Digital Realty Trust, Inc. — Q2 2013 Form 10-Q
Business context and reporting period. The filing covers the quarter and six months ended June 30, 2013. Digital Realty is a REIT focused on owning, acquiring, developing and managing technology-related real estate, principally data centers. Its portfolio comprised 127 properties and approximately 23.7 million rentable square feet, including 2.8 million square feet held for development. The filing combines Digital Realty Trust, Inc. and its operating partnership; substantially all operations, assets and debt sit in the partnership.
Financial performance and position
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Operating revenue | $363.5 million | $303.7 million | $721.9 million | $586.9 million |
| Operating income | $100.0 million | $88.4 million | $198.6 million | $174.4 million |
| Net income | $59.6 million | $54.0 million | $111.3 million | $103.2 million |
| Net income available to common stockholders | $47.1 million | $42.0 million | $89.7 million | $81.2 million |
| Diluted earnings per share | $0.37 | $0.38 | $0.70 | $0.75 |
| Diluted FFO per share and unit | $1.22 | $1.09 | $2.37 | $2.15 |
- Q2 revenue increased approximately 19.7%; six-month revenue rose 23.0%. Management attributed growth to same-store leasing and completed development space, as well as acquisitions. Same-store rental revenue increased $18.4 million in Q2; new properties added $32.6 million.
- Operating income grew more slowly than revenue: operating expenses increased 22.4% in Q2, while interest expense rose $9.9 million to $47.6 million. Higher utilities, property costs, depreciation and acquisition-related debt contributed.
- Net income included a $5.6 million insurance-settlement gain in Q2. Despite higher net income, diluted EPS declined year over year, alongside an increase in weighted-average common shares from 109.8 million to 128.6 million.
- For the six months, operating cash flow was $275.5 million, versus $231.2 million. Investing cash outflow was $712.2 million, including $577.1 million of improvements and development spending and $117.3 million of property acquisitions. Financing cash flow was $404.7 million; cash declined $32.0 million to $24.3 million.
- At June 30, total assets were $9.18 billion and total liabilities $5.60 billion. Consolidated debt was $4.70 billion, compared with $4.28 billion at December 31, 2012. Debt to total enterprise value was approximately 35%; management’s stated limit is 60%. The effective interest rate was 4.25%, and 16.8% of debt was unhedged variable-rate debt.
- Cash and cash equivalents were $24.3 million, with an additional $39.0 million of restricted cash. The $1.8 billion revolving facility had $610.3 million drawn and $35.4 million in letters of credit, leaving approximately $1.2 billion available. The company reported compliance with debt covenants.
Material changes and notable items
- The company issued £400 million of 4.25% guaranteed notes due 2025, generating approximately $624.2 million of net proceeds, used initially to repay revolver borrowings. Total debt nevertheless increased from year-end, reflecting financing and investment activity.
- Digital Realty issued $250 million of Series G preferred stock at a 5.875% cumulative annual dividend rate. Series D convertible preferred stock converted into common shares; common shares outstanding rose to 128.4 million from 125.1 million at year-end.
- Six-month FFO available to common stockholders and unitholders increased to $318.7 million from $255.1 million; diluted FFO per share and unit increased to $2.37 from $2.15.
- Occupancy was 93.1%, excluding development space and unconsolidated joint ventures, compared with 93.2% a year earlier. Lease expirations through year-end 2014 represented 9.1% of rentable square feet. Management reported strong demand in most key markets; renewal rents rose 0.9% for Turn-Key Flex and 25.9% for Powered Base Building space in the first half, on a GAAP basis.
- Development and improvement capital expenditures were substantial: cash-basis total capital expenditures were $546.0 million for the first half, up from $370.4 million. The filing also reports a $3.4 million benefit to rental-property operating expense from a refinement of capitalization practices, applied retrospectively from January 1, 2013.
Outlook, risks and contingencies
- Management expected $375 million to $475 million of development-program capital expenditures in the second half of 2013. Approximately 1.28 million square feet was under construction; expected completion for identified projects was generally within the next 12 months. Open construction-contract commitments were approximately $172.3 million.
- Management expects to fund liquidity needs through operating cash flow, debt and equity issuance, and revolving-credit borrowings. It cautioned that reduced capital availability could force cuts to acquisitions or development plans. The filing provides no quantified earnings or revenue guidance.
- Key disclosed risks include tenant concentration and defaults or non-renewals, data-center supply and demand, development and leasing execution, interest rates and refinancing, foreign-exchange movements, utility and energy costs, global economic conditions, and maintaining REIT status. London accounted for 11.3% of annualized rent; England represented 13.3% of first-half revenue and 20.0% of long-lived assets.
- Sentrum acquisition contingent consideration was valued at approximately $81.7 million at quarter-end; changes in its fair value affect earnings. A separate 29A International Business Park earnout could reach approximately $39.4 million. Environmental cleanup work at two properties could entail material costs, and the company said recovery from a prior tenant and the ultimate impact could not be estimated.
- The company received $8.6 million in insurance proceeds related to disputed construction costs, recognizing $5.6 million as a gain in the quarter. It reported no legal proceedings believed likely to have a material adverse effect. Management concluded disclosure controls were effective and reported no material change in internal control over financial reporting.
Investor verification priorities
- Confirm the drivers and durability of revenue and FFO growth, particularly same-store leasing versus acquisitions, and reconcile FFO with GAAP earnings and cash available after recurring capital needs.
- Assess whether development spending, completion timelines, leasing and expected returns support the $375–$475 million second-half capital expenditure plan.
- Review debt maturities and refinancing needs, especially the approximately $1.13 billion scheduled for 2015 and the exchangeable debentures’ first holder put date in April 2014; assess interest-rate and foreign-currency exposure.
- Monitor occupancy, lease expirations, renewal spreads, major tenants and geographic concentration, including the material England and London exposure.
- Track contingent consideration, the potential 29A earnout, construction commitments and environmental remediation exposure; determine whether distributions remain covered by operating cash flow as investment and dividend needs grow.