Digital Realty Trust, Inc. — Q3 2010 Form 10-Q
Reporting period: Quarter ended September 30, 2010; financial statements are unaudited. The filing combines Digital Realty Trust, Inc. and its operating partnership, which holds substantially all assets and debt and conducts operations. Amounts below are in U.S. dollars; financial statement figures are converted from thousands to millions where appropriate.
Business context
The company owns, acquires, develops and manages technology-related real estate, principally data centers. At quarter-end it reported 95 properties, approximately 16.4 million rentable square feet including redevelopment space, and 95.0% occupancy excluding 1.9 million square feet held for redevelopment. Its portfolio is concentrated in major U.S. technology markets, with properties also in Europe and Canada.
Financial results and key metrics
| Metric | Q3 2010 | Q3 2009 | Nine months 2010 | Nine months 2009 |
|---|---|---|---|---|
| Operating revenue | $237.5M | $163.2M | $626.7M | $467.4M |
| Operating income | $60.4M | $45.7M | $169.7M | $127.7M |
| Net income | $23.6M | $23.9M | $69.1M | $66.3M |
| Net income available to common stockholders | $9.6M | $12.4M | $33.5M | $33.0M |
| Diluted earnings per share | $0.11 | $0.16 | $0.40 | $0.43 |
| Interest expense | $36.7M | $22.6M | $100.8M | $64.0M |
- Revenue rose 45.5% in Q3 and 34.1% for the first nine months. Management attributed growth primarily to acquisitions and new leasing, including redevelopment space.
- Operating income increased 32.3% in Q3 and 32.9% year to date. Calculated operating margin was approximately 25.4% in Q3 2010 versus 28.0% in Q3 2009, and 27.1% versus 27.3% for the nine-month periods.
- Q3 net income was slightly lower despite higher operating income, as interest expense rose and the company recorded a $1.1M debt-extinguishment loss and $4.2M in Series A preferred-stock redemption costs. Nine-month net income increased, but diluted EPS declined.
- Operating cash flow was $240.3M for the first nine months, versus $218.7M in 2009. Investing cash use was $1.459B, chiefly reflecting $1.182B of property acquisitions and $248.7M of real estate improvements. Financing provided $1.213B, principally through debt and equity issuance. Cash declined by $5.8M to $66.5M; restricted cash was an additional $61.6M.
- Total assets were $5.171B and total liabilities $3.122B at September 30, 2010. Total debt was $2.722B, up from $1.784B at December 31, 2009. Reported debt-to-enterprise-value was approximately 30%.
- Debt was 91.9% fixed-rate or hedged and 8.1% unhedged variable-rate. The effective interest rate was 5.35% overall; unhedged variable-rate debt carried a 1.39% rate. The $750M revolving facility had $220.6M drawn, $16.8M of letters of credit, and approximately $512.5M available.
Material changes and unusual items
- The company acquired properties for an aggregate stated purchase price of approximately $1.208B during the first nine months, including the $375M New England Portfolio and $725M 365 Main Portfolio. Portfolio growth and new-property contribution were major drivers of reported revenue growth.
- The company issued $500M of 5.875% notes due 2020 and $375M of 4.50% notes due 2015, as well as additional Prudential shelf notes. It also raised approximately $536.4M net from common equity issuance and redeemed all Series A preferred stock for $103.5M.
- Institutional holders exchanged approximately $62.5M principal of 2026 exchangeable debentures for common shares and cash. A $2.6M year-to-date loss was recorded on early extinguishment of debt. Remaining 2026 debentures had a $110.0M principal balance; the filing estimated $103.2M of excess exchange value at quarter-end.
- Operating expenses rose with property growth, higher utilities and maintenance, depreciation from redevelopment projects placed in service, and acquisition-related transaction expenses. Interest expense increased primarily because average debt balances were higher.
- Cash from operations covered distributions during the period. Series B preferred stock redemption was announced after quarter-end for December 10, 2010, to be funded with revolving-credit borrowings.
Outlook, management commentary and risks
- Management expected to spend approximately $100M–$150M on redevelopment capital expenditures in Q4 2010; the amount could vary with demand, leasing, and capital availability. The company also reported approximately $101.5M of open construction-contract commitments.
- The company planned to pursue acquisitions and redevelopment, funded through operations, debt, equity and its revolving facility. It stated a debt-to-enterprise-value policy limit of 60%, compared with approximately 30% at quarter-end. No specific earnings or revenue guidance is provided in the supplied filing text.
- Management cited continued uncertainty in global credit and economic conditions, including potential effects on tenant finances, financing availability and liquidity. Other key risks include data-center demand and competition, tenant defaults or non-renewals, redevelopment execution and leasing, energy costs and regulation, interest and foreign-exchange movements, geographic concentration, joint-venture exposure, and maintaining REIT qualification.
- Debt maturities require attention: the maturity schedule includes approximately $486M in 2011, including the revolving facility and 2026 debentures assuming repurchase at their first put date. The revolver maturity had been extended to August 31, 2011, subject to conditions; a further one-year extension option was available.
- Interest-rate derivatives hedged approximately $278.2M of variable-rate debt; their reported fair value was a liability of $10.6M. The filing estimated an additional $5.7M would be reclassified as increased interest expense over the following 12 months.
- Other notable exposures include related-party leasing revenue from tel(x), and contingent revenue-sharing arrangements. The filing reported no legal proceedings, defaults upon senior securities, or material control changes; management concluded disclosure controls were effective.
Most important facts for investors to verify
- Whether occupancy, same-store leasing and redevelopment conversion support continued revenue growth, and whether the 1.9 million square feet held for redevelopment earns attractive returns.
- Funding and refinancing plans for 2011 maturities, the revolving facility, the Series B redemption, and planned redevelopment spending; confirm covenant compliance and available borrowing capacity.
- Acquisition performance and integration, including the contribution and leasing progress of the New England and 365 Main portfolios.
- The effect of rising interest expense, preferred-stock redemptions, equity issuance and exchangeable securities on common earnings per share and dilution.
- Tenant, geographic and related-party concentration, including tel(x) arrangements, and the sensitivity of results to energy costs, foreign exchange and data-center market conditions.