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DFT > SEC Filings for DFT > Form 10-Q on 25-Oct-2012All Recent SEC Filings

Show all filings for DUPONT FABROS TECHNOLOGY, INC. | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for DUPONT FABROS TECHNOLOGY, INC.


25-Oct-2012

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Special Note Regarding Forward-Looking Statements The following discussion should be read in conjunction with the financial statements and notes thereto appearing elsewhere in this report. This report contains forward-looking statements within the meaning of the federal securities laws. The Company cautions investors that any forward-looking statements presented in this report are based on management's beliefs and assumptions made by, and information currently available to, management. When used, the words "anticipate," "believe," "expect," "intend," "may," "might," "plan," "estimate," "project," "should," "will," "result" and similar expressions, which do not relate solely to historical matters, are intended to identify forward-looking statements. Such statements are subject to risks, uncertainties and assumptions and are not guarantees of future performance, which may be affected by known and unknown risks, trends, uncertainties and factors that are beyond the Company's control. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, estimated or projected. The Company cautions you that while forward-looking statements reflect its good faith beliefs when the Company makes them, they are not guarantees of future performance and are impacted by actual events when they occur after the Company makes such statements. The Company expressly disclaims any responsibility to update forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law. Accordingly, investors should use caution in relying on past forward-looking statements, which are based on results and trends at the time they are made, to anticipate future results or trends.
For a detailed discussion of certain risks and uncertainties that could cause the Company's future results to differ materially from any forward-looking statements, see Item 1A, "Risk Factors" in the Company's Annual Report on Form 10-K for the year ended December 31, 2011. You should also review the risks, uncertainties and other factors discussed in this Quarterly Report on Form 10-Q and identified in other documents that the Company files from time to time with the Securities and Exchange Commission ("SEC"). The risks and uncertainties discussed in these reports are not exhaustive. The Company operates in a very competitive and rapidly changing environment and new risk factors may emerge from time to time. It is not possible for management to predict all such risk factors, nor can it assess the impact of all such risk factors on the Company's business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements. Given these risks and uncertainties, investors should not place undue reliance on forward-looking statements as a prediction of actual results.

Overview
DuPont Fabros Technology, Inc. (the "REIT" or "DFT") was formed on March 2, 2007, is a real estate investment trust, or REIT, and is headquartered in Washington, D.C. DFT is a fully integrated, self-administered and self-managed company that owns, acquires, develops and operates wholesale data centers. DFT is the sole general partner of, and, as of September 30, 2012, owned 77.1% of the common economic interest in, DuPont Fabros Technology, L.P. (the "Operating Partnership" or "OP" and collectively with DFT and their operating subsidiaries, the "Company"). DFT's common stock trades on the New York Stock Exchange, or NYSE, under the symbol "DFT". DFT's Series A and Series B preferred stock also trade on the NYSE under the symbols "DFTPrA" and "DFTPrB", respectively. As of September 30, 2012, the Company owns and operates ten data centers, seven of which are located in Northern Virginia, one in suburban Chicago, Illinois, one in Piscataway, New Jersey and one in Santa Clara, California. As discussed below, the Company also owns certain properties for future development and parcels of land that it intends to develop in the future, into wholesale data centers. In April 2012, the Company began development of ACC6 Phase II, with completion expected in late 2012. With this portfolio of properties, the Company believes that it is well positioned as a fully integrated wholesale data center provider, capable of developing, leasing, operating and managing its growing portfolio.


Table of Contents

The following tables present certain data of the operating properties and development projects as of September 30, 2012:

                              Operating Properties
                            As of September 30, 2012

                                                                 Gross        Raised       Critical                       %
                                                Year Built/    Building       Square         Load           %         Commenced
Property                  Property Location      Renovated     Area (2)      Feet (3)       MW (4)      Leased(5)        (5)
Stabilized (1)
ACC2                    Ashburn, VA              2001/2005       87,000        53,000         10.4         100 %          100 %
ACC3                    Ashburn, VA              2001/2006      147,000        80,000         13.9         100 %          100 %
ACC4                    Ashburn, VA                2007         347,000       172,000         36.4         100 %          100 %
ACC5                    Ashburn, VA              2009-2010      360,000       176,000         36.4         100 %          100 %
ACC6 Phase I            Ashburn, VA                2011         131,000        65,000         13.0         100 %          100 %
CH1 Phase I             Elk Grove Village, IL      2008         285,000       122,000         18.2          98 %           98 %
VA3                     Reston, VA                 2003         256,000       147,000         13.0          56 %           56 %
VA4                     Bristow, VA                2005         230,000        90,000          9.6         100 %          100 %
Subtotal - stabilized                                         1,843,000       905,000        150.9          96 %           96 %
Completed not Stabilized
CH1 Phase II            Elk Grove Village, IL      2,012        200,000       109,000         18.2          86 %           71 %
NJ1 Phase I             Piscataway, NJ             2010         180,000        88,000         18.2          36 %           36 %
SC1 Phase I             Santa Clara, CA            2011         180,000        88,000         18.2          44 %           44 %

Subtotal - non-stabilized 560,000 285,000 54.6 55 % 50 % Total Operating Properties 2,403,000 1,190,000 205.5 85 % 84 %

(1) Stabilized operating properties are either 85% or more leased and commenced or have been 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 the tenants' computer servers are located), tenant common areas, areas controlled by the Company (such as the mechanical, telecommunications and utility rooms) and, in some facilities, individual office and storage space leased on an as available basis to the tenants.

(3) Raised square footage is that portion of gross building area where the tenants locate their computer servers. The Company considers raised square footage to be the net rentable square footage in each of its 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 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. Percentage commenced is expressed as a percentage of critical load where the lease has commenced under generally accepted accounting principles. Leases executed as of September 30, 2012 (including one lease amendment executed October 2012) represent $229 million of base rent on a straight-line basis and $225 million on a cash basis over the next twelve months.


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                               Lease Expirations
                            As of September 30, 2012
The following table sets forth a summary schedule of lease expirations of the
operating properties for each of the ten calendar years beginning with 2012. The
information set forth in the table below assumes that tenants exercise no
renewal options and takes into account tenants' early termination options.

                                  Raised Square Feet
                    Number             Expiring          % of Leased       Total kW                         % of
Year of Lease     of Leases        (in thousands)           Raised        of Expiring        % of        Annualized
Expiration       Expiring (1)            (2)             Square Feet      Leases (3)      Leased kW       Base Rent
2012                       -                      -              - %               -              - %            - %
2013 (4)                   2                      8            0.8 %           1,567            0.9 %          0.9 %
2014                       6                     35            3.5 %           6,287            3.6 %          3.7 %
2015                       4                     70            7.0 %          13,812            7.9 %          7.1 %
2016 (5)                   4                     32            3.2 %           4,686            2.7 %          2.6 %
2017 (5)                   9                     66            6.7 %          11,470            6.6 %          6.3 %
2018 (5)                  10                    118           11.9 %          24,511           14.0 %         14.3 %
2019                      11                    168           16.9 %          31,035           17.7 %         16.3 %
2020                       9                     96            9.7 %          15,196            8.7 %          9.2 %
2021                       7                    130           13.1 %          21,669           12.4 %         13.9 %
After 2021
(5)                       20                    270           27.2 %          44,597           25.5 %         25.7 %
Total                     82                    993            100 %         174,830            100 %          100 %

(1) Represents 33 tenants with 82 lease expiration dates, including two leases that have not yet commenced as of October 24, 2012 for one existing tenant. Top three tenants represent 47% of annualized base rent as of September 30, 2012 (including one lease amendment executed October 2012).

(2) Raised square footage is that portion of gross building area where the tenants locate their computer servers. The Company considers raised square footage to be the net rentable square footage in each of its facilities.

(3) One MW is equal to 1,000 kW.

(4) One lease has an option to terminate on six months notice and has a scheduled maturity on September 30, 2013 with no notice received as of today. Notice has been provided on the second lease and it will expire on December 31, 2013, representing 2,800 raised square feet, 430 kW of critical load and 0.2% of annualized base rent.

(5) Reflects the fact that, in October 2012, the Company entered into a lease amendment with one tenant, which lease provided for scheduled lease expirations of 13,900 kW of critical load between 2016 and 2018, to extend the term of each lease expiration by 8.2 years. This lease represents 80,000 raised square feet and 8.0% of leased raised square feet as of September 30, 2012.


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                              Development Projects
                            As of September 30, 2012
                                ($ in thousands)

                                                                                                    Construction
                                          Gross        Raised       Critical                        in Progress &
                                        Building       Square         Load        Estimated         Land Held for           %
Property           Property Location    Area (1)      Feet (2)       MW (3)     Total Cost (4)     Development (5)      Pre-leased

Current Development Projects
ACC6 Phase II      Ashburn, VA           131,000        65,000         13.0     $    115,000     $          88,243          67 %

Future Development Projects/Phases
SC1 Phase II       Santa Clara, CA       180,000        88,000         18.2                                 61,653
NJ1 Phase II       Piscataway, NJ        180,000        88,000         18.2                                 39,212
                                         360,000       176,000         36.4                                100,865
Land Held for Development
ACC7 Phase I /II   Ashburn, VA           360,000       176,000         36.4                                 10,191
ACC8               Ashburn, VA           100,000        50,000         10.4                                  3,670
SC2 Phase I/II     Santa Clara, CA       300,000       171,000         36.4                                  1,992
                                         760,000       397,000         83.2                                 15,853
Total                                  1,251,000       638,000        132.6                      $         204,961

(1) Gross building area is the entire building area, including raised square footage (the portion of gross building area where the tenants' computer servers are located), tenant common areas, areas controlled by the Company (such as the mechanical, telecommunications and utility rooms) and, in some facilities, individual office and storage space leased on an as available basis to the tenants.

(2) Raised square footage is that portion of gross building area where the tenants locate their computer servers. The Company considers raised square footage to be the net rentable square footage in each of its 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 tenants expressed in terms of MW or kW (1 MW is equal to 1,000 kW).

(4) Current development projects include land, capitalization for construction and development, capitalized interest and capitalized operating carrying costs, as applicable, upon completion.

(5) Amount capitalized as of September 30, 2012. Future Phase II development projects include only land, shell, underground work and capitalized interest through Phase I opening.

Leasing Update
The Company derives substantially all of its revenue from rents received from tenants under existing leases at each of the operating properties. Because the Company believes that critical load is the primary factor used by tenants in evaluating data center requirements, rents are based primarily on the amount of power that is made available to tenants, rather than the amount of space that they occupy. During the first nine months of 2012, the Company executed eight leases and a pre-lease representing a total of 27.86 MW of critical load and 139,713 raised square feet of space with an average lease term of 11.4 years. Three leases were at SC1 Phase I comprising 5.69 MW of critical load and 27,295 raised square feet, three leases were at ACC6 Phase I comprising 11.92 MW of critical load and 58,950 raised square feet, one lease was at CH1 Phase II comprising 1.30 MW of critical load and 8,150 raised square feet and one lease was at NJ1 Phase I comprising 0.28 MW of critical load and 1,385 raised square feet. The pre-lease was at ACC6 Phase II totaling 8.67 MW and 43,933 raised square feet. Separately, the Company granted this tenant a delay of the rent commencements of 3.9 MW scheduled for 2012 and 2013 until 2013 and 2014 at the CH1 Phase II facility; however, the tenant has the ability to commence those leases earlier if it so chooses. In addition, the tenant also has the right to relinquish 2.6 MW of the 3.9 MW leased by notifying the Company by January 2013. Because of this leasing activity, which results in ACC6 Phase I being 100% leased and ACC6 Phase II being 67% pre-leased, the Company commenced development of ACC6 Phase II in the second quarter 2012. The ACC6 Phase II development has an anticipated completion date of late 2012.
Through October 24, 2012, the Company has extended the maturity of four leases totaling 23.81 MW and 148,687 raised square feet for a weighted average additional 7.5 years. One of these leases was at ACC3 totaling 13.90 MW and 80,000 raised square feet, one lease was at CH1 totaling 3.90 MW and 24,851 raised square feet, one lease was at ACC5 totaling 3.41 MW


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and 16,400 raised square feet and one lease was at VA3 totaling 2.60 MW and 27,436 raised square feet. The four extended leases' base rent is approximately 5.9% lower than base rent prior to the extensions on a straight line basis. Cash base rent declines approximately 18.5% at the time the renewal rents take effect as compared to current cash rents. Cash base rent does not decline until the original lease term has expired. The original lease terms expire from 2013 to 2018 and the extended lease terms expire from 2017 to 2026. For certain of these extensions we made a strategic decision to agree to certain cash rent reductions in exchange for obtaining long-term lease extensions. These cash rent reductions will not have an impact on our cash position in 2013 or 2014 compared to current rents we receive, but there will be an impact in 2015 and future years. Overall, we believe these lease extensions strengthen our business going forward. Each of the Company's leases includes pass-through provisions under which tenants are required to pay for their pro rata share of most of the property-level operating expenses, such as real estate taxes and insurance - commonly referred to as a triple net lease. In addition, under the Company's triple-net lease structure, tenants pay for only the power they use to run their servers and other computer equipment and power that is used to cool their space. The Company intends to continue to structure future leases as triple net leases. The Company's leases also provide it with a property management fee based on a percentage of base rent collected and property-level operating expenses, other than charges for power used by tenants to run their servers and cool their space. Also, most of the Company's leases provide for annual rent increases, generally at a rate of 3% or a function of the consumer price index.

The Company leases space on a long-term basis, and after taking into account a renewal that took place in October 2012, the Company's weighted average remaining lease term was approximately 7.5 years as of September 30, 2012. Although less than 15% of the Company's leases - in terms of annualized base rent - are scheduled to expire through 2016, the Company's ability to generate rental income over time will depend on its ability to retain tenants when their leases expire and re-lease space available from leases that expire or are terminated at attractive rates. During the second quarter of 2012, the Company's second largest tenant, Yahoo!, elected not to renew one of its leases comprising 2.8% of the Company's consolidated annualized base rent as of March 31, 2012. The Company is actively marketing this space, but it can provide no assurances regarding when the space will be re-leased or the rates that it will be able to charge for the space, particularly in light of some of the factors discussed below.

Market Conditions

Changes in the conditions of any of the markets in which the Company's operating properties are located will impact the overall performance of the Company's current and future operating properties and the Company's ability to fully lease its properties. The ability of the Company's tenants to fulfill their lease commitments could be impacted by future economic or regional downturns in the markets in which the Company operates or downturns in the technology industry. The opportunity for revenue growth in the near term primarily depends on the Company's ability to lease vacant space in three of its operating properties that were recently placed into service - NJ1 Phase I, SC1 Phase I and CH1 Phase II - and ACC6 Phase II after it has been placed into service. The Company takes into account various factors when negotiating the terms of its leases, which can vary among leases, including the following factors: the tenant's strategic importance, growth prospects and credit quality, the length of the lease term, the amount of power leased and competitive market conditions. In each of its stabilized properties, the Company has been able to lease vacant space at rates that provide a favorable return on its investment in these facilities. There appears to be increased pricing pressure in some of the markets in which the Company competes, including lower rates and concessions. It is unclear to what extent this will adversely impact the rental rates, and, in turn, the rates of return of its investment, that the Company can obtain as it pursues leasing available space at the four properties recently placed into service or at the Company's stabilized properties in which there is vacant space. The returns on the Company's investments it has achieved to date at the properties recently placed into service would be impacted negatively if it is unable to lease vacant space with rents equal to or above its historic rates.
The Company receives expense reimbursement from tenants only on space that is leased. Vacant space results in portions of the Company's operating expenses being unreimbursed, which in turn negatively impacts revenues and net income. It is difficult for the Company to predict the timing for signing and commencing leases for available space. This uncertainty is particularly true with respect to the leasing of vacant space in data center facilities that are located in new markets for the Company - NJ1 Phase I in Piscataway, New Jersey and SC1 Phase I in Santa Clara, California. The Company can provide no assurances regarding its ability to lease vacant space at its NJ1 Phase I facility in Piscataway, New Jersey and SC1 Phase I in Santa Clara, California in a timely manner, at favorable rates or at all.
After taking into account a renewal that took place in October 2012, the Company's three largest tenants comprised 47% of its annualized base rent as of September 30, 2012. None of the leases of the Company's three largest tenants have early termination rights. The Company expects these tenants to evaluate their lease expirations in the year before expiration is scheduled to occur, taking into account, among other factors, their anticipated need for server capacity and economic factors. If


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the Company cannot renew these leases at similar rates or attract replacement tenants on similar terms in a timely manner, the Company's rental income could be materially adversely impacted in future periods.
The Company's taxable REIT subsidiary ("TRS"), DF Technical Services, LLC, generates revenue by providing certain technical services to the Company's tenants on a non-recurring contract or purchase-order basis, which the Company refers to as "a la carte" services. Such services include the installation of circuits, racks, breakers and other tenant requested items. The TRS will generally charge tenants for these services on a cost-plus basis. Because the degree of utilization of the TRS for these services varies from period to period depending on the needs of the tenants for technical services, the Company has limited ability to forecast future revenue from this source. Moreover, as a taxable corporation, the TRS is subject to federal, state and local corporate taxes and is not required to distribute its income, if any, to the Company for purposes of making additional distributions to DFT's stockholders. Because demand for its services is unpredictable, the Company anticipates that the TRS may retain a significant amount of its cash to fund future operations, and therefore the Company does not expect to receive distributions from the TRS on a regular basis.
In the current economic environment, certain types of real estate have experienced declines in value. If this trend were to be experienced by any of the Company's data centers, the Company may have to write down the value of that data center, which would result in the Company recording a charge against earnings.

Results of Operations
This Quarterly Report on Form 10-Q contains stand-alone unaudited financial statements and other financial data for each of DFT and the Operating Partnership. DFT is the sole general partner of the Operating Partnership and, as of September 30, 2012, owned 77.1% of the common economic interest in the Operating Partnership, of which approximately 1.0% is held as general partnership units. All of the Company's operations are conducted by the Operating Partnership which is consolidated by DFT, and therefore the following information is the same for DFT and the Operating Partnership, except that net income attributable to common shares is not a line item in the Operating Partnership's consolidated statement of operations.

Three Months Ended September 30, 2012 Compared to Three Months Ended September 30, 2011
Operating Revenue. Operating revenue for the three months ended September 30, 2012 was $85.4 million. This includes base rent of $56.6 million, tenant recoveries of $27.8 million, which includes the Company's property management fee, and other revenue of $1.0 million, partially from a la carte projects for the Company's tenants performed by its TRS. This compares to revenue of $73.8 million for the three months ended September 30, 2011. The increase of $11.6 million, or 15.7%, was primarily due to leases commencing at CH1 Phase II, NJ1 Phase I, SC1 Phase I and ACC6 Phase I partially offset by one lease that expired on April 30, 2012.
Operating Expenses. Operating expenses for the three months ended September 30, 2012 were $56.4 million, compared to $45.5 million for the three months ended September 30, 2011. The increase of $10.9 million, or 24.0%, was primarily due to the following: $6.3 million of increased operating costs, real estate taxes and insurance as ACC6 Phase I and SC1 Phase I were opened in the second half of 2011, CH1 Phase II was opened in February 2012 and real estate taxes increased at NJ1; and a $4.1 million increase from depreciation and amortization from the opening of these new data centers. The percentage increase in operating expenses was greater than the increase in operating revenue, described above, primarily due to placing into service ACC6 Phase I, SC1 Phase I and CH1 Phase II, whose operating expenses were not yet fully recoverable as SC1 Phase I and CH1 Phase II are not yet fully leased and ACC6 Phase I became fully leased in September 2012.
Interest Expense. Interest expense, including amortization of deferred financing costs, for the three months ended September 30, 2012 was $12.8 million compared to interest expense of $4.4 million for the three months ended September 30, . . .

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