in each of our facilities.
(3) Critical load (also referred to as IT load or load used by tenants’ servers or related equipment) is the power available for exclusive use by our tenants expressed in terms of MW or kW (1 MW is equal to 1,000 kW).
(4) Includes estimated capitalization for construction and development, including closing costs, capitalized interest and capitalized operating carrying costs, as applicable, upon completion.
(5) Amount capitalized as of December 31, 2008.
(6) Construction temporarily suspended in Q4 2008. All estimated commitments were accrued and included in Construction costs payable on the Consolidated Balance Sheets as of December 31, 2008.
(7) ACC5 Phase I is 57.3% pre-leased as of February 11, 2009, and the Company resumed development.
(8) CH1 Phase I is 9.5% leased as of February 11, 2009.
Competition
We believe we have two types of competitors:
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Tenants who choose to build, own and operate their own datacenters rather than to outsource to us, and
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Developers of both wholesale and collocation data centers.
In operating and managing our portfolio, we compete for tenants based on factors including location, critical load, raised square footage, flexibility and expertise in the design and operation of data centers.
Based on the current economic environment and lack of available capital, we believe that some companies that would otherwise build their own datacenter may not be able to secure sufficient capital, or may choose not to utilize available capital. We believe that this situation will reduce the inventory of available data center space and could reduce competition over the next several years.
In addition, we face competition for the acquisition of land suitable for the development of wholesale data centers from real estate developers in our and in other industries. Such competition may have the effect of reducing the number of available properties for acquisition, increasing the price of any acquisition, and reducing the supply of wholesale data center space in the markets we seek to serve.
Regulation
Americans With Disabilities Act
Our properties must comply with Title III of the Americans with Disabilities Act, or ADA, to the extent that such properties are “public accommodations” as defined by the ADA. The ADA may require removal of structural barriers to access by persons with disabilities in certain public areas of our properties where such removal is readily achievable. We believe that our operating properties are in substantial compliance with the ADA and that we will not be required to make substantial capital expenditures to address the requirements of the ADA. However, noncompliance with the ADA could result in imposition of fines or an award of damages to private litigants. The obligation to make readily achievable accommodations is an ongoing one, and we will continue to assess our properties and make alterations as appropriate in this respect.
Environmental Matters
Under various federal, state and local laws, regulations and ordinances relating to the protection of the environment, a current or former owner, operator or tenant of real property may be liable for the cost to remove or remediate contamination resulting from the presence or discharge of hazardous or toxic substances, wastes or petroleum products on, under, from or in such property. These costs could be substantial and liability under these laws may attach without regard to whether the owner or operator knew of, or was responsible for, the presence of the contaminants, and the liability may be joint and several. Previous owners used some of our properties for industrial and retail purposes (CH1, NJ1, SC1 and ACC7), so those properties may contain some level of environmental contamination. In addition, many of our properties presently contain large fuel storage tanks for emergency power, which is critical to our operations. If any of our tanks has a release of fuel to the environment, we would likely have to pay to clean up the contamination. The presence of contamination or the failure to remediate contamination at our properties may expose us to third-party liability or materially adversely affect our ability to sell, lease or develop the real estate or to borrow using the real estate as collateral.
Some of our properties may contain asbestos-containing building materials. Environmental laws require that owners or operators of buildings with asbestos-containing building materials properly manage and maintain these materials, adequately inform or train those who may come into contact with asbestos and undertake special precautions, including removal or other abatement, in the event that asbestos is disturbed during building renovation or demolition. These laws may impose fines and penalties on building owners or operators for failure to comply with these requirements. In addition, these laws may also allow third parties to seek recovery from owners or operators for personal injury associated with exposure to asbestos-containing building materials.
Environmental laws and regulations regarding the handling of regulated substances and wastes apply to our properties, in particular regulations regarding the storage of petroleum for emergency/auxiliary power. The properties in our portfolio are also subject to various federal, state and local health and safety requirements, such as state and local fire requirements. If we or our tenants fail to comply with these various requirements, we might incur governmental fines or private damage awards. Moreover, we do not know whether existing requirements will change or whether future requirements will require us to make significant unanticipated expenditures that will materially adversely impact our financial condition, results of operations, cash flow, cash available for distributions, the per share trading price of our common stock and our ability to satisfy our debt service obligations. Environmental noncompliance liability could also affect a tenant’s ability to make rental payments to us. We require our tenants to comply with these environmental, health and safety laws and regulations and to indemnify us for any related liabilities.
Although our properties have been subjected to Phase I environmental site assessments, they are limited in scope, and may not identify all potential environmental liabilities or risks associated with our properties. Unless required by applicable laws or regulations, we may not further investigate, remedy or ameliorate the liabilities disclosed in the Phase I assessments.
Our property in Piscataway, New Jersey, is subject to New Jersey’s Industrial Site Recovery Act, or ISRA. Under ISRA, the state’s Department of Environmental Protection, or NJDEP, can require a landowner to undertake efforts to remediate pollution caused by its activities on the site. In our case, the prior owner of our New Jersey site, GlaxoSmithKline (“the Seller”) ceased operation at the site in 2004 and has undertaken remediation efforts in accordance with ISRA, including removal of certain structures on the site and remediation of soil and groundwater. We were not involved in the activities that led to the pollution of this site and the prior owner remains liable for the cleanup costs. In addition to its responsibilities under ISRA, the prior owner is obligated under the surviving provisions of our purchase contract to diligently proceed with ISRA compliance, to take all reasonable action to complete the work set forth in the NJDEP-approved remedial actions work plan, and to obtain no further action letters with regard to soils and groundwater. The prior owner has applied to self-insure its obligations to NJDEP, and the prior owner’s certified application states that its net worth is approximately $67 billion. The prior owner has indemnified us with regard to any fines, charges or liability in connection with ISRA and compliance therewith. Moreover, we are named as an additional insured on a number of the seller’s environmental, worker’s compensation, and professional liability insurance policies, and we carry insurance regarding some of the risks associated with the known contamination as well. Nonetheless, as the current landowner, under ISRA, we may be held liable for all or a portion of the cost to clean up the site to the extent that GlaxoSmithKline is unable or is otherwise not required to pay for the cleanup. The prior owner is legally obligated to continue to operate the existing groundwater remediation system for a number of years in accordance with the Remedial Action Work Plan approved by NJDEP in accordance with ISRA. If the prior owner were to cease its monitoring activities, we could be required to continue them under applicable law. However, we do not anticipate that such costs would be material and we would seek to recover them from the prior owner. The existence of this remediation system has the potential to interfere with the future development of the property. However, the NJDEP has already approved the abandonment of monitoring wells presently located within the proposed footprint of the facility, so we do not expect the groundwater remediation system to have a material impact on the development of the site as presently planned, although it could make it more difficult to sell the property in the future. As a result of the contamination, there are or will be restrictions on certain uses of the property, such as for residential use. However, our proposed use is not subject to such restrictions and, furthermore, has been confirmed as a permitted use under applicable zoning regulations and ordinances by the relevant zoning authority, so we do not expect such restrictions to have a material impact on us. We are also aware that we may incur additional construction costs associated with the removal and disposal of contaminated soils. For example, we are required to install a vapor intrusion barrier or system in any building constructed on the site for indoor air quality purposes. We do not anticipate these costs will be material. However, if we were to be held liable for any unanticipated costs associated with the environmental contamination or on-going cleanup of this site, such costs could be material and could have a material adverse impact on our financial condition and results of operations.
Insurance
We carry comprehensive liability, fire, extended coverage, business interruption and rental loss insurance covering all of the properties in our portfolio under a blanket policy, which includes coverage for riots, terrorism, acts of God and floods. We have policy specifications and insured limits which we believe to be appropriate given the relative risk of loss, the cost of the coverage and industry practice and, in the opinion of our management, the properties in our portfolio are currently adequately insured. See “Item 1A.
ITEM 1A. RISK FACTORS
Set forth below are the risks that we believe are material to our stockholders. You should carefully consider the following risks in evaluating our Company, our properties and our business. The occurrence of any of the following risks could materially adversely impact our financial condition, results of operations, cash flow, the per share trading price of our common stock and our ability to satisfy our debt service obligations and to make distributions to our stockholders, which in turn could cause our stockholders to lose all or a part of their investment. Some statements in this report including statements in the following risk factors constitute forward-looking statements. Please refer to the section entitled “Special Note Regarding Forward-Looking Statements” at the beginning of this report.
Risks Related to Our Business and Operations
Any decrease in the demand for data centers, including resulting from a downturn in the technology industry, could materially adversely affect our business.
Our portfolio of properties consists entirely of wholesale data centers leased primarily by technology companies. A decline in the technology industry could lead to a decrease in the demand for space in our data centers, which may have a greater adverse effect on our business and financial condition than if we owned a more diversified real estate portfolio. We are also susceptible to adverse developments in the technology industry such as business layoffs or downsizing, industry slowdowns, relocations of businesses, costs of complying with government regulations or increased regulation and other factors. We also may be materially adversely affected by any downturns in the market for data centers due to, among other things, oversupply of or reduced demand for space or a slowdown in web-based commerce. Also, a lack of demand for data center space by enterprise customers could have a material adverse effect on our business and business prospects.
Our current portfolio of completed operating properties is located entirely in Northern Virginia and suburban Chicago, Illinois, and any adverse developments in the economies of these areas may materially adversely affect our operating results.
We are potentially exposed to greater economic risks than if we owned a more geographically diverse portfolio. We are susceptible to adverse developments in the Northern Virginia and Chicago economic and regulatory environment (including, but not limited to, business layoffs or downsizing, industry slowdowns, relocations of businesses, increases in real estate and other taxes, costs of complying with governmental regulations or increased regulation and other factors). Any adverse developments in the economy or real estate market in Northern Virginia or Chicago in general, or any decrease in demand for data center space resulting from the Northern Virginia or Chicago regulatory or business environment, could materially adversely impact our business and results of operations.
As of January 1, 2009, our two largest tenants, Microsoft and Yahoo!, collectively accounted for 67.2% of our annualized base rent, and the loss of either tenant or any other significant tenant could have a materially adverse affect on our business.
As of January 1, 2009, our two largest tenants, Microsoft and Yahoo!, accounted for 67.2% of our annualized base rent. Our tenants may experience a downturn in their businesses, which may weaken their financial condition and result in their failure to make timely rental payments or their default under their leases. In the event of any tenant default, we may experience delays in enforcing our rights as landlord and may incur substantial costs in protecting our investment. This risk would be particularly significant if one of our largest tenants, such as Microsoft and Yahoo!, were to default under its lease. In addition, if one or more of our significant tenants fail to renew their leases with us and we cannot find new tenants to utilize this space at the same rental rates, the expiration of these leases, as well as any future expirations, could have a material adverse affect on our business.
Some of our largest tenants may compete with one another in various aspects of their businesses. The competitive pressures on our tenants may have a negative impact on our operations.
The bankruptcy or insolvency of a major tenant would have a material adverse impact on our business.
The bankruptcy or insolvency of a major tenant also may materially adversely affect the income produced by our properties. If any tenant becomes a debtor in a case under the federal Bankruptcy Code, we cannot evict the tenant solely because of the bankruptcy. In addition, the bankruptcy court might authorize the tenant to reject and terminate its lease with us. Our claim against the tenant for unpaid future rent would be subject to a statutory cap that might be substantially less than the remaining rent owed under the lease. In either case, our claim for unpaid rent would likely not be paid in full. Our revenue and cash available for distribution to our stockholders could be materially adversely affected if any of our significant tenants were to become bankrupt or insolvent, suffer a downturn in its business, or fail to renew its lease at all or renew on terms less favorable to us than its current terms.
Our tenants may choose to develop new data centers or expand their own existing data centers, which could result in the loss of one or more key tenants or reduce demand for our newly developed data centers, which could have a material adverse effect on our revenues and results of operations.
Our tenants may choose to develop new data centers or expand any existing data centers of their own in the future. In the event that any of our key tenants were to do so, it could result in a loss of business to us or put pressure on our pricing. If we lose a tenant, there is no assurance that we would be able to replace that tenant at a competitive rate or at all, which could have a material adverse effect on our revenues and results of operations.
Future consolidation in the technology industry could materially adversely affect our revenues by eliminating some of our potential tenants and could make us more dependent on a more limited number of tenants.
Mergers or consolidations of technology companies in the future could reduce the number of our tenants and potential tenants. If our tenants merge with or are acquired by other entities that are not our tenants, they may discontinue or reduce the use of our data centers in the future. Any of these developments could have a material adverse effect on our revenues and results of operations.
Our data center infrastructure may become obsolete and we may not be able to upgrade our power and cooling systems cost-effectively or at all, which could have a material adverse effect on our business and results of operations.
The markets for the data centers we own and operate, as well as the industries in which our tenants operate, are characterized by rapidly changing technology, evolving industry standards, frequent new service introductions, shifting distribution channels and changing tenant demands. Our data center infrastructure may become obsolete due to the development of new systems to deliver power to or eliminate heat from the servers we house. Additionally, our data center infrastructure could become obsolete as a result of the development of new server technology that does not require the levels of critical load and heat removal that our facilities are designed to provide and could be run less expensively on a different platform. In addition, our power and cooling systems are difficult and expensive to upgrade. Accordingly, we may not be able to efficiently upgrade or change these systems to meet new demands without incurring significant costs that we may not be able to pass on to our tenants. The obsolescence of our power and cooling systems could have a material adverse effect on our business and results of operations.
Our tax protection agreements could limit our ability to sell or otherwise dispose of certain properties.
In connection with our formation transactions and IPO in October 2007, we entered into tax protection agreements that provide that if we dispose of any interest in ACC2, ACC3, VA3, VA4 or CH1 in a taxable transaction through 2016, we will indemnify certain investors, including Messrs. du Pont, Fateh and certain directors for their tax liabilities attributable to the built-in gain that exists with respect to such property interest as of the time of our IPO (and tax liabilities incurred as a result of the reimbursement payment) if those tax liabilities exceed a certain amount. Therefore, although it may be in our stockholders’ best interest that we sell one of these properties, it may be economically prohibitive for us to do so because of these obligations. In addition, any such sale must be approved by at least 75% of our disinterested directors. Additionally, the agreement contains various provisions to achieve minimum liability allocations to certain investors and indemnifies them for their tax liabilities resulting from any gain or income recognized due to breach of those provisions by the partnership.
The terms of the agreements that govern our indebtedness limit our ability to sell the data center properties that have been pledged as collateral for our indebtedness, which could reduce our liquidity.
All of our income producing data center properties-VA3, VA4, ACC2, ACC3, ACC4 and CH1-serve as collateral to either our revolving credit facility (the “Credit Facility”) or our ACC4 credit agreement (the “ACC4 Term Loan”). The agreements that govern these loans limit our ability to sell these properties. Consequently, our ability to raise capital through the disposition of assets is limited.
Our properties are not suitable for lease other than as data centers, which could make it difficult to reposition them if we are not able to lease available space.
Our data centers are highly specialized real estate containing extensive electrical and mechanical systems that are designed uniquely to run and maintain computer servers. As a result, they are not suited for use by tenants as anything other than as data centers and major renovations and expenditures would be required in order for us to re-lease vacant space for more traditional uses, or for us to sell a property to a buyer for use other than as a data center.
The departure of any key personnel, including either Messrs. du Pont or Fateh, who have developed significant relationships with leading technology tenants in the highly specialized data center business, could have a material adverse impact on our results of operations.
We depend on the efforts of key personnel, particularly Messrs. du Pont and Fateh, the Executive Chairman of our board of directors and our President and Chief Executive Officer, respectively. In particular, our reputation among and our relationships with our key tenants are the direct result of a significant investment of time and effort by Messrs. du Pont and Fateh to build our credibility in a highly specialized industry. If we lost their services, our business and investment opportunities and our relationships with existing and prospective tenants and industry personnel and our reputation among our key tenants could be diminished, which could materially adversely affect our results of operations.
The other senior members of our executive team also have strong technology development, management and real estate industry reputations, which aid us in identifying acquisition opportunities and negotiating with tenants and build-to-suit prospects. The loss of any of their services could materially adversely affect our results of operations because of diminished relationships with existing and prospective tenants and industry personnel.
Our growth depends upon the successful development of our properties and any delays or unexpected costs in such development may delay and materially adversely affected our growth prospects, future operating results and our financial condition.
We own certain development projects, including ACC5, NJ1 and SC1, and land held for development, and our future growth depends upon the successful completion of these development projects. As of February 26, 2009, we have temporarily suspended construction of NJ1 and SC1 due to lack of financing for these projects,
and, although we have since resumed development, we were required to suspend construction on ACC5 during 2008. With respect to our current and any future developments, we will be subject to certain risks, including risks related to financing, zoning, regulatory approvals, construction costs and delays. In addition, we will be subject to risks and, potentially, unanticipated costs associated with obtaining access to a sufficient amount of power from local utilities, including the need, in some cases, to develop utility substations on our properties in order to accommodate our power needs, constraints on the amount of electricity that a particular locality’s power grid is capable of providing at any given time, and risks associated with the negotiation of long-term power contracts with utility providers. We may not be able to successfully negotiate such contracts on acceptable terms or at all. Any inability to negotiate utility contracts on a timely basis or on acceptable financial terms or in volumes sufficient to supply the critical load presently anticipated for each of our development properties would have a material adverse effect on our growth and future results of operations and financial condition.
In the past, we have developed properties prior to obtaining commitments from tenants to lease them-known as developing “on speculation,” which involves the risk that we will be unable to attract tenants to the properties we are developing on a timely basis or at all. If our properties remain vacant for a significant amount of time, our business and financial condition could be materially adversely affected.
Recent disruptions in the financial markets have negatively affected our ability to obtain financing, and may negatively affect our ongoing efforts to secure additional financing for development of our properties and other purposes on reasonable terms, or at all, and have other adverse effects on us.
Because our current stabilized operating properties do not generate sufficient cash flows to fund our development, we are dependent on outside sources of capital, on acceptable terms. The credit markets have recently experienced significant price volatility, dislocations and liquidity disruptions, which have caused spreads on prospective debt financings to widen considerably or lenders to stop making capital available. These conditions, which have continued into 2009, have materially impacted liquidity in the financial markets, making terms for certain financings less attractive, and in some cases have resulted in the unavailability of financing. Continued uncertainty in the stock and credit markets have negatively impacted, and may negatively affect, our ongoing efforts to secure additional financing for development of our properties and other purposes at reasonable terms, which may have a material adverse affect our business. A prolonged downturn in the financial markets may cause us to seek alternative sources of potentially less attractive financing, and may require us to adjust our business plan accordingly. These events also may make it more difficult or costly for us to raise capital through the issuance of our common stock or preferred stock.
Any losses to our properties which are not covered by insurance, or which exceed our policy coverage limits, would materially adversely affect our financial condition and results of operations.
We carry comprehensive liability, fire, extended coverage, business interruption and rental loss insurance covering all of the properties in our portfolio under a blanket policy, which includes coverage for riots, terrorism, acts of God and floods that are subject to policy specifications and insured limits. In addition, some of our policies, like those covering losses due to floods, are subject to limitations involving large deductibles or co-payments and policy limits that may not be sufficient to cover potential losses. If we experience a loss which is uninsured or which exceeds policy limits, we could lose the capital invested in the damaged properties as well as the anticipated future cash flows from those properties. In addition, if the damaged properties are subject to recourse indebtedness, we would continue to be liable for the indebtedness, even if these properties were irreparably damaged.
We face significant competition and may be unable to renew existing leases, lease vacant space or re-lease space as leases expire, which may have a material adverse affect on our business and results of operations.
We compete with numerous developers, owners and operators of technology-related real estate, many of which own properties similar to ours in the same submarkets in which our properties are located. If our
competitors offer space at rental rates below current market rates, or below the rental rates we currently charge our tenants, we may lose potential tenants and we may be pressured to reduce our rental rates below those we currently charge in order to retain tenants when their leases expire. In addition, some of our tenants, including Microsoft, and Yahoo!, own or may in the future develop their own data centers, which could increase the risk that such tenants fail to renew their leases by, among other things, making it easier for such tenants to transfer their server functions. We may be unable to renew leases or re-lease at net effective rental rates equal to or above the current average net effective rental rates. If the rental rates for our properties decrease, or our existing tenants do not renew their leases or we do not re-lease a significant portion of our available space and space for which leases are scheduled to expire, our business and results of operations could be materially adversely affected.
We have significant outstanding indebtedness, which may materially adversely affect our ability to make distributions, expose us to interest rate fluctuations and expose us to the risk of default under our debt obligations.
As of December 31, 2008, our total consolidated indebtedness was $666.8 million. We may incur additional debt for various purposes, including, without limitation, to fund future acquisition and development activities and operational needs. Payments of interest on borrowings may leave us with insufficient cash resources to operate our properties or to make the distributions currently contemplated or necessary to qualify and maintain our qualification as a REIT. Our outstanding indebtedness, and the limitations imposed on us by our debt agreements, could have other significant adverse consequences, including the following:
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our cash flow may be insufficient to meet our required principal and interest payments;
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we may be unable to refinance our indebtedness at maturity or the refinancing terms may be less favorable than the terms of our original indebtedness;
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we may violate restrictive covenants in our loan documents, which would entitle our lenders to accelerate our debt obligations;
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we may default on our obligations, and lenders or mortgagees may foreclose on our properties that secure their loans and receive an assignment of our rents and leases; and
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we may be forced to dispose of one or more of our properties, possibly on unfavorable terms or in violation of certain covenants that we may be subject to.
If any one of these events were to occur, our ability to satisfy our debt service obligations could be materially adversely affected. In addition, any foreclosure on our properties could create taxable income without accompanying cash proceeds, which could materially adversely affect our ability to meet the REIT distribution requirements imposed by the Code.
Our senior secured credit agreements restrict our ability to engage in some business activities, which could materially adversely affect our growth prospects, future operating results and financial condition.
Our senior secured credit agreements contain customary negative covenants and other financial and operating covenants that, among other things:
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restrict our and our subsidiaries’ ability to incur additional indebtedness;
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restrict our and our subsidiaries’ ability to make certain investments;
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restrict our and our subsidiaries’ ability to merge with another company;
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restrict our and our subsidiaries’ ability to create, incur or assume liens;
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restrict our ability to make distributions to our stockholders; and
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require us to maintain financial coverage ratios.
Specifically, the agreements that govern the Credit Facility and ACC4 Term Loan require that we maintain certain financial ratios. Under the ACC4 credit agreement, one such covenant provides that the total indebtedness of the Operating Partnership and its subsidiaries cannot exceed 65% of the value of the assets of the Operating Partnership and its subsidiaries, determined based on the appraised value of stabilized data center properties, the amount of unrestricted cash and the book value of development properties and undeveloped land. Under our Credit Facility, one such covenant provides that the total indebtedness of the borrowers-which include our subsidiaries that own VA3, VA4, ACC2 and ACC3-cannot exceed 65% of the value of the assets of the borrowers, determined based on the appraised value of each of VA3, VA4, ACC2 and ACC3. Under each of the Credit Facility and ACC4 Term Loan, the administrative agent has the right to have each of the data center properties appraised on an annual basis, or more often only if required by regulatory agencies, following an event of default, or if the agent reasonably believes that there is a material change to the market value of any such property. If the total indebtedness of the Operating Partnership or the Credit Facility borrowers, as applicable, exceeded 65% of the applicable asset value, the indebtedness in question would have to be reduced to a level that resulted in compliance with this ratio. Under the Credit Facility, the borrowers are permitted to add to the security package new collateral in the form of income producing data center property acceptable to the administrative agent. Currently, we have no income producing properties not collateralizing one of these loans. As of February 26, 2009, we have not received any such notices.
If we do not continue to satisfy these ratios, we will be in default under our credit agreements, which could trigger defaults under our other debt obligations, which in turn could result in the maturities of certain debt obligations being accelerated.
Our growth depends on external sources of capital which may not be available to us on commercially reasonable terms or at all.
In order to qualify and maintain our qualification as a REIT, we are required under the Code to distribute at least 90% of our net taxable income annually, determined without regard to the dividends paid deduction and excluding any net capital gain. In addition, we are subject to income tax at regular corporate rates to the extent that we distribute less than 100% of our net taxable income, including any net capital gains. Because of these distribution requirements, we may not be able to fund future capital needs, including any necessary acquisition financing, from operating cash flow. Consequently, we intend to rely on third-party sources to fund a substantial amount of our future capital needs. We may not be able to obtain such financing on favorable terms or at all. Any additional debt we incur will increase our leverage, expose us to the risk of default and impose operating restrictions on us. In addition, any stock that we issue in any equity financing could be materially dilutive to the equity interests held by our stockholders. Our access to third-party sources of capital depends, in part, on:
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general market conditions;
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the market’s perception of our growth potential;
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our current debt levels;
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our current and expected future earnings;
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the occupancy levels and performance of our data center properties;
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our cash flow and cash distributions; and
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the market price per share of our common stock.
If we cannot obtain capital when needed, we may not be able to acquire or develop properties when strategic opportunities exist, satisfy our debt service obligations or make the cash distributions to our stockholders necessary to qualify and maintain our qualification as a REIT, which would expose us to significant penalties and corporate-level taxation.
Mortgage debt obligations expose us to the possibility of foreclosure, which could result in the loss of our investment in a facility or group of facilities subject to mortgage debt.
Incurring mortgage and other secured debt obligations (including any increase in the amount outstanding under our Credit Facility) increases our risk of property losses because defaults on indebtedness secured by properties may result in foreclosure actions initiated by lenders and ultimately our loss of the property securing any loans for which we are in default. For tax purposes, a foreclosure of any of our properties would be treated as a sale of the property for a purchase price equal to the outstanding balance of the debt secured by the mortgage. If the outstanding balance of the debt secured by the mortgage exceeds our tax basis in the property, we would recognize taxable income on foreclosure, but would not receive any cash proceeds from the disposition of the properties.
As we continue to execute our business plan, we will assume mortgage indebtedness or incur substantial new mortgage indebtedness with respect to properties that we own or in connection with property acquisitions. Any default under any one of our mortgage debt obligations may increase the risk of our default on our other indebtedness.
As the present or former owner or operator of real property, we could become subject to liability for environmental contamination, regardless of whether we caused such contamination.
Under various federal, state and local laws, regulations and ordinances relating to the protection of the environment, a current or former owner, operator or tenant of real property may be liable for the cost to remove or remediate contamination resulting from the presence or discharge of hazardous or toxic substances, wastes or petroleum products on, under, from or in such property. These costs could be substantial and liability under these laws may attach without regard to whether the owner or operator knew of, or was responsible for, the presence of the contaminants, and the liability may be joint and several. Previous owners used some of our properties for industrial and retail purposes (CH1, NJ1, SC1 and ACC7). As a result, those properties may contain some level of environmental contamination. In addition, many of our properties presently contain large underground fuel storage tanks for emergency power, which is critical to our operations. If any of our tanks has a release of fuel to the environment, we would likely have to pay to clean up the contamination. Moreover, the presence of contamination or the failure to remediate contamination at our properties may expose us to third-party liability or materially adversely affect our ability to sell, lease or develop the real estate or to borrow using the real estate as collateral.
Hedging transactions may limit our gains or result in material losses.
The terms of our loan agreements require us to maintain certain hedges with respect to our variable rate loans to the extent those loans were to exceed 35.0% of our gross asset value. Subject to the REIT qualification requirements, we may also use derivatives to hedge other liabilities of ours. As of December 31, 2008, we have an interest rate swap in place that effectively fixes the interest rate at 6.497% on $200.0 million of our Credit Facility. This and any future hedging transactions expose us to certain risks, including:
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losses on a hedge position may reduce the cash available for distribution to stockholders and such losses may exceed the amount invested in such instruments;
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counterparties to a hedging arrangement could default on their obligations; and
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we may have to pay certain costs, such as transaction or brokerage fees.
Although the REIT rules impose certain restrictions on our ability to utilize hedges, swaps, and other types of derivatives to hedge our liabilities, we may use these hedging instruments in our risk management strategy to limit the effects of changes in interest rates on our operations. However, neither our current nor any future hedge may be effective in eliminating all of the risks inherent in any particular position. Our profitability may be materially adversely affected during any period as a result of the use of derivatives.
Hedging instruments often are not traded on regulated exchanges, guaranteed by an exchange or its clearing house, or regulated by any U.S. or foreign governmental authorities and involve risks and costs.
The cost of using hedging instruments increases as the period covered by the instrument lengthens and during periods of rising and volatile interest rates. We may increase our hedging activity and thus increase our hedging costs during periods when interest rates are volatile or rising and hedging costs have increased.
In addition, hedging instruments involve risks since they often are not traded on regulated exchanges, guaranteed by an exchange or its clearing house, or regulated by any U.S. or foreign governmental authorities. Consequently, there are no requirements with respect to record keeping, financial responsibility or segregation of customer funds and positions. Furthermore, the enforceability of agreements underlying derivative transactions may depend on compliance with applicable statutory and commodity and other regulatory requirements and, depending on the identity of the counterparty, applicable international requirements. The business failure of a hedging counterparty with whom we have entered or may enter into a hedging transaction would most likely result in a default. Default by a party with whom we enter into a hedging transaction may result in the loss of unrealized profits and force us to cover our resale commitments, if any, at the then current market price. It may not always be possible to dispose of or close out a hedging position without the consent of the hedging counterparty, and we may not be able to enter into an offsetting contract to cover our risk. A liquid secondary market may not exist for hedging instruments purchased or sold, and we may be required to maintain a position until exercise or expiration, which could result in losses.
Failure to abide by applicable service level commitments could subject us to material liability under the terms of our leases, which could materially adversely affect our operating results.
Our leases generally include terms requiring us to meet certain service level commitments in terms of electrical output, cooling levels and levels of redundancy in all key systems. Any failure to meet these commitments, including as a result of mechanical failure, power outage, human error or for other reasons, could subject us to liability under our lease terms, including loss of management fee reimbursements or rent abatement. Any such failures could also materially adversely affect our reputation and adversely impact our ability to lease our properties, which could have a material adverse effect on our business, financial condition and results of operations.
Additional risks may arise if we make international investments.
We may, in the future, purchase properties located outside the United States. These investments may be affected by factors peculiar to the laws and business practices of the jurisdictions in which the properties are located. These laws may expose us to risks that are different from and in addition to those commonly found in the United States.
We depend on third parties to provide Internet connectivity to the tenants in our data centers and any delays or disruptions in connectivity may materially adversely affect our operating results and cash flow.
We are not a telecommunications carrier. Although our tenants are responsible for providing their own network connectivity, we still depend upon the presence of telecommunications carriers’ fiber networks serving the locations of our data centers in order to attract and retain tenants. We believe that the availability of carrier capacity will directly affect our ability to achieve our projected results. Any carrier may elect not to offer its services within our data centers. Any carrier that has decided to provide Internet connectivity to our data centers may not continue to do so for any period of time. Further, some carriers are experiencing business difficulties or have announced consolidations. As a result, some carriers may be forced to downsize or terminate connectivity within our data centers, which could have an adverse effect on the business of our tenants and, in turn, our own operating results.
Our new data centers require construction and operation of a sophisticated redundant fiber network. The construction required to connect multiple carrier facilities to our data centers is complex and involves factors outside of our control, including regulatory requirements and the availability of construction resources. If the establishment of highly diverse Internet connectivity to our data centers does not occur, is materially delayed or is discontinued, or is subject to failure, our operating results and cash flow may be materially adversely affected. Any hardware or fiber failures on this network may result in significant loss of connectivity to our data centers. This could negatively affect our ability to attract new tenants or retain existing tenants.
The loss of access to key third-party service providers could materially adversely affect our current and any future development projects.
Our success depends, to a significant degree, on having timely access to certain key technical personnel who are in limited supply and great demand, such as engineering firms capable of developing our properties. For our current and any future development projects, we will continue to rely on these personnel who have the requisite expertise in the technical environments necessary to develop wholesale data centers. Competition for such technical expertise is intense and we may not always have or retain access to the key third-party service providers that we currently rely on or may rely on in the future.
Risks Related to the Real Estate Industry
Our operating performance is subject to risks associated with the real estate industry and we may not achieve our return objectives.
Real estate investments are subject to various risks and fluctuations and cycles in value and demand, many of which are beyond our control. Certain events may decrease our cash available for distribution, as well as the value of our properties. These events include, but are not limited to:
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inability to collect rent from tenants;
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vacancies or our inability to rent space on favorable terms, including possible market pressures to offer tenants rent abatements, tenant improvements, early termination rights or below-market renewal options;
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adverse changes in financial conditions of buyers, sellers and tenants of properties, including data centers;
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reductions in the level of demand or increase in the supply for data center space;
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competition from other real estate investors with significant capital, including other real estate operating companies, publicly traded REITs and institutional investment funds;
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fluctuations in interest rates, which could adversely affect our ability, or the ability of buyers and tenants of properties, including data centers, to obtain financing on favorable terms or at all;
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increases in expenses that are not paid for by or cannot be passed on to our tenants, such as the cost of complying with laws, regulations and governmental policies; and
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changes in and changes in enforcement of, laws, regulations and governmental policies, including, without limitation, health, safety, environmental, zoning and tax laws, governmental fiscal policies and the Americans with Disabilities Act of 1990, or ADA.
Our performance and value are subject to risks associated with real estate assets and with the real estate industry.
Our ability to make expected distributions to our stockholders depends on our ability to generate revenues in excess of expenses, scheduled principal payments on debt and capital expenditure requirements. Events and conditions generally applicable to owners and operators of real property that are beyond our control may decrease cash available for distribution to our stockholders and the value of our properties. These events include:
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local oversupply, increased competition or reduction in demand for technology-related space;
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inability to collect rent from tenants;
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vacancies or our inability to rent space on favorable terms;
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increased operating costs to the extent not paid for by our tenants;
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inability to finance development on favorable terms;
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costs of complying with changes in governmental regulations;
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the relative illiquidity of real estate investments, especially the specialized real estate properties that we hold and seek to acquire and develop; and
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changing submarket demographics.
Illiquidity of real estate investments and the terms of certain of our leases could significantly impede our ability to respond to adverse changes in the performance of our properties, which could materially adversely affect our financial condition and results of operations.
Because real estate investments are relatively illiquid, our ability to promptly sell one or more properties in our portfolio to raise cash in response to adverse changes in the performance of such properties may be limited, thus materially adversely affecting our financial condition.
In addition, data centers represent an illiquid part of the overall real estate market. This illiquidity is driven by a number of factors, including the relatively small number of potential purchasers of such data centers-including other data center operators and large corporate users-and the relatively high cost per square foot to develop data centers, which effectively limits a potential buyer’s ability to purchase a data center property with the intention of redeveloping it for an alternative use, such as an office building, or may substantially reduce the price buyers are willing to pay.
In addition, the leases for certain of our facilities, including all of VA4 and ACC3 and a portion of ACC4, give the tenants of those facilities a right of first refusal to purchase those properties as well as the property upon which we intend to develop ACC5 if we propose to sell those properties to a third party. In addition, the leases in effect at VA4, ACC3 and ACC2 prohibit us, during the lease terms, from selling those properties to a third party that is a competitor of the tenant. The existence of such restrictions could hinder our ability to promptly sell one or more of these properties, which could materially adversely affect our financial condition and results of operations.
As the owner of real property, we could become subject to liability for failure to comply with environmental requirements regarding the handling and disposal of regulated substances and wastes or for non-compliance with health and safety requirements.
Environmental laws and regulations regarding the handling of regulated substances and wastes apply to our properties, including, in particular, regulations regarding the storage of petroleum for auxiliary or emergency power. The properties in our portfolio are also subject to various federal, state and local health and safety requirements, such as state and local fire requirements. If we or our tenants fail to comply with these various requirements, we might incur governmental fines or private damage awards. Moreover, we do not know whether existing requirements will change or whether future requirements will require us to make significant unanticipated expenditures that will materially adversely impact our financial condition, results of operations, cash flow, cash available for distribution to our stockholders, the per share trading price of our common stock and our ability to satisfy our debt service obligations. Environmental noncompliance liability could also materially adversely affect a tenant’s ability to make rental payments to us.
As the owner of real property, we could become subject to liability for asbestos-containing building materials in the buildings on our property.
Some of our properties may contain asbestos-containing building materials. Environmental laws require that owners or operators of buildings with asbestos-containing building materials properly manage and maintain these
materials, adequately inform or train those who may come into contact with asbestos and undertake special precautions, including removal or other abatement, in the event that asbestos is disturbed during building renovation or demolition. These laws may impose fines and penalties on building owners or operators for failure to comply with these requirements. In addition, these laws may also allow third parties to seek recovery from owners or operators for personal injury associated with exposure to asbestos-containing building materials.
Our properties may contain or develop harmful mold or suffer from other adverse conditions, which could lead to liability for adverse health effects and costs of remediation.
When excessive moisture accumulates in buildings or on building materials, mold growth may occur, particularly if the moisture problem remains undiscovered or is not addressed over a period of time. Some molds may produce airborne toxins or irritants. Indoor air quality issues can also stem from inadequate ventilation, chemical contamination from indoor or outdoor sources and other biological contaminants such as pollen, viruses and bacteria. Indoor exposure to airborne toxins or irritants above certain levels can be alleged to cause a variety of adverse health effects and symptoms, including allergic or other reactions. As a result, the presence of significant mold or other airborne contaminants at any of our properties could require us to undertake a costly remediation program to contain or remove the mold or other airborne contaminants from the affected property or increase indoor ventilation. In addition, the presence of significant mold or other airborne contaminants could expose us to liability from our tenants, employees of our tenants and others if property damage or health concerns arise.
We may incur significant costs complying with the Americans with Disabilities Act and similar laws, which could materially adversely affect our operating results.
Under the ADA, all places of public accommodation must meet federal requirements related to access and use by disabled persons. A number of additional federal, state and local laws may also require modifications to our properties. We have not conducted an audit or investigation of all of our properties to determine our compliance with the ADA. If one or more of the properties in our portfolio is not in compliance with the ADA, we would be required to incur additional costs to bring the property or properties into compliance. Additional federal, state and local laws may require modifications to our properties, or restrict our ability to renovate our properties. We cannot predict the ultimate amount of the cost of compliance with the ADA or other legislation. If we incur substantial costs to comply with the ADA and any other similar legislation, our financial condition, results of operations, cash flow, cash available for distribution to our stockholders, the per share trading price of our common stock and our ability to satisfy our debt service obligations could be materially adversely affected.
We may incur significant costs complying with other regulations, which could materially adversely affect our operating results.
The properties in our portfolio are subject to various federal, state and local regulatory requirements. If we fail to comply with these various requirements, we might incur governmental fines or private damage awards. In addition, we do not know whether existing requirements will change or whether future requirements will require us to make significant unanticipated expenditures that could materially adversely affect our financial condition, results of operations, cash flow, cash available for distribution to our stockholders, the per share trading price of our common stock and our ability to satisfy our debt service obligations.
Risks Related to Our Organizational Structure
Conflicts of interest exist or could arise in the future with holders of units of partnership interest in our Operating Partnership, or OP units, which may impede business decisions that could benefit our stockholders.
Conflicts of interest exist or could arise in the future as a result of the relationships between us and our affiliates, on the one hand, and our Operating Partnership or any partner thereof, on the other. Our directors and
officers have duties to our Company and our stockholders under applicable Maryland law. At the same time, we, as general partner, have fiduciary duties to our Operating Partnership and to its limited partners under Maryland law. Our duties as general partner to our Operating Partnership and its partners may come into conflict with the duties of our directors and officers to our Company and our stockholders. The partnership agreement of our Operating Partnership provides that for so long as we are the general partner of our Operating Partnership, any conflict that cannot be resolved in a manner not adverse to either our stockholders or the limited partners will be resolved in favor of our stockholders.
Additionally, the partnership agreement expressly limits our liability by providing that we and our officers, directors, agents and employees, will not be liable or accountable to our Operating Partnership for losses sustained, liabilities incurred or benefits not derived if we, or such officer, director, agent or employee acted in good faith. In addition, our Operating Partnership is required to indemnify us, and our officers, directors, employees, agents and designees to the extent permitted by applicable law from and against any and all claims arising from operations of our Operating Partnership, unless it is established that (1) the act or omission was committed in bad faith, was fraudulent or was the result of active and deliberate dishonesty, (2) the indemnified party received an improper personal benefit in money, property or services or (3) in the case of a criminal proceeding, the indemnified person had reasonable cause to believe that the act or omission was unlawful. The provisions of Maryland law that allow the fiduciary duties of a general partner to be modified by a partnership agreement have not been resolved in a court of law, and we have not obtained an opinion of counsel covering the provisions set forth in the partnership agreement that purport to waive or restrict our fiduciary duties that would be in effect were it not for the partnership agreement.
We are also subject to the following additional conflicts of interest with holders of OP units:
We may pursue less vigorous enforcement of terms of the employment agreements with members of our senior management and their affiliates because of our dependence on them and conflicts of interest. Messrs. du Pont and Fateh entered into employment agreements with us, including clauses prohibiting them from competing with us, subject to certain exceptions, in the data center market. None of these agreements were negotiated on an arm’s-length basis. We may choose not to enforce, or to enforce less vigorously, our rights under these employment agreements because of our desire to maintain our ongoing relationship with members of our senior management and their affiliates and because of conflicts of interest with them, including allowing them to devote significant time to non-data center projects outside of our Company, to engage in activities that may compete with us, or to engage in transactions with us without receiving the appropriate board approval.
Tax consequences upon sale or refinancing. Sales of properties and repayment of related indebtedness will have different effects on holders of OP units than on our stockholders. The parties that contributed properties to our Operating Partnership may incur tax consequences upon the sale of these properties and on the repayment of related debt which differ from the tax consequences to us and our stockholders. Consequently, these holders of OP units may have different objectives regarding the appropriate pricing and timing of any such sale or repayment of debt. While we have exclusive authority under the partnership agreement of our Operating Partnership to determine when to refinance or repay debt or whether, when, and on what terms to sell a property, any such decision would require the approval of our board of directors, and our ability to take such actions, to the extent that they may reduce the liabilities of our Operating Partnership, may be limited pursuant to the tax protection agreements that we entered into upon completion of our IPO. Certain of our directors and executive officers could exercise their influence in a manner inconsistent with the interests of some, or a majority, of our stockholders, including in a manner which could delay or prevent completion of a sale of a property or the repayment of indebtedness.
Messrs. du Pont and Fateh have the right to hold a significant percentage of our stock. Our charter generally authorizes our directors to take such actions as are necessary and desirable to preserve our qualification as a REIT and to limit any person (other than a qualified institutional investor) to actual or constructive ownership of no more than 3.3% of the outstanding shares of our common stock by value or by number of shares,
whichever is more restrictive and 3.3% of our outstanding capital stock by value. However, our board of directors may grant an exemption from the ownership limits described above if such exemption does not jeopardize our status as a REIT. In addition, our charter provides that Mr. du Pont, certain of his affiliates, family members and trusts formed for the benefit of the foregoing, may own up to 20.0% of the outstanding shares of our common stock by value or by number of shares, whichever is more restrictive, and 20.0% of our outstanding capital stock by value, and that Mr. Fateh, certain of his affiliates, family members and trusts formed for the benefit of the foregoing, may own up to 20.0% of the outstanding shares of our common stock by value or by number of shares, whichever is more restrictive, and 20.0% of our outstanding capital stock by value. These exemptions from the general ownership limits give Messrs. du Pont and Fateh the ability to own a combined interest in our stock equal to 40.0% of our shares outstanding. In addition, pursuant to their employment agreements, each of Messrs. du Pont and Fateh, as long as he holds at least 9.8% of our outstanding shares on a fully diluted basis, will have a contractual right to be nominated to the board of directors. These exemptions and contractual rights could allow Messrs. du Pont and Fateh to exercise, individually or in concert, a substantial degree of control over our affairs even if they are no longer executive officers.
Our senior management team has significant influence over our affairs. As of December 31, 2008, Messrs. du Pont and Fateh, own an aggregate of approximately 0.7% of our common stock and approximately 38.1% of our OP units (not including those units held by us), equal to approximately 18.3% of our common stock, on a fully diluted basis. As a result, our senior management team, to the extent they vote their shares in a similar manner, can have influence over our affairs and could exercise such influence in a manner that is not in the best interests of our other stockholders, including by attempting to delay, defer or prevent a change in control transaction that might otherwise be in the best interests of our stockholders. If our senior management team exercises their redemption rights with respect to their OP units and we issue common stock in exchange thereof, our senior management team’s influence over our affairs would increase substantially.
Messrs. du Pont and Fateh have outside business interests that could require time and attention and may interfere with their ability to devote time to our business and affairs. Messrs. du Pont and Fateh own interests in non-data center real estate assets that were not contributed to us in our IPO, including, among other investments, the office building where our corporate headquarters is located, approximately 40 acres of undeveloped land outside of Phoenix, Arizona and an aggregate of approximately 510 acres of undeveloped land in Northern Virginia. The office building is managed by an unaffiliated third party and Messrs. du Pont and Fateh are not currently engaged in any development projects with respect to the undeveloped land. Pursuant to the terms of our employment agreements with Messrs. du Pont and Fateh, each has agreed to devote substantially all of his business attention and time to our affairs. Messrs. du Pont and Fateh have also agreed, for the terms of their employment with us not to sell any of this land to a competitor of our Company, as determined by at least 75% of our independent directors. Any purchase by us of the undeveloped land held by Messrs. du Pont and Fateh would require the approval of at least 75% of our independent directors. In addition, we entered into non-compete agreements with Messrs. du Pont and Fateh upon completion of our IPO pursuant to which each of them have agreed not to compete with us. We may choose not to enforce, or to enforce less vigorously, our rights under these agreements due to our ongoing relationship with Messrs. du Pont and Fateh and, as a result, our business could be materially adversely affected.
Our charter and Maryland law contain provisions that may delay, defer or prevent a change in control transaction, even if such a change in control may be in our stockholders’ interest, and as a result may depress our stock price.
Our charter contains a 3.3% ownership limit. Our charter, subject to certain exceptions, authorizes our directors to take such actions as are necessary and desirable to ensure our qualification as a REIT and to limit any person (other than a qualified institutional investor or an excepted holder) to actual or constructive ownership of no more than 3.3% of the outstanding shares of our common stock by value or by number of shares, whichever is more restrictive, and 3.3% of our outstanding capital stock by value. This ownership limit may delay, defer or prevent a transaction or a change in control that might involve a premium price for our common stock or otherwise be in the best interest of our stockholders.
We could increase the number of authorized shares of stock and issue stock without stockholder approval. Our charter authorizes our board of directors, without stockholder approval, to increase the aggregate number of authorized shares of stock or the number of authorized shares of stock of any class or series, to issue authorized but unissued shares of our common stock or preferred stock and to classify or reclassify any unissued shares of our common stock or preferred stock and to set the preferences, rights and other terms of such classified or unclassified shares. Although our board of directors has no such intention at the present time, it could establish a series of preferred stock that could, depending on the terms of such series, delay, defer or prevent a transaction or a change in control that might involve a premium price for our common stock or otherwise be in the best interest of our stockholders.
Certain provisions of Maryland law could inhibit changes in control. Certain provisions of the Maryland General Corporation Law, or MGCL, may have the effect of inhibiting a third party from making a proposal to acquire us or of impeding a change in control under circumstances that otherwise could provide the holders of shares of our common stock with the opportunity to realize a premium over the then-prevailing market price of such shares, including:
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“business combination” provisions that, subject to limitations, prohibit certain business combinations between us and an “interested stockholder” (defined generally as any person who beneficially owns 10% or more of the voting power of our shares or an affiliate or associate of ours who, at any time within the two-year period prior to the date in question, was the beneficial owner of 10% or more of our then outstanding voting shares) or an affiliate thereof for five years after the most recent date on which the stockholder becomes an interested stockholder, and thereafter imposes special appraisal rights and special stockholder voting requirements on these combinations; and
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“control share” provisions that provide that “control shares” of our Company (defined as shares which, when aggregated with other shares controlled by the stockholder, entitle the stockholder to exercise one of three increasing ranges of voting power in electing directors) acquired in a “control share acquisition” (defined as the direct or indirect acquisition of ownership or control of “control shares”) have no voting rights except to the extent approved by our stockholders by the affirmative vote of at least two-thirds of all the votes entitled to be cast on the matter, excluding all interested shares.
We have opted out of these provisions of the MGCL, in the case of the business combination provisions of the MGCL by resolution of our board of directors, and in the case of the control share provisions of the MGCL by a provision in our bylaws. However, our board of directors may by resolution elect to opt in to the business combination provisions of the MGCL and we may, by amendment to our bylaws, opt in to the control share provisions of the MGCL in the future.
The provisions of our charter on removal of directors and the advance notice provisions of our bylaws could delay, defer or prevent a transaction or a change in control of our Company that might involve a premium price for holders of our common stock or otherwise be in their best interest. Likewise, if our Company’s board of directors were to opt in to the business combination provisions of the MGCL or adopt a classified board of directors pursuant to Title 3, Subtitle 8 of the MGCL, or if the provision in our bylaws opting out of the control share acquisition provisions of the MGCL were rescinded, these provisions could have similar anti-takeover effects. Further, our partnership agreement provides that we may not engage in any merger, consolidation or other combination with or into another person, sale of all or substantially all of our assets or any reclassification or any recapitalization or change in outstanding shares of our common stock, unless in connection with such transaction we obtain the consent of holders of at least 50% of the OP units of our Operating Partnership (not including OP units held by us) and/or certain other conditions are met.
Certain provisions in the partnership agreement for our Operating Partnership may delay or prevent unsolicited acquisitions of us. Provisions in the partnership agreement for our Operating Partnership may delay or make more difficult unsolicited acquisitions of us or changes in our control. These provisions could discourage third parties from making proposals involving an unsolicited acquisition of us or change of our control, although some stockholders might consider such proposals, if made, desirable. These provisions include, among others:
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redemption rights of qualifying parties;
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transfer restrictions on our OP units;
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our ability, as general partner, in some cases, to amend the partnership agreement without the consent of the limited partners; and
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the right of the limited partners to consent to transfers of the general partnership interest and mergers under specified circumstances.
Our board of directors has no policy regarding the level of indebtedness that we may incur.
Our board of directors has not adopted a policy regarding the maximum level of indebtedness, as a percentage of our market capitalization, that we may incur. Accordingly, we could, without stockholder approval, become more highly leveraged which could result in an increase in our debt service and which could materially adversely affect our cash flow and our ability to make expected distributions to our stockholders. Higher leverage also increases the risk of default on our obligations. Even in the event that our board does adopt a policy regarding maximum indebtedness, our board of directors may alter or eliminate our current investment and financing policies at any time without stockholder approval.
Our rights and the rights of our stockholders to take action against our directors and officers are limited.
Maryland law provides that a director or officer has no liability in that capacity if he or she performs his or her duties in good faith, in a manner he or she reasonably believes to be in our best interests and with the care that an ordinarily prudent person in a like position would use under similar circumstances. As permitted by the MGCL, our charter limits the liability of our directors and officers to us and our stockholders for money damages, except for liability resulting from:
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actual receipt of an improper benefit or profit in money, property or services; or
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a final judgment based upon a finding of active and deliberate dishonesty by the director or officer that was material to the cause of action adjudicated.
In addition, our charter authorizes us to obligate our Company, and our bylaws require us, to indemnify our directors and officers for actions taken by them in those capacities to the maximum extent permitted by Maryland law. As a result, we and our stockholders have more limited rights against our directors and officers than might otherwise exist under common law. Accordingly, in the event that actions taken in good faith by any of our directors or officers impede the performance of our Company, stockholders’ ability to recover damages from such director or officer will be limited.
If we fail to establish and maintain an effective system of integrated internal controls, we may not be able to accurately report our financial results.
If we fail to maintain proper overall business controls, our results of operations could be materially adversely affected or we could fail to meet our reporting obligations. In addition, the existence of a material weakness could result in errors in our consolidated financial statements that could require a restatement of our consolidated financial statements, cause us to fail to meet our reporting obligations and cause investors to lose confidence in our reported financial information, leading to a decline in the market value of our common stock.
Future offerings of debt or equity securities or preferred stock, which would be senior to our common stock upon liquidation and for the purpose of distributions, may cause the market price of our common stock to decline.
In the future, we may attempt to increase our capital resources by making additional offerings of debt or equity securities, including commercial paper, medium-term notes, senior or subordinated notes and classes of preferred stock or common stock. We will be able to issue additional shares of common stock or preferred stock without stockholder approval, unless stockholder approval is required by applicable law or the rules of any stock exchange or automated quotation system on which our securities may be listed or traded. Upon liquidation, holders of our debt securities and shares of preferred stock and lenders with respect to other borrowings will receive a distribution of our available assets prior to the holders of our common stock. Additional equity offerings may dilute the holdings of our existing stockholders or reduce the market price of our common stock, or both. Holders of our common stock are not entitled to preemptive rights or other protections against dilution. As data center acquisition or development opportunities arise from time to time, we may issue additional shares of common stock or preferred stock to raise the capital necessary to finance these acquisitions or developments or may issue common stock or preferred stock or OP units, which are redeemable on a one-to-one basis for our common stock, to acquire such properties. Such issuances could result in dilution of stockholders’ equity. Preferred stock and debt, if issued, could have a preference on liquidating distributions or a preference on dividend or interest payments that could limit our ability to make a distribution to the holders of our common stock. Because our decision to issue securities in any future offering or acquisition will depend on market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing or nature of our future offerings. Thus, our stockholders bear the risk of our future offerings reducing the market price of our common stock and diluting their interest.
Risks Related to Our Status as a REIT
Failure to qualify as a REIT would have significant adverse consequences to us and the value of our stock.
We intend to operate in a manner that will allow us to qualify as a REIT for federal income tax purposes under the Code. Requirements for qualification and taxation as a REIT are extremely complex, however, and interpretations of the federal income tax laws governing qualification and taxation as a REIT are limited. Accordingly, we cannot be certain that our organization and operation will enable us to qualify as a REIT for federal income tax purposes. In addition, new laws, regulations, interpretations, or court decisions subsequent to this offering may change the federal income tax laws or the federal income tax consequences of our qualification and taxation as a REIT. As a result, no assurance can be provided that we will qualify as a REIT or that new legislation, treasury regulations, administrative interpretations or court decisions will not significantly change the federal income tax laws with respect to our qualification and taxation as a REIT or the federal income tax consequences of our qualification and taxation as a REIT. If we lose our REIT status, we will face serious tax consequences that would substantially reduce our cash available for distribution to our stockholders for each of the years involved because:
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we would not be allowed a deduction for dividends paid to stockholders in computing our taxable income and would be subject to federal income tax at regular corporate rates;
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we also could be subject to the federal alternative minimum tax and increased state and local taxes; and
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unless we are entitled to relief under applicable statutory provisions, we could not elect to be taxed as a REIT for four taxable years following the year during which we were disqualified.
The additional tax liability to us for the year or years in which we did not qualify as a REIT would reduce our net earnings available for investment, debt service or distribution to our stockholders. Furthermore, if we failed to qualify as a REIT, non-U.S. stockholders that otherwise might not be subject to federal income tax on the sale of our shares might be subject to federal income tax with respect to any gain on a net basis similar to the
taxation of a U.S. stockholder, if the non-U.S. stockholders own 5% or more of any class of our shares. In addition, if we fail to qualify as a REIT, we will not be required to make distributions to stockholders, and all distributions to stockholders will be subject to tax as ordinary dividend income to the extent of our current and accumulated earnings and profits. As a result of all these factors, our failure to qualify as a REIT also could impair our ability to expand our business and raise capital, and would materially adversely affect the value of our common stock.
Qualification as a REIT involves the application of highly technical and complex Code provisions for which there are only limited judicial and administrative interpretations. The complexity of these provisions and of the applicable Treasury regulations that have been promulgated under the Code is greater in the case of a REIT that, like us, holds its assets through a partnership. The determination of various factual matters and circumstances not entirely within our control may affect our ability to qualify as a REIT. In order to qualify as a REIT, we must satisfy a number of requirements, including requirements regarding the composition of our assets, the sources of our income and the diversity of our stock ownership. Also, we must make distributions to stockholders aggregating annually at least 90% of our net taxable income, excluding net capital gains. In addition, legislation, new regulations, administrative interpretations or court decisions may materially adversely affect our investors, our ability to qualify as a REIT for federal income tax purposes or the desirability of an investment in a REIT relative to other investments.
Failure to qualify as a domestically-controlled REIT could subject our non-U.S. stockholders to adverse federal income tax consequences.
We will be a domestically-controlled REIT if, at all times during a specified testing period, less than 50% in value of our shares is held directly or indirectly by non-U.S. stockholders. However, because our shares are publicly traded, we cannot guarantee that we will, in fact, be a domestically-controlled REIT. If we fail to qualify as a domestically-controlled REIT, our non-U.S. stockholders that otherwise would not be subject to federal income tax on the gain attributable to a sale of our shares of common stock would be subject to taxation upon such a sale if either (a) the shares of common stock were not considered to be regularly traded under applicable Treasury Regulations on an established securities market, such as The New York Stock Exchange, or the NYSE, or (b) the selling non-U.S. stockholder owned, actually or constructively, more than 5% in value of the outstanding shares of common stock being sold during specified testing periods. If gain on the sale or exchange of our shares of common stock was subject to taxation for these reasons, the non-U.S. stockholder would be subject to regular U.S. income tax with respect to any gain on a net basis in a manner similar to the taxation of a taxable U.S. stockholder, subject to any applicable alternative minimum tax and special alternative minimum tax in the case of nonresident alien individuals, and corporate non-U.S. stockholders may be subject to an additional branch profits tax.
If the structural components of our properties were not treated as real property for purposes of the REIT qualification requirements, we would fail to qualify as a REIT.
A significant portion of the value of our properties is attributable to structural components related to the provision of electricity, heating ventilation and air conditioning, humidification regulation, security and fire protection, and telecommunication services. We have received a private letter ruling from the Internal Revenue Service (the “IRS”) holding, among other things, that our buildings, including the structural components, constitute real property for purposes of the REIT qualification requirements. We are entitled to rely upon that private letter ruling only to the extent that we did not misstate or omit a material fact in the ruling request we submitted to the IRS and that we operate in the future in accordance with the material facts described in that request. Moreover, the IRS, in its sole discretion, may revoke the private letter ruling. If our structural components are determined not to constitute real property for purposes of the REIT qualification requirements, including as a result of our being unable to rely upon the private letter ruling or the IRS revoking that ruling, we would fail to qualify as a REIT, which could have a material adverse impact on the value of our common stock.
If our Operating Partnership failed to qualify as a partnership for federal income tax purposes, we would fail to qualify as a REIT and suffer other adverse consequences.
We believe that our Operating Partnership is organized and operated in a manner so as to be treated as a partnership, and not an association or publicly traded partnership taxable as a corporation, for federal income tax purposes. As a partnership, it is not subject to federal income tax on its income. Instead, each of its partners, including us, is allocated that partner’s share of our Operating Partnership’s income. No assurance can be provided, however, that the IRS will not challenge our Operating Partnership’s status as a partnership for federal income tax purposes, or that a court would not sustain such a challenge. If the IRS were successful in treating our Operating Partnership as an association or publicly traded partnership taxable as a corporation for federal income tax purposes, we would fail to meet the gross income tests and certain of the asset tests applicable to REITs and, accordingly, would cease to qualify as a REIT. Also, the failure of our Operating Partnership to qualify as a partnership would cause it to become subject to federal corporate income tax, which would reduce significantly the amount of its cash available for debt service and for distribution to its partners, including us.
We will be subject to some taxes even if we qualify as a REIT.
Even if we qualify as a REIT for federal income tax purposes, we will be subject to some federal, state and local taxes on our income and property. For example, we will pay tax on certain types of income that we do not distribute. In addition, if assessed, we would incur a 100% excise tax on transactions with our TRS, DF Technical Services LLC, that are not conducted on an arm’s-length basis. A TRS is a corporation which is owned, directly or indirectly, by us and which, together with us, makes an election to be treated as our TRS. In addition, our TRS is subject to federal income tax as a corporation on its taxable income, if any, which consists of the revenues mainly derived from providing technical services, on a contract basis, to our tenants. The after-tax net income of our TRS is available for distribution to us but is not required to be distributed.
Moreover, if we have net income from “prohibited transactions,” that income will be subject to a 100% tax. In general, prohibited transactions are sales or other dispositions of property held primarily for sale to customers in the ordinary course of business. The determination as to whether a particular sale is a prohibited transaction depends on the facts and circumstances related to that sale.
Changes in taxation of corporate dividends may materially adversely affect the value of our shares.
The maximum marginal rate of tax payable by domestic non-corporate taxpayers on dividends received from a regular “C” corporation under current law is 15% through 2010, as opposed to higher ordinary income rates. The reduced tax rate, however, does not apply to distributions paid to taxpayers taxed at individual rates by a REIT on its stock, except for certain limited amounts. Although the earnings of a REIT that are distributed to its stockholders generally remain subject to less federal income taxation than earnings of a non-REIT “C” corporation that are distributed to its stockholders net of corporate-level income tax, legislation that extends the application of the 15% rate to dividends paid after 2010 by “C” corporations could cause taxpayers taxed at individual rates to view the stock of regular “C” corporations as more attractive relative to the stock of a REIT, because the dividends from regular “C” corporations would continue to be taxed at a lower rate while distributions from REITs (other than distributions designated as capital gain dividends and qualified dividend income) are generally taxed at the same rate as the taxpayer’s other ordinary income.
We will have a reduced carryover tax basis on certain of our assets as a result of the formation transactions, which could reduce our depreciation deductions.
All of our operating properties have a carryover tax basis that is lower than the fair market value of the property. This position could give rise to lower depreciation deductions on these assets that would have the effect of (1) increasing the distribution requirement imposed on us, which could materially adversely affect our ability to satisfy the REIT distribution requirement, and (2) decreasing the extent to which our distributions are treated as tax-free “return of capital” distributions.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
Not applicable.
ITEM 2.
ITEM 2. PROPERTIES
The information set forth under the captions “Our Properties” and “Offices” in Item 1 of this Annual Report on Form 10-K is incorporated by reference herein.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
We are involved from time to time in other various legal proceedings, lawsuits, examinations by various tax authorities, and claims that have arisen in the ordinary course of business. Management believes that the resolution of such matters will not have a material adverse effect on the financial condition or results of operations.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of our security holders during the fourth quarter of the fiscal year ended December 31, 2008.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Price of and Dividends on the Registrant’s Common Equity
Shares of our common stock, par value $.001 per share (“common stock”) trade on the New York Stock Exchange (“NYSE”) under the symbol “DFT.” As of February 18, 2009, we had approximately 6,042 holders of record of our common stock. This figure does not reflect the beneficial ownership of shares held in nominee name. The following table sets forth, for the indicated periods, the high and low closing sale prices for our common stock on the NYSE and the cash distributions declared per share:
To qualify and maintain our qualification as a REIT, we intend to make annual distributions to our stockholders of at least 90% of our taxable income (which does not necessarily equal net income as calculated in accordance with generally accepted accounting principles). Distributions will be authorized by our board of directors and declared by us based upon a variety of factors deemed relevant by our directors, and no assurance can be given that our dividend policy will not change in the future. We currently do not plan to declare a dividend for either the first or second quarter of 2009 in order to preserve liquidity. The Company estimates 2009 dividends of approximately $0.17 to $0.23 per share to meet its 2009 REIT distribution requirement. Our ability to pay distributions to our stockholders will depend, in part, upon our receipt of distributions from our Operating Partnership, which may depend upon receipt of rent payments with respect to our properties from our tenants. In addition, our Credit Facility (defined herein) limits our ability to pay distributions to our common stockholders in excess of 95% of our funds from operations but not less than the minimum necessary to enable us to meet our REIT income distribution requirements.
Issuer Purchases of Equity Securities
We have not purchased any of our registered equity securities during the year ended December 31, 2008.
Performance Graph
The following line graph sets forth, for the period from October 18, 2007 through December 31, 2008, a comparison of the percentage change in the cumulative total stockholder return on the Company’s common stock compared to the cumulative total return of the S&P 500 Index, the Russell 2000 index and the FTSE National Association of Real Estate Investment Trusts Equity REIT Index. The graph assumes that the shares of the Company’s common stock were bought at the price of $100 per share and that the value of the investment in each of the Company’s common stock and the indices was $100 at the beginning of the period.
The foregoing graph and chart shall not be deemed incorporated by reference by any general statement incorporating by reference this Annual Report on Form 10-K into any filing under the Securities Act of 1933, as amended, or under the Securities Exchange Act of 1934, as amended, except to the extent we specifically incorporate this information by reference, and shall not otherwise be deemed filed under those acts.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
DuPont Fabros Technology, Inc. (“we”, “us” or the “Company”) was formed on March 2, 2007 and is headquartered in Washington, D.C. We are a leading owner, developer, operator and manager of wholesale data centers. Our data centers are highly specialized, secure facilities used by our tenants-primarily national and international technology companies, including Microsoft, Yahoo!, Google and Facebook-to house, power and cool the computer servers that support many of their most critical business processes. We lease the raised square footage and available power of each of our facilities to our tenants under long-term triple-net leases, which contain annual rental increases. The phrase “wholesale data center,” or “wholesale infrastructure,” refers to specialized real estate assets consisting of large-scale data center facilities provided to tenants under long-term leases.
We completed our IPO on October 24, 2007. The IPO resulted in the sale of 35,075,000 common shares, including 4,575,000 shares pursuant to the exercise of the underwriter’s over-allotment option, at a price per share of $21.00, generating gross proceeds to the Company of $736.6 million. The proceeds to the Company, net of underwriters’ discounts, commissions, financial advisory fees and other offering costs, were $676.9 million.
Prior to August 7, 2007, each of our initial properties, or data centers, was directly owned by a single-property entity. To facilitate the closing of a credit facility (the “Credit Facility”) on August 7, 2007 and in contemplation of the IPO, we combined the entities holding interests in several of our operating and development properties-VA3, VA4, ACC2, ACC3 and CH1-into one holding company, Safari Ventures LLC (“Safari”), in order for those properties to serve as collateral for the Credit Facility. Following the closing of the Credit Facility, each of the former members of the property-holding entities held a direct or indirect equity interest in Safari. Safari made borrowings under the Credit Facility to purchase land in Ashburn, Virginia that is being held for use in the development of ACC5 and ACC6. For accounting purposes, Quill Ventures LLC, the entity that owns ACC3, was determined to be the accounting acquirer (the “Predecessor”) based on the guidance in Statement of Financial Accounting Standards (“SFAS”) No. 141, Business Combinations, in the Safari transaction and the other data center properties-ACC2, VA3, VA4 and CH1-were determined to be the “Acquired Properties”. The Predecessor is presented on a historical cost basis and the contribution of the interests of ACC2, VA3, VA4 and CH1 has been recorded at their estimated fair value. Subsequent to August 6, 2007, Safari is the accounting predecessor, resulting in the recording of the financial position and results of operations of Safari at historical cost basis at the IPO.
We also acquired as part of the IPO formation transactions on October 24, 2007, a data center known as ACC4, land held for the development of a data center in Ashburn, Virginia (ACC7), land held for development of a data center in Piscataway, New Jersey (NJ1), a contract to acquire land in Santa Clara, California and property management, development, leasing, asset management and technical services agreements and arrangements for all of our properties from entities affiliated with Lammot J. du Pont, the Executive Chairman of our board of directors, and Hossein Fateh, our President and Chief Executive Officer. The contribution of the interests of ACC4 and the two undeveloped parcels of land were recorded at their estimated fair value.
Prior to October 24, 2007, operating results are presented for the Predecessor. Operating results for the Acquired Properties are only reflected for the period subsequent to August 7, 2007. Subsequent to October 24, 2007, operating results are presented for the Company, which includes the Predecessor, the Acquired Properties, ACC4, NJ1 and ACC7 and the other formation transactions.
The following data should be read in conjunction with the financial statements and notes thereto included in “Item 8” of this report and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in “Item 7” of this report.
(1) Funds from operations, or FFO, is used by industry analysts and investors as a supplemental operating performance measure for REITs. We calculate FFO in accordance with the definition that was adopted by the Board of Governors of the National Association of Real Estate Investment Trusts, or NAREIT. FFO, as defined by NAREIT, represents net income (loss) determined in accordance with GAAP, excluding extraordinary items as defined under GAAP and gains or losses from sales of previously depreciated operating real estate assets, plus specified non-cash items, such as real estate asset depreciation and amortization, and after adjustments for unconsolidated partnerships and joint ventures.
We use FFO as a supplemental performance measure because, in excluding real estate related depreciation and amortization and gains and losses from property dispositions, it provides a performance measure that, when compared year over year, captures trends in occupancy rates, rental rates and operating expenses. We also believe that, as a widely recognized measure of the performance of equity REITs, FFO will be used by investors as a basis to compare our operating performance with that of other REITs. However, because FFO excludes real estate related depreciation and amortization and captures neither the changes in the value of our properties that result from use or market conditions nor the level of capital expenditures and leasing commissions necessary to maintain the operating performance of our properties, all of which have real economic effects and could materially impact our results from operations, the utility of FFO as a measure of our performance is limited.
While FFO is a relevant and widely used measure of operating performance of equity REITs, other equity REITs may use different methodologies for calculating FFO and, accordingly, FFO as disclosed by such other REITs may not be comparable to our FFO. Therefore, we believe that in order to facilitate a clear understanding of our historical operating results, FFO should be examined in conjunction with net income (loss) as presented in the consolidated statements of operations. FFO should not be considered as an alternative to net income (loss) or to cash flow from operating activities (each as computed in accordance with GAAP) or as an indicator of our liquidity, nor is it indicative of funds available to fund our cash needs, including our ability to pay dividends or make distributions.
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
DuPont Fabros Technology, Inc. (“we”, “us” or the “Company”, and includes all subsidiaries) was formed on March 2, 2007 and is headquartered in Washington, D.C. We are a leading owner, developer, operator and manager of wholesale data centers-specialized real estate assets consisting of large-scale data center facilities provided to tenants under long-term leases. Our data centers are highly specialized, secure facilities used by our tenants-primarily national and international technology companies, including Microsoft, Yahoo!, Google and Facebook-to house, power and cool the computer servers that support many of their most critical business processes. We lease the raised square footage and available power of each of our facilities to our tenants under long-term triple-net leases, which contain annual rental increases.
We currently have five stabilized operating properties-properties that are 85% leased or have been in service for at least 24 months-as follows:
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ACC2, located in Ashburn, Virginia;
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ACC3, located in Ashburn, Virginia;
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ACC4, located in Ashburn, Virginia;
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VA3, located in Reston, Virginia; and
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VA4, located in Bristow, Virginia.
We have one developed property that is not stabilized-CH1-located in Elk Grove Village, Illinois.
We have three properties under development, as follows:
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ACC5, located in Ashburn, Virginia, Phase I of which is scheduled for completion in the third quarter 2009;
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NJ1, located in Piscataway, New Jersey, a development that we temporarily suspended in the fourth quarter 2008; and
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SC1, located in Santa Clara, California, a development that we temporarily suspended in the fourth quarter 2008.
We also own other land available for future development.
We completed our initial public offering of our common shares (the “IPO”) on October 24, 2007. The IPO resulted in the sale of 35,075,000 common shares and resulted in proceeds to us, net of underwriters’ discounts, commissions, financial advisory fees and other offering costs, of $676.9 million.
Prior to August 7, 2007, VA3, VA4, ACC2, ACC3 and CH1 were each owned by a single-property entity. On August 7, 2007, to facilitate the closing of a credit facility (the “Credit Facility”) and in contemplation of the IPO, we combined the ownership of these entities into one holding company, Safari Ventures LLC (“Safari”), in order for these properties to serve as collateral for the Credit Facility, other than CH1, which was under development at the time. Following the closing of the Credit Facility, each of the former members of these entities held a direct or indirect equity interest in Safari. Safari made borrowings under the Credit Facility to purchase land in Ashburn, Virginia that is being held for use for the development of ACC5 and another data center facility, ACC6.
For accounting purposes, Quill Ventures LLC, the entity that owns ACC3, was determined to be the accounting acquirer (the “Predecessor”) based on the guidance in Statement of Financial Accounting Standards
(“SFAS”) No. 141, Business Combinations, in the Safari transaction, and the other data center properties-ACC2, VA3, VA4 and CH1-were determined to be the “Acquired Properties”. The Predecessor is presented on a historical cost basis and the contribution of the interests of ACC2, VA3, VA4 and CH1 has been recorded at their estimated fair value. Subsequent to August 6, 2007, Safari is the accounting predecessor, resulting in the recording of the financial position and results of operations of Safari at historical cost basis at the IPO.
As part of the IPO formation transactions that were completed on October 24, 2007, we acquired ACC4, land held for the development of a data center in Ashburn, Virginia (ACC7), land held for development of NJ1, a contract to acquire land in Santa Clara, California and property management, development, leasing, asset management and technical services agreements and arrangements for all of our properties. The contribution of the interests of ACC4 and the two undeveloped parcels of land were recorded at their estimated fair value.
Prior to October 24, 2007, operating results are presented for the Predecessor. Operating results for the Acquired Properties are only reflected for the period subsequent to August 7, 2007. For the periods subsequent to October 24, 2007, the IPO date, operating results are presented for the Company, which includes the Predecessor, the Acquired Properties, ACC4, NJ1 and ACC7 and the other formation transactions.
The following tables present both the Company’s five stabilized operating properties and the Company’s development projects as of December 31, 2008:
Stabilized Operating Properties
As of December 31, 2008
(1) Stabilized operating properties are either 85% or more leased or are in service for 24 months or greater.
(2) Gross building area is the entire building area, including raised square footage (the portion of gross building area where our tenants’ computer servers are located), tenant common areas, areas controlled by us (such as the mechanical, telecommunications and utility rooms) and, in some facilities, individual office and storage space leased on an as available basis to our tenants.
(3) Raised square footage is that portion of gross building area where our tenants locate their computer servers. We consider raised square footage to be the net rentable square footage in each of our facilities.
(4) Critical load (also referred to as IT load or load used by tenants’ servers or related equipment) is the power available for exclusive use by our tenants expressed in terms of megawatt, or MW, or kilowatt, or kW (1 MW is equal to 1,000 kW).
(5) Percentage leased is expressed as a percentage of critical load that is subject to an executed lease. As of the February 11, 2009, we have executed one additional lease at ACC4, increasing the percentage leased for ACC4 to 93.8% and percentage leased for the stabilized operating properties to 97.3%.
(6) Annualized base rent on a straight-lined basis for leases executed and/or amended as of January 1, 2009 over the non-cancellable terms of the respective leases and excludes approximately $7.0 million net amortization increase in revenue of above and below market leases. Annualized base rent on a cash basis for the 2009 calendar year is $89.5 million assuming no additional leasing or changes to existing leases.
Development Projects
As of December 31, 2008
($ in thousands)
* Development costs have not yet been estimated.
(1) Gross building area is the entire building area, including raised square footage (the portion of gross building area where our tenants’ computer servers are located), tenant common areas, areas controlled by us (such as the mechanical, telecommunications and utility rooms) and, in some facilities, individual office and storage space leased on an as available basis to our tenants.
(2) Raised square footage is that portion of gross building area where our tenants locate their computer servers. We consider raised square footage to be the net rentable square footage in each of our facilities.
(3) Critical load (also referred to as IT load or load used by tenants’ servers or related equipment) is the power available for exclusive use by our tenants expressed in terms of MW or kW (1 MW is equal to 1,000 kW).
(4) Includes estimated capitalization for construction and development, including closing costs, capitalized interest and capitalized operating carrying costs, as applicable, upon completion.
(5) Amount capitalized as of December 31, 2008.
(6) Construction temporarily suspended in Q4 2008. All estimated commitments were accrued and included in Construction costs payable on the Consolidated Balance Sheets as of December 31, 2008.
(7) ACC5 Phase I is 57.3% pre-leased as of February 11, 2009, and the Company resumed development.
(8) CH1 Phase I is 9.5% leased as of February 11, 2009.
We derive substantially all of our revenue from rents received from tenants under existing leases at each of our operating properties. Because we believe that critical load is the primary factor that tenants evaluate in choosing a data center, we establish our rents based on both the amount of power that we make available to our tenants and the amount of raised square footage that our tenants occupy. The relationship between raised square footage and critical load varies from one facility to the next. For example, a data center that is smaller in terms of raised square footage may contain infrastructure that provides its tenants with critical load that exceeds the power capacity of a data center with a significantly larger footprint.
Each of our leases includes pass-through provisions under which our tenants are required to pay for their pro rata share of most of our operating expenses-commonly referred to as a triple net lease. In particular, our tenants are required to pay all of their direct operating expenses, including direct electric, as well as their pro rata share of indirect operating expenses, such as real estate taxes and insurance. We intend to continue to structure future leases as triple net leases.
Although our leases provide for annual escalation of rents, we derive revenue growth primarily from leasing up vacant data center space. As of December 31, 2008, we had a 12.5% vacancy rate at ACC4 and a 90.5% vacancy rate at CH1. In February 2009, we executed a lease at ACC4 that lowered our vacancy rate to 6.2%. Our revenue will fluctuate based upon the speed in which these properties and any development properties that are placed into service are leased up. Additionally, under our triple net leases, we receive expense reimbursement from tenants only on space that is leased. Vacant space results in portions of our operating expenses being unreimbursed, which in turn impacts net income negatively.
The amount of net rental income generated by the properties in our portfolio depends on our ability to maintain the historical lease rates of currently leased space and to re-lease space available from lease terminations. As of December 31, 2008, 3.3% of the total critical load available in our stabilized data center properties, accounting for 1.2% of annualized rent from these properties, is subject to a lease expiring on December 31, 2009. Our operating properties are located in Northern Virginia and suburban Chicago, Illinois. Changes in the conditions of these markets will impact the overall performance of our operating properties. The ability of our tenants to fulfill their lease commitments could be impacted by future economic or regional downturns in the markets in which we operate or downturns in the technology industry. If these or other conditions cause a tenant to default on its payment or other obligations, we could be forced to terminate the related lease. We believe that most of our tenants will renew their leases and that our tenants will continue to make their rental and other payments when due. Nevertheless, if we cannot attract replacement tenants on similar terms in a timely manner for any leases that are not renewed or are terminated, our rental income will be impacted adversely in future periods.
Our taxable REIT subsidiary (“TRS”), DF Technical Services, LLC, generates revenue by providing certain technical services to our tenants on a contract or purchase-order basis, which we commonly refer to as “a la carte” services. Our TRS will generally charge our tenants for these services on a cost-plus basis. Because the degree of utilization of our TRS for these services is within the control of our tenants, we have limited ability to forecast future revenue from this source. Moreover, as a taxable corporation, our TRS is subject to federal, state and local corporate taxes and is not required to distribute its income, if any, to us for purposes of making additional distributions to our stockholders. Because demand for its services is unpredictable, we anticipate that our TRS may retain a significant amount of its revenue to fund future services, and therefore we may not be able to regularly receive distributions from our TRS.
Our future growth is dependent on completing the construction and lease-up of our development properties. As of the date of this report, construction on NJ1 and SC1 has been suspended until we achieve a certain level of pre-leasing at these properties and we obtain financing to complete development. Suspension of development not only impedes future growth, but negatively impacts our net income in current periods. For instance, we cannot capitalize interest on either of these projects until the project is restarted, resulting in a negative impact to earnings in 2009. Additionally, if we obtain financing at interest rates greater than our average cost of capital,
once the project is completed and interest expense is no longer capitalized, our interest expense would increase. Last, if financing cannot be obtained to complete these projects, one or both of the projects in the future may be deemed to be impaired from an accounting perspective, which would require us to take a charge against net income equal to the amount of impairment.
In the current economic environment, certain types of real estate are experiencing declines in value. If this trend were to be experienced by our datacenters, we may have to write down the value of the datacenters resulting in a charge against earnings, and could result in violations of covenants in the loan agreements that govern our long-term indebtedness.
Results of Operations
Since our formation on March 2, 2007 until the closing of our IPO on October 24, 2007, we did not have any corporate activity other than the issuance of shares of common stock in connection with the initial capitalization of our Company. Prior to October 24, 2007, operating results are presented for our Predecessor. Operating results for the Acquired Properties are only reflected for the period subsequent to August 7, 2007. For the periods after the IPO, operating results are presented for the Company, which includes the Predecessor, the Acquired Properties, ACC4, NJ1, SC1 and ACC7 and the other formation transactions.
To facilitate a comparison of results of operations for 2008 and 2007, we have combined in the discussion below the operating results for our Predecessor for the period from January 1, 2007 to October 23, 2007 with the operating results for the Company for the period from October 24, 2007 to December 31, 2007. Nonetheless, management believes that a year over year comparison may be of limited usefulness due to significant differences in the composition of our portfolio over such time. In addition, the comparison may be of limited value because, prior to our IPO, our Predecessor paid management and asset management fees to affiliates of our sponsors.
Year Ended December 31, 2008 Compared to Year Ended December 31, 2007
Operating Revenue. Operating revenue for the year ended December 31, 2008 was $173.7 million. This includes base rent of $104.1 million, tenant recoveries of $58.8 million, which includes our property management fee, and other revenue of $10.8 million, primarily from projects for our tenants performed by our TRS. This compares to revenue of $61.3 million for the year ended December 31, 2007. The increase of $112.4 million is due to revenue in 2007 relating only to ACC3 for the complete year; ACC2, VA3 and VA4 for the period subsequent to August 6, 2007; and ACC4 for the period subsequent to October 23, 2007.
Operating Expenses. Operating expenses for the year ended December 31, 2008 were $125.2 million. This compares to operating expenses of $232.4 million for the year ended December 31, 2007. The decrease of $107.2 million is primarily the result of $176.5 million for the acquisition of service agreements in 2007 as part of our IPO, $15.0 million of non-cash stock based compensation expense related to the issuance of restricted stock and LTIPs in the fourth quarter of 2007, partially offset by operating expenses in 2007 relating only to ACC3 for the complete year; ACC2, VA3 and VA4 for the period subsequent to August 6, 2007; and ACC4 for the period subsequent to October 23, 2007.
Interest Expense. Interest expense for the year ended December 31, 2008 was $12.6 million. This compares to interest expense of $17.4 million expensed for the year ended December 31, 2007 which is a decrease of $4.8 million. Total interest incurred for 2008 was $28.0 million, of which $15.4 million was capitalized for the development projects of CH1, ACC5, NJ1 and SC1. Total interest incurred in 2007 was $21.3 million of which $3.9 million was capitalized primarily for CH1. The increase in total interest in 2008 is due to an increase in indebtedness and to 2007 relating only to ACC3 for the complete year; ACC2, VA3 and VA4 for the period subsequent to August 6, 2007; and ACC4 for the period subsequent to October 23, 2007.
Net Income (Loss). Net income for the year ended December 31, 2008 was $19.1 million. This compares to a net loss of $100.9 million for the year ended December 31, 2007. The improvement of $120.0 million in 2008 is primarily due to 2007 relating only to ACC3 for the complete year; ACC2, VA3 and VA4 for the period subsequent to August 6, 2007; and ACC4 for the period subsequent to October 23, 2007 and the acquisition of service agreements of $176.5 million and $15.0 million of non-cash stock based compensation expense related to the issuance of restricted stock and LTIPs in the fourth quarter of 2007, partially offset by an increase in the allocation to minority interests of $104.3 million.
Year Ended December 31, 2007 Compared to Year Ended December 31, 2006
Operating Revenue. Operating revenue for the year ended December 31, 2007 was $61.3 million. This includes base rent of $39.8 million and tenant recoveries of $20.8 million, which includes our property management fee, and other revenue of $0.7 million primarily from projects for our tenants performed by our TRS. This compares to revenue of $10.7 million for the year ended December 31, 2006. The increase of $50.6 million is due to revenue in 2006 consisting of only one property, ACC3.
Operating Expenses. Operating expenses for the year ended December 31, 2007 were $232.4 million. This compares to operating expenses of $5.1 million for the year ended December 31, 2006. The increase of $227.3 million is primarily the result of $176.5 million for the acquisition of service agreements in 2007 as part of our IPO, $15.0 million of non-cash stock based compensation expense related to the issuance of restricted stock and LTIPs in the fourth quarter of 2007, and the inclusion of our headquarters general and administrative expenses of $1.7 million subsequent to the IPO on October 24, 2007. Additionally, due to expenses in 2006 being only for ACC3, we had a $16.0 million increase in property operating costs, a $0.8 million increase in real estate taxes, an increase in depreciation and amortization expense of $15.1 million and a $0.5 million increase in other expenses related to projects for our tenants in the Acquired Properties and ACC4.
Interest Expense. Interest expense for the year ended December 31, 2007 was $17.4 million. This compares to interest expense of $6.3 million for the year ended December 31, 2006. The increase of $11.1 million is due to interest expense in 2006 being only for ACC3 and the inclusion in 2007 of the write-off of unamortized deferred financing costs of $1.4 million and the payment of unaccrued exit fees of $0.7 million due to the early payoff of the ACC3 mortgage loan as a result of closing the Credit Facility.
Net Loss. Net loss for the year ended December 31, 2007 was $100.9 million. This compares to a net loss of $0.5 million for the year ended December 31, 2006. The increase of $100.4 million in the net loss is primarily due to the acquisition of service agreements of $176.5 million and non-cash stock based compensation expense of $15.0 million, partially offset by the allocation of $87.2 million of the loss to minority interests.
Liquidity and Capital Resources
Discussion of Cash Flows
Year Ended December 31, 2008 Compared to Year Ended December 31, 2007
Net cash provided by operating activities increased by $71.6 million to $59.3 million for the year ended December 31, 2008, compared to cash used of $12.3 million for the prior year. The increase was due to 2007 relating only to ACC3 for the complete year; ACC2, VA3 and VA4 for the period subsequent to August 6, 2007 and ACC4 for the period subsequent to the IPO.
Net cash used in investing activities decreased by $416.5 million to $334.8 million for the year ended December 31, 2008 compared to $751.3 million for the prior year. Cash used in investing activities for the year ended December 31, 2008 consisted of $330.5 million for the development of CH1, ACC5, NJ1 and SC1 (CH1 was placed into service in August 2008), $3.7 million for improvements to operating properties and $0.6 million for non-real estate acquisitions. Cash used in investing activities for the year ended December 31, 2007 consisted
of the use of $222.3 million to acquire ACC2, VA3, VA4 and CH1, $378.6 million to acquire ACC4, ACC7, NJ1 and SC1, $21.1 million to acquire the land that will be used to develop SC1, $11.9 million for the acquisition of land that will be used to develop ACC5 and ACC6 and $117.4 million related to the development of CH1, ACC5, NJ1 and SC1 and small projects at the operating properties.
Net cash provided by financing activities decreased by $452.7 million to $317.5 million for the year ended December 31, 2008 compared to $770.2 million for the prior period. Cash provided by financing activities for the year ended December 31, 2008 consisted of $233.7 million of proceeds from our Line of Credit under the Credit Facility, $36.7 million of proceeds from the CH1 Construction Loan and $100.0 million of proceeds from the ACC4 Term Loan, which closed in October 2008, partially offset by dividends and distributions of $47.7 million, financing costs of $4.8 million related to the CH1 Construction Loan and the ACC4 Term Loan, $0.3 million of repayments to our Line of Credit and $0.1 million of costs related to 2007’s IPO. Cash provided by financing activities for the year ended December 31, 2007 primarily reflects the net proceeds from our IPO of $677.0 million and borrowings under the our debt instruments of $643.7 million. A portion of the proceeds from the IPO and our debt instruments was partially used to pay off the mortgage loan at ACC3 of $125.2 million, pay off the old construction loan at CH1 of $27.1 million and repay amounts under our Credit Facility of $332.0 million. In connection with obtaining the Credit Facility we expended $8.3 million of various fees and costs and in connection with obtaining the CH1 Construction Loan, we expended $2.3 million of various fees and costs. Additionally, we repaid $32.0 million of borrowings from affiliates, distributed $9.8 million to members of ACC3 prior to the formation of Safari and subsequently distributed $13.8 million to members of Safari.
Year Ended December 31, 2007 Compared to Year Ended December 31, 2006
Net cash used in operating activities increased by $11.4 million to $12.3 million for the year ended December 31, 2007, compared to cash used of $0.9 million for the prior year. The increase was the result of a decrease in accounts payable and accrued expenses of $25.3 million in 2007 partially offset by an increase in cash from operations as ACC3 was placed in service in June 2006 and we acquired the Acquired Properties on August 7, 2007 and ACC4 on October 24, 2007.
Net cash used in investing activities increased by $687.5 million to $751.3 million for the year ended December 31, 2007 compared to $63.8 million for the prior year. Cash used in investing activities for the year ended December 31, 2007 consisted of the use of $222.3 million to acquire ACC2, VA3, VA4 and CH1, $378.6 million to acquire ACC4, ACC7, NJ1 and SC1, $21.1 million to acquire the land that will be used to develop SC1, $11.9 million for the acquisition of land that will be used to develop ACC5 and ACC6 and $117.4 million related to the development of CH1, ACC5, NJ1 and SC1 and small projects at the operating properties. For the year ended December 31, 2006, cash used in investing activities primarily consisted of the use of $77.0 million for the development of ACC3, which was placed in service in June 2006, partially offset by the repayment of $13.2 million of borrowings from affiliates.
Net cash provided by financing activities increased by $700.6 million to $770.2 million for the year ended December 31, 2007 compared to $69.6 million for the prior period. Cash provided by financing activities for the year ended December 31, 2007 primarily reflects the net proceeds from our IPO of $677.0 million and borrowings under the our debt instruments of $643.7 million. A portion of the proceeds from the IPO and our debt instruments was partially used to pay off the mortgage loan at ACC3 of $125.2 million, pay off the old construction loan at CH1 of $27.1 million and repay amounts under our Credit Facility of $332.0 million. In connection with obtaining the Credit Facility, we expended $8.3 million of various fees and costs and in connection with obtaining the CH1 Construction Loan, we expended $2.3 million of various fees and costs. Additionally, we repaid $32.0 million of borrowings from affiliates, distributed $9.8 million to members of ACC3 prior to the formation of Safari and subsequently distributed $13.8 million to members of Safari. Cash provided by financing activities for the year ended December 31, 2006 represents $84.6 million of loan proceeds related to the construction of ACC3 partially offset by repayments to affiliates of $2.0 million and distributions of $13.0 million to members of ACC3.
Market Capitalization
The following table sets forth our total market capitalization as of December 31, 2008 (in thousands except per share data):
Capital Structure as of December 31, 2008
(in thousands except per share data)
Capital Resources
The development and construction of wholesale datacenters is capital intensive. This development not only requires us to make substantial capital investments, but also increases our operating expenses, which impacts our cash flows from operations negatively until leases are executed and we begin to realize revenue. In addition, we elected to be taxed as a REIT for federal income tax purposes commencing with our taxable year ended December 31, 2007 and are required to distribute at least 90% of our taxable income to our stockholders on an annualized basis.
We expect to meet our datacenter development needs through secured borrowings, mezzanine financings, construction financings and the issuance of additional debt and equity securities when market conditions permit. Any increases in project development costs (including the cost of labor and materials and costs resulting from construction delays), and rising interest rates would increase the additional funds necessary to complete these projects and, in turn, the amount of additional capital that we would need to raise. In determining the source of capital to meet our long-term liquidity needs, we will evaluate our level of indebtedness and leverage ratio, our cash flow expectations, the state of the capital markets, interest rates and other terms for borrowing, and the relative timing considerations and costs of borrowing or issuing additional securities.
In the fourth quarter of 2008, we announced the temporary suspension of three projects under development, Phase I of ACC5, NJ1 and SC1, because funding from a term loan secured by ACC4 described below was less than anticipated. In the first quarter of 2009, we obtained additional financing and restarted development at ACC5. The estimated cost to complete Phase I of ACC5 is approximately $35 million as of February 2009. The estimated cost to complete Phase I of NJ1 and SC1 is approximately $225 million to $281 million as of February 2009. Construction of these development properties will remain suspended until we obtain additional funds. Particularly in the current credit environment, there is no assurance that we will be successful in obtaining additional funds on favorable terms or at all.
The Company currently does not plan to declare a dividend for either the first or second quarter of 2009 in order to preserve liquidity. The Company estimates 2009 dividends of approximately $0.17 to $0.23 per share to meet its 2009 REIT distribution requirement. We met our REIT distribution requirement to pay out 90% of our taxable income for 2008.
A summary of the Company’s total debt and maturity schedule as of December 31, 2008 are as follows:
Debt Summary as of December 31, 2008
($ in thousands)
Note: The Company capitalized interest of $3.8 million and $15.4 million during the quarter and year ended December 31, 2008, respectively.
(1) Rate as of December 31, 2008.
(2) Rate is fixed by an interest rate swap.
(3) On February 10, 2009, the CH1 Construction Loan was paid off and the ACC4 Term Loan increased to $250.0 million.
Debt Maturity Schedule as of December 31, 2008
($ in thousands)
(1) This loan matures on December 20, 2009 subject to a one-year extension option exercisable by the Company upon satisfaction of certain customary covenants. The loan was paid off on February 10, 2009.
(2) Amount outstanding on the Company’s $275 million Line of Credit which matures on August 7, 2010, subject to a one-year extension option exercisable by the Company upon satisfaction of certain customary conditions. A borrowing base covenant based on the initial appraised values of our Safari properties limits the amount available to $244 million.
(3) $200 million Safari Term Loan matures on August 7, 2011 with no extension option. $100 million ACC4 Term Loan matures on October 24, 2011 and includes a one-year extension option exercisable by the Company upon satisfaction of certain customary conditions. ACC4 Term Loan increased to $250 million on February 10, 2009.
(4) Rate as of December 31, 2008.
(5) Rate on $200 million Safari Term Loan is fixed at 6.5% by an interest rate swap.
Credit Facility
On August 7, 2007, we entered into a credit facility that consists of a $200.0 million secured term loan (the “Safari Term Loan”) and a $275.0 million senior secured revolving credit facility (the “Line of Credit”) (together the “Credit Facility”), of which a principal balance of $433.4 million was outstanding as of December 31, 2008. A borrowing base covenant, based on the initial appraisal values of the properties securing the loan, limits the amounts available to $444.0 million.
Four of our properties-VA3, VA4, ACC2 and ACC3-comprise our current borrowing base on the Credit Facility. In the future, we may add additional properties to our borrowing base, which would subject those properties to additional restrictions. Also, any equity interest that we may hold in any of our properties, whether or not included in our borrowing base, will provide additional collateral with respect to our Credit Facility.
Upon consent of the lender, the Line of Credit may be increased by up to $200.0 million depending on certain factors, including the value of, and debt service on, the properties included in our borrowing base. In order to take advantage of all of the $200.0 million increase in the Line of Credit, we anticipate that, among other things, we would need to add properties to the borrowing base, subject to the consent of our lenders, and modify the pricing terms of the Credit Facility. The Line of Credit matures on August 7, 2010, but includes an option whereby we may elect, once, to extend the maturity date by 12 months. The extension is subject to us paying an extension fee of $0.4 million and other customary conditions. The agent for the lender has the right to ask for a new appraisal which could change our borrowing capacity. The Safari Term Loan is an interest-only loan with the full principal amount due at maturity on August 7, 2011, with no option to extend.
On August 15, 2007, we entered into a $200.0 million interest rate swap to manage the interest rate risk associated with a portion of the principal amount outstanding under our Credit Facility effective August 17, 2007. This swap agreement effectively fixes the interest rate on $200.0 million of the principal amount at 4.997% plus the applicable credit spread, which is 1.50%. We have designated this agreement as a hedge for accounting purposes. As of December 31, 2008, the cumulative reduction in the fair value of the interest rate swap of $17.8 million was recognized as a liability and recorded as other comprehensive loss in stockholders’ equity and no amounts were recognized in earnings as hedge ineffectiveness.
Future interest rates on the revolving facility will depend on our applicable leverage ratio, which defined by our credit agreement is the ratio of our total consolidated indebtedness to our gross asset value, as set forth in the following schedule:
The credit agreement contains affirmative and negative covenants customarily found in facilities of this type, including limits on our ability to engage in mergers and other similar transactions, as well as requirements that we comply with the following covenants on a consolidated basis: (i) consolidated total debt shall not exceed 65% of our consolidated asset value, (ii) debt service coverage shall not be less than 1.35 to 1.0, (iii) total leverage shall not exceed 65% of the appraised value of the properties securing the facility, (iv) adjusted consolidated EBITDA to consolidated fixed charges shall not be less than 1.45 to 1.0, (v) the consolidated net worth shall not be less than 85% of the net proceeds of the IPO plus 75% of the sum of (a) any additional offering proceeds occurring after the IPO and (b) the value of interests in the Company issued upon the contribution of assets to the Company and (vi) unhedged variable rate debt of the Company shall not exceed 35% of the Company’s asset value. Upon completion of the IPO, we assumed this credit agreement and became subject to the covenants in accordance with the credit agreement. As of December 31, 2008, we were in compliance with all covenants in this credit agreement and we expect to be in compliance with these covenants in 2009.
CH1 Construction Loan
On December 20, 2007, we entered into a $148.9 million construction loan to which CH1 was pledged as collateral (the “CH1 Construction Loan”). As of December 31, 2008, amounts outstanding under this loan totaled $133.4 million. This loan was paid off on February 10, 2009.
ACC4 Term Loan
On October 24, 2008, we entered into a credit agreement relating to a $100.0 million term loan with a syndicate of lenders (the “ACC4 Term Loan”). We increased this loan to $250.0 million on February 10, 2009 through the exercise of the loan’s “accordion” feature. This term loan is secured by ACC4.
The ACC4 Term Loan matures on October 24, 2011 and includes a one-year extension option subject to, among other things, the payment of an extension fee equal to 50 basis points on the outstanding loan amount, there being no existing event of default, a debt service coverage ratio of no less than 2 to 1, and a loan to value ratio of no more than 40%. Borrowings under the loan will bear interest at (i) LIBOR plus 350 basis points during the initial term of the loan, and (ii) LIBOR plus 400 basis points during the additional one-year period if the Company exercises the one-year extension option. We may elect to have borrowings bear interest at (i) the prime rate plus 200 basis points during the initial term of the loan or (ii) the prime rate plus 250 basis points during the additional one-year period if the Company exercises the one-year extension option, but only if such interest rate is not less than LIBOR plus the applicable margin set forth above. As of December 31, 2008 the interest rate for this loan was 4.81%. The loan requires quarterly principal installment payments of $0.5 million beginning on April 1, 2009, and may be prepaid in whole or in part without penalty at any time after October 24, 2009, subject to the payment of certain LIBOR rate breakage fees.
The Operating Partnership and its subsidiaries’ investments in development projects (as defined in the ACC4 Term Loan) is limited to $1 billion, provided that the Operating Partnership and its subsidiaries shall not at anytime have more than five development projects (as defined in the ACC4 Term Loan) ongoing. We expect to be in compliance with these covenants in 2009.
The Operating Partnership has guaranteed for the benefit of the lenders of the ACC4 Term Loan the payment of $100.0 million of the principal amount of the ACC4 Term Loan plus all outstanding interest, and is also liable for certain costs under the loan.
On February 10, 2009, we utilized the accordion feature to increase the loan to $250.0 million. In connection with the exercise of the accordion feature, the parties entered into an amendment to the ACC4 Term Loan which provides that another subsidiary of ours will guaranty the obligations under the ACC4 Term Loan and this guaranty in turn will be secured by CH1. Under the terms of the amendment, CH1 will be released as security if the Company makes a principal reduction payment of $50.0 million and there is no event of default. Furthermore, if the maturity date of the ACC4 Term Loan is extended upon maturity to October 24, 2012, the quarterly installments of principal will increase from $0.5 million to $2.0 million during the extension period.
Covenants-Credit Facility and ACC4 Term Loan
Both the Credit Facility and ACC4 Term Loan require ongoing compliance by us with various covenants, including with respect to restrictions on liens, incurring indebtedness, making investments, effecting mergers and/or assets sales, maintenance of certain leases and the occurrence of a change of control (as defined in the respective credit agreements) of the Company or the Operating Partnership. In addition, the credit agreements require that certain financial covenants are adhered to, including, without limitation, the following:
•
The Company must maintain the following minimum debt service coverage ratios:
•
October 24, 2008 to March 31, 2009-1.15 to 1;
•
April 1, 2009 to August 11, 2011-1.35 to 1;
•
August 11, 2011 to October 24, 2011-1.75 to 1; and
•
October 24, 2011 to October 24, 2012-2 to 1 (to the extent that the Company exercises the one-year extension option on the ACC4 Term Loan).
•
Consolidated total indebtedness of the Operating Partnership and its subsidiaries to gross asset value of the Operating Partnership and its subsidiaries must be less than or equal to 65% during the terms of the loans.
•
Ratio of adjusted consolidated Earnings Before Interest Taxes Depreciation and Amortization to consolidated fixed charges must be at least 1.45 to 1 during the terms of the loans.
•
Minimum consolidated tangible net worth (as defined in the respective credit agreements) of the Operating Partnership and its subsidiaries must be greater than or equal to approximately $575 million (plus an increase of 75% of the sum of (i) the net proceeds from any future equity offerings and (ii) the value of any interests in the Operating Partnership or the Company issued upon the contribution of assets to the Company, the Operating Partnership or its subsidiaries after October 24, 2008) during the terms of the loans.
•
For the Credit Facility exclusively, a borrowing base covenant limits the amount available on the Line of Credit to 65% of the appraised value of the secured properties.
As of December 31, 2008, we were in compliance with all covenants, and we expect to be in compliance in 2009.
ACC5 Loan
On February 6, 2009, the Company entered into a construction loan agreement (the “ACC5 Loan”) to borrow up to $25.0 million to pay for a portion of the costs to complete the construction of Phase I of ACC5. Borrowings under the ACC5 Loan, which are secured by ACC5 and a $4.0 million cash deposit, bear interest at a fixed rate of 12% per annum and mature on February 6, 2010. As of the date of this filing, borrowings under the ACC5 Loan were $25.0 million.
The Company may extend the maturity date of the ACC5 Loan for two years if a certificate of occupancy has been issued by February 6, 2010, we have complied with all payment terms and there is no event of default. We also may extend for two additional one year periods if we have complied with all payment terms, there is no event of default and there is no material adverse change in the market value of ACC5. If the maturity date is extended, we must begin to pay monthly installments of principal and interest equal to the amount that, as of the commencement of the first extension term, would fully amortize the unpaid principal balance of the ACC5 Loan in 180 equal payments.
In connection with the ACC5 Loan, the Operating Partnership has agreed to guaranty our obligations to pay the lender any scheduled monthly installments of principal and interest to be paid prior to maturity.
SC1 Loan
On February 6, 2009, the Company received a $5.0 million term loan (the “SC1 Loan”) that is secured by SC1, bears interest at a fixed rate of 12% per annum and matures on February 6, 2010. We will use these proceeds to pay a portion of our construction cost payable related to SC1.
We may extend the maturity date of the SC1 Loan for two years if we have complied with all payment terms and there is no event of default. We also may extend for two additional one year periods if we have complied with all payment terms, there is no event of default and there is no material adverse change in the market value of SC1. If the maturity date is extended, we must begin to pay monthly installments of principal and interest equal to the amount that, as of the commencement of the first extension term, would fully amortize the unpaid principal balance of the SC1 Loan in 180 equal payments.
In connection with the SC1 Loan, the Operating Partnership has agreed to guaranty our obligations to pay the lender any scheduled monthly installments of principal and interest to be paid prior to maturity.
Contractual Obligations
The following table summarizes our contractual obligations as of December 31, 2008, including the maturities without extensions and scheduled principal repayments of our Safari Term Loan, Line of Credit, CH1 Construction Loan and ACC4 Term Loan (in thousands):
(1) These amounts include obligations for payment of both principal and interest. All interest on our debt is variable rate with the exception of our Safari Term Loan which is fixed at 6.497% through an interest rate swap. For purposes of this table, we have not assumed any loan extensions. The ACC4 Term Loan and the Line of Credit have extension options of one year assuming payment of extension fees and meeting certain covenants.
(2) In February 2009, we increased the ACC4 Term Loan from $100.0 million to $250.0 million. A portion of these proceeds were used to retire the CH1 Construction Loan. We also entered into $30.0 million of new financing secured by ACC5 and SC1. These transactions are not reflected in the table above.
Off-Balance Sheet Arrangements
As December 31, 2008, we did not have any off-balance sheet arrangements.
Critical Accounting Policies
We have provided a summary of our significant accounting policies in Note 2 to our financial statements included elsewhere in this Form 10-K. The preparation of these financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the reporting period. Our actual results may differ from these estimates. We describe below those accounting policies that we deem critical and require material subjective or complex judgments and that have the most significant impact on our financial condition and results of operations. Our management evaluates these estimates on an ongoing basis, based upon information currently available and on various assumptions management believes are reasonable as of the date hereof.
Revenue Recognition. Rental income is recognized using the straight-line method over the terms of the tenant leases, which commences when control of the space and the critical power have been provided to the tenant. Deferred rent included in our consolidated balance sheets represents the aggregate excess of rental revenue recognized on a straight-line basis over the contractual rental payments that will be recognized under the remaining terms of the leases. Our leases contain provisions under which the tenants reimburse us for a portion of property operating expenses incurred by us. Such reimbursements are recognized in the period that the expenses are incurred. We recognize amortization of the value of acquired above market tenant leases as a reduction of rental revenue and of below market leases as an increase to rental revenue.
We must make subjective estimates as to when our revenue is earned, including a determination of the lease commencement date for accounting purposes and the collectability of our accounts receivable related to minimum rent, deferred rent, expense reimbursements, and other income. We analyze individual accounts receivable and historical bad debts, tenant concentrations, tenant creditworthiness and current economic trends when evaluating the adequacy of the allowance for bad debts. These estimates have a direct impact on our net income because a higher bad debt allowance would result in lower net income, and recognizing rental revenue as earned in one period versus another would result in higher or lower net income for a particular period.
Capitalization of costs. We capitalize pre-acquisition costs related to probable property acquisitions. We also capitalize direct and indirect costs related to construction and development, including property taxes, insurance and financing costs relating to properties under development. Costs previously capitalized related to any potential property acquisitions no longer considered probable are expensed, which may have a material adverse effect on our net income. In addition, the Company ceases cost capitalization after a wind down period when a development is temporarily suspended. The selection of costs to capitalize and the determination of whether a proposed acquisition is probable are subjective and depends on many assumptions including the timing of potential acquisitions and the probability that future acquisitions occur. Variations in these assumptions would yield different amounts of capitalized costs in the periods presented. All capital improvements for the income producing properties that extend the property’s useful life are capitalized.
Useful lives of assets. We are required to make subjective assessments as to the useful lives of the major components of our properties for purposes of determining the amount of depreciation to record on an annual basis with respect to our investments in real estate. These assessments have a direct impact on our net income. For example, if we were to shorten the expected useful lives of our investments in real estate, we would depreciate such investments over fewer years, resulting in more depreciation expense and lower net income on an annual basis. The opposite is true if we were to lengthen the expected useful lives of such properties.
Asset impairment evaluation. We review the carrying value of our net real estate on a quarterly and annual basis. We base our review on an estimate of the undiscounted future cash flows (excluding interest charges) expected to result from the real estate investment’s use and eventual disposition. We consider factors such as future operating income, trends and prospects, as well as the effects of leasing demand, competition and other factors. If our evaluation indicates that we may be unable to recover the carrying value of a real estate investment, an impairment loss would be recorded to the extent that the carrying value exceeds the estimated fair value of the property, which would result in an immediate negative adjustment to net income. The evaluation of anticipated cash flows is highly subjective and is based in part on assumptions regarding future occupancy, rental rates and capital requirements that could differ materially from actual results in future periods. One of our key assumptions in the analysis is that we will complete Phase I of NJ1 and SC1, which are temporarily suspended as of the date of this filing.
Since cash flows from properties considered to be long-lived assets to be held and used are considered on an undiscounted basis to determine whether an asset has been impaired, our strategy of holding properties over the long-term directly decreases the likelihood of recording an impairment loss. If our strategy changes or market conditions dictate an earlier sale date or if we determine that development of a project is no longer viable, an impairment loss may be recognized and such loss could be material. If we determine that impairment has occurred, the affected assets must be reduced to their fair value. No such impairment losses have been recognized to date. We estimate the fair value of rental properties utilizing a discounted cash flow analysis that includes projections of future revenues, expenses and capital improvement costs, similar to the income approach that is commonly utilized by appraisers.
Recent Accounting Pronouncements
In February 2007, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities-Including an Amendment of FASB Statement No. 115. This statement permits an entity to elect to measure eligible items at fair value (“fair value option”) including many financial instruments. The objective of this statement is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. The provisions of this statement were effective for us as of January 1, 2008. If the fair value option is elected, the reporting company reports unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. Upfront costs and fees related to items for which the fair value option is elected is recognized in earnings as incurred and not deferred. The fair value option may be applied for a single
eligible item without electing it for other identical items, with certain exceptions, and must be applied to the entire eligible item and not to a portion of the eligible item. The Company did not elect the fair value option with respect to any eligible item and, therefore, the adoption of this standard did not have a material effect on the Company’s financial position and results of operations.
In December 2007, the FASB issued SFAS No. 141(R), Business Combinations. This statement changes the accounting for acquisitions specifically eliminating the step acquisition model, changing the recognition of contingent consideration from being recognized when it is probable to being recognized at the time of acquisition, disallowing the capitalization of transaction costs and delays when restructurings related to acquisitions can be recognized. The standard is effective for fiscal years ending after December 15, 2008 and will impact the accounting only for acquisitions we make after its adoption.
In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements, an Amendment of ARB No. 51. Under this statement, noncontrolling interests are considered equity and thus our practice of reporting minority interests in the mezzanine section of the balance sheet will be eliminated. Also, under the new standard, net income will encompass the total income of all consolidated subsidiaries and there will be separate disclosure on the face of the income statement of the attribution of that income between controlling and noncontrolling interests. Last, increases and decreases in noncontrolling interests will be treated as equity transactions. The standard is effective for fiscal years ending after December 15, 2008.
In March 2008, the FASB issued FASB Statement No. 161, “Disclosures about Derivative Instruments and Hedging Activities (an amendment of FASB Statement No. 133).” This statement require entities to provide greater transparency about how and why an entity uses derivative instruments, how derivative instruments and related hedged items are accounted for under SFAS No. 133 and its related interpretations, and how derivative instruments and related hedged items affect an entity’s financial positions, results of operations, and cash flows. SFAS No. 161 is effective for fiscal years beginning after November 15, 2008. The Company will adopt the expanded disclosure requirements of this standard effective January 1, 2009.
In June 2008, the FASB issued FSP EITF 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions are Participating Securities.” In this FSP, the FASB concluded that all outstanding invested share-based payment awards that contain rights to non-forfeitable dividends or dividend equivalents participate in undistributed earnings with common shareholders and, accordingly, are considered participating securities that shall be included in the two-class method of computing basic and diluted EPS. The FSP does not address awards that contain rights to forfeitable dividends. The FSP is effective for the Company’s fiscal year beginning January 1, 2009, with early adoption prohibited. The Company does not believe the provisions of FSP EITF 03-6-1 will have a material impact on its financial position or results of operations.
Funds From Operations
(1) Funds from operations, or FFO, is used by industry analysts and investors as a supplemental operating performance measure for REITs. We calculate FFO in accordance with the definition that was adopted by the Board of Governors of the National Association of Real Estate Investment Trusts, or NAREIT. FFO, as defined by NAREIT, represents net income (loss) determined in accordance with GAAP, excluding extraordinary items as defined under GAAP and gains or losses from sales of previously depreciated operating real estate assets, plus specified non-cash items, such as real estate asset depreciation and amortization, and after adjustments for unconsolidated partnerships and joint ventures.
We use FFO as a supplemental performance measure because, in excluding real estate related depreciation and amortization and gains and losses from property dispositions, it provides a performance measure that, when compared year over year, captures trends in occupancy rates, rental rates and operating expenses. We also believe that, as a widely recognized measure of the performance of equity REITs, FFO will be used by investors as a basis to compare our operating performance with that of other REITs. However, because FFO excludes real estate related depreciation and amortization and captures neither the changes in the value of our properties that result from use or market conditions nor the level of capital expenditures and leasing commissions necessary to maintain the operating performance of our properties, all of which have real economic effects and could materially impact our results from operations, the utility of FFO as a measure of our performance is limited.
While FFO is a relevant and widely used measure of operating performance of equity REITs, other equity REITs may use different methodologies for calculating FFO and, accordingly, FFO as disclosed by such other REITs may not be comparable to our FFO. Therefore, we believe that in order to facilitate a clear understanding of our historical operating results, FFO should be examined in conjunction with net income (loss) as presented in the consolidated statements of operations. FFO should not be considered as an alternative to net income (loss) or to cash flow from operating activities (each as computed in accordance with GAAP) or as an indicator of our liquidity, nor is it indicative of funds available to fund our cash needs, including our ability to pay dividends or make distributions.
Related Party Transactions
Leasing Arrangements
As of December 31, 2008, we leased approximately 9,337 square feet of office space in Washington, D.C., an office building owned by entities affiliated with our Executive Chairman and our President and Chief Executive Officer. For the year ended December 31, 2008, we paid $0.4 million under the lease. We believe that the terms of this lease are fair and reasonable and reflect the terms we could expect to obtain in an arm’s length transaction for comparable space elsewhere in Washington, D.C.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our future income, cash flows and fair values relevant to financial instruments are dependent upon prevalent market interest rates. Market risk refers to the risk of loss from adverse changes in market prices and interest rates. On August 15, 2007, we entered into a $200.0 million interest rate swap to manage the interest rate risk associated with a portion of the Credit Facility effective August 17, 2007 through the maturity of this loan. This swap agreement effectively fixes the interest rate on $200.0 million of the Credit Facility at 4.997% plus the applicable credit spread, which as of December 31, 2008 was fixed at 1.50%. We have designated this agreement as a hedge for accounting purposes. We do not intend to use derivatives for trading or speculative purposes and, to the extent we elect to enter into hedging arrangements under the terms of our loan agreement, we intend to enter into contracts with financial institutions based on their credit rating and other factors.
If interest rates were to increase by 1%, the increase in interest expense on our variable rate debt outstanding as of December 31, 2008 (excluding the portion of the Credit Facility that is hedged through our interest rate swap) would decrease future income before minority interests and cash flows by approximately $4.7 million
annually less the impact of capitalization on our income before minority interests. If interest rates were to decrease 1%, the decrease in interest expense on the variable rate debt outstanding as of December 31, 2008 would be approximately $4.7 million annually less the impact of capitalization on our income before minority interests. Interest risk amounts were determined by considering the impact of hypothetical interest rates on our financial instruments. These analyses do not consider the effect of any change in overall economic activity that could occur in that environment. Further, in the event of a change of that magnitude, we may take actions to further mitigate our exposure to the change. However, due to the uncertainty of the specific actions that would be taken and their possible effects, these analyses assume no changes in our financial structure.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders of DuPont Fabros Technology, Inc.
We have audited the accompanying consolidated balance sheets of DuPont Fabros Technology, Inc. (the “Company”) as of December 31, 2008 and 2007, and the related consolidated statements of operations, stockholders’ equity and members’ deficit, and cash flows for the year ended December 31, 2008 (representing the Company), for the period from January 1, 2007 through October 23, 2007 (representing Safari Ventures LLC (the “Predecessor”)), for the period from October 24, 2007 through December 31, 2007 (representing the Company), and for the year ended December 31, 2006 (representing the Predecessor). Our audits also included the financial statement schedule listed in the Index at Item 15(a). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of DuPont Fabros Technology, Inc. at December 31, 2008 and 2007, and the consolidated results of its operations and its cash flows for the year ended December 31, 2008 (representing the Company), for the period from January 1, 2007 through October 23, 2007 (representing the Predecessor), for the period from October 24, 2007 through December 31, 2007 (representing the Company), and for the year ended December 31, 2006 (representing the Predecessor), in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects, the information set forth herein.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), DuPont Fabros Technology, Inc.’s internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 24, 2009 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
McLean, Virginia
February 24, 2009
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders of DuPont Fabros Technology, Inc.
We have audited DuPont Fabros Technology, Inc.’s (the “Company”) internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). DuPont Fabros Technology Inc.’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control Over Financial Reporting in Item 9A. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, DuPont Fabros Technology, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2008, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of DuPont Fabros Technology, Inc. as of December 31, 2008 and 2007, and the related consolidated statements of operations, stockholders’ equity and members’ deficit, and cash flows for the year ended December 31, 2008 (representing the Company), for the period from January 1, 2007 through October 23, 2007 (representing Safari Ventures LLC (the “Predecessor”)), for the period from October 24, 2007 through December 31, 2007 (representing the Company), and for the year ended December 31, 2006 (representing the Predecessor) and our report dated February 24, 2009 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
McLean, Virginia
February 24, 2009
DUPONT FABROS TECHNOLOGY, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands except share data)
See accompanying notes
DUPONT FABROS TECHNOLOGY, INC. (THE COMPANY)
AND ITS PREDECESSOR, SAFARI VENTURES LLC
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands except share and per share data)
See accompanying notes
DUPONT FABROS TECHNOLOGY, INC. (THE COMPANY)
AND ITS PREDECESSOR, SAFARI VENTURES LLC
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND MEMBERS’ DEFICIT
(in thousands, except share data)
See accompanying notes
DUPONT FABROS TECHNOLOGY, INC. (THE COMPANY)
AND ITS PREDECESSOR, SAFARI VENTURES LLC
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
See accompanying notes
DUPONT FABROS TECHNOLOGY, INC. (THE COMPANY)
AND ITS PREDECESSOR, SAFARI VENTURES LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2008
1. Description of Business
DuPont Fabros Technology, Inc. (“we”, “us”, the “Company” or “DFT”) was formed on March 2, 2007 and is headquartered in Washington, D.C. The Company is a fully integrated, self-administered and self-managed company formed primarily to own, acquire, develop and operate wholesale data centers. We elected to be taxed as a real estate investment trust, or REIT, for federal income tax purposes commencing with our taxable year ended December 31, 2007. We are the sole general partner of, and own 53.2% of the economic interest in, DuPont Fabros Technology, L.P. (the “Operating Partnership”). Through the Operating Partnership as of December 31, 2008, we hold a fee simple interest in six operating data centers-referred to as ACC2, ACC3, ACC4, VA3, VA4 and CH1, three data center properties under development-referred to as ACC5, NJ1 and SC1, and land that may be used to develop two additional data centers-referred to as ACC6 and ACC7. For more information regarding these properties, see Notes 3 and 4 of the notes to consolidated financial statements.
We completed our initial public offering of common stock (the “IPO”) on October 24, 2007. The IPO resulted in the sale of 35,075,000 shares of common stock, including 4,575,000 shares as a result of the underwriters exercising their over-allotment option, at a price per share of $21.00, generating gross proceeds to the Company of $736.6 million. The proceeds to the Company, net of underwriters’ discounts, commissions, financial advisory fees and other offering costs, were $676.9 million. We contributed the proceeds of our IPO to our Operating Partnership in exchange for a number of units of limited partnership interest of our Operating Partnership (“OP units”) equal to the number of common shares sold in the IPO.
Prior to August 7, 2007, each of our initial properties, or data centers, was directly owned by a single-property entity. To facilitate the closing of a Credit Facility (defined herein) on August 7, 2007 and in contemplation of the IPO, we combined the membership interests in the entities that hold interests in VA3, VA4, ACC2, ACC3 and CH1 into one holding company, Safari Ventures LLC (“Safari”), in order for those membership interests and certain of those properties to serve as collateral for the Credit Facility. Following the closing of the Credit Facility, each of the former members of the property-holding entities held a direct or indirect equity interest in Safari. Safari made borrowings under the Credit Facility to purchase land in Ashburn, Virginia that is being held for use in the development of ACC5 and ACC6. For accounting purposes, Quill Ventures LLC, the entity that owns ACC3, was determined to be the accounting acquirer (the “Predecessor”) based on the guidance in Statement of Financial Accounting Standards (“SFAS”) No. 141, Business Combinations, in the Safari transaction, and ACC2, VA3, VA4 and CH1 were determined to be the “Acquired Properties”. The financial position and results of operations of the Predecessor are presented on a historical cost basis and the contribution of the interests of ACC2, VA3, VA4 and CH1 has been recorded at their estimated fair value. Subsequent to August 6, 2007, Safari is the accounting predecessor of the Company, resulting in the recording of the financial position and results of operations of Safari at historical cost basis at the IPO.
Upon completion of the IPO, the Company entered into various formation transactions. The formation transactions included the issuance of 23,045,366 Operating Partnership Units (“OP Units”) and cash payments of $372.5 million (which included $274.0 million of cash used to retire the debt and fund other obligations related to ACC4) for total consideration of $856.5 million for the acquisition of the equity interests in Safari, the entity that owns ACC4 (a data center that was fully completed on October 30, 2007), land that is being held for use in the future development of data centers we refer to as NJ1 and ACC7 and a contract to acquire the land that will be used to develop SC1 and SC2. The contribution of the interests of ACC4 and the two undeveloped parcels of land were recorded at their estimated fair value. The Company also issued 8,116,906 OP units and made a cash payment of $6.1 million for total consideration of $176.5 million for the acquisition of the management, development, leasing, asset management and technical services agreements for these properties.
2. Significant Accounting Policies
Basis of Presentation
The accompanying consolidated financial statements have been prepared by management in accordance with U.S. generally accepted accounting principles, or GAAP. All significant intercompany accounts and transactions have been eliminated in the consolidated financial statements.
We have one reportable segment consisting of investments in data centers located in the United States.
These consolidated financial statements include the financial position and results of operations of our Predecessor through August 6, 2007 and reflect its acquisition of the Acquired Properties (effective August 7, 2007) and the acquisition of ACC4 and land held for the development of ACC7 and NJ1 (effective October 24, 2007) at their estimated fair values. Accordingly, the results of operations for 2007 include the results of operations of the Predecessor for all months in the reporting periods and the results of operations of the Acquired Properties from their date of acquisition, August 7, 2007 and ACC4, ACC7 and NJ1 from their date of acquisition, October 24, 2007. The financial statements up through October 23, 2007 also do not reflect the Company’s acquisition of property management and other services agreements and thus, the internalization of these services.
Use of Estimates
The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosures of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.
Income-Producing Property
The Predecessor’s data center, ACC3, is recorded at cost, including the external direct costs of the acquisition. The Acquired Properties’ data centers (ACC2, VA3, VA4 and CH1) were recorded at their estimated fair value on the date of acquisition, August 7, 2007. ACC4, ACC7, NJ1 and SC1 were recorded at their estimated fair value on the date of acquisition, October 24, 2007.
We allocated the purchase price of the Acquired Properties, ACC4, ACC7, and NJ1, to the related physical assets and in-place leases based on their relative fair values, in accordance with SFAS No. 141. The fair values of acquired buildings are determined on an “as-if-vacant” basis considering a variety of factors, including the physical condition and quality of the buildings, estimated rental and absorption rates, estimated future cash flows, and valuation assumptions consistent with current market conditions. The “as-if-vacant” fair value is allocated to land, building, improvements, and any personal property based on replacement cost estimates and other relevant information.
The fair value of in-place leases consists of the following components as applicable-(1) the estimated cost to replace the leases, including foregone rents during the period of finding a new tenant, foregone recovery of tenant pass-through, tenant improvements, and other direct costs associated with obtaining a new tenant (referred to as Tenant Origination Costs); (2) the estimated leasing commissions associated with obtaining a new tenant (referred to as Leasing Commissions); and (3) the above/below market cash flow of the leases, determined by comparing the projected cash flows of the leases in place to projected cash flows of comparable market-rate leases (referred to as Lease Intangibles). Tenant Origination Costs are included in buildings and improvements on the Company’s consolidated balance sheet and are amortized as depreciation expense on a straight-line basis over the remaining life of the underlying leases. Leasing Commissions are classified as deferred costs and are amortized as amortization expense on a straight-line basis over the remaining life of the underlying leases. Lease Intangible assets and liabilities are classified as lease contracts above and below market value, respectively, and
amortized on a straight-line basis as decreases and increases, respectively, to rental revenue over the remaining term of the underlying leases. Should a tenant terminate its lease, the unamortized portions of the Tenant Origination Cost, Leasing Commissions, and Lease Intangibles associated with that lease are written off to depreciation expense, amortization expense, or rental revenue, respectively.
All capital improvements for the income-producing properties that extend their useful life are capitalized to individual building components, including interest and real estate taxes incurred during the period of development, and depreciated over their estimated useful lives. Interest is capitalized during the period of development based upon applying the property’s weighted-average borrowing rate to the actual development costs expended up to specific borrowings and then applying the weighted-average borrowing rate of the Company to the residual actual development costs expended during the construction period. Interest is capitalized until the property has reached substantial completion and is ready for its intended use in accordance with SFAS No. 34, Capitalization of Interest Cost. Interest costs capitalized totaled $15.4 million for the year ended December 31, 2008, $2.9 million for the period from October 24, 2007 to December 31, 2007, $1.0 million for the period from January 1, 2007 to October 23, 2007 and $2.6 million for the year ended December 31, 2006. In addition, the Company ceases interest capitalization after a wind down period when a development is temporarily suspended.
In accordance with SFAS No. 67, Accounting for Costs and Initial Rental Operations of Real Estate Projects, the Company capitalizes pre-development costs, including internal costs, incurred in pursuit of new development opportunities for which the Company currently believes future development is probable. Future development is dependent upon various factors, including zoning and regulatory approval, rental market conditions, construction costs and availability of capital. Pre-development costs incurred for which future development is not yet considered probable are expensed as incurred. In addition, if the status of such a pre-development opportunity changes, making future development by the Company no longer probable, any capitalized pre-development costs are written-off with a charge to expense. Furthermore, as provided under the guidance of SFAS No. 67, the revenue from incidental operations received from the current improvements in excess of any incremental costs are being recorded as a reduction of total capitalized costs of the development project and not as a part of net income. The capitalization of costs during the development of assets (including interest and related loan fees, property taxes and other direct and indirect costs) begins when development efforts commence and ends when the asset, or a portion of the asset, is delivered and ready for its intended use.
Depreciation on buildings is generally provided on a straight-line basis over 40 years from the date the buildings were placed in service. Building components are depreciated over the life of the respective improvement ranging from 20 to 40 years from the date the components were placed in service. Personal property is depreciated over three to seven years. Depreciation expense was $46.0 million for the year ended December 31, 2008, $8.1 million for the period from October 24, 2007 to December 31, 2007, $7.2 million for the period from January 1, 2007 to October 23, 2007 and $1.7 million for the year ended December 31, 2006. Included in these amounts is amortization expense related to tenant origination costs, which was $4.8 million for the year ended December 31, 2008, $0.9 million for the period from October 24, 2007 to December 31, 2007, $0.7 million for the period from January 1, 2007 to October 23, 2007 and $0 for the year ended December 31, 2006. Repairs and maintenance costs are expensed as incurred.
We record impairment losses on long-lived assets used in operations or in development when events or changes in circumstances indicate that the assets might be impaired, and the estimated undiscounted cash flows to be generated by those assets are less than the carrying amounts. If circumstances indicating impairment are present, an impairment loss is recognized based on the excess of the carrying amount of the impaired asset over its fair value. Management assesses the recoverability of the carrying value of its assets on a property-by-property basis. No impairment losses were recorded for during the three years ended December 31, 2008.
In accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, we classify a data center property as held-for-sale when it meets the necessary criteria, which include when we commit to and actively embark on a plan to sell the asset, the sale is expected to be completed within one year
under terms usual and customary for such sales, and actions required to complete the plan indicate that it is unlikely that significant changes to the plan will be made or that the plan will be withdrawn. Data center properties held-for-sale are carried at the lower of cost or fair value less costs to sell. As of December 31, 2008, there were no data center properties classified as held-for-sale and discontinued operations.
Cash and Cash Equivalents
We consider all demand deposits and money market accounts purchased with a maturity date of three months or less, at the date of purchase to be cash equivalents. Our account balances at one or more institutions periodically exceed the Federal Deposit Insurance Corporation (“FDIC”) insurance coverage and, as a result, there is a concentration of credit risk related to amounts on deposit in excess of FDIC insurance coverage. We have not experienced any losses and believe that the risk is not significant.
Deferred Costs
Deferred costs, net on the Company’s consolidated balance sheets include both financing costs and leasing costs.
Financing costs, which represent fees and other costs incurred in obtaining debt, are amortized on a straight-line basis, which approximates the effective-interest method, over the term of the loan and are included in interest expense. On August 7, 2007, we paid off the ACC3 mortgage loan with borrowings under the Credit Facility. This resulted in the write-off of the remaining unamortized deferred financing costs related to the ACC3 mortgage loan in the amount of $1.4 million, which was recorded as interest expense in the accompanying consolidated statements of operations. Amortization of the deferred financing costs included in interest expense totaled $1.8 million for the year ended December 31, 2008, $0.2 million for the period from October 24, 2007 to December 31, 2007, $1.0 million for the period from January 1, 2007 to October 23, 2007 and $0.6 million for the year ended December 31, 2006. Balances, net of accumulated amortization, at December 31, 2008 and 2007 are as follows (in thousands):
Leasing costs, which are either external fees and costs incurred in the successful negotiations of leases, internal costs expended in the successful negotiations of leases or the estimated leasing commissions resulting from the allocation of the purchase price of the Acquired Properties and ACC4 under SFAS No. 141, are deferred and amortized over the terms of the related leases on a straight-line basis. If an applicable lease terminates prior to the expiration of its initial term, the carrying amount of the costs are written off to amortization expense. For the year ended December 31, 2008, we recorded $0.8 million of leasing costs. On August 7, 2007, in connection with the acquisition of the Acquired Properties, we recorded $10.6 million of leasing costs. On October 24, 2007, in connection with the acquisition of ACC4, we recorded $17.0 million of leasing costs. Amortization of deferred leasing costs totaled $4.4 million for the year ended December 31, 2008, $0.8 million for the period from October 24, 2007 to December 31, 2007, $1.2 million for the period from January 1, 2007 to October 23, 2007 and $0.5 million for the year ended December 31, 2006. Balances, net of accumulated amortization, at December 31, 2008 and 2007 are as follows (in thousands):
Inventory
We maintain fuel inventory for our generators, which is recorded at the lower of cost (on a first-in, first-out basis) or market. At December 31, 2008 and 2007, the fuel inventory was $1.5 million and $1.0 million, respectively, and is included in prepaid expenses and other assets in the accompanying consolidated balance sheets.
Debt Obligations
Prior to the IPO, we entered into a debt agreement whose terms required certain additional costs and fees to be paid upon retirement of the debt. These additional costs and fees were accrued using the effective interest method and were recorded in interest expense. This debt was retired in August 2007.
Interest Rate Derivative Instruments
We account for derivative activities in accordance with SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities and SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities, which requires all derivative instruments to be carried at fair value as either assets or liabilities on the consolidated balance sheets. For those derivative instruments that are designated, and qualify, as hedging instruments, we designate the hedging instrument, based upon the exposure being hedged, as a fair value hedge or a cash flow hedge. For derivatives that do not meet the criteria for hedge accounting, changes in fair value are immediately recognized in earnings. For those derivatives that qualify for hedge accounting, the effective portion of the gain or loss on the hedge instruments is reported as a component of accumulated other comprehensive income (loss) and reclassified into earnings in the same line item associated with the forecasted transaction in the same period or periods during which the hedged transaction affects earnings. Any ineffective portion of a derivative’s change in fair value is immediately recognized in earnings.
Prepaid Rents
Prepaid rents, typically prepayment of the following month’s rent, consist of payments received from tenants prior to the time the payments are earned and are recognized as revenue in subsequent periods when earned.
Rental Income
We, as a lessor, have retained substantially all the risks and benefits of ownership and account for our leases as operating leases. For lease agreements that provide for fixed and determinable scheduled rent increases, rental income is recognized on a straight-line basis over the non-cancellable term of the leases, which commences when control of the space and the critical power have been provided to the tenant. Straight-line rents receivable are included in deferred rent on the consolidated balance sheets. Lease Intangible assets and liabilities that have resulted from above market and below market leases that were acquired are amortized on a straight-line basis as decreases and increases, respectively, to rental revenue over the remaining term of the underlying leases. Should a tenant terminate its lease, the unamortized portion of Lease Intangibles associated with that lease will be written off to rental revenue. Balances, net of accumulated amortization, at December 31, 2008 and 2007 are as follows (in thousands):
We record a provision for losses on accounts receivable equal to the estimated uncollectible accounts. The estimate is based on management’s historical experience and a review of the current status of our receivables. We will also establish, as necessary, an appropriate allowance for doubtful accounts for receivables arising from the straight-lining of rents. This receivable arises from revenue recognized in excess of amounts currently due under the lease. As of December 31, 2008 and 2007, no allowance was considered necessary.
Tenant leases generally contain provisions under which the tenants reimburse us for a portion of the property’s operating expenses and real estate taxes incurred by us. Recoveries from tenants are included in revenue in the consolidated statements of operations in the period the applicable expenditures are incurred. Recoveries from tenants also include the property management fees that we earn from our tenants.
Other Revenue
Other revenue primarily consists of services provided to our tenants on a non-recurring basis. This includes projects such as the purchase and installation of circuits, racks, breakers and other tenant requested items. Revenue is recognized on a completed contract basis. Costs of providing these services are in included other expenses in the accompanying consolidated statements of operations.
Equity IPO Costs
Underwriting discount and commissions, financial advisory fees and additional IPO costs of $59.7 million are reflected as reductions to additional paid-in capital in the consolidated balance sheet of the Company as of December 31, 2008.
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, 2007. In general, a REIT that meets certain organizational and operational requirements and distributes at least 90 percent of its REIT taxable income to its shareholders in a taxable year will not be subject to income tax to the extent of the income it distributes. We currently qualify and intend to continue to qualify as a REIT under the Code. As a result, no provision for federal income taxes on income from continuing operations is required, except for taxes on certain property sales and on income, if any, of our taxable REIT subsidiary (“TRS”). If we fail to qualify as a REIT in any taxable year, we will be subject to federal income tax (including any applicable alternative minimum tax) on our income at regular corporate tax rates for the year in which we do not qualify and the succeeding four years. Although we expect to qualify for taxation as a REIT, we may be subject to state and local income and franchise taxes and to federal income and excise taxes on any undistributed income.
We have elected to treat DF Technical Services LLC, a 100% owned subsidiary of our Operating Partnership, as a TRS. In general, a TRS may perform non-customary services for tenants, hold assets that the Company cannot hold directly and generally may engage in any real estate or non-real estate related business. A TRS is subject to corporate federal and state income taxes on its taxable income at regular statutory tax rates.
The Predecessor was not subject to U.S. federal income tax on its income. Results of operations of the Predecessor were included proportionately in the federal income tax returns of the individual members; therefore, no provision for federal income taxes is included in the accompanying consolidated financial statements for periods prior to October 24, 2007.
Comprehensive Income (Loss)
Comprehensive income (loss), as reflected on the Consolidated Statements of Stockholders’ Equity and Members’ Deficit, is defined as all changes in equity during each period except those resulting from investments by or distributions to shareholders or members. Accumulated other comprehensive loss, as also reflected on the Consolidated Statements of Stockholders’ Equity and Members’ Deficit, reflects the effective portion of cumulative changes in the fair value of derivatives in qualifying cash flow hedge relationships.
Earnings Per Share
Basic earnings per share is calculated by dividing the net income (loss) applicable to common stockholders for the period by the weighted average number of common shares outstanding during the period. Diluted earnings per share is calculated by dividing the net income (loss) applicable to common stockholders for the period by the weighted average number of common and dilutive securities outstanding during the period using the treasury stock method.
Stock-based Compensation
We have awarded stock-based compensation to employees, contractors and members of our Board of Directors in the form of common stock and LTIP units. These awards are accounted for under SFAS No. 123(R), Accounting for Stock-Based Compensation, as amended by SFAS No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure-an amendment to FASB Statement No. 123, which was effective January 1, 2006. We had no stock-based compensation awards outstanding prior to our IPO in October 2007. This pronouncement requires that we estimate the fair value of the awards and recognize this value over the requisite vesting period. The fair value of restricted stock-based compensation is based on the market value of our common stock on the date of the grant. The fair value of LTIP units is based on the market value of our common stock on the date of the grant less a discount for post-vesting transferability restrictions estimated by a third-party consultant. Compensation paid with Company common shares, which is included in general and administrative expense on the consolidated statements of operations, totaled $1.0 million for the year ended December 31, 2008, $15.0 million for the period from October 24, 2007 to December 31, 2007 and $0 for periods prior to October 24, 2007, respectively.
Profits, Losses and Distributions
For periods prior to October 24, 2007, the profits and losses of the Predecessor were allocated to the individual members in accordance with their respective limited liability company agreements.
Recent Accounting Pronouncements
In February 2007, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities-Including an Amendment of FASB Statement No. 115. This statement permits an entity to elect to measure eligible items at fair value (“fair value option”) including many financial instruments. The objective of this statement is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. The provisions of this statement were effective for us as of January 1, 2008. If the fair value option is elected, the Company would report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. Upfront costs and fees related to items for which the fair value option is elected shall
be recognized in earnings as incurred and not deferred. The fair value option may be applied for a single eligible item without electing it for other identical items, with certain exceptions, and must be applied to the entire eligible item and not to a portion of the eligible item. The Company did not elect the fair value option with respect to any eligible item and, therefore, the adoption of this standard did not have a material effect on the Company’s financial position and results of operations.
In December 2007, the FASB issued SFAS No. 141(R), Business Combinations. This statement changes the accounting for acquisitions specifically eliminating the step acquisition model, changing the recognition of contingent consideration from being recognized when it is probable to being recognized at the time of acquisition, disallowing the capitalization of transaction costs and delays when restructurings related to acquisitions can be recognized. The standard is effective for fiscal years ending after December 15, 2008 and will impact the accounting only for acquisitions we make after its adoption.
In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements, an Amendment of ARB No. 51. Under this statement, noncontrolling interests are considered equity and thus our practice of reporting minority interests in the mezzanine section of the balance sheet will be eliminated. Also, under the new standard, net income will encompass the total income of all consolidated subsidiaries and there will be separate disclosure on the face of the income statement of the attribution of that income between controlling and noncontrolling interests. Last, increases and decreases in noncontrolling interests will be treated as equity transactions. The standard is effective for fiscal years ending after December 15, 2008.
In March 2008, the FASB issued FASB Statement No. 161, “Disclosures about Derivative Instruments and Hedging Activities (an amendment of FASB Statement No. 133).” This statement require entities to provide greater transparency about how and why an entity uses derivative instruments, how derivative instruments and related hedged items are accounted for under SFAS No. 133 and its related interpretations, and how derivative instruments and related hedged items affect an entity’s financial positions, results of operations, and cash flows. SFAS No. 161 is effective for fiscal years beginning after November 15, 2008. The Company will adopt the expanded disclosure requirements of this standard effective January 1, 2009.
In June 2008, the FASB issued FSP EITF 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions are Participating Securities.” In this FSP, the FASB concluded that all outstanding invested share-based payment awards that contain rights to non-forfeitable dividends or dividend equivalents participate in undistributed earnings with common shareholders and, accordingly, are considered participating securities that shall be included in the two-class method of computing basic and diluted EPS. The FSP does not address awards that contain rights to forfeitable dividends. The FSP is effective for the Company’s fiscal year beginning January 1, 2009, with early adoption prohibited. The Company does not believe the provisions of FSP EITF 03-6-1 will have a material impact on its financial position or results of operations.
3. Acquisitions
In connection with our IPO on October 24, 2007, we acquired the following properties:
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four stabilized data centers located in Northern Virginia, which we refer to as VA3, VA4, ACC2 and ACC3, having an aggregate critical load of 46.0 megawatts (“MW”) and which were, as of December 31, 2008 and 2007, 100% leased;
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our prototype ground-up development in Northern Virginia, ACC4, which has an aggregate critical load of 36.4 MW. We completed the final phase of this facility in October 2007 which was 87.5% and 84.6% leased as of December 31, 2008 and 2007, respectively.
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one data center under development in suburban Chicago, which we refer to as CH1, which also is expected to have an aggregate 36.4 MW of critical load and a flexible design. The first phase of 18.2 MW of critical load was placed into service in the third quarter of 2008 which was 9.5% leased as of December 31, 2008; and
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undeveloped properties in Northern Virginia, which we refer to as ACC5, ACC6 and ACC7, and Piscataway, New Jersey, which we refer to as NJ1, and a contract to acquire land in Santa Clara, California, which we refer to as SC1. We subsequently closed on the acquisition of land in Santa Clara, CA in December 2007 and began construction on Phase I of ACC5, NJ1 and SC1 in 2008. This construction was temporarily suspended in the fourth quarter of 2008 pending the Company securing additional financing for these projects. Subsequent to December 31, 2008, we have resumed construction of ACC5. We believe that these properties will, in the aggregate, support the development of six new data centers with an aggregate critical load of 187.2 MW.
Concurrent with our acquisition of the properties and interests described above, we also acquired property management, development, leasing, asset management and technical services agreements and arrangements for these properties from entities affiliated with our Executive Chairman and our President and Chief Executive Officer.
On August 7, 2007, the Predecessor acquired the following income producing properties: ACC2, VA3 and VA4, and a property under development, CH1. Phase I of CH1 was placed into service in the third quarter of 2008.
The allocation of the purchase price of the Acquired Properties to the assets acquired and liabilities assumed in accordance with SFAS No. 141 was as follows:
In conjunction with the IPO on October 24, 2007, the Company acquired the entity that owns ACC4, land that is being held for use in the future development of data centers we refer to as NJ1 and ACC7 and a contract to acquire the land that will be used to develop SC1 and SC2. The Company issued 10,981,339 OP units, paid cash of $288.9 million (including $274.0 million of cash used to retire the debt and fund other obligations at ACC4) and assumed liabilities of $39.7 million to acquire these properties and contracts.
The allocation of the purchase price of these assets to the assets acquired and liabilities assumed in accordance with SFAS No. 141 was as follows:
If the acquisition of the Acquired Properties and ACC4 had occurred on January 1, 2006, then the unaudited results of operations for the years ended December 31, 2007 and 2006 on a pro forma basis would have been as follows:
The unaudited pro forma amounts are presented for illustrative purposes only and are not necessarily indicative of future consolidated results of operations. The unaudited pro forma condensed consolidated results of operations include the pro forma impact of: (i) the adjustment of revenue for straight-line revenue and amortization of above market and below market lease contracts, (ii) the adjustment of depreciation and amortization expense for the step-up of the real estate assets’ value and the adjustment to lease commissions under SFAS No. 141 and (iii) the adjustment of interest expense for the refinancing of the Acquired Properties’ mortgage loans with borrowings under the Credit Facility. For the year ended December 31, 2007, expenses include charges of $176.5 million for the acquisition of service agreements and $15.0 million of non-cash stock based compensation.
4. Real Estate Assets
The following is a summary of properties owned by the Company at December 31, 2008:
(1) Properties located in Ashburn, VA (ACC5, ACC6 and ACC7); Elk Grove Village, IL (CH1 Phase II); Piscataway, NJ (NJ1) and Santa Clara, CA (SC1 and SC2).
5. Intangible Assets
Leasing Commissions are classified as deferred costs and are amortized as amortization expense on a straight-line basis over the remaining life of the underlying leases. As of December 31, 2008, these assets have a weighted average remaining life of 8.4 years with estimated future amortization as follows (in thousands):
Lease Intangible assets and liabilities are classified as lease contracts above and below market value, respectively, and amortized on a straight-line basis as decreases and increases, respectively, to rental revenue over the remaining term of the underlying leases. As of December 31, 2008, these net Lease Intangible liabilities have a weighted average remaining life of 7.4 years for above market leases and 6.3 years for below market leases with estimated net future amortization (increase to rental income) as follows (in thousands):
Tenant Origination Costs are included in buildings and improvements on the Company’s consolidated balance sheet and are amortized as depreciation expense on a straight-line basis over the remaining life of the underlying leases. As of December 31, 2008, these assets have a weighted average remaining life of 7.0 years with estimated future amortization as follows (in thousands):
6. Leases
For the years ended December 31, 2008, 2007 and 2006, the following tenants comprised more than 10% of our consolidated revenue:
As of December 31, 2008, these two tenants accounted for $0.3 million and $0.2 million of rents and other receivables and $10.9 million and $2.0 million of deferred rent, respectively. As of December 31, 2007, these two tenants accounted for $8.2 million and $3.1 million of deferred rent and $4.3 million and $0 of prepaid rents, respectively. The Company does not hold security deposits from these tenants. All tenants operate within the technology industry and, as such, their viability is subject to market fluctuations in that industry.
Future minimum lease payments to be received under noncancelable operating leases are as follows for the years ending December 31, excluding properties under development (in thousands):
7. Debt
Debt Summary as of December 31, 2008 and 2007
($ in thousands)
Note: The Company capitalized interest of $3.8 million and $15.4 million during the quarter and year ended December 31, 2008, respectively.
(1) Rate as of December 31, 2008.
(2) Rate is fixed by an interest rate swap.
(3) On February 10, 2009, the CH1 Construction Loan was paid off and the ACC4 Term Loan increased to $250.0 million.
Credit Facility
On August 7, 2007, we entered into a credit facility that consists of a $200.0 million secured term loan (the “Safari Term Loan”) and a $275.0 million senior secured revolving credit facility (the “Line of Credit”) (together the “Credit Facility”), of which a principal balance of $433.4 million and $200.0 million was outstanding as of December 31, 2008 and 2007, respectively. A borrowing base covenant, based on the initial appraisal values of the properties securing the loan, limits the amounts available to $444.0 million, leaving $10.6 million available to be drawn as of December 31, 2008. The agent for the lender has the right to ask for a new appraisal which could change our borrowing capacity .The Credit Facility is secured by VA3, VA4, ACC2 and ACC3.
Upon consent of the lender, the Line of Credit may be increased by up to $200.0 million depending on certain factors, including the value of, and debt service on, the properties included in our borrowing base. In order to take advantage of all of the $200.0 million increase in the Line of Credit, we anticipate that, among other things, we would need to add properties to the borrowing base, subject to the consent of our lenders, and modify the pricing terms of the Credit Facility. The Line of Credit matures on August 7, 2010, but includes an option whereby we may elect, once, to extend the maturity date by 12 months. The extension is subject to us paying an extension fee of $0.4 million and other customary conditions. The agent for the lender has the right to ask for a new appraisal which could change our borrowing capacity. The Safari Term Loan is an interest-only loan with the full principal amount due at maturity on August 7, 2011, with no option to extend.
Four of our operating properties-VA3, VA4, ACC2 and ACC3-comprise our current borrowing base with an aggregate book value of $586.9 million as of December 31, 2008, along with the assignments of rents and leases at these properties. In addition, we may in the future choose to add some or all of the other properties that we acquired upon the completion of the IPO or other properties that we may acquire or develop in the future to the borrowing base in order to, among other things, increase the amount that we may borrow under the revolving facility. Once added to the borrowing base, properties may be removed only with the approval of our lenders.
ACC3 Mortgage Loan
As part of the Credit Facility financing, the Company repaid a mortgage loan on ACC3 totaling $125.2 million in the third quarter of 2007 and wrote off the remaining unamortized deferred financing cost balance of $1.4 million.
CH1 Construction Loan
On December 20, 2007, the Company entered into a $148.9 million construction loan relating to the refinancing of CH1 (the “CH1 Construction Loan”), of which $133.4 million and $96.7 million was outstanding at December 31, 2008 and 2007, respectively. This loan was paid off on February 10, 2009.
ACC4 Term Loan
On October 24, 2008, we entered into a credit agreement relating to a $100.0 million term loan secured by ACC4 with a syndicate of lenders (the “ACC4 Term Loan”). We have the option to increase the amount of the loan by up to an additional $150 million at any time during the eighteen-month period following the closing date, to the extent that any one or more lenders commit to being a lender for the additional amount and certain other conditions are met. We increased this loan to $250.0 million on February 10, 2009 through the exercise of the loan’s “accordion” feature. We utilized the loan proceeds to pay off the CH1 Construction Loan of $135.1 million and fund a portion of the Company’s development of the first phase of ACC5.
The ACC4 Term Loan matures on October 24, 2011 and includes a one-year extension option subject to, among other things, the payment of an extension fee equal to 50 basis points on the outstanding loan amount, there being no existing event of default, a debt service coverage ratio of no less than 2 to 1, and a loan to value ratio of no more than 40%. Borrowings under the loan will bear interest at (i) LIBOR plus 350 basis points during the initial term of the loan, and (ii) LIBOR plus 400 basis points during the additional one-year period if the Company exercises the one-year extension option. We may elect to have borrowings bear interest at (i) the prime rate plus 200 basis points during the initial term of the loan or (ii) the prime rate plus 250 basis points during the additional one-year period if the Company exercises the one-year extension option, but only if such interest rate is not less than LIBOR plus the applicable margin set forth above. The loan requires quarterly principal installment payments of $0.5 million beginning on April 1, 2009, and may be prepaid in whole or in part without penalty at any time after October 24, 2009, subject to the payment of certain LIBOR rate breakage fees. During the extension period, the quarterly principal installment payments increase to $2.0 million.
The Operating Partnership and its subsidiaries’ investments in development projects (as defined in the credit agreement) is limited to $1 billion, provided that the Operating Partnership and its subsidiaries shall not at anytime have more than five development projects (as defined in the credit agreement) ongoing.
The Operating Partnership has guaranteed for the benefit of the lenders under the credit agreement the payment of $100.0 million of the principal amount of the ACC4 Term Loan plus all outstanding interest, and is also liable for certain costs under the loan. As of December 31, 2008, $100.0 million was outstanding under the ACC4 Term Loan.
Covenants-Credit Facility and ACC4 Term Loan
Both the Credit Facility and ACC4 Term Loan require ongoing compliance by us with various covenants, including with respect to restrictions on liens, incurring indebtedness, making investments, effecting mergers and/or assets sales, maintenance of certain leases and the occurrence of a change of control (as defined in the respective credit agreements) of the Company or the Operating Partnership. In addition, the credit agreements require that certain financial covenants are adhered to, including, without limitation, the following:
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The Company must maintain the following minimum debt service coverage ratios:
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October 24, 2008 to March 31, 2009-1.15 to 1;
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April 1, 2009 to August 11, 2011-1.35 to 1;
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August 11, 2011 to October 24, 2011-1.75 to 1; and
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October 24, 2011 to October 24, 2012-2 to 1 (to the extent that the Company exercises the one-year extension option on the ACC4 Term Loan).
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Consolidated total indebtedness of the Operating Partnership and its subsidiaries to gross asset value of the Operating Partnership and its subsidiaries must be less than or equal to 65% during the terms of the loans.
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Ratio of adjusted consolidated Earnings Before Interest Taxes Depreciation and Amortization to consolidated fixed charges must be at least 1.45 to 1 during the terms of the loans.
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Minimum consolidated tangible net worth (as defined in the respective credit agreements) of the Operating Partnership and its subsidiaries must be greater than or equal to approximately $575 million (plus an increase of 75% of the sum of (i) the net proceeds from any future equity offerings and (ii) the value of any interests in the Operating Partnership or the Company issued upon the contribution of assets to the Company, the Operating Partnership or its subsidiaries after October 24, 2008) during the terms of the loans.
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For the Credit Facility exclusively, a borrowing base covenant limits the amount available on the Line of Credit to 65% of the appraised value of the secured properties.
In addition, the Credit Facility contains other customary covenants. As of December 31, 2008, we were in compliance with all covenants.
Debt Maturity Schedule as of December 31, 2008
($ in thousands)
(1) This loan matures on December 20, 2009 subject to a one-year extension option exercisable by the Company upon satisfaction of certain customary covenants. The loan was paid off on February 10, 2009.
(2) Amount outstanding on the Company’s $275 million floating rate Line of Credit which matures on August 7, 2010, subject to a one-year extension option exercisable by the Company upon satisfaction of certain customary conditions. A borrowing base covenant based on the initial appraised values of our Safari properties limits the amount available to $244 million.
(3) $200 million Safari Term Loan matures on August 7, 2011 with no extension option. $100 million ACC4 Term Loan matures on October 24, 2011 and includes a one-year extension option exercisable by the Company upon satisfaction of certain customary conditions. ACC4 Term Loan increased to $250 million on February 10, 2009.
(4) Rate as of December 31, 2008.
(5) Rate on $200 million Safari Term Loan is fixed at 6.5% by an interest rate swap.
8. Derivative Instruments
On August 15, 2007, the Company entered into a $200.0 million interest rate swap agreement to manage the interest rate risk associated with a portion of the Credit Facility effective August 17, 2007 with a maturity date of August 7, 2011. This swap agreement effectively fixes the interest rate on $200.0 million of the Credit Facility at
4.997% plus the credit spread of 1.5%. We have designated this agreement as a hedge for accounting purposes. Therefore, the effective portion of the changes in the fair value of the interest rate swap has been recorded in other comprehensive income (loss) and will be reclassified into interest expense as the hedged forecasted interest payments are recognized. Any ineffective portion of the hedging relationship will be recorded directly to earnings.
As of December 31, 2008 and 2007, the cumulative reduction in fair value of the interest rate swap of $17.8 million and $7.9 million, respectively, was recognized as a liability in prepaid rents and other liabilities and deferred in accumulated other comprehensive loss in the accompanying consolidated balance sheet and no amounts were recognized in earnings as hedge ineffectiveness. Within the next twelve months, we expect to recognize interest of $6.9 million currently recorded in accumulated other comprehensive loss.
Derivative financial instruments expose the Company to credit risk in the event of non-performance by the counterparties under the terms of the derivative instrument. The Company minimizes its credit risk on these transactions by dealing with major, creditworthy financial institutions as determined by management, and therefore, the Company believes the likelihood of realizing losses from counterparty non-performance is remote.
9. Related Party Transactions
Prior to the closing of the IPO on October 24, 2007:
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DFD Technical Services LLC (DFTS) was responsible for the management of the properties. Management fees incurred with DFTS were generally based on 5% of gross receipts collected for the properties and totaled $1.4 million for the period from January 1, 2007 to October 23, 2007 and $0.5 million for the year ended December 31, 2006.
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DuPont Fabros Development LLC (DFD) earned an asset management fee. Asset management fees, which are included in management fees in the consolidated statements of operations, incurred with DFD totaled $0.4 million for the period from January 1, 2007 to October 23, 2007 and $0.1 million for the year ended December 31, 2006.
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DFD bookkeeping fees incurred with DFD totaled less than $0.1 million for the period from January 1, 2007 to October 23, 2007 and for the year ended December 31, 2006 and are included in general and administrative expenses in the accompanying consolidated statements of operations.
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DFD was reimbursed for salaries and overhead expenses related to operation management totaling $1.1 million for the period from January 1, 2007 to October 23, 2007 and $0.2 million for the year ended December 31, 2006. These fees are included in property operating costs in the accompanying consolidated statements of operations.
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DFD was paid leasing commissions, which were capitalized and amortized over the term of the lease. Leasing commissions were determined based on approximately 5% of the total rental revenue of the executed lease. $0 was incurred for the period from January 1, 2007 to October 23, 2007 and $4.5 million was incurred for the year ended December 31, 2006.
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DFD was paid development and construction management fees, which were capitalized, for their services in the development of properties and build-out of the infrastructure. $0 was incurred for the period from January 1, 2007 to October 23, 2007 and $2.7 million was incurred for the year ended December 31, 2006.
Subsequent to the closing of the IPO, we have been paying rent for our headquarters building to an affiliate of Messrs. du Pont and Fateh. Rent expense for the year ended December 31, 2008 was $0.4 million and for the period from October 24, 2007 to December 31, 2007 was less than $0.1 million.
In addition, prepaid expenses and other assets includes amounts due from DFD and affiliated entities of less than $0.1 million and $0.2 million at December 31, 2008 and 2007, respectively.
Related party payables are due on demand without interest.
10. Commitments and Contingencies
Concurrent with our IPO, we entered into tax protection agreements with some of the contributors of the initial properties including our Executive Chairman and our President and CEO. Pursuant to the terms of these agreements, if we dispose of any interest in ACC2, ACC3, VA3, VA4 or CH1 that generates more than a certain allowable amount of built-in gain for the contributors, as a group, in any single year through 2016, we will indemnify the contributors for tax liabilities incurred with respect to the amount of built-in gain and tax liabilities incurred as a result of the reimbursement payment. The required indemnification will decrease ratably over the course of each year of tax protection by 10% of the estimated tax on the built-in gain, declining to zero by the end of 2016. The aggregate built-in gain on the initial properties as of December 31, 2007 was approximately $750.0 million (unaudited). Any sale by us that requires payments to any of our executive officers or directors pursuant to these agreements requires the approval of at least 75% of the disinterested members of our board of directors.
In 2007, we received three Notice of Violation from the Virginia Department of Environmental Quality (“VDEQ”) related to generators at three of our facilities. First, in March 2007, we were cited by the VDEQ compliance office about our emissions from the ACC2 diesel generators exceeding short-term emission limits. Second, on October 5, 2007, we received a notice of violation from VDEQ regarding certain diesel generators at ACC4. The notice asserts that construction and operation of the generators was commenced prior to receiving a required air permit from VDEQ for construction and operation of the generators and that the generators have been operating since June 2007 without an air permit. Third, on October 19, 2007, we received a notice of violation from VDEQ regarding certain diesel generators at one of our facilities in Northern Virginia, VA4. The notice asserts that the operation of our generators has not been in conformity with our air permit and that certain equipment added to the generators to reduce emissions has not been constructed, tested, and maintained in compliance with applicable regulations.
On August 4, 2008, we entered into a consent order with the VDEQ to resolve these matters. The order provided that we pay a $ 0.5 million civil penalty and undertake various remedial actions to bring the facilities into compliance and reduce future emissions, including installation of pollution control equipment at certain facilities, at a cost of $1.9 million, of which $1.5 million has been incurred and the remainder has been accrued at December 31, 2008. The civil penalty was paid as of December 31, 2008.
At the time of our IPO, our Executive Chairman and President and Chief Executive Officer agreed to indemnify us against certain costs that we may incur as a result of the alleged violations cited in the October 5 and 19, 2007 notices from VDEQ, and set aside, as partial collateral for a portion of these obligations, certain funds accruing for the account of the former members of the entity that contributed VA4 to our Company. We, with the approval of our disinterested directors, determined that $0.4 million of the costs incurred by us in connection with the notices of violation, including a portion of our attorney’s fees, are covered by these indemnification obligations, which they have paid as of December 31, 2008.
We are involved from time to time in other various legal proceedings, lawsuits, examinations by various tax authorities, and claims that have arisen in the ordinary course of business. Management believes that the resolution of such matters will not have a material adverse effect on the financial condition or results of operations.
11. Minority Interests
Minority interests relates to the interest in the Operating Partnership not owned by the Company. OP unitholders receive distributions per unit equivalent to the per share distributions made to the Company’s common shareholders. Minority interests are adjusted for income, losses and distributions allocated to OP units not held by the Company. In the event of changes in common equity, an adjustment to minority interests in the Operating Partnership is recorded to reflect the Company’s increased or decreased ownership interest in the
Operating Partnership. Upon completion of our IPO and contribution of the net proceeds to the Operating Partnership, minority interests owned 31,162,272 OP units, or 46.8% of the Operating Partnership. Limited partners have the right to tender their units for redemption. The units can be exchanged for cash based on the fair market value of the Company’s common shares or at the election of the Company for common shares which have been registered. The redemption value of our minority interests (31,162,272 OP Units) at December 31, 2008 was $64.5 million, based on the closing share price of $2.07.
During the fourth quarter of 2007, the Company issued 341,145 fully vested LTIP units at $20.80 per share to certain officers, employees and consultants and recorded compensation expense of $6.4 million. LTIP units are a special class of partnership interests in our Operating Partnership. LTIP units, whether vested or not, will receive the same quarterly per unit profit distributions as units of our Operating Partnership, which profit distribution will generally equal per share distributions on our shares of common stock. Initially, LTIP units will not have full parity with Operating Partnership units with respect to liquidating distributions. Under the terms of the LTIP units, our Operating Partnership will revalue its assets upon the occurrence of certain specified events, and any increase in valuation from the time of grant until such event will be allocated first to the holders of LTIP units to equalize the capital accounts of such holders with the capital accounts of Operating Partnership unit holders. Upon equalization of the capital accounts of the holders of LTIP units with the holders of Operating Partnership units, the LTIP units will achieve full parity with Operating Partnership units for all purposes, including with respect to liquidating distributions. If such parity is reached, vested LTIP units may be converted into an equal number of Operating Partnership units at any time, and thereafter receive all the rights of Operating Partnership units. However, there are circumstances under which such parity would not be reached. Until and unless such parity is reached, the value that a recipient will realize for a given number of vested LTIP units will be less than the value of an equal number of OP units. As of December 31, 2008, parity with the Operating Partnership units had not been achieved and the LTIP units could not be converted into Operating Partnership units.
12. Stockholders’ Equity
We completed our initial public offering of our common shares (the “IPO”) on October 24, 2007. The IPO resulted in the sale of 35,075,000 common shares at a price per share of $21.00, generating gross proceeds to the Company of $736.6 million. The proceeds to the Company, net of underwriters’ discounts, commissions and financial advisory fees and other offering costs, were $676.9 million.
In connection with the IPO, we issued 377,833 shares of common stock at $21.00 per share to directors, employees and consultants in October 2007, of which 306,404 were vested as of December 31, 2007 and 71,429 vested in 2008. We recorded compensation expense of $8.6 million in 2007.
On December 14, 2007, we declared a dividend of $0.15 per share that was paid on January 11, 2008 to shareholders of record as of December 28, 2007. We recorded a payable as of December 31, 2007 of $10.0 million for this dividend and distribution. The dividend was classified for 2007 income tax purposes as a 100% return of capital (unaudited) and was therefore not taxable to the shareholders of the REIT.
For the year ended December 31, 2008, the Company declared and paid the following cash dividends on a fully diluted basis:
13. Equity Compensation Plan
Concurrent with our IPO, our Board of Directors adopted the 2007 Equity Compensation Plan (“the Plan”). The Plan is administered by the Compensation Committee of the Board of Directors. The plan allows for the issuance of common stock, stock options, stock appreciation rights (“SARs”), performance unit awards and LTIP units. As of December 31, 2008, the maximum aggregate number of shares of common stock that may be issued under this Plan pursuant to the exercise of options and SARs, the grant of stock awards, or LTIP units and the settlement of performance units is equal to 4,967,795, of which 842,541 share equivalents had been issued leaving 4,125,254 shares available for future issuance.
Beginning January 1, 2008, and on each January 1 thereafter during the term of the Plan, the maximum aggregate number of shares of common stock that may be issued under this Plan pursuant to the exercise of options and SARs, the grant of stock awards or other-equity based awards and the settlement of performance units shall be increased by seven and one-half percent (7 1/2%) of any additional shares of common stock or interests in the Operating Partnership issued by the Company or the Operating Partnership; provided, however, that the maximum aggregate number of shares of common stock that may be issued under this Plan shall be 11,655,525 shares.
If any award or grant under the Plan (including LTIP units) expires, is forfeited or is terminated without having been exercised or paid, then any shares of common stock covered by such lapsed, cancelled, expired or unexercised portion of such award or grant and any forfeited, lapsed, cancelled or expired LTIP units shall be available for the grant of other options, SARs, stock awards, other equity-based awards and settlement of performance units under this Plan.
The following table discloses the number of unvested shares of restricted stock and the weighted average fair value of these shares at the date of grant:
As of December 31, 2008, total unearned compensation on restricted stock was $0.8 million and the weighted average vesting period was 1.3 years.
During the year ended December 31, 2008, we issued 53,270 shares of restricted stock which had a value of $1.0 million on the grant dates, and 71,429 shares vested at a value of $1.3 million on the vesting dates.
14. Earnings Per Share
The following table sets forth the reconciliation of basic and diluted average shares outstanding used in the computation of income (loss) per share of common stock (in thousands):
For the year ending December 31, 2008, approximately 0.4 million shares of unvested and restricted common stock and LTIP units have been excluded from the calculation of diluted earnings per share as their effect would have been antidilutive. For the period from October 24, 2007 to December 31, 2007, approximately 0.4 million shares of unvested and restricted common stock and LTIP units have been excluded from the calculation of diluted earnings per share as their effect would have been antidilutive.
15. Employee Benefit Plan
Upon completion of the IPO, we established a tax qualified retirement plan (“401(k) Plan”) that provides employees with an opportunity to save for retirement on a tax advantaged basis. Employees will be able to participate in the 401(k) Plan on their first day of employment and are able to defer compensation up to the limits established by the Internal Revenue Service. We match 50% of the employees’ contributions up to a maximum match contribution of 4% of the employee’s salary. Our contributions vest immediately. During the year ended December 31, 2008 and the period from October 24, 2007 to December 31, 2007, we contributed $0.2 million and less than $0.1 million, respectively, to the 401(k) Plan.
16. Fair Value of Financial Instruments
Assets and Liabilities Measured at Fair Value
On January 1, 2008, the Company adopted SFAS No. 157, Fair Value Measurements (“SFAS No. 157”). SFAS No. 157 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. SFAS No. 157 applies to reported balances that are required or permitted to be measured at fair value under existing accounting pronouncements; accordingly, the standard does not require any new fair value measurements of reported balances. In February 2008, the FASB issued two Staff Positions on SFAS No. 157: (1) FASB Staff Position No. FAS 157-1 (“FSP 157-1”), Application of FASB Statement No. 157 to FASB Statement No. 13 and Other Accounting Pronouncements That Address Fair Value Measurements for Purposes of Lease Classification or Measurement Under Statement 13, and (2) FASB Staff Position No. FAS 157-2 (“FSP 157-2”), Effective Date of FASB Statement No. 157. FSP 157-1 excludes FASB Statement No. 13,
Accounting for Leases, as well as other accounting pronouncements that address fair value measurements on lease classification or measurement under SFAS No. 13, from SFAS No. 157’s scope. FSP 157-2 partially defers SFAS No. 157’s effective date to January 1, 2009 for all non financial assets and non financial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis. We have elected to defer implementation of SFAS No. 157 for non-financial assets and liabilities which is primarily our real estate assets.
SFAS No. 157 emphasizes that fair value is a market-based measurement, not an entity-specific measurement. Therefore, a fair value measurement should be determined based on the assumptions that market participants would use in pricing the asset or liability. As a basis for considering market participant assumptions in fair value measurements, SFAS No. 157 establishes a fair value hierarchy that distinguishes between market participant assumptions based on market data obtained from sources independent of the reporting entity (observable inputs that are classified within Levels 1 and 2 of the hierarchy) and the reporting entity’s own assumptions about market participant assumptions (unobservable inputs classified within Level 3 of the hierarchy).
Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access. Level 2 inputs are inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs may include quoted prices for similar assets and liabilities in active markets, as well as inputs that are observable for the asset or liability (other than quoted prices), such as interest rates, foreign exchange rates, and yield curves that are observable at commonly quoted intervals. Level 3 inputs are unobservable inputs for the asset or liability, which are typically based on an entity’s own assumptions, as there is little, if any, related market activity. In instances where the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability.
Derivative financial instruments
Currently, the Company uses one interest rate swap to manage its interest rate risk. The valuation of this instrument is determined using widely accepted valuation techniques including discounted cash flow analysis on the expected cash flows of the derivative. This analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs, including interest rate curves. The fair value of our interest rate swap is 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 an expectation of future interest rates (forward curves) derived from observable market interest rate curves.
To comply with the provisions of SFAS No. 157, the Company incorporates credit valuation adjustments to appropriately reflect both its own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements. In adjusting the fair value of its derivative contract for the effect of nonperformance risk, the Company has considered the impact of netting and 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 the derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with its derivative utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by itself and its counterparties. However, as of December 31, 2008, the Company has assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative position and has determined that the credit valuation adjustment is not significant to the overall valuation of the interest rate swap. As a result, the Company has determined that its derivative valuation, in its entirety, is classified in Level 2 of the fair value hierarchy.
The table below presents the Company’s liabilities measured at fair value on a recurring basis as of December 31, 2008, aggregated by the level in the fair value hierarchy within which those measurements fall. These liabilities are recorded in prepaid rents and other liabilities in the consolidated balance sheet.
(in thousands)
SFAS No. 107, Disclosures About Fair Value of Financial Instruments, requires disclosure of the fair value of financial instruments. Fair value estimates are subjective in nature and are dependent on a number of important assumptions, including estimates of future cash flows, risks, discount rates, and relevant comparable market information associated with each financial instrument. The use of different market assumptions and estimation methodologies may have a material effect on the reported estimated fair value amounts. Accordingly, the amounts are not necessarily indicative of the amounts we would realize in a current market exchange.
The following methods and assumptions were used in estimating the fair value amounts and disclosures for financial instruments as of December 31, 2008:
•
Cash and cash equivalents: The carrying amount of cash and cash equivalents reported in the consolidated balance sheet approximates fair value because of the short maturity of these instruments (i.e., less than 90 days).
•
Rents and other receivables, accounts payable and accrued liabilities, and prepaid rents: The carrying amount of these assets and liabilities reported in the balance sheet approximates fair value because of the short-term nature of these amounts.
•
Debt: The combined balance of our Line of Credit and mortgage notes payable was $666.8 million with a fair value of $669.8 million as of December 31, 2008 based on the Company’s most recent financings.
17. Quarterly Financial Information (unaudited)
The table below reflects the selected quarterly information for the years ended December 31, 2008 and 2007 (in thousands except share data):
(1) Includes $176.5 million for the acquisition of service agreements and $15.0 million of non-cash stock based compensation expense related to the issuance of restricted stock and LTIPs in the fourth quarter of 2007.
18. Subsequent Events
OP Unit Redemption
From January 1, 2009 through February 24, 2009, holders of 3,939,929 OP units elected to redeem these units. The Company had the option to pay the OP unitholders with cash or issue shares of its common stock. The Company elected to issue 3,939,929 shares of its common stock.
ACC5 Loan
On February 6, 2009 (the “Closing Date”), the Company entered into a construction loan agreement (the “ACC5 Loan”) under which the lender agreed to lend up to $25 million to pay for a portion of the costs to complete the construction of Phase I of ACC5. Borrowings under the ACC5 Loan, which are secured by ACC5 and a $4 million cash deposit, bear interest at a fixed rate of 12% per annum and mature on February 6, 2010 (such period, the “Initial Term”). Upon execution of the ACC5 Loan, the Company drew down $5 million under the loan.
Under a separate agreement dated February 6, 2009, the Company may extend the maturity date of the ACC5 Loan for two years (the “First Extension Term”) if a certificate of occupancy has been issued by February 6, 2010, the Company has complied with all payment terms and there is no event of default. The Company also may extend for two additional one year periods if the Company has complied with all payment terms, there is no event of default and there is no material adverse change in the market value of ACC5. If the maturity date is extended for the First Extension Term, the Company must begin to pay monthly installments of principal and interest equal to the amount that, as of the commencement of the First Extension Term, would fully amortize the unpaid principal balance of the ACC5 Loan in 180 equal payments.
In connection with the ACC5 Loan, the Company executed a Deed of Trust which provides, among other things, that the lender may declare the borrowings under the agreement immediately due if the Company sells or transfers ACC5. The Deed of Trust also provides for customary events of default, including failure to pay a sum due or defects in the collateral under the Deed of Trust that are not cured prior to the expiration of the applicable notice and cure period. Upon the occurrence of an event of default and following the expiration of the applicable notice and cure period, the lender may, among other things, accelerate the obligation and declare amounts outstanding to be immediately due and payable, withhold disbursements and take possession of ACC5.
In connection with the ACC5 Loan, the Operating Partnership has agreed to guaranty obligations to pay to the lender any scheduled monthly installments of principal and interest to be paid prior to maturity.
SC1 Loan
On February 6, 2009, the Company received a $5 million term loan (the “SC1 Loan”) that is secured by SC1, bears interest at a fixed rate of 12% per annum and matures on February 6, 2010.
Under a separate agreement dated February 6, 2009, the Company may extend the maturity date of the SC1 Loan for two years (the “SC1 First Extension Term”) if the Company has complied with all payment terms and there is no event of default. The Company also may extend for two additional one year periods if the Company has complied with all payment terms, there is no event of default and there is no material adverse change in the market value of SC1. If the maturity date is extended for the SC1 First Extension Term, the Company must begin to pay monthly installments of principal and interest equal to the amount that, as of the commencement of the SC1 First Extension Term, would fully amortize the unpaid principal balance of the SC1 Loan in 180 equal payments.
In connection with the SC1 Loan, the Operating Partnership has agreed to guaranty obligations to pay to the lender any scheduled monthly installments of principal and interest to be paid prior to maturity.
On February 10, 2009, the Company received an additional $150 million in borrowings under an “accordion” feature of the ACC4 Term Loan, which was entered into on October 24, 2008. Approximately $135.1 million of the additional borrowings were used to repay in full the CH1 Construction Loan. In connection with the exercise of the accordion feature, the parties entered into an amendment to the ACC4 Term Loan which provides that another subsidiary of the Company will guaranty the obligations under the ACC4 Term Loan and this guaranty in turn will be secured by CH1. Under the terms of the amendment, CH1 will be released as security if the Company makes a principal reduction payment of $50 million and there is no event of default. Under the terms of the amendment, if the maturity date of the ACC4 Term Loan is extended from October 24, 2011 to October 24, 2012, the quarterly installments of principal will increase from $0.5 million to $2.0 million during the extension period.
Stock Compensation Plan (unaudited)
On February 26, 2009, the compensation committee of the Company’s board of directors granted incentive compensation awards to employees of the Company consisting of 0.6 million shares of restricted stock and options to purchase 1.3 million shares of its common stock, in the aggregate. One-third of these vest on each of March 1, 2010, 2011 and 2012, so long as the recipients remain employed with the Company. The options have a life of 10 years.
DUPONT FABROS TECHNOLOGY, INC.
SCHEDULE III
CONSOLIDATED REAL ESTATE AND ACCUMULATED DEPRECIATION
DECEMBER 31, 2008
(1) Properties pledged as collateral for the Credit Facility which has an outstanding balance of $433.4 million as of December 31, 2008.
DUPONT FABROS TECHNOLOGY, INC.
SCHEDULE III
CONSOLIDATED REAL ESTATE AND ACCUMULATED DEPRECIATION
DECEMBER 31, 2008
The following is a reconciliation of real estate assets and accumulated depreciation for the years ended December 31, 2008, 2007 and 2006:
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, as of the end of the period covered by this report (the “Evaluation Date”). Based on this evaluation, our principal executive officer and principal financial officer concluded as of the Evaluation Date that our disclosure controls and procedures were effective such that the information relating to DFT, including our consolidated subsidiaries, required to be disclosed in our Securities and Exchange Commission (“SEC”) reports (i) is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and (ii) is accumulated and communicated to DFT’s management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.
Changes in Internal Control over Financial Reporting
Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of any changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during our most recently completed fiscal quarter. Based on that evaluation, our principal executive officer and principal financial officer concluded that there has not been any change in our internal control over financial reporting during that quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Management’s Report on Internal Control over Financial Reporting
DuPont Fabros Technology, Inc.’s (“DFT”) management is responsible for establishing and maintaining adequate internal control over financial reporting for DFT. DFT’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. DFT’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of DFT; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of DFT are being made only in accordance with authorizations of management and directors of DFT; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of DFT’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
DFT’s management assessed the effectiveness of DFT’s internal control over financial reporting as of December 31, 2008, utilizing the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework. Based on the assessment by DFT’s management, we determined that DFT’s internal control over financial reporting was effective as of December 31, 2008. The effectiveness of DFT’s internal control over financial reporting as of December 31, 2008 has been audited by Ernst & Young LLP, DFT’s independent registered public accounting firm, as stated in their report which appears on page 54 of this Annual Report on Form 10-K.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
Not applicable.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Information on our directors and executive officers and the Audit Committee of our Board of Directors is incorporated by reference from the Company’s Proxy Statement (under the headings “Proposal 1: Election of Directors,” “Committees and Meetings of our Board of Directors,” “Executive Officers” and “Section 16(a) Beneficial Ownership Reporting Compliance”) with respect to the 2009 Annual Meeting of Stockholders to be filed with the SEC no later than April 30, 2009.
Because our common stock is listed on the New York Stock Exchange (“NYSE”), our President and Chief Executive Officer is required to make, and will make, an annual certification to the NYSE stating that he was not aware of any violation by us of the corporate governance listing standards of the NYSE. Our President and Chief Executive Officer will make his annual certification to that effect to the NYSE within the 30-day period following the 2009 Annual Meeting of Stockholders. In addition, we have filed, as exhibits to this Annual Report on Form 10-K for the year ended December 31, 2008, the certifications of our principal executive officer and principal financial officer required under Section 302 of the Sarbanes Oxley Act of 2002.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
This information is incorporated by reference from the Company’s Proxy Statement (under the headings “Executive Compensation,” “Director Compensation,” “Compensation Committee Interlocks and Insider Participation” and “Compensation Committee Report”) with respect to the 2009 Annual Meeting of Stockholders to be filed with the SEC no later than April 30, 2009.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERS MATTERS
This information is incorporated by reference to the Company’s Proxy Statement (under the headings “Security Ownership of Certain Beneficial Owners and Management” and “Securities Authorized for Issuance Under Equity Compensation Plan”) with respect to the 2009 Annual Meeting of Stockholders to be filed with the SEC no later than April 30, 2009.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE
This information is incorporated by reference from the Company’s Proxy Statement (under the headings “Certain Relationships and Related Transactions” and “Committees and Meetings of Our Board of Directors”) with respect to the 2009 Annual Meeting of Stockholders to be filed with the SEC no later than April 30, 2009.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
This information is incorporated by reference from the Company’s Proxy Statement (under the heading “Principal Accountant Fees and Services”) with respect to the 2009 Annual Meeting of Stockholders to be filed with the SEC no later than April 30, 2009.
PART IV
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) Financial Statements and Schedules. The following financial statements and schedules are included in this report:
(1) FINANCIAL STATEMENTS
The response to this portion of Item 15 is submitted under Item 8 of this Report on Form 10-K.
(2) FINANCIAL STATEMENT SCHEDULES
Schedule III - Consolidated Real Estate and Accumulated Depreciation.
All other schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and therefore have been omitted.
(3) EXHIBITS
Any shareholder who wants a copy of the following Exhibits may obtain one from us upon request at a charge that reflects the reproduction cost of such Exhibits. Requests should be made to DuPont Fabros Technology, Inc., 1212 New York Avenue, NW, Suite 900, Washington, DC 20005.
(b) Exhibits. The exhibits required by Item 601 of Regulation S-K are listed below. Management contracts or compensatory plans are filed as Exhibits 10.13 through 10.16 and 10.20 through 10.25.
* Filed herewith.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
EXHIBIT INDEX
* Filed herewith.