DIGITAL REALTY TRUST, INC. annual report, FY2015

Digital Realty Trust, Inc. — 2015 Form 10-K

Business context and reporting period. This annual report covers the fiscal year ended December 31, 2015. Digital Realty owns, develops and operates data centers and related colocation and interconnection facilities; its operating partnership holds substantially all assets and conducts the business. On October 9, 2015, the company acquired Telx for approximately $1.886 billion, adding a U.S. colocation and interconnection platform. At year-end, the portfolio comprised 139 operating properties, including joint-venture holdings, across North America, Europe, Australia and Asia; portfolio occupancy was 91.4% excluding development and future-development space.

Financial performance and condition

Metric	2015	2014	Change
Operating revenue	$1.763 billion	$1.616 billion	+9.1%
Operating income	$401.9 million	$258.7 million	+55.4%
Net income	$301.6 million	$203.4 million	+48.2%
Net income available to common stockholders	$217.3 million	$132.7 million	+63.7%
Diluted EPS	$1.56	$0.99	+$0.57
Diluted FFO per share and unit	$4.86	$5.04	-3.6%
Operating cash flow	$799.2 million	$655.9 million	+$143.3 million

Operating margin was approximately 22.8%, compared with 16.0% in 2014; net margin was approximately 17.1%, compared with 12.6%. The comparisons reflect material one-time and nonrecurring items, as discussed below.
Rental revenue rose 7.9% to $1.355 billion; tenant reimbursements increased 2.8% to $359.9 million. Interconnection and other revenue was $40.8 million, reported as a new revenue category following the Telx acquisition.
Operating expenses were $1.361 billion, broadly flat year over year. Interest expense increased 5.4% to $201.4 million.
Cash and cash equivalents were $57.1 million, plus $18.0 million of restricted cash. Total liabilities were $6.915 billion; total assets were $11.451 billion. Net real estate investments were $8.770 billion.
Consolidated debt was approximately $5.934 billion, versus $4.673 billion a year earlier. Debt to enterprise value was approximately 32%; 76% of debt was fixed-rate or hedged, and the weighted-average interest rate was 3.72%. The filing reports approximately $0.9 billion of availability under the then-current revolver at December 31, 2015.
Investing cash outflow was $2.526 billion, largely reflecting the Telx acquisition; financing cash inflow was $1.749 billion. Reported 2015 capital expenditures, excluding indirect costs, were $626.7 million.
Common dividends were $3.40 per share for 2015, up from $3.32 in 2014. The board declared a $0.88-per-share common dividend for the first quarter of 2016.

Material changes versus prior periods

Revenue growth reflected acquisitions, new leasing and development deliveries. Telx contributed approximately $42.2 million to rental revenue growth and $38.9 million to interconnection revenue growth after acquisition; its post-acquisition period included $81.1 million of rental revenue and $71.3 million of operating expenses.
Operating income and net income improved substantially from 2014, when the company recorded $126.5 million of real estate impairment. In 2015, the company recorded a $94.6 million gain on property sales, compared with $15.9 million in 2014; 2014 also included $95.4 million of gains on property contributions to joint ventures and a $14.6 million gain on sale of an equity investment.
2015 results included a $44.3 million reduction in operating expense from fair-value changes in contingent consideration, primarily the Sentrum acquisition earnout. These items, property-sale gains and acquisition accounting make GAAP earnings less comparable to recurring property performance.
FFO available to common stockholders and unitholders was $687.9 million, down from $692.0 million, and diluted FFO per share and unit declined despite higher revenue and GAAP earnings.
Quarterly results were uneven: Q4 2015 revenue was $500.4 million, but the company reported a $16.6 million net loss and a $40.0 million loss available to common stockholders, or $0.28 per diluted share. Telx-related lease write-offs and other expenses, together with preferred dividends, were significant factors.

Outlook, risks and unusual items

Management expected $750 million to $900 million of development capital expenditures in 2016, subject to demand, leasing, financing availability and other conditions. Construction-contract commitments at year-end were $157.6 million.
Management reported strong demand in many key markets, but said supply and demand in Virginia, Dallas and London were broadly aligned. It expected rents on 2016-expiring leases, on average, to be higher on a GAAP basis and flat on a cash basis, while cautioning that outcomes vary by market and space type.
Management said near-term acquisitions could represent a smaller share of growth because private-investor demand had lowered capitalization rates and seller price expectations did not always meet the company’s return requirements.
The January 2016 refinancing replaced the $2.0 billion revolving facility with a new $2.0 billion facility maturing in 2020, with two six-month extensions and an accordion up to $2.5 billion. The company also refinanced its term loan with $1.25 billion due in 2021 and $300 million due in 2023. It reported approximately $1.5 billion available on the refinanced revolver as of February 26, 2016.
Key risks include the capital-intensive nature of development; leasing, renewal and tenant-credit risks; concentration among major tenants (the top 20 generated 43.6% of annualized rent); competition and potential oversupply; power availability and cost; service interruptions and cybersecurity; foreign exchange exposure; interest rates and refinancing; and integrating Telx and realizing anticipated benefits.
Other notable items: the preliminary Telx purchase-price allocation included $316.3 million of goodwill and remained subject to finalization. The acquisition also involved a $75.3 million write-off of Telx-related deferred rent receivables and $17.4 million of transaction expenses. The former CEO settlement included an $8.0 million payment; the company reversed $4.6 million of previously recorded severance expense.
The company reported no legal proceedings expected to have a material adverse effect and stated that it was in compliance with debt covenants at year-end. Management and the auditor concluded internal control over financial reporting was effective; Telx’s controls, associated with $1.9 billion of assets and $81 million of revenue, were excluded from the assessment.

Important facts for investors to verify

How much of 2015 growth and the Q4 loss reflects recurring operations versus Telx integration, purchase accounting, lease write-offs, contingent-consideration adjustments and property-sale gains.
Whether Telx delivers expected customer retention, interconnection growth, synergies and returns relative to its $1.886 billion purchase price.
Actual 2016 development spending, delivery timing, lease-up and returns compared with the $750 million to $900 million capital-expenditure outlook.
Debt maturities and liquidity after the January 2016 refinancing, including covenant headroom, interest-rate exposure and the cost and terms of future financing.
Lease expirations, renewal spreads and tenant concentration, particularly exposure to IBM, CenturyLink and other large customers, and occupancy trends in key markets.
The final Telx purchase-price allocation and any subsequent changes to goodwill, intangible assets, taxes or reported earnings.