Business context and reporting period
Digital Realty Trust, Inc. and its operating partnership filed this unaudited Form 10-Q for the three months ended March 31, 2015, compared with the first quarter of 2014. The company owns, develops and manages data-center and other technology-related real estate. At quarter-end, its portfolio comprised 130 properties, including 14 held through unconsolidated joint ventures; occupancy was approximately 92.1%, excluding active and future development space. The company is a REIT; substantially all operations and debt are held by the operating partnership.
Financial and operating results
| Metric | Q1 2015 | Q1 2014 |
|---|---|---|
| Operating revenue | $406.6 million | $390.6 million |
| Operating income | $149.3 million | $90.0 million |
| Net income | $122.3 million | $46.7 million |
| Net income available to common stockholders | $101.7 million | $34.2 million |
| Diluted EPS | $0.75 | $0.26 |
| FFO per diluted share and unit | $1.56 | $1.22 |
| Cash from operating activities | $138.9 million | $116.4 million |
Revenue rose 4.1%, led by rental revenue and growth from completed and leased development space. GAAP operating margin was approximately 36.7%, versus 23.0%; the comparison is materially affected by a $43.0 million reduction in contingent consideration expense in 2015, versus $3.4 million in 2014. The company also recorded $17.8 million in property-sale gains. FFO, a supplemental non-GAAP measure, increased approximately 31% to $216.4 million; it excludes property-sale gains and real-estate depreciation and amortization.
Investing cash outflow was $149.1 million, compared with $227.5 million in the prior-year quarter, reflecting lower real-estate investment spending and property-sale proceeds. Financing provided $6.2 million, versus $124.6 million; the prior-year period included approximately $289.9 million of net proceeds from preferred-stock issuance. Cash and cash equivalents were $37.3 million at quarter-end, down from $41.3 million at year-end 2014; restricted cash was $11.9 million.
Total debt was $4.82 billion, up from $4.67 billion at December 31, 2014. Debt to total enterprise value was approximately 32%; 74.7% of debt was fixed-rate or hedged. The effective interest rate was 3.79%, and weighted-average term to initial maturity was 4.4 years. The $2.0 billion revolving facility had $826.9 million drawn and approximately $1.1 billion available, after letters of credit. The company reported compliance with debt covenants.
Changes, outlook and notable matters
- Net income increased sharply, but the contingent-consideration fair-value reduction and property-sale gains were significant contributors. The $43.0 million reduction relates to the Sentrum acquisition earnout and reflects management’s assessment that no further qualifying leases would be signed before the contingency expired.
- Stabilized-property revenue declined partly because the pound and euro weakened against the U.S. dollar; revenue growth came mainly from pre-stabilized properties, including leased development space. Management reported strong demand in most key markets, but identified potential oversupply risk in Silicon Valley.
- Management expected rents on 2015 expirations, in aggregate, to be higher on a GAAP basis and flat on a cash basis than current rents, while cautioning that renewals and re-leasing rates are not assured. First-quarter renewals showed mixed results: Turn-Key Flex rents fell 10.0% on a GAAP basis, while Powered Base Building rents rose 24.5%.
- The company expected to spend approximately $625 million to $725 million on development capital expenditures during the remaining nine months of 2015. It had approximately $124.4 million of construction commitments and about 1.2 million square feet under active development. Management noted spending could change materially with demand, leasing and capital availability.
- Two properties sold during the quarter for approximately $45.3 million gross proceeds, generating $17.8 million in gains. After quarter-end, 833 Chestnut Street sold for approximately $161 million, with about $150 million net proceeds and a $77 million net gain. The company also gave notice to redeem $375 million of 4.5% notes due 2015 on May 26, 2015.
- Key risks include tenant concentration and lease renewals, data-center supply and demand, development costs and lease-up timing, foreign-currency movements, interest rates and refinancing, access to capital, power costs and regulation, and REIT qualification. Foreign-currency translation reduced comprehensive income by $45.8 million in the quarter.
- Commitments and contingencies include a $12.4 million accrued acquisition earnout, up to approximately $36.4 million of potential additional consideration under another earnout, and a disputed former-executive separation arrangement. Management said no current legal proceeding was expected to have a material adverse effect; the filing provides no clear estimate of any recovery related to the dispute.
- Management stated that disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter. No formal earnings guidance was provided.
Important facts for investors to verify
- How much of the earnings and FFO growth reflects recurring leasing and operations versus the contingent-consideration remeasurement and property dispositions.
- Actual cash rent and leasing spreads as leases renew or expire, including progress in Silicon Valley and other development markets.
- Development spending, project completion and lease-up against the $625–$725 million remaining-2015 capital expenditure estimate.
- Funding and terms for the $375 million note redemption, upcoming maturities and any change in revolving-credit availability or covenant headroom.
- Exposure to foreign exchange, floating interest rates, tenant concentration, power costs and the disclosed earnout and executive-separation contingencies.