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DFT > SEC Filings for DFT > Form 10-K on 12-Feb-2014All Recent SEC Filings

Show all filings for DUPONT FABROS TECHNOLOGY, INC.

Form 10-K for DUPONT FABROS TECHNOLOGY, INC.


12-Feb-2014

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview
DuPont Fabros Technology, Inc. ("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 December 31, 2013, owned 80.6% of the common economic interest in, DuPont Fabros Technology, L.P. (the "Operating Partnership" or "OP"). Unless otherwise indicated or unless the context requires otherwise, all references to "we," "us," "our," "our company" or "the company" refer to DFT and the Operating Partnership, collectively. 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 December 31, 2013, we owned and operated 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, we also own certain properties for future development and parcels of land that we intend to develop in the future, into wholesale data centers. With this portfolio of properties, we believe that we are well positioned as a fully integrated wholesale data center provider, capable of developing, leasing, operating and managing our growing portfolio.
The following table presents a summary of our operating properties as of January 1, 2014:

                              Operating Properties
                             As of January 1, 2014
                                                          Gross       Computer Room     Critical       %           %
                                         Year Built/    Building         Square           Load      Leased     Commenced
Property           Property Location      Renovated     Area (2)        Feet (2)         MW (3)       (4)         (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        98 %         98 %
ACC6             Ashburn, VA              2011-2013      262,000           130,000         26.0       100 %        100 %
CH1              Elk Grove Village, IL    2008-2012      485,000           231,000         36.4       100 %        100 %
NJ1 Phase I      Piscataway, NJ             2010         180,000            88,000         18.2        52 %         52 %
SC1 Phase I      Santa Clara, CA            2011         180,000            88,000         18.2       100 %        100 %
VA3              Reston, VA                 2003         256,000           147,000         13.0        71 %         71 %
VA4              Bristow, VA                2005         230,000            90,000          9.6       100 %        100 %

Total Operating Properties 2,534,000 1,255,000 218.5 94 % 94 %

(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 computer room square footage (the portion of gross building area where our customers' computer servers are located), common areas, areas controlled by us (such as the mechanical, telecommunications and utility rooms) and, in some facilities, individual office and storage space leased on an as available basis to our customers.

(3) Critical load (also referred to as IT load or load used by customers' servers or related equipment) is the power available for exclusive use by customers expressed in terms of megawatt, or MW, or kilowatt, or kW (1 MW is equal to 1,000 kW).

(4) Percentage leased is expressed as a percentage of critical load that is subject to an executed lease totaling 205.3 MW. Leases executed as of January 1, 2014 represent $275 million of base rent on a GAAP basis and $283 million of base rent on a cash basis over the next twelve months. Both amounts include $17 million of revenue from management fees over the next twelve months.

(5) Percentage commenced is expressed as a percentage of critical load where the lease has commenced under generally accepted accounting principles.


Table of Contents

                               Lease Expirations
                             As of January 1, 2014
The following table sets forth a summary schedule of lease expirations at our
operating properties for each of the ten calendar years beginning with 2014. The
information set forth in the table below assumes that customers exercise no
renewal options and takes into account customers' early termination options in
determining the life of their leases under GAAP.

                                    Computer Room
                                   Square Feet of
                                      Expiring                            Total kW
                     Number       Commenced Leases      % of Leased      of Expiring                        % of
Year of Lease      of Leases       (in thousands)      Computer Room      Commenced         % of         Annualized
Expiration        Expiring (1)           (2)            Square Feet      Leases (2)      Leased kW      Base Rent (3)
2014                        2                   8             0.7 %           1,705            0.8 %           1.1 %
2015                        4                  70             6.0 %          13,812            6.7 %           6.7 %
2016                        4                  32             2.7 %           4,686            2.3 %           2.4 %
2017                       13                  96             8.2 %          17,619            8.6 %           8.7 %
2018                       19                 215            18.3 %          39,298           19.1 %          18.4 %
2019                       13                 171            14.5 %          31,337           15.3 %          14.8 %
2020                       10                 106             9.0 %          16,496            8.0 %           8.7 %
2021                        9                 159            13.5 %          27,682           13.5 %          13.8 %
2022                        6                  75             6.4 %          12,812            6.1 %           7.2 %
2023                        4                  48             4.1 %           6,475            3.2 %           2.7 %
After 2023                 12                 196            16.6 %          33,425           16.4 %          15.5 %
Total                      96               1,176             100 %         205,347            100 %           100 %

(1) Represents 33 customers with 96 lease expiration dates. Top four customers represent 62% of annualized base rent.

(2) Computer room square footage is that portion of gross building area where customers locate their computer servers. One MW is equal to 1,000 kW.

(3) Annualized base rent represents the monthly contractual base rent (defined as cash base rent before abatements) multiplied by 12 for commenced leases totaling 205.3 MW as of January 1, 2014.


Table of Contents

                              Development Projects
                            As of December 31, 2013
                                ($ in thousands)

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

Current Development Projects
SC1 Phase IIA    Santa Clara, CA            90,000            44,000          9.1     $105,000 - $115,000   $        64,972          50 %
ACC7 Phase I     Ashburn, VA               126,000            70,000         11.9       85,000 - 90,000              68,402           0 %
                                           216,000           114,000         21.0      190,000 - 205,000            133,374

Future Development Projects/Phases
SC1 Phase IIB    Santa Clara, CA            90,000            44,000          9.1       46,000 - 50,000              44,610
ACC7 Phases II
to IV            Ashburn, VA               320,000           176,000         29.7       78,000 - 82,000              59,705
NJ1 Phase II     Piscataway, NJ            180,000            88,000         18.2           39,212                   39,212
                                           590,000           308,000         57.0     $163,212 - $171,212           143,527
Land Held for Development
ACC8             Ashburn, VA               100,000            50,000         10.4                                     3,855
CH2              Elk Grove Village, IL     338,000           167,000         25.6                                    15,702
SC2              Santa Clara, CA           200,000           125,000         26.0                                     5,610
                                           638,000           342,000         62.0                                    25,167
Total                                    1,444,000           764,000        140.0                           $       302,068

(1) Gross building area is the entire building area, including computer room square footage (the portion of gross building area where our customers' computer servers are located), common areas, areas controlled by us (such as the mechanical, telecommunications and utility rooms) and, in some facilities, individual office and storage space leased on an as available basis to our customers. The amount listed for CH2 is an estimate.

(2) Computer room square footage is that portion of gross building area where customers locate their computer servers. The amount listed for CH2 is an estimate.

(3) Critical load (also referred to as IT load or load used by customers' servers or related equipment) is the power available for exclusive use by customers expressed in terms of MW or kW (1 MW is equal to 1,000 kW). The amount listed for CH2 is an estimate.

(4) Current development projects include land, capitalization for construction and development and capitalized operating carrying costs, as applicable, upon completion. Capitalized interest is excluded. Future development projects/phases other than SC1 Phase IIB include land, shell and underground work through Phase I opening only. SC1 Phase IIB also includes a portion of the electrical and mechanical infrastructure.

(5) Amount capitalized as of December 31, 2013. Future development projects/phases other than SC1 Phase IIB include, land, shell and underground work through Phase I opening only. SC1 Phase IIB also includes a portion of the electrical and mechanical infrastructure.

Current Development Projects
In May 2013, we executed an agreement with our general contractor to build the entire shell and portions of the underground conduit at ACC7 and to fully develop the first phase of ACC7 (11.89 MW of critical load) with expected completion in the early summer of 2014. ACC7 is expected to be built in four phases totaling 41.60 MW of available critical load. In August 2013, we executed an agreement with our general contractor to fully develop Phase IIA of SC1 totaling 9.10 MW of critical load. SC1 Phase IIA is 50% pre-leased and is expected to be completed in the second quarter of 2014.


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Leasing
We derive substantially all of our revenue from rents received from customers under existing leases at each of our operating properties. Because we believe that critical load is the primary factor used by customers in evaluating data center requirements, rents are based primarily on the amount of power that is made available to customers, rather than the amount of space that they occupy. During 2013, we executed five leases and one pre-lease representing a total of
15.71 MW of critical load and 106,130 computer room square feet of space with a weighted average lease term of 5.5 years that are expected to generate approximately $16.0 million of annualized GAAP base rent revenue which includes $1.0 million of management fees. Two leases were at SC1 Phase I comprising 4.55 MW of critical load and 21,573 computer room square feet, one lease was at CH1 comprising 1.73 MW of critical load and 10,151 computer room square feet, one lease was at NJ1 comprising 2.28 MW of critical load and 22,353 computer room square feet, one lease was at VA3 comprising 2.60 MW of critical load and 30,053 computer room square feet and the pre-lease was at SC1 Phase IIA comprising 4.55 MW of critical load and 22,000 computer room square feet. In 2013, we renewed five leases for a weighted average of 3.8 years totaling
5.72 MW and 31,460 computer room square feet. Two renewals were at ACC5 totaling
2.84 MW and 13,700 computer room square feet, two renewals were at ACC4 totaling
2.28 MW and 10,700 computer room square feet and one renewal was at VA3 totaling
0.60 MW and 7,060 computer room square feet. GAAP base rent of the five renewals is 3% higher than GAAP base rent prior to the renewal, in the aggregate, on a straight line basis. Cash base rent of these five renewals will decline 10%, in the aggregate, at the time the renewal rates take effect compared to cash base rents in place at the end of the original lease term. Each of our leases includes pass-through provisions under which customers are required to pay for their pro rata share of most of the property level operating expenses, including real estate taxes and insurance - commonly referred to as a triple net lease. Also, customers pay for certain of our operating properties' capital expenditures over their estimated life. In addition, under our triple-net lease structure, customers pay directly for the power they use to run their servers and other computer equipment and power that is used to cool their space. We intend to continue to structure future wholesale leases as triple net leases. Our leases also provide us 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 customers to run their servers and cool their space. Also, most of our leases provide for annual rent increases, generally at a rate of 2%-3% or a function of the consumer price index.

As of January 1, 2014, our operating portfolio was 94% leased and commenced. We are actively marketing the remaining 6% of vacancy, but can provide no assurances regarding when the power and space will be leased or the rates that we will be able to charge for the power and space.

We lease power and space on a long-term basis, and our weighted average remaining lease term for commenced leases was approximately seven years as of December 31, 2013. Although approximately 10% of our leases - in terms of annualized base rent - are scheduled to expire through 2016, our ability to generate rental income over time will depend on our ability to retain customers when their leases expire and re-lease power and space available from leases that expire or are terminated at attractive rates. Also, we receive expense reimbursement from customers only on power and space that is leased. Vacancies result in portions of our operating expenses being unreimbursed, which in turn negatively impacts our revenues and net income.

Market Conditions

Changes in the conditions of any of the markets in which our operating properties are located will impact the overall performance of our current and future operating properties and our ability to fully lease our properties. The ability of our customers to fulfill their lease commitments could be impacted by future economic or regional downturns in the markets in which we operate or downturns in the technology industry.
The opportunity for revenue growth in the near term primarily depends on our ability to lease the 6% remaining vacant space in our operating portfolio. The opportunity for revenue growth beyond the near term will depend on our ability to lease space at the two data center facilities currently under development. We have two data center facilities with significant amounts of vacant space - VA3 and NJ1 Phase I. VA3 has available for lease 29% of both the critical load power and computer room floor space. NJ1 Phase I has available for lease 48% of its critical load power and 36% of its computer room floor space. Generally, under each lease, the percentage of available critical load power leased is equal to the percentage of square feet of computer room floor space leased. At NJ1 Phase I, however, the terms of the NJ1 Phase I lease entered into in the third quarter of 2013 provide for the lease of 25% of the square footage of computer room floor space of the facility, but only 12.5% of the total available critical load of the facility. During the term of this lease, the customer has the right to lease (at the then escalated rental rate) all or a portion of the critical load associated with the additional 12.5% of computer room floor space leased. If, however, this customer does not utilize this additional critical load


Table of Contents

power, it may not be possible for us to lease this available power to another customer as part of a NJ1 Phase I lease. Consequently, we will seek to divert this power for use in NJ1 Phase II, if and when that phase is developed. There is no assurance that we will be able to utilize this critical load power in NJ1 Phase II.
Our two data center facilities currently under development are ACC7 Phase I, located in Ashburn, Virginia, and SC1 Phase IIA, located in Santa Clara, California. As discussed above, when completed, ACC7 Phase I will have 11.89 MW of critical load available for use by customers and SC1 Phase IIA will have 9.10 MW of critical load available for use by customers. ACC7 Phase I is expected to be completed in early summer 2014 and SC1 Phase IIA is expected to be completed in the second quarter of 2014. The entire 11.89 MW of critical load in ACC7 Phase I remains available to be leased, but only 4.55 MW of critical load in SC1 Phase IIA remains available to be leased, as 50% of the critical load of SC1 Phase IIA was pre-leased in the third quarter of 2013, as discussed above. We take into account various factors when negotiating the terms of our leases, which can vary among leases, including the following factors: the customer'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 our stabilized properties, we have been able to lease space and power at rates that provide a favorable return on our investment in these facilities. There appears to be pricing pressure in the markets in which we compete, including lower rates and increased concessions. It is unclear to what extent this will adversely impact the rental rates, and, in turn, the rates of return of our investment, that we can obtain as we pursue leasing available space and power. The returns on our investments we have achieved to date at the properties recently placed into service would be impacted negatively if we are unable to lease vacant space with rents equal to or above historic rates. Our four largest customers comprised 62% of our annualized base rent as of December 31, 2013. None of the leases of our three largest customers have early termination rights. The fourth largest customer has early termination rights in certain of its leases, and we have reflected these leases in the Lease Expiration Table above at the early termination dates. We expect these customers 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 we cannot renew these leases at similar rates or attract replacement customers on similar terms in a timely manner, our rental income could be materially adversely impacted in future periods. Our taxable REIT subsidiary ("TRS"), DF Technical Services, LLC, generates revenue by providing certain technical services to our customers on a non-recurring contract or purchase-order basis, which we refer to as "a la carte" services. Such services include the installation of circuits, racks, breakers and other customer requested items. The TRS will generally charge customers 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 customers for technical services, we have 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, we anticipate that the TRS may retain a significant amount of its cash to fund future operations, and therefore we do 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 our data centers, we may have to write down the value of that data center, which would result in us recording a charge against earnings.

Results of Operations
This Annual Report on Form 10-K contains stand-alone audited 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 December 31, 2013, owned 80.6% of the common economic interest in the Operating Partnership, of which approximately 1.0% is held as general partnership units. All of our 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 redeemable noncontrolling interests is not a line item in the Operating Partnership's consolidated statement of operations.

Year Ended December 31, 2013 Compared to Year Ended December 31, 2012 Operating Revenues. Operating revenues for the year ended December 31, 2013 were $375.1 million. This includes base rent of $265.7 million which includes our property management fee, customer recoveries of $104.3 million and other revenues of $5.1 million, partially from a la carte projects for our customers performed by the TRS. This compares to revenues of $332.4 million for the year ended December 31, 2012. The increase of $42.7 million, or 12.8%, was primarily due to new leases commencing at ACC6, SC1 Phase I, NJ1 Phase I and CH1 Phase II, partially offset by one lease at VA3 that expired on April 30, 2012.


Table of Contents

Operating Expenses. Operating expenses for the year ended December 31, 2013 were $230.9 million, compared to $220.5 million for the year ended December 31, 2012. The increase of $10.4 million, or 4.7%, was primarily due to the following:
$10.6 million of increased operating costs, real estate taxes and insurance as ACC6 Phase II was opened in January 2013, CH1 Phase II was opened in February 2012 and real estate taxes increased at SC1 and CH1; and a $3.9 million increase in depreciation and amortization from the opening of CH1 Phase II and ACC6 Phase
II. These increases were partially offset by a decrease in other expenses of $3.3 million primarily due to lower bad debt expense and a decrease in general and administrative expense of $0.8 million primarily due to increases in capitalization for development properties. Interest Expense. Interest expense, including amortization of deferred financing costs, for the year ended December 31, 2013 was $49.8 million compared to interest expense of $51.3 million for the year ended December 31, 2012. Total interest incurred for the year ended December 31, 2013 was $53.8 million, of which $4.0 million was capitalized, as compared to $55.9 million for 2012, of which $4.7 million was capitalized. The decrease in total interest incurred period over period was primarily due to lower interest rates from the refinancing of the ACC5 Term Loan in March 2013 and the Senior Notes due 2017 in September 2013. Interest capitalized decreased period over period as the Company had higher cumulative development costs paid for our development project in 2012 compared to 2013. Loss on Early Extinguishment of Debt. For the year ended December 31, 2013 we incurred losses of $41.0 million on the early extinguishment of two pieces of debt. We extinguished the $550.0 million Unsecured Notes due 2017 under a tender offer in the third quarter of 2013 and a call in the fourth quarter of 2013 incurring a loss of $39.3 million. The loss consists of $32.6 million of cash expended for the tender and call premiums and fees and the non-cash write off of $6.7 million of unamortized deferred financing costs. We also extinguished the ACC5 Term Loan in the first quarter of 2013 incurring a loss of $1.7 million which was made up entirely of a non-cash write off of unamortized deferred financing costs. Net Income Attributable to Redeemable Noncontrolling interests - Operating Partnership (DFT only). Net income attributable to redeemable noncontrolling interests - operating partnership for the year ended December 31, 2013 was $5.2 million as compared to $7.8 million for the year ended December 31, 2012. The decrease of $2.6 million was primarily due to the Operating Partnership receiving its allocation of lower net income partially offset by a decrease in ownership of redeemable noncontrolling interests - operating partnership due to OP unitholders redeeming 3.4 million OP units in exchange for an equal number of shares of DFT's common stock during the period from January 1, 2012 through December 31, 2013. Net Income Attributable to Common Shares. Net income attributable to common shares for the year ended December 31, 2013 was $21.1 million as compared to $26.0 million for the year ended December 31, 2012. The decrease of $4.9 million was primarily due to the controlling interests' share of the loss on early extinguishment of debt of $41.0 million, partially offset by higher operating revenues and a decrease in ownership of redeemable noncontrolling interests - operating partnership due to redemptions of OP units by OP unitholders.

Year Ended December 31, 2012 Compared to Year Ended December 31, 2011

Operating Revenues. Operating revenues for the year ended December 31, 2012 were $332.4 million. This includes base rent of $236.8 million which includes our property management fee, customer recoveries of $91.0 million and other revenues of $4.6 million, partially from a la carte projects for our customers performed by the TRS. This compares to revenues of $287.4 million for the year ended December 31, 2011. The increase of $45.0 million, or 15.7%, was primarily due to . . .

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