S-11 1 d541696ds11.htm S-11 S-11
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As filed with the Securities and Exchange Commission on August 16, 2013

Registration No. 333-            

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

 

FORM S-11

FOR REGISTRATION

UNDER

THE SECURITIES ACT OF 1933 OF SECURITIES

OF CERTAIN REAL ESTATE COMPANIES

 

 

QTS REALTY TRUST, INC.

(Exact Name of Registrant as Specified in Governing Instruments)

 

 

12851 Foster Street

Overland Park, Kansas 66213

(913) 814-9988

(Address, Including Zip Code, and Telephone Number, Including Area Code, of Registrant’s Principal Executive Offices)

 

 

Shirley E. Goza

General Counsel

QTS Realty Trust, Inc.

12851 Foster Street

Overland Park, Kansas 66213

(913) 312-5503

(Name, Address, Including Zip Code, and Telephone Number, Including Area Code, of Agent for Service)

 

 

Copies to:

 

David W. Bonser

Eve N. Howard

Matt N. Thomson

Hogan Lovells US LLP

555 Thirteenth Street, N.W.

Washington, D.C. 20004

Phone: (202) 637-5600

Facsimile: (202) 637-5910

 

J. Gerard Cummins

Edward F. Petrosky

Sidley Austin LLP

787 Seventh Avenue

New York, NY 10019

Phone: (212) 839-5300

Facsimile: (212) 839-5599

 

 

Approximate date of commencement of proposed sale to the public: As soon as practicable after the effective date of this Registration Statement.

If any of the Securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act, check the following box:  ¨

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If delivery of the prospectus is expected to be made pursuant to Rule 434, check the following box.  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check One):

 

Large accelerated filer   ¨    Accelerated filer   ¨
Non-accelerated filer   x  (do not check if a smaller reporting company)    Smaller reporting company   ¨

 

 

CALCULATION OF REGISTRATION FEE

 

 

 

Title of Each Class of

Securities to be Registered

 

Maximum

Aggregate

Offering Price

 

Amount of

Registration Fee

Class A Common Stock, $0.01 par value per share

  $300,000,000   $40,920(1)

 

 

 

(1) Estimated solely for the purpose of calculating the registration fee pursuant to Rule 457(o) under the Securities Act of 1933, as amended.

 

 

The registrant hereby amends this registration statement on such date or dates as may be necessary to delay its effective date until the registrant shall file a further amendment which specifically states that this registration statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933, as amended, or until this registration statement shall become effective on such date as the Commission, acting pursuant to Section 8(a), may determine.

 

 

 


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The information in this prospectus is not complete and may be changed. We and the Selling Stockholder may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any jurisdiction where the offer or sale is not permitted.

 

Subject to Completion, dated August 16, 2013

PROSPECTUS

 

            Shares

 

LOGO

QTS REALTY TRUST, INC.

CLASS A COMMON STOCK

 

 

This is the initial public offering of QTS Realty Trust, Inc., and, prior to this offering, there has been no public market for our shares. We are selling                     shares of Class A common stock, and GA QTS Interholdco, LLC, referred to herein as the Selling Stockholder or General Atlantic, is selling                      shares of Class A common stock. We expect to qualify as a real estate investment trust, or REIT, for federal income tax purposes commencing with our taxable year ending December 31, 2013.

We expect the initial public offering price of our Class A common stock to be between $        and $        per share.

Our charter contains restrictions on ownership and transfer of our common stock intended to assist us in maintaining our status as a REIT for federal and/or state income tax purposes. For example, our charter generally restricts any person from actually or constructively owning more than    % of the aggregate of the outstanding shares of our common stock by value or by number of shares, whichever is more restrictive, except for certain designated investment entities that may own up to 9.8% of the aggregate of the outstanding shares of our common stock, subject to certain conditions. See “Description of Securities—Restrictions on Ownership and Transfer.”

 

 

We intend to apply to have our Class A common stock listed on The New York Stock Exchange under the symbol “QTS.”

 

 

We are an “emerging growth company” under the federal securities laws and will be subject to reduced public company reporting requirements. Investing in our Class A common stock involves risks. See “Risk Factors” beginning on page 24.

 

     Per Share      Total  

Public offering price

   $                    $                

Underwriting discounts and commissions

   $         $     

Proceeds, before expenses, to us(1)

   $         $     

Proceeds, before expenses, to the Selling Stockholder

   $         $     

 

(1) We refer you to the section captioned “Underwriting” of this prospectus for additional information regarding underwriter compensation.

We will not receive any proceeds from the sale of our Class A common stock by the Selling Stockholder.

We have and the Selling Stockholder has granted the underwriters a 30-day option to purchase up to an additional            shares of Class A common stock.

Neither the Securities and Exchange Commission nor any state or other securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

 

 

The underwriters expect to deliver the Class A common stock on or about            , 2013.

 

 

Joint Book-Running Managers

 

Goldman, Sachs & Co.   Jefferies

 

BofA Merrill Lynch    Deutsche Bank Securities    KeyBanc Capital Markets    Morgan Stanley

 

 

                , 2013


Table of Contents

TABLE OF CONTENTS

 

Prospectus Summary

     1   

Risk Factors

     24   

Special Note Regarding Forward-Looking Statements

     60   

Use of Proceeds

     61   

Distribution Policy

     62   

Capitalization

     66   

Dilution

     67   

Selected Financial Data

     69   

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     75   

Industry Overview and Market Opportunity

     108   

Business and Properties

     114   

Management

     156   

Certain Relationships and Related Party Transactions

     180   

Investment Policies and Policies with Respect to Certain Activities

     186   

Structure and Formation of Our Company

     192   

Description of the Partnership Agreement of QualityTech, LP

     199   

Principal and Selling Stockholders

     207   

Description of Securities

     210   

Material Provisions of Maryland Law and of Our Charter and Bylaws

     217   

Shares Eligible for Future Sale

     224   

U.S. Federal Income Tax Considerations

     228   

Underwriting

     255   

Legal Matters

     261   

Experts

     261   

Where You Can Find More Information

     261   

Index to Financial Statements

     F-1   

You should rely only on the information contained in this prospectus and any free writing prospectus prepared by us. We, the Selling Stockholder and the underwriters have not authorized anyone to provide you with different or additional information. We, the Selling Stockholder and the underwriters are not making an offer to sell these securities in any jurisdiction where the offer or sale is not permitted. The information in this prospectus is current as of the date such information is presented. Our business, financial condition, liquidity, results of operations and prospects may have changed since those dates.

We use market data and industry forecasts and projections throughout this prospectus, and in particular in the sections entitled “Industry Overview and Market Opportunity” and “Business and Properties.” These sources generally state that the information they provide has been obtained from sources believed to be reliable, but that the accuracy and completeness of the information are not guaranteed. The forecasts and projections are based on industry surveys and the preparers’ experience in the industry, and there can be no assurance that any of the forecasts or projections will be achieved. We believe that the surveys and market research others have performed are reliable, but we have not independently investigated or verified this information. In addition, the statements and projections obtained from 451 Research, LLC and International Data Corporation that we have included in this prospectus have not been expertized and are, therefore, solely our responsibility. As a result, 451 Research, LLC and International Data Corporation do not and will not have any liability or responsibility whatsoever for any market data and industry statements and forecasts or projections that are contained in this prospectus or otherwise disseminated in connection with the offer or sale of our Class A common stock. If you purchase our Class A common stock, your sole recourse for any alleged or actual inaccuracies in the market data and industry statements and any forecasts or projections used in this prospectus will be against us.

 


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Until        , 2013 (25 days after the date of this prospectus), all dealers that effect transactions in these securities, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to a dealer’s obligation to deliver a prospectus when acting as an underwriter and with respect to unsold allotments or subscriptions.

Class A and Class B Common Stock and OP units

Following this offering, we will have two classes of common stock, Class A common stock and Class B common stock. Our Class B common stock is designed to give the holder thereof a right to vote that is proportional to such holder’s economic interest in our company on a fully diluted basis and therefore does not provide any disproportionate voting rights. Without the votes afforded by the Class B common stock, a holder of OP units (as defined below) in QualityTech, LP, or our operating partnership, would not have a vote proportionate to its economic interest, as OP units have no voting rights with respect to QTS Realty Trust, Inc. matters. References in this prospectus to “common stock” refer either to our Class A common stock or to our Class A common stock and Class B common stock collectively, as the context requires; it does not refer solely to our Class B common stock. Our Class B common stock will not be listed on the New York Stock Exchange. Chad L. Williams, our Chairman and Chief Executive Officer, has elected to exchange one OP unit out of every 50 OP units owned by him or entities controlled by him immediately prior to the commencement of this offering for shares of our Class B common stock on a one-for-one basis. Each outstanding share of Class B common stock entitles its holder to 50 votes on all matters on which Class A common stockholders are entitled to vote, including the election of directors, and holders of shares of Class A common stock and Class B common stock will vote together as a single class. The Class B common stock automatically converts into Class A common stock in certain circumstances and is convertible at any time into Class A common stock at the option of the holder. Holders of our Class A common stock and Class B common stock have equal dividend rights. See “Description of Securities.”

Interests in our operating partnership are denominated in units of limited partnership interest. Following completion of this offering and our formation transactions, our operating partnership will have two classes of limited partnership interest authorized and outstanding—OP units and Class RS LTIP units. References in this prospectus to “LTIP units” refer to our operating partnership’s Class O LTIP units and Class RS LTIP units collectively. References in this prospectus to “OP units” refer to the common units of limited partnership interest in our operating partnership. References in this prospectus to “units of limited partnership interest” or “limited partnership units” refer to both the OP units and the LTIP units collectively. When vested, LTIP units are convertible by the holder into OP units on the terms set forth in our operating partnership’s partnership agreement. OP units are redeemable for cash or, at our election, shares of our Class A common stock on a one-for-one basis, beginning one year after the closing of this offering. See “Description of the Partnership Agreement of QualityTech, LP.”

The term “fully diluted basis” means all outstanding shares of our Class A common stock at such time, plus (i) shares of Class A common stock that may be issuable upon the redemption of OP units (assuming (a) LTIP units are converted into OP units in accordance with their terms and (b) all outstanding OP units are redeemed for shares of Class A common stock on a one-for-one basis) and (ii) shares of Class A common stock issuable upon the conversion of shares of Class B common stock on a one-for-one basis, but excluding options to acquire shares of Class A common stock expected to be outstanding upon completion of this offering. This definition is not the same as the meaning of “fully diluted” under generally accepted accounting principles in the United States of America, or GAAP.

 

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PROSPECTUS SUMMARY

You should read the following summary together with the more detailed information regarding our company, including under the caption “Risk Factors,” as well as our predecessor’s consolidated financial statements, our pro forma financial statements and the combined statements of revenues and certain operating expenses of our Sacramento data center, and, in each case, the related notes appearing elsewhere in this prospectus. Unless the context requires otherwise, references in this prospectus to “we,” “our,” “us” and “our company” refer to QTS Realty Trust, Inc., a Maryland corporation, together with its consolidated subsidiaries after giving effect to the formation transactions described in this prospectus, including QualityTech, LP, a Delaware limited partnership, which we refer to in this prospectus as our “operating partnership” or “predecessor.” Unless otherwise indicated, the information contained in this prospectus assumes that the underwriters’ option to purchase additional shares is not exercised and that the common stock to be sold in this offering is sold at $         per share, the mid-point of the price range set forth on the cover of this prospectus.

Overview

We are a leading owner, developer and operator of state-of-the-art, carrier-neutral, multi-tenant data centers. Our data centers are facilities that house the network and computer equipment of multiple customers and provide access to a range of communications carriers. We have a fully integrated platform through which we own and operate our data centers and provide a broad range of information technology, or IT, infrastructure solutions. We believe that we own and operate one of the largest portfolios of multi-tenant data centers in the United States, as measured by gross square footage, and have the capacity to almost triple our leased raised floor square footage without constructing any new buildings.

We believe that our fully integrated platform sets us apart from our competitors in the data center industry and makes our offerings more attractive to customers. Our spectrum of core data center products, which we refer to as our “3Cs”, consists of Custom Data Center, Colocation and Cloud and Managed Services. Our Custom Data Center, or C1, product features large, private spaces that house customer-critical IT infrastructure and we believe provides our customers with a cost-effective, efficient and low-risk alternative to building, buying or expanding their own data centers. Our Colocation, or C2, product features data center space in the form of leased cages, cabinets or suites, which typically provide smaller amounts of space than our C1 product, to house customer IT infrastructure. We offer our Cloud and Managed Services, or C3, products through a portfolio of highly secure, regulatory compliant and scalable IT infrastructure and services designed to support varied business applications and requirements. Our Cloud product offers a private cloud solution (on-demand access to a pool of servers) through QTS Cloud Pods, which are installed in our larger data centers adjacent to the interconnect hubs in each facility. Our Managed Services are support services that include the management of networks, security, operating systems and data back-up, as well as applications monitoring and testing.

Our C1, C2 and C3 products represented approximately 38%, 51% and 11%, respectively, of our monthly recurring revenue, or MRR, as of June 30, 2013. According to 451 Research, LLC, we are the only national multi-tenant data center provider to offer a full complement of solutions catering to a broad range of customers, which includes wholesale data center (or custom data centers), colocation, interconnection (connection and data exchange between multiple communication carriers and customers), hosting (making websites accessible on the Internet) and/or cloud services.

 

 

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Our Portfolio

We operate a portfolio of 10 data centers across seven states, located in some of the top U.S. data center markets plus other high-growth markets. We own two of the largest multi-tenant data centers in the world, including the fifth largest data center in the world according to a Forbes magazine article published in November 2012. We believe that our data centers are best-in-class and engineered to among the highest specifications commercially available to customers. Our data center portfolio contains approximately 3.8 million gross square feet of space (approximately 92% of which is wholly owned by us). As of June 30, 2013, our data center portfolio included approximately 714,000 raised floor operating net rentable square feet, or NRSF, out of approximately 1.8 million “basis-of-design” raised floor square feet. Our “basis-of-design” represents the total data center raised floor potential of our existing data center facilities or the estimated amount of space in our existing buildings that could be leased following full build-out, depending on the configuration that we deploy.

Our facilities collectively have access to over 500 megawatts, or MW, of gross utility power with 390 MW of available utility power, which is the installed power capacity that can be delivered to the facility by the local utility provider. We believe such access to power gives us a competitive advantage in redeveloping data center space, since access to power is usually the most limiting and expensive component in data center redevelopment.

Operating Properties

The following table presents an overview of the initial portfolio of operating properties that we own or lease, referred to herein as our operating properties, based on information as of June 30, 2013:

 

                Operating Net Rentable Square Feet
(Operating NRSF)(3)
          Annualized
Rent(8)
    Available
Utility
Power
(MW)(9)
    Total
Available for
Redevelopment
(NRSF)(10)
 

Property

  Year
Acquired(1)
    Gross
Square
Feet(2)
    Raised
Floor(4)
    Office
&
Other(5)
    Supporting
Infrastructure(6)
    Total         %
Leased(7)
       

Richmond, VA

    2010        1,318,353        59,930        27,214        91,342        178,486        89.7   $ 12,319,848        110        1,084,759   

Atlanta, GA (Metro)

    2006        968,695        358,016        24,851        305,291        688,158        84.9     60,572,339        72        237,270   

Dallas, TX*

    2013        698,000                                    N/A               140        698,000   

Suwanee, GA

    2005        367,322        140,422        4,368        101,191        245,981        67.1     36,665,202        36        74,000   

Santa Clara, CA**

    2007        135,322        55,494        945        45,721        102,160        88.6     18,778,846        11        22,000   

Jersey City, NJ***

    2006        122,448        29,064        14,220        35,387        78,671        88.7     8,528,583        7        25,660   

Sacramento, CA

    2012        92,644        45,595        3,592        27,100        76,287        60.7     11,739,426        8        9,423   

Overland Park, KS***

    2003        32,706        2,493               5,338        7,831        78.3     604,201        1          

Miami, FL

    2008        30,029        19,887               6,592        26,479        51.9     3,479,738        4          

Wichita, KS

    2005        14,000        2,612        2,854        8,534        14,000        100.0     222,120        1          
   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total/weighted average

      3,779,519        713,513        78,044        626,496        1,418,053        81.0   $ 152,910,303        390        2,151,112   
   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

* This facility was acquired in February 2013 and is under redevelopment.
** Owned facility subject to long-term ground sublease.
*** Represents facilities that we lease.
(1) Represents the year a property was acquired or, in the case of a property under lease, the year our initial lease commenced for the property.
(2) With respect to our owned properties, gross square feet represents the entire building area. With respect to leased properties, gross square feet represents that portion of the gross square feet subject to our lease. This includes approximately 210,354 square feet of our own office space, which is not included in operating NRSF.
(3) Represents the total square feet of a building that is currently leased or available for lease plus developed supporting infrastructure, based on engineering drawings and estimates, but does not include space held for redevelopment or space used for our own office space.
(4) Represents management’s estimate of the portion of operating NRSF of the facility with available power and cooling capacity that is currently leased or readily available to be leased to customers as data center space based on engineering drawings, inclusive of raised floor common areas.
(5) Represents the operating NRSF of the facility other than data center space (typically office and storage space) that is currently leased or available to be leased.
(6) Represents required data center support space, including mechanical, telecommunications and utility rooms, as well as building common areas.

 

 

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(7) Calculated as data center raised floor that is subject to a signed lease for which billing has commenced as of June 30, 2013 divided by leasable raised floor based on the current configuration of the properties (522,965 square feet as of June 30, 2013), expressed as a percentage. Leasable raised floor is the amount of raised floor square footage that we have leased plus the available capacity of raised floor square footage that is in a leasable format as of a particular date and according to a particular product configuration.
(8) Annualized rent is presented for leases commenced as of June 30, 2013. We define annualized rent as MRR multiplied by 12. We calculate MRR as monthly contractual revenue under signed leases as of a particular date, which includes revenue from our C1, C2 and C3 rental and cloud and managed services activities, but excludes customer recoveries, deferred set-up fees, variable related revenues, non-cash revenues and other one-time revenues. MRR does not include the impact from booked-not-billed leases (which represent customer leases that have been executed but for which lease payments have not commenced) as of a particular date, unless otherwise specifically noted. This amount reflects the annualized cash rental payments. It does not reflect any free rent, rent abatements or future scheduled rent increases and also excludes operating expense and power reimbursements.
(9) Represents installed power capacity that can be delivered to the facility by the local utility provider. As of June 30, 2013, 117 MW of the total available utility power could be delivered to the data center floor for customer use.
(10) Reflects space under roof that could be developed into operating NRSF in the future, excluding space currently used by us for our own office space, which could also be repurposed in the future.

Note: The information above excludes our approximately 35,000 gross square foot facility at Lenexa, Kansas, which is not an operating data center.

Redevelopment Pipeline

The following table presents an overview of our redevelopment pipeline, based on information as of June 30, 2013.

 

    Redevelopment NRSF    
    Under Construction(1)   Near Term(2)   Future Available(3)    

Property

  Raised
Floor
  Office &
Other
  Supporting
Infrastructure
  Total Under
Construction
  Raised
Floor
  Office/Other/
Supporting
Infrastructure
  Total
Near
Term
  Raised
Floor
  Office/Other/
Supporting
Infrastructure
  Total
Future
Available
  Total
Available for
Redevelopment
(NRSF)

Richmond

      78,000         5,000         45,320         128,320         44,000         63,300         107,300         373,000         476,139         849,139         1,084,759  

Atlanta Metro

      35,000         5,270                 40,270         62,600         27,800         90,400         71,600         35,000         106,600         237,270  

Dallas

      26,000         22,000         30,600         78,600                                 236,000         383,400         619,400         698,000  

Suwanee

      45,000                         45,000                                 29,000                 29,000         74,000  

Santa Clara

      12,000                         12,000                                 10,000                 10,000         22,000  

Jersey City

                      4,419         4,419                                 21,241                 21,241         25,660  

Sacramento

      9,000                         9,000                                 423                 423         9,423  
   

 

 

     

 

 

     

 

 

     

 

 

     

 

 

     

 

 

     

 

 

     

 

 

     

 

 

     

 

 

     

 

 

 

Totals

      205,000         32,270         80,339         317,609         106,600         91,100         197,700         741,264         894,539         1,635,803         2,151,112  
   

 

 

     

 

 

     

 

 

     

 

 

     

 

 

     

 

 

     

 

 

     

 

 

     

 

 

     

 

 

     

 

 

 

 

(1) Reflects NRSF at a facility which we expect will be operational by June 30, 2014.
(2) Reflects NRSF at a facility which we expect will be operational between June 30, 2014 and June 30, 2016. Redevelopment of certain of this space is at our discretion and will depend on a number of factors, including our estimate of the demand for data center space in the applicable market.
(3) Reflects NRSF at a facility which we expect to redevelop in the future, but at this time such space is expected to become operational after June 30, 2016. The redevelopment of this space is at our discretion and will depend on a number of factors, including availability of capital and our estimate of the demand for data center space in the applicable market.

The table below sets forth our estimated costs for completion of our seven redevelopment projects currently under construction and expected to be operational by June 30, 2014 (dollars in millions):

 

     Under Construction Costs  

Property

   Actual(1)      Estimated Cost to
Completion(2)
     Total      Expected
Completion
Date
 

Richmond

   $ 53       $ 25       $ 78         Q2 2014   

Atlanta Metro

     7         47         54         Q2 2014   

Dallas

     5         83         88         Q2 2014   

Suwanee

     11         5         16         Q3 2013   

Santa Clara

     3         25         27         Q2 2014   

Jersey City

     0.3         3         4         Q4 2013   

Sacramento

     3         7         10         Q3 2013   
  

 

 

    

 

 

    

 

 

    

Totals

   $ 82       $ 195       $ 277      
  

 

 

    

 

 

    

 

 

    

 

(1) Actual costs incurred for NRSF under construction through June 30, 2013 (excluding acquisition costs).
(2) Represents management’s estimate of the additional costs required to complete the current NRSF under construction. There may be an increase in costs if customers require greater power per area of use, or power density.

 

 

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In addition to projects currently under construction, our near term redevelopment projects are expected to be delivered in a modular manner, and we currently expect to invest between $110 and $155 million of additional capital to complete these near term projects. We have also commenced certain pre-development activities with respect to future redevelopment projects that are not expected to be completed until after June 30, 2016. The ultimate timing and completion of, and the commitment of capital to, our future redevelopment projects is within our discretion and will depend upon a variety of factors, including the availability of financing and our estimation of the future market for data center space in each particular market.

Market Opportunity

According to 451 Research, LLC, or 451 Research, the North American multi-tenant data center market, which includes wholesale and retail colocation offerings, is estimated to grow from $8.2 billion in 2011 to $13.7 billion in 2014, representing a compound annual growth rate of 19%. In addition, according to 451 Research, the market for cloud infrastructure-as-a-service, or IaaS, which allows customers to install their operating system and application software on virtual servers, is estimated to grow from $1.4 billion in 2011 to $5.2 billion in 2014, representing a compound annual growth rate of 55%. Combined, this represents an estimated cumulative compound annual growth rate of over 25% for the multi-tenant data center and cloud IaaS markets from 2011 to 2014.

The data center industry encompasses a wide range of facility types that correspond to different customer technology, cost, regulatory and industry/business requirements. We believe that the table below summarizes the three primary types of multi-tenant data center offerings:

 

   

Data Center Offerings

Typical Characteristics

 

Wholesale

 

Retail Colocation

  

Cloud
and Managed Services

Power   500 kW or more; costs are passed on to customers (metered power)   Specified kW included in lease; overages charged separately    Bundled with service
Space   3,000 square feet or more of raised floor   Up to 3,000 square feet of raised floor    Small amounts of space; customers rent managed virtual servers
Lease Term   5 to 10 years   Up to 3 years    Up to 3 years
Customer   Large corporations, government agencies and global Internet businesses   Large corporations, small and medium businesses and government agencies    Large corporations, small and medium businesses and government agencies

 

 

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Industry Demand Drivers

We believe that the data center industry enjoys strong growth dynamics principally driven by the following trends:

The Rapid Growth of Data is Transforming the Way Businesses Operate.    We believe that as the growth of data accelerates, large and small organizations increasingly will seek sophisticated and enhanced information and content management, security, storage infrastructure and archiving solutions, which will translate into continued demand growth for data center space.

Increasing Demand to Outsource IT Functions.    We believe that the data center industry has reached a tipping point in the last decade whereby the significant security and the required power per area of use, or power density, of customers can be more efficiently delivered through purpose-built facilities rather than at a customer’s existing premises, such as office buildings. We believe that businesses continue to recognize that outsourcing could improve their cost structure, accelerate the deployment process and lower their overall IT risk, and that they are increasingly looking to outsource their IT infrastructure requirements to third-party data center operators.

Attractive Supply / Demand Imbalance

We believe that a supply and demand imbalance currently exists in certain markets for secure, high-quality, high-power, fully redundant facilities and will persist over the next several years. According to 451 Research, average utilization in the top ten U.S. data center markets will increase from 82% in 2012 to 91% in 2014, due to demand growth considerably outpacing supply growth in these markets over that period. We believe this imbalance will be driven by a number of factors in addition to the industry demand drivers described above, including the following:

High Barriers to Entry.    Several factors make it difficult for other companies to enter the data center market, including limited land suitable for data center development with access to sufficient power and significant fiber optic networks, the substantial upfront costs associated with developing modern data center infrastructure and the significant knowledge and expertise required for data center design and development.

High Customer Retention.    We believe that customer retention in the data center industry is higher than in more traditional forms of real estate, such as office or retail. Because data centers typically house customers’ critical networking and computer equipment, the cost, downtime and execution risk incurred by a customer in relocating its equipment to another location are substantial.

Our Competitive Strengths

We believe that we are uniquely positioned in the data center industry and distinguish ourselves from other data center providers through the following competitive strengths:

 

  Ÿ  

Fully Integrated Platform Offers Scalability and Flexibility to Our Customers and Us.    Our differentiated, fully integrated 3Cs approach, allows us to serve a wide variety of customers in a large, addressable market and to scale to the level of IT infrastructure outsourcing desired by our customers. We believe that customers who are looking to outsource their IT infrastructure usually anticipate future growth and/or evolving technology needs and prefer to remain with a single provider. As of June 30, 2013, approximately 39% of our monthly recurring revenue, or MRR, was attributable to customers who use more than one of our 3Cs products.

 

 

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We believe our ability to offer a full spectrum of 3Cs product offerings enhances our leasing velocity, allows for an individualized pricing mix, results in more balanced lease terms and optimizes cash flows from our assets.

 

  Ÿ  

Platform Anchored by Strategically Located, Owned “Mega” Data Centers.    Our larger “mega” data centers, Atlanta Metro, Dallas, Richmond and Suwanee, allow us to deliver our fully integrated platform and 3Cs products by building and leasing space more efficiently than in single-use or smaller data centers. We believe that our data centers are engineered to among the highest specifications commercially available. Our national portfolio of 10 data centers are strategically located in nine metropolitan areas, including four of the nation’s top multi-tenant data center markets (Atlanta, Dallas, New York/New Jersey and Silicon Valley), as defined by 451 Research, along with three metropolitan areas that we believe represent high-growth data center markets (Miami, Richmond and Sacramento). As of June 30, 2013, over 81% of our MRR was derived from our data centers in the top multi-tenant data center markets in the United States.

 

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Significant Expansion Opportunity within Existing Data Center Facilities at Lower Costs.    We have developed substantial expertise in redeveloping facilities through the acquisition and redevelopment of all 10 of our operating facilities. Our data center redevelopment model is primarily focused on redeveloping space within our current facilities, which allows us to build additional leasable raised floor at a lower incremental cost compared to ground-up development and to rapidly scale our redevelopment in a modular manner to coincide with customer acquisition and our estimates of optimal product utilization between our C1, C2 and C3 products.

 

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Diversified, High-Quality Customer Base.    We have significantly grown our customer base from 510 in 2009 to over 870 as of June 30, 2013, with no single customer accounting for more than 8% of our MRR and only three of our customers individually accounting for more than 3% of our MRR. As of June 30, 2013, Fortune 1000 and equivalently sized private and/or foreign companies accounted for approximately 57% of our MRR, including our booked-not-billed MRR balance (which represents customer leases that have been executed but for which lease payments have not commenced) as of that date. Our focus on our customers and our ability to scale with their needs allows us to achieve a low rental churn rate (which is the MRR impact from a customer completely departing our platform in a given period compared to the total MRR at the beginning of the period). For the six months ended June 30, 2013, we experienced a rental churn rate of 1.5%.

 

  Ÿ  

Robust In-House Sales Capabilities.    Our in-house sales force has deep knowledge of our customers’ businesses and IT infrastructure needs and is supported by sophisticated sales management, reporting and incentive systems. Our internal sales force is structured by product offerings, specialized industry segments and, with respect to our C2 product, by geographical region. Therefore, unlike certain other data center companies, we are less dependent on data center brokers to identify and acquire or renew our customers, which we believe is a key enabler of our 3Cs strategy. During the past three years, approximately 82% of new customers were identified and acquired solely by our in-house sales force.

 

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Balance Sheet Positioned to Fund Continued Growth.    Upon completion of this offering, we expect to have approximately $         million of cash available on our balance sheet and the ability to borrow up to an additional $350 million under our unsecured revolving credit facility. We believe we will be appropriately capitalized with sufficient funds and available borrowing capacity to pursue our anticipated business and growth strategies.

 

 

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  Ÿ  

Founder-Led Management Team with Proven Track Record and Strong Alignment with Our Stockholders.    Our senior management team has significant experience in the ownership, management and redevelopment of commercial real estate through multiple business cycles. We believe our executive management team’s experience will enable us to capitalize on industry relationships by providing an ongoing pipeline of attractive leasing and redevelopment opportunities. Upon completion of this offering, our senior management team is expected to own approximately    % of our common stock on a fully diluted basis, and therefore their interests will be highly aligned with those of our stockholders.

 

  Ÿ  

Commitment to Sustainability.    We have a commitment to sustainability that focuses on managing our power and space as effectively and efficiently as possible. We believe that our continued efforts and proven results from sustainably redeveloping properties give us a distinct advantage over our competitors in attracting new customers.

Business and Growth Strategies

Our primary business objectives are to maximize cash flow and to achieve long-term growth in our business in order to maximize stockholder value through the prudent management of a high-quality portfolio of properties and our fully integrated platform used to deliver our 3Cs product offerings. Our business and growth strategies to achieve these objectives include the following elements:

 

  Ÿ  

Continued Redevelopment of Our Existing Footprint.    We believe our redevelopment pipeline provides us with a multi-year growth opportunity at very attractive risk-adjusted returns without the need to construct new buildings or acquire additional properties or land for development. Currently, we expect to complete the redevelopment of 312,000 additional square feet of raised floor by June 30, 2016. Our redevelopment pipeline, including future redevelopment projects, will add approximately 160 MW of incremental power and approximately 1.1 million potential square feet of raised floor space, which would allow us to almost triple our leased raised floor square footage without constructing or acquiring any new buildings. We currently target a stabilized return on invested capital of at least 15% on average for our redevelopment projects.

 

  Ÿ  

Increase Cash Flow of Our In-Place Data Center Space.    We seek to increase cash flow by proactively managing, leasing and optimizing space, rent and occupancy levels across our portfolio. Over the past few years, we have reclaimed space that we have re-leased at higher rates. As of June 30, 2013, our existing data center facilities had approximately 99,000 square feet of raised floor available for lease. We believe this space, together with available power, provides us an opportunity to generate incremental revenue within our existing data center footprint without extensive capital expenditures.

 

  Ÿ  

Expand Our Cloud and Managed Services Product Offerings.    We intend to continue to expand our C3 product offerings and penetration by providing self-service and automation capabilities and targeting both new and existing customers, as our Cloud and Managed Services products can be used as an alternative to, or in conjunction with, our C1 and C2 products. Through our C3 product offerings, we believe that we will be able to capture a larger addressable market, increase our ability to retain customers and increase cash flow from our properties.

 

  Ÿ  

Increase Our Margins through Our Operating Leverage.    We anticipate that our business and growth strategies can be substantially supported by our existing platform, will not require significant incremental general and administrative expenditures and will allow us to continue to benefit from operational leverage and increase operating margins. This operational leverage

 

 

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was demonstrated historically in 2011 and 2012 when 100% of our incremental revenue was reflected in our property-level net operating income. Moreover, we also achieved 73% growth in Adjusted EBITDA from 2010 to 2012 (on a pro forma basis) compared to a 31% growth in revenue during the same period (on a pro forma basis).

 

  Ÿ  

Selectively Expand Our Fully Integrated Platform to Other Strategic Markets.    We will selectively pursue attractive opportunities in strategic locations where we believe our fully integrated platform would give us a competitive advantage in the acquisition and leasing of that facility or portfolio of assets. We also believe we can integrate additional data center facilities into our platform without adding significant incremental headcount or general and administrative expenses, as evidenced by our recent acquisition of our Sacramento data center.

Summary Risk Factors

You should carefully consider the following important risks, as well as the additional risks described in “Risk Factors,” before making a decision to invest in our Class A common stock:

 

  Ÿ  

Because we are focused on the ownership, operation and redevelopment of data centers, any decrease in the demand for data center space or managed services could have a material adverse effect on us.

 

  Ÿ  

Our data center infrastructure may become obsolete or unmarketable and we may not be able to upgrade our power, cooling, security or connectivity systems cost-effectively or at all.

 

  Ÿ  

We face considerable competition in the data center industry and may be unable to renew existing leases, lease vacant space or re-let space on more favorable terms, or at all, as leases expire, which could have a material adverse effect on us.

 

  Ÿ  

Our two largest properties in terms of annualized rent, Atlanta Metro and Suwanee, collectively accounted for approximately 64% of our annualized rent as of June 30, 2013, and any inability, temporarily or permanently, to fully and consistently operate either of these properties could have a material adverse effect on us.

 

  Ÿ  

Our future growth depends upon the successful redevelopment of our existing properties, and any delays or unexpected costs in such redevelopment could have a material adverse effect on us.

 

  Ÿ  

We depend on third parties to provide Internet, telecommunication and fiber optic network connectivity to the customers in our data centers, and any delays or disruptions in service could have a material adverse effect on us.

 

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Power outages, limited availability of electrical resources and increased energy costs could have a material adverse effect on us.

 

  Ÿ  

Upon completion of this offering, our pro forma indebtedness outstanding as of June 30, 2013 will be approximately $315 million, which will expose us to interest rate fluctuations and the risk of default thereunder.

 

  Ÿ  

We have no operating history as a public company, and our inexperience may impede our ability to successfully manage our business.

 

  Ÿ  

Upon completion of this offering and our formation transactions, Chad L. Williams and General Atlantic will own approximately     % and     % of our outstanding common stock on a fully diluted basis, respectively, and will have the ability to exercise significant influence on our company and any matter presented to our stockholders.

 

 

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  Ÿ  

Our tax protection agreement, during its term, could limit our ability to sell or otherwise dispose of certain properties and may require our operating partnership to maintain certain debt levels that otherwise would not be required to operate our business.

 

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Our formation transactions were not negotiated in arm’s length transactions, and the value received by GA REIT and Mr. Williams as a result of the formation transactions and this offering may exceed the fair market value of the assets they originally contributed to our operating partnership.

 

  Ÿ  

Following the repayment of certain indebtedness with the net proceeds of this offering, management will have broad discretion in the application of any remaining net proceeds, and we may not use the proceeds effectively.

 

  Ÿ  

Our cash available for distribution to stockholders may not be sufficient to pay distributions at expected or REIT-required levels, or at all, and we may need to borrow or rely on other third-party capital in order to make such distributions, as to which no assurance can be given, which could cause the market price of our common stock to decline significantly.

 

  Ÿ  

If we do not qualify as a REIT, or fail to remain qualified as a REIT, we will be subject to federal income tax as a regular corporation and could face significant tax liability, which would reduce the amount of cash available for distribution to our stockholders and could have a material adverse effect on us.

Structure and Formation of Our Company

Our Operating Partnership

Following the completion of this offering, we will be the sole general partner and majority owner of our operating partnership. Substantially all of our assets will be held by, and our operations will be conducted through, our operating partnership. We will contribute the net proceeds received by us from this offering to our operating partnership in exchange for OP units therein. Our interest in our operating partnership will generally entitle us to share in cash distributions from, and in the profits and losses of, our operating partnership in proportion to our percentage ownership. As the sole general partner of our operating partnership, we will generally have the exclusive power under the partnership agreement to manage and conduct its business and affairs, subject to certain limited approval and voting rights of the limited partners, which are described more fully below in “Description of the Partnership Agreement of QualityTech, LP.” Our board of directors will manage our business and affairs.

Beginning on or after the date that is the later of (1) 12 months from the beginning of the first full calendar month following the completion of this offering and (2) the date of issuance of the OP units, each limited partner of our operating partnership will have the right to require our operating partnership to redeem part or all of its OP units for cash, based upon the value of an equivalent number of shares of our common stock at the time of the redemption, or, at our election, shares of our common stock on a one-for-one basis, subject to certain adjustments and the restrictions on ownership and transfer of our stock set forth in our charter and described under the section entitled “Description of Securities—Restrictions on Ownership and Transfer.” Each redemption of OP units will increase our percentage ownership interest in our operating partnership and our share of its cash distributions and profits and losses. See “Description of the Partnership Agreement of QualityTech, LP.”

Our Taxable REIT Subsidiary

We currently provide our Cloud and Managed Services product to our customers through Quality Technology Services Holding, LLC, a Delaware limited liability company, which is wholly owned by our

 

 

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operating partnership. Quality Technology Services Holding, LLC has elected to be treated as a taxable REIT subsidiary, or TRS, for federal income tax purposes. A taxable REIT subsidiary generally may provide non-customary and other services to our customers and engage in activities that we may not engage in directly without adversely affecting our qualification as a REIT. We may form additional taxable REIT subsidiaries in the future, and our operating partnership may contribute some or all of its interests in certain wholly owned subsidiaries or their assets to our taxable REIT subsidiaries. Any income earned by our taxable REIT subsidiaries will be included in our income in our consolidated financial statements, but will not be included in our taxable income for purposes of the 75% or 95% gross income tests, except to the extent such income is distributed to us as a dividend, in which case such dividend income will qualify under the 95%, but not the 75%, gross income test. Because a taxable REIT subsidiary is subject to federal income tax, and state and local income tax (where applicable) as a corporation, the income earned by our taxable REIT subsidiaries generally will be subject to an additional level of tax as compared to the income earned by our other subsidiaries.

Formation Transactions

QualityTech, LP, our operating partnership and our predecessor, was formed in 2009 in connection with an investment by General Atlantic in our operating partnership.

Prior to or concurrently with the completion of this offering, we will consummate a series of transactions pursuant to which we will become the sole general partner and majority owner of QualityTech, LP, which then will become our operating partnership. We refer to these transactions, which are described below, as our “formation transactions.”

 

  Ÿ  

We were formed as a Maryland corporation on May 17, 2013.

 

  Ÿ  

We will consummate a tax-free merger transaction in which the entity that holds General Atlantic’s interest in our predecessor, or GA REIT, will merge with and into us and we will succeed to GA REIT’s majority limited partnership interest in our predecessor, which then will become our operating partnership. Pursuant to the merger, we will issue                 shares of our Class A common stock to General Atlantic, and $105,000 in cash (plus accumulated dividends, if any) will be paid to the current preferred shareholders of GA REIT, in each case as consideration for their shares of GA REIT.

 

  Ÿ  

Mr. Williams will contribute to our operating partnership all of his ownership interest in QualityTech GP, LLC, the current general partner of our operating partnership, in exchange for 1,000 OP units, and we will be admitted as the sole general partner of our operating partnership. Following this contribution, we will dissolve QualityTech GP, LLC.

 

  Ÿ  

We will issue                 shares of our Class B common stock to Mr. Williams in exchange for an equivalent number of OP units. The OP units exchanged will represent 2% of Mr. Williams’ OP units. Each outstanding share of Class B common stock entitles its holder to 50 votes on all matters on which Class A common stockholders are entitled to vote, including the election of directors, and holders of shares of Class A common stock and Class B common stock will vote together as a single class. Our Class B common stock is designed to give the holder thereof a right to vote that is proportional to such holder’s economic interest in our company on a fully diluted basis, and therefore does not provide any disproportionate voting rights. The Class B common stock automatically converts into Class A common stock in certain circumstances and is convertible at any time into Class A common stock at the option of the holder.

 

  Ÿ  

In order to simplify our operating partnership’s outstanding limited partnership units, we will eliminate our outstanding Class O LTIP units (which is a class of incentive units that previously

 

 

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were granted to certain employees and non-employee directors of our operating partnership) in a manner that preserves the economic position of each holder of Class O LTIP units and provides additional incentives by:

 

  Ÿ  

converting each of the                      outstanding Class O LTIP units into a fraction of an OP unit representing the “in the money” value of the converted Class O LTIP unit, which is calculated as the difference between the value of an OP unit on the date of conversion and the value of an OP unit on the date of grant of such Class O LTIP unit, which will result in an aggregate issuance of                      OP units (based on the mid-point of the price range set forth on the cover of this prospectus) upon the closing of this offering, and

 

  Ÿ  

granting to each former holder of Class O LTIP units options to purchase a number of shares of our Class A common stock equal to the number of such holder’s converted Class O LTIP units, which will result in an aggregate grant of options to acquire              shares of Class A common stock (based on the mid-point of the price range set forth on the cover of this prospectus) upon the closing of this offering with an exercise price equal to the public offering price of our Class A common stock in this offering.

The OP units and stock options issued upon conversion of each holder’s Class O LTIP units will be subject to vesting to the same extent as the holder’s Class O LTIP units prior to conversion. The options will be granted under our 2013 Equity Incentive Plan and will expire ten years from the date of grant. See “Structure and Formation of Our Company—Formation Transactions” for a further description of the conversion terms of Class O LTIP units.

 

 

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Our Structure

The following diagram depicts our ownership structure upon completion of this offering, based on the mid-point of the price range set forth on the cover of this prospectus.

 

LOGO

On a fully diluted basis, our public stockholders, General Atlantic and our directors, executive officers and employees and their affiliates are expected to own    %,    % and    %, respectively, of our outstanding common stock. If the underwriters exercise their option to purchase additional shares of our common stock in full, on a fully diluted basis, these parties are expected to own    %,    % and    %, respectively, of our outstanding common stock.

 

 

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Benefits to Related Parties

Upon completion of this offering, certain owners of our operating partnership, or continuing investors, directors, members of our senior management team and employees will receive material benefits, including the following:

 

  Ÿ  

We will issue             shares of our Class B common stock to Chad L. Williams, our Chairman and Chief Executive Officer, in exchange for an equivalent number of OP units. The OP units exchanged will represent 2% of Mr. Williams OP units. Each outstanding share of Class B common stock entitles its holder to 50 votes on all matters on which Class A common stockholders are entitled to vote, including the election of directors, and holders of shares of Class A common stock and Class B common stock will vote together as a single class. Our Class B common stock is designed to give the holder thereof a right to vote that is proportional to such holder’s economic interest in our company on a fully diluted basis and therefore does not provide any disproportionate voting rights.

 

  Ÿ  

We will enter into a registration rights agreement with our continuing investors, including certain of our directors and executive officers, pursuant to which we will agree to file one or more registration statements covering the issuance to them of shares of our Class A common stock upon redemption of their OP units. See “Certain Relationships and Related Transactions—Registration Rights” and “Shares Eligible for Future Sale—Registration Rights.”

 

  Ÿ  

We will enter into a tax protection agreement with Mr. Williams and his affiliates and family members who own OP units pursuant to which we will agree to indemnify them against certain tax liabilities resulting from: (1) the sale, exchange, transfer, conveyance or other disposition of our Atlanta Metro, Suwanee or Santa Clara data centers in a taxable transaction prior to January 1, 2026, referred to as the protected period; (2) causing or permitting any transaction that results in the disposition by Mr. Williams or his affiliates and family members who own OP units of all or any portion of their interests in the operating partnership in a taxable transaction during the protected period; or (3) our failure prior to the expiration of the protected period to maintain approximately $150 million of indebtedness that would be allocable to Mr. Williams and his affiliates for tax purposes or, alternatively, failing to offer Mr. Williams and his affiliates and family members who own OP units the opportunity to guarantee specific types of the operating partnership’s indebtedness in order to enable them to continue to defer certain tax liabilities. See “Certain Relationships and Related Party Transactions—Tax Protection Agreement.”

 

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We will enter into indemnification agreements with our directors and executive officers providing for the indemnification by us for certain liabilities and expenses incurred as a result of actions brought, or threatened to be brought, against such parties.

 

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We will grant an aggregate of (i)             restricted shares of our common stock (based on the mid-point of the price range set forth on the cover of this prospectus), subject to certain vesting requirements, to our executive officers, (ii) options to acquire        shares of Class A common stock (based on the mid-point of the price range set forth on the cover of this prospectus) to our executive officers, (iii)              restricted shares of our common stock (based on the mid-point of the price range set forth on the cover of this prospectus), subject to certain vesting requirements, to certain of our independent directors and (iv) options to acquire        shares of Class A common stock (based on the mid-point of the price range set forth on the cover of this prospectus) to certain of our independent directors. See “Management—Executive Compensation—2013 Equity Incentive Plan.”

 

  Ÿ  

In order to preserve the economic position of the holders of our Class O LTIP units and provide additional incentives, we will convert our outstanding Class O LTIP units into OP units equal in value to the “in the money” portion of such Class O LTIP units, and we will grant to each former holder of Class O LTIP units options to purchase a number of shares of our Class A common

 

 

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stock equal to the number of such holder’s converted Class O LTIP units, which will result in an aggregate grant of options to acquire              shares of Class A common stock (based on the mid-point of the price range set forth on the cover of this prospectus) upon the closing of this offering with an exercise price equal to the public offering price of our Class A common stock in this offering. See “Structure and Formation of Our Company—Formation Transactions.”

Restrictions on Ownership of Our Shares

In order to assist us in complying with the limitations on the concentration of ownership of REIT stock imposed by the Internal Revenue Code of 1986, as amended, or the Code, and for strategic reasons, our charter generally prohibits any person (other than a person who has been granted an exception) from actually or constructively owning more than    % of the aggregate of the outstanding shares of our common stock by value or by number of shares, whichever is more restrictive, except for certain designated investment entities that may own up to 9.8% of the aggregate of the outstanding shares our common stock, subject to certain conditions. Chad L. Williams, his family members and certain entities controlled by them will be excepted holders under our charter, and none of them will be permitted to own more than    % of the aggregate of the outstanding shares of such class or series of our common stock by value or by number of shares, whichever is more restrictive, after application of the relevant attribution rules. In addition, General Atlantic will be an excepted holder under our charter, and no beneficial owner of General Atlantic will be permitted to own more than    % of the aggregate of the outstanding shares of such class or series of our common stock by value or by number of shares, whichever is more restrictive, after application of the relevant attribution rules. Our charter permits exceptions to be made for stockholders provided our board of directors determines such exceptions will not jeopardize our qualification as a REIT.

Distribution Policy

To satisfy the requirements to qualify as a REIT, and to avoid paying tax on our income, we intend to make regular quarterly distributions of all, or substantially all, of our REIT taxable income (excluding net capital gains) to our stockholders. We intend to make a pro rata initial distribution with respect to the period commencing on the completion of this offering and ending             , 2013, based on a distribution of $        per share for a full quarter. On an annualized basis, this would be $        per share, or an initial annual distribution rate of approximately    % based on an assumed initial public offering price at the mid-point of the price range indicated on the cover of this prospectus. We estimate that this initial annual distribution rate will represent approximately    % of estimated cash available for distribution to our common stockholders for the 12-month period ending June 30, 2014. We do not plan to reduce our intended initial annual distribution rate if the underwriters exercise their option to purchase additional shares of Class A common stock. Furthermore, we plan to maintain this rate for the 12-month period following completion of this offering unless circumstances change materially. All distributions will be made at the discretion of our board of directors and will depend on our historical and projected results of operations, liquidity and financial condition and other factors our board of directors deem relevant from time to time. No assurance can be given that our estimated cash available for distribution to our stockholders will be accurate or that our actual cash available for distribution to our stockholders will be sufficient to pay distributions to them at any expected or REIT-required level or at any particular yield, or at all. See “Distribution Policy.”

Our Tax Status

We intend to elect and qualify to be taxed as a REIT under the Code beginning with our taxable year ending December 31, 2013. We believe that our organization and proposed method of operation

 

 

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will enable us to meet the requirements for qualification and taxation as a REIT for federal income tax purposes, but we cannot assure you that our operations will allow us to satisfy the requirements for qualification and taxation as a REIT. To qualify and maintain our qualification as a REIT, we must meet a number of organizational and operational requirements on a continuing basis, including the requirement that we annually distribute at least 90% of our REIT taxable income, determined without regard to the dividends paid deduction and excluding net capital gains, to our stockholders.

As a REIT, we generally will not be subject to U.S. federal income tax on REIT taxable income we currently distribute to our stockholders. If we fail to qualify as a REIT in any taxable year and do not qualify for certain statutory savings provisions, we will be subject to federal, state and local income tax at regular corporate rates. Even if we qualify for taxation as a REIT, we may be subject to some federal, state and local taxes on our income and property, and our TRSs will be subject to federal, state and local income taxes. See “U.S. Federal Income Tax Considerations.”

Emerging Growth Company Status

We are an “emerging growth company,” as defined in the Jumpstart Our Business Startups Act of 2012, or the JOBS Act, and we are eligible to take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not “emerging growth companies,” including not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statement and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and stockholder approval of any golden parachute payments not previously approved. We have not yet made a decision as to whether we will take advantage of any or all of these exemptions. If we do take advantage of any of these exemptions, we do not know if some investors will find our common stock less attractive, and the result may be a less active trading market for our common stock and our stock price may be more volatile.

In addition, the JOBS Act also provides that an emerging growth company can take advantage of the extended transition period provided in the Securities Act for complying with new or revised accounting standards. In other words, an emerging growth company can delay the adoption of certain accounting standards until those standards would otherwise apply to private companies. However, we have chosen to “opt out” of this extended transition period, and, as a result, we will comply with new or revised accounting standards on the relevant dates on which adoption of such standards is required for all public companies that are not emerging growth companies. Our decision to opt out of the extended transition period for complying with new or revised accounting standards is irrevocable.

We will remain an “emerging growth company” until the earliest to occur of (i) the last day of the fiscal year during which our total annual revenue equals or exceeds $1 billion (subject to adjustment for inflation), (ii) the last day of the fiscal year following the fifth anniversary of this offering, (iii) the date on which we have, during the previous three-year period, issued more than $1 billion in non-convertible debt or (iv) the date on which we are deemed to be a “large accelerated filer” under the Securities Exchange Act of 1934, or the Exchange Act.

Our Principal Office

Our principal executive office is located at 12851 Foster Street, Overland Park, Kansas 66213. Our telephone number is (913) 814-9988. Our web address is                                                  . The information on or accessible through our website does not constitute a part of this prospectus.

 

 

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This Offering

 

Class A common stock offered by us

               shares(1)

Class A common stock offered by the Selling Stockholder

  

            shares(1)

Class A common stock to be outstanding upon completion of this offering

  

            shares(1)(2)

Class B common stock to be outstanding after the formation transactions

  

            shares

Class A common stock, Class B common stock and units of limited partnership interest to be outstanding upon completion of this offering and the formation transactions (excluding OP units held by us)

  







            shares of Class A common stock, Class B common stock and units of limited partnership interest(1)(2)(3)
Use of proceeds    The net proceeds of this offering to us, after deducting underwriting discounts and commissions and estimated expenses, will be approximately $         million ($         million if the underwriters exercise their option to purchase additional shares of Class A common stock in full). We intend to contribute the net proceeds received by us from this offering to our operating partnership in exchange for OP units. Our operating partnership intends to use the proceeds as follows:
  

Ÿ   approximately $         million to repay amounts outstanding under our unsecured revolving credit facility; and

 

Ÿ    the remaining balance to fund ongoing development costs, to fund future acquisitions and for general corporate purposes.

  

Affiliates of each of the underwriters of this offering are lenders under our unsecured credit facility. As described above, our operating partnership intends to use a portion of the net proceeds to repay borrowings outstanding under our unsecured revolving credit facility. As such, these affiliates will receive their proportionate shares of any amount of our unsecured revolving credit facility that is repaid with the net proceeds of this offering. See “Underwriting.”

 

We will not receive any proceeds from the sale of our Class A common stock by the Selling Stockholder.

 

 

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Table of Contents
Risk Factors    See “Risk Factors” and other information included in this prospectus for a discussion of factors that you should consider before making a decision to invest in our Class A common stock.
Proposed New York Stock Exchange symbol    QTS

 

(1) Excludes                 shares issuable by us upon the exercise of the underwriters’ option to purchase up to an additional                 shares of Class A common stock from us and shares reserved for issuance under our equity incentive plan.
(2) Includes                 shares issued to our continuing investors in connection with our formation transactions and                 restricted shares (based on the mid-point of the price range set forth on the cover of this prospectus) to be issued to certain of our directors, executive officers and employees upon completion of this offering. Excludes options to acquire                  shares of Class A common stock (based on the mid-point of the price range set forth on the cover of this prospectus) expected to be outstanding upon completion of this offering and                  additional shares available for issuance under our equity incentive plan.
(3) Includes                 OP units,                 Class RS LTIP units and                 shares of Class B common stock expected to be outstanding upon the completion of our formation transactions. The OP units may, subject to the terms in the operating partnership agreement, be exchanged for cash or, at our option, shares of our Class A common stock on a one-for-one basis generally commencing 12 months after completion of this offering. Class RS LTIP units are convertible by the holder thereof into OP units as described in “Description of the Partnership Agreement of QualityTech, LP.” Shares of Class B common stock are subject to automatic conversion into an equal number of shares of our Class A common stock upon a direct or indirect transfer of Class B common stock or certain OP units held by the holder of such Class B common stock to a person other than a qualified transferee (as defined in our charter). In addition, shares of Class B common stock are convertible at any time into shares of Class A common stock at the option of the holder.

 

 

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Summary Historical and Pro Forma Financial Data

The following table sets forth summary selected financial data on an historical basis for QualityTech, LP, which is our predecessor. We have not presented historical data for QTS Realty Trust, Inc. because we have not had any corporate activity since our formation other than the issuance of shares of common stock in connection with our initial capitalization and activity in connection with this offering. Accordingly, we do not believe that a discussion of the historical results of QTS Realty Trust, Inc. would be meaningful. Prior to or concurrently with the completion of this offering, we will consummate a series of transactions pursuant to which we will become the sole general partner and majority owner of our predecessor, which then will be our operating partnership, and thereby indirectly acquire the properties and data center business described in this prospectus. We refer to these transactions as our “formation transactions.” Substantially all of our assets will be held by, and our operations will be conducted through, our operating partnership. We will contribute the net proceeds received by us from this offering to our operating partnership in exchange for OP units therein. For more information regarding our predecessor and the formation transactions, please see “Structure and Formation of Our Company.”

The summary selected historical financial data as of December 31, 2012 and 2011 and for each of the years ended December 31, 2012, 2011 and 2010 has been derived from our predecessor’s audited financial statements included elsewhere in this prospectus. The summary selected historical balance sheet data as of December 31, 2010 has been derived from our predecessor’s audited financial statements not otherwise included in this prospectus. The summary selected historical financial data as of June 30, 2013 and for each of the six months ended June 30, 2013 and 2012 has been derived from our predecessor’s unaudited financial statements included elsewhere in this prospectus and includes all adjustments that management considers necessary to present fairly the information set forth therein. The summary selected historical financial data for our predecessor is not necessarily indicative of our results of operations, cash flows or financial condition following the completion of this offering and our formation transactions.

The unaudited pro forma condensed consolidated financial data for the year ended December 31, 2012 and as of and for the six months ended June 30, 2013 are presented as if this offering, the formation transactions, the acquisition of the Sacramento data center in December 2012 and the effect of certain financing transactions as described in the pro forma condensed consolidated financial statements included elsewhere in this prospectus had all occurred on June 30, 2013 for the pro forma condensed consolidated balance sheet and on January 1, 2012 for the pro forma condensed consolidated statement of operations. Our pro forma condensed consolidated financial data is not necessarily indicative of what our actual financial condition and results of operations would have been as of the date and for the periods indicated, nor does it purport to represent our future financial condition or results of operations.

The following table sets forth summary selected financial and operating data on a consolidated historical basis for our predecessor. You should read the following summary selected financial data in conjunction with our pro forma financial statements, our predecessor’s historical consolidated financial statements, the combined statements of revenues and certain operating expenses of our Sacramento data center, and, in each case, the related notes thereto, along with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” which are included elsewhere in this prospectus.

 

 

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Table of Contents
    Six Months Ended June 30,
(unaudited)
    Year Ended December 31,  
    Pro
Forma
2013
    2013     2012     Pro Forma
2012

(unaudited)
    2012     2011     2010  
    ($ in thousands)  

Statement of Operations Data

             

Revenues:

             

Rental

  $ 68,589      $ 68,589      $ 59,516      $ 131,135      $ 120,758      $ 104,051      $ 92,800   

Recoveries from customers

    6,322        6,322        4,489        10,613        9,294        12,154        12,506   

Cloud and managed services

    8,435        8,435        6,883        14,497        14,497        12,173        9,054   

Other

    1,092        1,092        444        1,385        1,210        2,018        5,795   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

    84,438        84,438        71,332        157,630        145,759        130,396        120,155   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses

             

Property operating costs

    29,292        29,292        25,556        56,993        51,506        57,900        60,408   

Real estate taxes and insurance

    2,203        2,203        1,525        4,304        3,632        2,621        2,378   

Depreciation and amortization

    22,061        22,061        16,394        39,438        34,932        26,165        19,086   

General and administrative

    19,290        19,290        17,187        36,610        35,986        28,470        22,844   

Transaction costs

                         897        897                 

Gain on legal settlement

                                       (3,357       

Restructuring charge

                  3,291        3,291        3,291                 
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

    72,846        72,846        63,953        141,533        130,244        111,799        104,716   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

    11,592        11,592        7,379        16,097        15,515        18,597        15,439   

Other income and expense:

             

Interest income

    13        13        46        69        61        71        233   

Interest expense

    (4,459     (11,634     (12,393     (10,105     (25,140     (19,713     (23,502

Other (expense) income, net

           (3,277     (1,434     (1,153     (1,151     136        22,214   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before gain on sale of real estate

    7,146        (3,306     (6,402     4,908        (10,715     (909     14,384   

Gain on sale of real estate

                         948        948                 
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

  $ 7,146      $ (3,306   $ (6,402   $ 5,856      $ (9,767   $ (909   $ 14,384   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Other Data (unaudited)

             

FFO(1)

  $ 26,763      $ 16,311      $ 8,753      $ 39,931      $ 20,253      $ 23,047      $ 31,771   

Operating FFO(1)

    26,763        19,588        13,171        45,246        25,568        13,900        2,456   

Recognized MRR (in the period)(2)

    73,785        73,785        63,188        141,151        128,533        108,942        98,832   

MRR (at period end)(2)

    12,743        12,743        11,021        11,857        11,857        9,898        9,138   

NOI(3)

    52,943        52,943        44,251        96,614        90,904        70,011        57,369   

EBITDA(4)

    33,653        30,376        22,339        55,330        50,244        44,898        56,739   

Adjusted EBITDA(4)

    34,448        34,448        27,253        60,416        55,330        42,306        34,857   

 

    As of June 30,
(unaudited)
    As of December 31,  
    Pro Forma
2013
    2013     2012     Pro Forma
2012

(unaudited)
    2012     2011     2010  
    ($ in thousands)  

Balance Sheet Data

             

Real estate at cost*

  $ 821,336      $ 821,336      $ 606,295        N/A      $ 734,828      $ 555,586      $ 432,233   

Real estate assets, net**

    701,760        701,760        518,357        N/A        631,928        481,050        379,967   

Total assets

    788,247        758,432        558,539        N/A        685,443        521,056        412,964   

Credit facility and mortgages payable

    314,903        558,903        461,136        N/A        487,791        407,906        302,765   

 

* Reflects undepreciated cost of real estate assets, does not include real estate intangible assets acquired in connection with acquisitions.
** Net investment in real estate includes building and improvements (net of accumulated depreciation), land, and construction in progress.

 

    Six Months Ended June 30,
(unaudited)
    Year Ended December 31,  
    Pro Forma
2013
    2013     2012     Pro Forma
2012

(unaudited)
    2012     2011     2010  
    ($ in thousands)  

Cash Flow Data

             

Cash flow provided by (used for):

             

Operating activities

  $ N/A      $ 19,990      $ 20,683      $ N/A      $ 35,098      $ 24,374      $ 13,277   

Investing activities

    N/A        (86,526     (66,503     N/A        (194,927     (118,746     (56,574

Financing activities

    N/A        63,004        44,139        N/A        160,719        94,669        5,610   

 

 

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(1) We calculate FFO in accordance with the standards established by the National Association of Real Estate Investment Trusts, or NAREIT. FFO represents net income (loss) (computed in accordance with GAAP), adjusted to exclude gains (or losses) from sales of property, real estate related depreciation and amortization and similar adjustments for unconsolidated partnerships and joint ventures. We generally calculate Operating FFO as FFO excluding certain non-recurring and primarily non-cash charges and gains and losses that management believes are not indicative of the results of our operating real estate portfolio. We believe that Operating FFO provides investors with another financial measure that may facilitate comparisons of operating performance and liquidity between periods and, to the extent other REITs calculate Operating FFO on a comparable basis, between us and these other REITs.

 

     A reconciliation of net income (loss) to FFO and Operating FFO is presented below:

 

    Six Months Ended June 30,
(unaudited)
    Year Ended December 31,
(unaudited)
 
    Pro
Forma
2013
    2013     2012     Pro
Forma
2012
    2012     2011     2010  
    ($ in thousands)  

FFO

             

Net income (loss)

  $ 7,146      $ (3,306   $ (6,402   $ 5,856      $ (9,767   $ (909   $ 14,384   

Real estate depreciation and amortizaton

    19,617        19,617        15,155        35,023        30,968        23,956        17,387   

Gain on sale of real estate

                         (948     (948              
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

FFO

    26,763        16,311        8,753        39,931        20,253        23,047        31,771   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating FFO

             

Restructuring charge

                  3,291        3,291        3,291                 

Write off of unamortized deferred financing costs

           3,277        1,434        1,434        1,434                 

Gain on legal settlement

                                       (3,357       

Transaction costs

                         897        897                 

Intangible revenue

                                       (960     (4,844

Gain on extinguishment of debt

                                              (22,214

Unrealized gain on derivatives

                  (307     (307     (307     (4,830     (2,257
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating FFO

  $ 26,763      $ 19,588      $ 13,171      $ 45,246      $ 25,568      $ 13,900      $ 2,456   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

 

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(2) We calculate MRR as monthly contractual revenue under signed leases as of a particular date, which includes revenue from our C1, C2 and C3 rental and cloud and managed services activities, but excludes customer recoveries, deferred set-up fees, variable related revenues, non-cash revenues and other one-time revenues. MRR does not include the impact from booked-not-billed leases (which represent customer leases that have been executed but for which lease payments have not commenced) as of a particular date, unless otherwise specifically noted. We calculate recognized MRR as the recurring revenue recognized during a given period, which includes revenue from our C1, C2 and C3 rental and cloud and managed services activities, but excludes customer recoveries, deferred set-up fees, variable related revenues, non-cash revenues and other one-time revenues. Management uses MRR and recognized MRR as supplemental performance measures because they provide useful measures of increases in contractual revenue from our customer leases. A reconciliation of total revenues to recognized MRR in the period and MRR at period-end is presented below:

 

    Six Months Ended June 30,
(unaudited)
    Year Ended December 31,
(unaudited)
 
    Pro
Forma
2013
    2013     2012     Pro
Forma
2012
    2012     2011     2010  
    ($ in thousands)  

Recognized MRR

             

Total period revenues (GAAP basis)

  $ 84,438      $ 84,438      $ 71,332      $ 157,630      $ 145,759      $ 130,396      $ 120,155   

Less: Total period recoveries

    (6,322     (6,322     (4,489     (10,613     (9,294     (12,154     (12,506

         Total period deferred set-up fees

    (2,188     (2,188     (1,862     (4,481     (4,317     (2,997     (2,710

         Total period other

    (2,143     (2,143     (1,793     (1,385     (3,615     (6,303     (6,107
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Recognized MRR (in the period)

  $ 73,785      $ 73,785      $ 63,188      $ 141,151      $ 128,533      $ 108,942      $ 98,832   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

MRR

             

Total period revenues (GAAP basis)

  $ 84,438      $ 84,438      $ 71,332      $ 157,630      $ 145,759      $ 130,396      $ 120,155   

Less: Total revenues excluding last month

    (69,802     (69,802     (59,008     (143,157     (132,338     (119,156     (109,497
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues for last month of period

    14,636        14,636        12,324        14,473        13,421        11,240        10,658   

Less: Last month recoveries

    (1,224     (1,224     (775     (981     (879     (897     (1,175

         Last month deferred set-up fees

    (391     (391     (352     (455     (441     (278     (195

         Last month other plus adjustments for period end

    (278     (278     (176     (1,180     (244     (167     (150
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

MRR (at period end)*

  $ 12,743      $ 12,743      $ 11,021      $ 11,857      $ 11,857      $ 9,898      $ 9,138   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

* Does not include our booked-not-billed MRR balance, which was $2.3 million and $1.2 million as of June 30, 2013 and 2012, respectively, and $1.1 million, $1.0 million and $1.0 million as of December 31, 2012, 2011, and 2010, respectively.

 

 

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(3) We calculate net operating income, or NOI, as net income (loss), excluding: interest expense, interest income, depreciation and amortization, write off of unamortized deferred financing costs, gain on extinguishment of debt, transaction costs, gain on legal settlement, gain on sale of real estate, restructuring charge and general and administrative expenses. We believe that NOI is another metric that is often utilized to evaluate returns on operating real estate from period to period and also, in part, to assess the value of the operating real estate. A reconciliation of net income (loss) to NOI is presented below:

 

    Six Months Ended June 30,
(unaudited)
    Year Ended December 31,
(unaudited)
 
    Pro
Forma
2013
    2013     2012     Pro
Forma
2012
    2012     2011     2010  
    ($ in thousands)  

Net Operating Income (NOI)

             

Net income (loss)

  $ 7,146      $ (3,306   $ (6,402   $ 5,856      $ (9,767   $ (909   $ 14,384   

Interest expense

    4,459        11,634        12,393        10,105        25,140        19,713        23,502   

Interest income

    (13     (13     (46     (69     (61     (71     (233

Depreciation and amortization

    22,061        22,061        16,394        39,438        34,932        26,165        19,086   

Write off of unamortized deferred financing costs

           3,277        1,434        1,434        1,434                 

Gain on extinguishment of debt

                                              (22,214

Transaction costs

                         897        897                 

Gain on legal settlement

                                       (3,357       

Gain on sale of real estate

                         (948     (948              

Restructuring charge

                  3,291        3,291        3,291                 

General and administrative expenses

    19,290        19,290        17,187        36,610        35,986        28,470        22,844   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

NOI

  $ 52,943      $ 52,943      $ 44,251      $ 96,614      $ 90,904      $ 70,011      $ 57,369   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Breakdown of NOI by Facility:

             

Atlanta Metro data center

  $ 25,000      $ 25,000      $ 20,048      $ 42,787      $ 42,787      $ 29,712      $ 26,595   

Suwanee data center

    13,428        13,428        16,766        30,471        30,471        32,258        28,508   

Santa Clara data center

    5,498        5,498        5,550        11,183        11,183        9,672        7,291   

Richmond data center

    4,679        4,679        2,116        6,094        6,094        267          

Other data centers

    4,338        4,338        (229     6,079        369        (1,898     (5,025
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

NOI

  $ 52,943      $ 52,943      $ 44,251      $ 96,614      $ 90,904      $ 70,011      $ 57,369   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

 

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(4) We calculate EBITDA as net income (loss) excluding interest expense and interest income, provision for income taxes (including income taxes applicable to sale of assets) and depreciation and amortization. We believe that EBITDA is another metric that is often utilized to evaluate and compare our ongoing operating results and also, in part, to assess the value of our operating portfolio.

 

     In addition to EBITDA, we calculate an adjusted measure of EBITDA, which we refer to as Adjusted EBITDA, as EBITDA excluding write off of unamortized deferred financing costs, gain on extinguishment of debt, transaction costs, equity-based compensation expense, restructuring charge, gain on legal settlement and gain on sale of real estate. We believe that Adjusted EBITDA provides investors with another financial measure that can facilitate comparisons of operating performance between periods and between REITs.

 

     A reconciliation of net income (loss) to EBITDA and Adjusted EBITDA is presented below:

 

    Six Months Ended June 30,
(unaudited)
    Year Ended December 31,
(unaudited)
 
    Pro
Forma
2013
    2013     2012     Pro
Forma
2012
    2012     2011     2010  
    ($ in thousands)  

EBITDA

             

Net income (loss)

  $ 7,146      $ (3,306   $ (6,402   $ 5,856      $ (9,767   $ (909   $ 14,384   

Interest expense

    4,459        11,634        12,393        10,105        25,140        19,713        23,502   

Interest income

    (13     (13     (46     (69     (61     (71     (233

Depreciation and amortization

    22,061        22,061        16,394        39,438        34,932        26,165        19,086   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

EBITDA

    33,653        30,376        22,339        55,330        50,244        44,898        56,739   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted EBITDA

             

Write off of unamortized deferred financing costs

           3,277        1,434        1,434        1,434                 

Gain on extinguishment of debt

                                              (22,214

Transaction costs

                         897        897                 

Equity-based compensation expense

    795        795        189        412        412        765        332   

Gain on legal settlement

                                       (3,357       

Gain on sale of real estate

                         (948     (948              

Restructuring charge

                  3,291        3,291        3,291                 
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted EBITDA

  $ 34,448      $ 34,448      $ 27,253      $ 60,416      $ 55,330      $ 42,306      $ 34,857   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

 

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RISK FACTORS

An investment in our common stock involves risks. Before making an investment decision, you should carefully consider the following risk factors, which address the material risks concerning our business and an investment in our Class A common stock, together with the other information contained in this prospectus. If any of the risks discussed in this prospectus were to occur, our business, prospects, financial condition, liquidity, funds from operations and results of operations and our ability to service our debt and make distributions to our stockholders could be materially and adversely affected, which we refer to herein collectively as a “material adverse effect on us,” the market price of our common stock could decline significantly and you could lose all or part of your investment. Some statements in this prospectus, including statements in the following risk factors, constitute forward-looking statements. Please refer to the section entitled “Special Note Regarding Forward-Looking Statements.”

Risks Related to Our Business and Operations

Because we are focused on the ownership, operation and redevelopment of data centers, any decrease in the demand for data center space or managed services could have a material adverse effect on us.

Because our portfolio of properties consists entirely of data centers, or properties to be converted to data centers, we are subject to risks inherent in investments in a single industry. Adverse developments in the data center market or in the industries in which our customers operate could lead to a decrease in the demand for data center space or managed services, which could have a greater material adverse effect on us than if we owned a more diversified real estate portfolio. These adverse developments could include: a decline in the technology industry, such as a decrease in the use of mobile or web-based commerce, industry slowdowns, business layoffs or downsizing, relocations of businesses, increased costs of complying with existing or new government regulations and other factors; a slowdown in the growth of the Internet generally as a medium for commerce and communication; a downturn in the market for data center space generally such as oversupply of or reduced demand for space; and the rapid development of new technologies or the adoption of new industry standards that render our or our customers’ current products and services obsolete or unmarketable and, in the case of our customers, that contribute to a downturn in their businesses, increasing the likelihood of a default under their leases or that they become insolvent or file for bankruptcy protection. To the extent that any of these or other adverse conditions occur, they are likely to impact market rents for, and cash flows from, our data center space, which could have a material adverse effect on us.

Our data center infrastructure may become obsolete or unmarketable and we may not be able to upgrade our power, cooling, security or connectivity systems cost-effectively or at all.

The markets for the data centers we own and operate, as well as certain of the industries in which our customers operate, are characterized by rapidly changing technology, evolving industry standards, frequent new service introductions, shifting distribution channels and changing customer demands. As a result, the infrastructure at our data centers may become obsolete or unmarketable due to demand for new processes and/or technologies, including, without limitation: (i) new processes to deliver power to, or eliminate heat from, computer systems; (ii) customer demand for additional redundancy capacity; or (iii) new technology that permits lower levels of critical load and heat removal than our data centers are currently designed to provide. In addition, the systems that connect our data centers to the Internet and other external networks may become outdated, including with respect to latency, reliability and diversity of connectivity. When customers demand new processes or technologies, we may not be able to upgrade our data centers on a cost effective basis, or at all, due to, among other things, increased

 

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expenses to us that cannot be passed on to customers or insufficient revenue to fund the necessary capital expenditures. The obsolescence of our power and cooling systems and/or our inability to upgrade our data centers, including associated connectivity, could reduce revenue at our data centers and could have a material adverse effect on us. Furthermore, potential future regulations that apply to industries we serve may require customers in those industries to seek specific requirements from their data centers that we are unable to provide. These may include physical security regulations applicable to the defense industry and government contractors and privacy and security requirements applicable to the financial services and health care industries. If such regulations were adopted, we could lose customers or be unable to attract new customers in certain industries, which could have a material adverse effect on us.

We face considerable competition in the data center industry and may be unable to renew existing leases, lease vacant space or re-let space on more favorable terms, or at all, as leases expire, which could have a material adverse effect on us.

Leases representing approximately 27% of our leased raised floor and approximately 44% of our annualized rent (including all month-to-month leases), in each case as of June 30, 2013, will expire in either 2013 or 2014. We compete with numerous developers, owners and operators in the data center industry, including managed service providers and other REITs, some of which own or lease properties similar to ours, or may do so in the future, in the same submarkets in which our properties are located. Our competitors may have significant advantages over us, including greater name recognition, longer operating histories, higher operating margins, pre-existing relationships with current or potential customers, greater financial, marketing and other resources, and access to greater and less expensive power. These advantages could allow our competitors to respond more quickly to strategic opportunities or changes in our industry or markets. If our competitors offer space at rental rates below current market rates or below the rental rates we currently charge our customers, or if our competitors offer products and services in a greater variety, that are more state-of-the-art or that are more competitively priced than the products and services we offer, we may lose customers or be unable to attract new customers without lowering our rental rates and improving the quality, mix and technology of our products and services. We cannot assure you that we will be able to renew leases with our existing customers or re-let space to new customers if our current customers do not renew their leases. Even if our customers renew their leases or we are able to re-let the space, the terms (including rental rates and lease periods) and costs (including capital) of renewal or re-letting may be less favorable than the terms of our current leases. In addition, there can be no assurances that the type of space and/or services currently available at our properties will be sufficient to retain current customers or attract new customers in the future. Finally, although we offer a full spectrum of data center products from Custom Data Centers to Colocation to Cloud and Managed Services, our competitors that specialize in only one of our product and service offerings may have competitive advantages in that space. If rental rates for our properties decline, we are unable to lease vacant space, our existing customers do not renew their leases or we do not re-let space from expiring leases, in each case, on favorable terms, it could have a material adverse effect on us.

The long sales cycle for data center products could have a material adverse effect on us.

A customer’s decision to lease space in one of our data centers and to purchase Cloud and Managed Services typically involves a significant commitment of resources, time-consuming contract negotiations regarding the service level commitments and substantial due diligence on the part of the customer regarding the adequacy of our infrastructure and attractiveness of our products and services. As a result, the leasing of data center space and Cloud and Managed Services has a long sales cycle. Furthermore, we may expend significant time and resources in pursuing a particular sale or customer that may not result in any revenue. Our inability to adequately manage the risks associated with leasing the space and products within our facilities could have a material adverse effect on us.

 

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Our customers may choose to develop new data centers or expand their own existing data centers, which could result in the loss of one or more key customers or reduce demand and pricing for our data centers and could have a material adverse effect on us.

Some of our customers may develop their own data center facilities. Other customers with their own existing data centers may choose to expand their data centers in the future. In the event that any of our key customers were to develop or expand their data centers, it could result in a loss of business to us or put pressure on our pricing. If we lose a customer, there is no assurance that we would be able to replace that customer at the same or a higher rate, or at all, which could have a material adverse effect on us.

The bankruptcy or insolvency of a major customer could have a material adverse effect on us.

The bankruptcy or insolvency of a major customer could have significant consequences for us. If any customer becomes a debtor in a case under the federal Bankruptcy Code, we cannot evict the customer solely because of the bankruptcy. In addition, the bankruptcy court might authorize the customer to reject and terminate its lease with us. Our claim against the customer for unpaid future rent would be subject to a statutory cap that might be substantially less than the remaining rent owed under the lease. In either case, our claim for unpaid rent would likely not be paid in full. If any of our significant customers were to become bankrupt or insolvent, suffer a downturn in its business, fail to renew its lease at all or renew on terms less favorable to us than its current terms, reject or terminate any leases with us and/or fail to pay unpaid or future rent owed to us, it could have a material adverse effect on us.

Our two largest properties in terms of annualized rent, Atlanta Metro and Suwanee, collectively accounted for approximately 64% of our annualized rent as of June 30, 2013, and any inability, temporarily or permanently, to fully and consistently operate either of these properties could have a material adverse effect on us.

Our two largest properties in terms of annualized rent, Atlanta Metro and Suwanee, collectively accounted for approximately 64% of our annualized rent as of June 30, 2013. Therefore, any inability, temporarily or permanently, to fully and consistently operate either of these properties could have a material adverse effect on us. In addition, because both properties are located in the Atlanta metropolitan area, we are particularly susceptible to adverse developments in this area, including as a result of natural disasters (such as hurricanes, floods, tornadoes and other events), that could cause, among other things, permanent damage to the properties and electrical power outages that may last beyond our backup and alternative power arrangements. Further, Atlanta Metro and Suwanee account for several of our largest leases in terms of MRR. Any nonrenewal, credit or other issues with large customers could adversely affect the performance of these properties.

We may be adversely affected by the economies and other conditions of the markets in which we operate, particularly in Atlanta and other metropolitan areas, where we have a high concentration of our data center properties.

We are susceptible to adverse economic or other conditions in the geographic markets in which we operate, such as periods of economic slowdown or recession, the oversupply of, or a reduction in demand for, data centers and cloud and managed services in a particular area, industry slowdowns, layoffs or downsizings, relocation of businesses, increases in real estate and other taxes and changing demographics. The occurrence of these conditions in the specific markets in which we have concentrations of properties could have a material adverse effect on us. Our Atlanta area (Atlanta Metro and Suwanee) and Santa Clara data centers accounted for approximately 64% and 12%, respectively, of our annualized rent as of June 30, 2013. As a result, we are particularly susceptible to adverse market conditions in these areas. In addition, other geographic markets could become more attractive for developers, operators and customers of data center facilities based on favorable costs

 

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and other conditions to construct or operate data center facilities in those markets. For example, some states have created tax incentives for developers and operators to locate data center facilities in their jurisdictions. These changes in other markets may increase demand in those markets and result in a corresponding decrease in demand in our markets. Any adverse economic or real estate developments in the geographic markets in which we have a concentration of properties, or in any of the other markets in which we operate, or any decrease in demand for data center space resulting from the local business climate or business climate in other markets, could have a material adverse effect on us.

The long-term continuance of challenging economic and other market conditions could have a material adverse effect on us.

Economic and other market conditions continue to be challenging in the United States, with tighter credit conditions and modest growth. While recent economic data reflects a stabilization of the economy and credit markets, the cost and availability of credit may continue to be limited. Furthermore, deteriorating economic and other market conditions that affect our customers could negatively impact commercial real estate fundamentals and result in lower occupancy, lower rental rates and declining values in our real estate portfolio. Additionally, the economic climate could have an impact on our lenders or customers, causing them to fail to meet their obligations to us. The long-term continuance of challenging economic and other market conditions could have a material adverse effect on us.

Future consolidation and competition in our customers’ industries could reduce the number of our existing and potential customers and make us dependent on a more limited number of customers.

Mergers or consolidations in our customers’ industries in the future could reduce the number of our existing and potential customers and make us dependent on a more limited number of customers. If our customers merge with or are acquired by other entities that are not our customers, they may discontinue or reduce the use of our data centers in the future. Additionally, some of our customers may compete with one another in various aspects of their businesses, which places additional competitive pressures on our customers. Any of these developments could have a material adverse effect on us.

Our failure to develop and maintain a diverse customer base could have a material adverse effect on us.

Our customers are a mix of C1, C2 and C3 customers. Each type of customer and their leases with us have certain features that distinguish them from our other customers, such as operating margin, space and power requirements and lease term. In addition, our customers engage in a variety of professional, financial, technological and other businesses. A diverse customer base helps to minimize exposure to economic fluctuations in any one industry, business sector or customer type, or any particular customer. Our relative mix of C1, C2 and C3 customers may change over time, as may the industries represented by our customers, the concentration of customers within specified industries and the economic value and risks associated with each customer, and there is no assurance that we will be able to maintain a diverse customer base, which could have a material adverse effect on us.

Our future growth depends upon the successful redevelopment of our existing properties, and any delays or unexpected costs in such redevelopment could have a material adverse effect on us.

We have initiated or are contemplating the redevelopment of seven of our existing data center properties: Atlanta Metro, Dallas, Jersey City, Richmond, Sacramento, Santa Clara and Suwanee. Our future growth depends upon the successful completion of these efforts. With respect to our current and

 

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any future expansions and any new developments or redevelopments, we will be subject to certain risks, including the following:

 

  Ÿ  

financing risks;

 

  Ÿ  

increases in interest rates or credit spreads;

 

  Ÿ  

construction and/or lease-up delays;

 

  Ÿ  

changes to plans or specifications;

 

  Ÿ  

construction site accidents or other casualties;

 

  Ÿ  

lack of availability of, and/or increased costs for, specialized data center components, including long lead-time items such as generators;

 

  Ÿ  

cost overruns, including construction or labor costs that exceed our original estimates;

 

  Ÿ  

contractor and subcontractor disputes, strikes, labor disputes or supply disruptions;

 

  Ÿ  

failure to achieve expected occupancy and/or rental rate levels within the projected time frame, if at all;

 

  Ÿ  

sub-optimal mix of 3Cs products;

 

  Ÿ  

environmental issues, fire, flooding, earthquakes and other natural disasters; and

 

  Ÿ  

delays with respect to obtaining or the inability to obtain necessary zoning, occupancy, environmental, land use and other governmental permits, and changes in zoning and land use laws, particularly with respect to build-outs at our Sacramento and Santa Clara facilities.

In addition, with respect to any future developments of new data center properties, we will be subject to risks and, potentially, unanticipated costs associated with obtaining access to a sufficient amount of power from local utilities, including the need, in some cases, to develop utility substations on our properties in order to accommodate our power needs, constraints on the amount of electricity that a particular locality’s power grid is capable of providing at any given time, and risks associated with the negotiation of long-term power contracts with utility providers. We may not be able to successfully negotiate such contracts on favorable terms, or at all. Any inability to negotiate utility contracts on a timely basis or on favorable terms or in volumes sufficient to supply the critical load anticipated for future developments could have a material adverse effect on us.

While we intend to develop data center properties primarily in markets with which we are familiar, we may in the future acquire properties in new geographic markets where we expect to achieve favorable risk-adjusted returns on our investment. We may not possess the same level of familiarity with development or redevelopment in these new markets and therefore cannot assure you that our development activities will generate attractive returns. Furthermore, development and redevelopment activities, regardless of whether they are ultimately successful, also typically require a substantial portion of our management’s time and attention. This may distract our management from focusing on other operational activities of our business.

These and other risks could result in delays or increased costs and could prevent completion of our development and expansion projects once undertaken, which could have a material adverse effect on us. In addition, we are expanding the aforementioned properties, and may develop or expand properties in the future, prior to obtaining commitments from customers to lease them. This is known as developing or expanding “on speculation” and involves the risk that we will be unable to attract customers to the properties on favorable terms in a timely manner, if at all. In addition to our internal sales force, through our channels and partners team, we intend to use our existing industry relationships with national technology companies to retain and attract customers for our existing data center properties as well as the expansions and developments of such properties. We believe these

 

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industry relationships provide an ongoing pipeline of attractive leasing opportunities, and we intend to capitalize on these relationships in order to increase our leasing network. If our internal sales force or channels and partners team is not successful in leasing new data center space on favorable terms, it could have a material adverse effect on us.

Our properties are designed primarily for lease as data centers, which could make it difficult to reposition them if we are not able to lease or re-let available space.

Our properties are highly specialized properties that contain extensive electrical, communications and mechanical systems. Such systems are often custom-designed to house, power and cool certain types of computer systems and networking equipment. Any office space (such as private office space, open office areas and conference centers) located at our properties is merely complementary to such systems, to facilitate our ability to service and maintain them. As a result, our properties are not well-suited for primary use by customers as anything other than data centers. Major renovations and expenditures would be required to convert the properties for use as commercial office space, or for any other use, which would substantially reduce the benefits from such a conversion. In the event of a conversion, the value of our properties may be impaired due to the costs of reconfiguring the real estate for alternate purposes and the removal or modification of the specialized systems and equipment. The highly specialized nature of our data center properties could make it difficult and costly to reposition them if we are not able to lease or re-let available space on favorable terms, or at all, which could have a material adverse effect on us.

We lease the space in which two of our data centers are located and the non-renewal of such leases could have a material adverse effect on us.

We lease the space housing our data center facilities located in Jersey City, New Jersey and Overland Park, Kansas, where our corporate headquarters is located. These leases expire (taking into account our extension options) in 2031 and 2023, respectively. We would incur significant costs if we were forced to vacate either of our leased facilities due to the high costs of relocating the equipment in our facilities and installing the necessary infrastructure in a new data center property. If we were forced to vacate either of our leased facilities, we could lose customers that chose our services based on our location. Our landlords could attempt to evict us for reasons beyond our control. Further, we may be unable to maintain good working relationships with our landlords, which would adversely affect our relationship with our customers and could result in the loss of current customers. In addition, we cannot assure you that we will be able to renew these leases prior to their expiration dates on favorable terms or at all. If we are unable to renew our lease agreements, we could lose a significant number of customers who are unwilling to relocate their equipment to another one of our data center properties, which could have a material adverse effect on us. Even if we are able to renew these leases, the terms and other costs of renewal may be less favorable than our existing lease arrangements. Failure to sufficiently increase revenue from customers at these facilities to offset these projected higher costs could have a material adverse effect on us.

The ground sublease structure at the Santa Clara property could prevent us from developing the property as we desire, and we may have to incur additional expenses prior the end of the ground sublease to restore the property to its prelease state.

Our interest in the Santa Clara property is subject to a ground sublease granted by a third party, as ground sublessor, to our indirect subsidiary Quality Investment Properties Santa Clara, LLC, or QIP Santa Clara. The ground sublease terminates in 2052 and we have two options to extend the original term for consecutive ten-year terms. The ground sublease structure presents special risks. We, as ground sublessee, will own all improvements on the land, including the buildings in which the data centers are located during the term of the ground sublease. Upon the expiration or earlier termination

 

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of the ground sublease, however, the improvements on the land will become the property of the ground sublessor. Unless we purchase a fee interest in the land and improvements subject to the ground sublease, we will not have any economic interest in the land or improvements at the expiration of the ground sublease. Therefore, we will not share in any increase in value of the land or improvements beyond the term of the ground sublease, notwithstanding our capital outlay to purchase our interest in the data center or fund improvements thereon, and will lose our right to use the building on the subleased property. In addition, upon the expiration of the ground sublease, the ground sublessor may require the removal of the improvements or the restoration of the improvements to their condition prior to any permitted alterations at our sole cost and expense. If we do not meet a certain net worth test, we also will be required to provide the ground sublessor with a bond in connection with such removal and restoration requirements. In addition, while we generally have the right to undertake alterations to the demised premises, the ground sublessor has the right to reasonably approve the quality of such work and the form and content of certain financial information of QIP Santa Clara. The ground sublessor need not give its approval to alterations if it or its affiliate determines that the work will have a material adverse impact on the fee interest in property adjacent to the demised premises. In addition, though the ground sublease provides that we may exercise the rights of ground lessor in the event of a rejection of the master ground lease, each of the master ground lease and the ground sublease may be rejected in bankruptcy. Finally, in the event of a condemnation, the ground lessor is entitled to an allocable share of any condemnation proceeds. The ground sublease, however, does contain important nondisturbance protections and provides that, in event of the termination of the master ground lease, the ground sublease will become a direct lease between the ground lessor and QIP Santa Clara.

We depend on third parties to provide Internet, telecommunication and fiber optic network connectivity to the customers in our data centers, and any delays or disruptions in service could have a material adverse effect on us.

Our products and infrastructure rely on third-party service providers. In particular, we depend on third parties to provide Internet, telecommunication and fiber optic network connectivity to the customers in our data centers, and we have no control over the reliability of the services provided by these suppliers. Our customers may in the future experience difficulties due to service failures unrelated to our systems and services. Any Internet, telecommunication or fiber optic network failures may result in significant loss of connectivity to our data centers, which could reduce the confidence of our customers and could consequently impair our ability to retain existing customers or attract new customers and could have a material adverse effect on us.

Similarly, we depend upon the presence of Internet, telecommunications and fiber optic networks serving the locations of our data centers in order to attract and retain customers. The construction required to connect multiple carrier facilities to our data centers is complex, requiring a sophisticated redundant fiber network, and involves matters outside of our control, including regulatory requirements and the availability of construction resources. Each new data center that we develop requires significant amounts of capital for the construction and operation of a sophisticated redundant fiber network. We believe that the availability of carrier capacity affects our business and future growth. We cannot assure you that any carrier will elect to offer its services within our data centers or that once a carrier has decided to provide connectivity to our data centers that it will continue to do so for any period of time. Furthermore, some carriers are experiencing business difficulties or have announced consolidations or mergers. As a result, some carriers may be forced to downsize or terminate connectivity within our data centers, which could adversely affect our customers and could have a material adverse effect on us.

 

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Power outages, limited availability of electrical resources and increased energy costs could have a material adverse effect on us.

Our data centers are subject to electrical power outages, regional competition for available power and increased energy costs. We attempt to limit exposure to system downtime by using backup generators and power supplies generally at a significantly higher operating cost than we would pay for an equivalent amount of power from a local utility. However, we may not be able to limit our exposure entirely even with these protections in place. Power outages, which may last beyond our backup and alternative power arrangements, would harm our customers and our business. During power outages, changes in humidity and temperature can cause permanent damage to servers and other electrical equipment. We could incur financial obligations or be subject to lawsuits by our customers in connection with a loss of power. Any loss of services or equipment damage could reduce the confidence of our customers in our services and could consequently impair our ability to attract and retain customers, which could have a material adverse effect on us.

In addition, power and cooling requirements at our data centers are increasing as a result of the increasing power and cooling demands of modern servers. Since we rely on third parties to provide our data centers with sufficient power to meet our customers’ needs, and we generally do not control the amount of power drawn by our customers, our data centers could have a limited or inadequate amount of electrical resources.

We also may be subject to risks and unanticipated costs associated with obtaining power from various utility companies. Utilities that serve our data centers may be dependent on, and sensitive to price increases for, a particular type of fuel, such as coal, oil or natural gas. The price of these fuels and the electricity generated from them could increase as a result of proposed legislative measures related to climate change or efforts to regulate carbon emissions. While our wholesale customers are billed based on a pass-through basis for their direct energy usage, our retail customers pay a fixed cost for services, including power, so any excess energy costs above such fixed costs are borne by us. Although, for technical and practical reasons, our retail customers often use less power than the amount we are required to provide pursuant to their leases, there is no assurance that this will always be the case. Although we have a diverse customer base, the concentration and mix of our customers may change and increases in the cost of power at any of our data centers would put those locations at a competitive disadvantage relative to data centers served by utilities that can provide less expensive power. This could adversely affect our relationships with our customers and hinder our ability to operate our data centers, which could have a material adverse effect on us.

We rely on the proper and efficient functioning of computer and data-processing systems, and a large-scale malfunction could have a material adverse effect on us.

Our ability to keep our data centers operating depends on the proper and efficient functioning of computer and data-processing systems. Since computer and data-processing systems are susceptible to malfunctions and interruptions, including those due to equipment damage, power outages, computer viruses and a range of other hardware, software and network problems, we cannot guarantee that our data centers will not experience such malfunctions or interruptions in the future. Additionally, expansions and developments in the products and services that we offer, including our Cloud and Managed Services, could increasingly add a measure of complexity that may overburden our data center and network resources and human capital, making service interruptions and failures more likely. A significant or large-scale malfunction or interruption of one or more of any of our data centers’ computer or data-processing systems could adversely affect our ability to keep such data centers running efficiently. If a malfunction results in a wider or sustained disruption to business at a property, it could have a material adverse effect on us.

 

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Interruptions in our provision of products or services, or security breaches at our facility or affecting our networks, could result in a loss of customers and damage our reputation, which could have a material adverse effect on us.

Our business and reputation could be adversely affected by any interruption or failure in the provision of products, services or security (whether network or physical) at our data centers, even if such events occur as a result of a natural disaster, human error, landlord maintenance failure, water damage, fiber cuts, extreme temperature or humidity, sabotage, vandalism, terrorist acts, unauthorized entry or other unanticipated problems. In addition, our network could be subject to unauthorized access, computer viruses, and other disruptive problems caused by customers, employees, or others. Unauthorized access, computer viruses, or other disruptive problems could lead to interruptions, delays and cessation of service to our customers. If a significant disruption occurs, we may be unable to implement disaster recovery or security measures in a timely manner or, if and when implemented, these measures may not be sufficient or could be circumvented through the reoccurrence of a natural disaster or other unanticipated problem, or as a result of accidental or intentional actions. Furthermore, such disruptions can cause damage to servers and may result in legal liability where interruptions in service violate service commitments in customer leases. Resolving network failures or alleviating security problems also may require interruptions, delays, or cessation of service to our customers. Accordingly, failures in our products and services, including problems at our data centers, network interruptions or breaches of security on our network may result in significant liability, a loss of customers and damage to our reputation, which could have a material adverse effect on us.

If we are unable to protect our or our customers’ information from theft or loss, our reputation could be harmed, which could have a material adverse effect on us.

We are vulnerable to negative impacts if sensitive information from our customers or their customers is inadvertently compromised or lost. We routinely process, store and transmit large amounts of data for our customers, which includes sensitive and personally identifiable information. Loss or compromise of this data could cost us both monetarily and in terms of customer goodwill and lost business. Unauthorized access also potentially could jeopardize the security of confidential information of our customers or our customers’ end-users, which might expose us to liability from customers and the government agencies that regulate us or our customers, as well as deter potential customers from renting our space and purchasing our services. For example, violations of the Health Insurance Portability and Accountability Act, or HIPAA, and Health Information Technology for Economic and Clinical Health Act can lead to fines of up to $1.5 million for all violations of a particular provision in a calendar year. In addition, we cannot predict how future laws, regulations and standards, or future interpretations of current laws, regulations and standards, related to privacy and security will affect our business and we cannot predict the cost of compliance. We may be required to expend significant financial resources to protect against physical or cybersecurity breaches that could result in the misappropriation of our or our customers’ information. As techniques used to breach security change frequently, and are generally not recognized until launched against a target, we may not be able to implement security measures in a timely manner or, if and when implemented, we may not be able to determine the extent to which these measures could be circumvented. Any internal or external breach in our network could severely harm our business and result in costly litigation and potential liability for us. To the extent our customers demand that we accept unlimited liability and to the extent there is a competitive trend to accept it, such a trend could affect our ability to retain these limitations in our leases at the risk of losing the business. Such a trend may be particularly likely to occur with regard to our Cloud and Managed Services. We may experience a data loss or security breach, which could have a material adverse effect on us.

 

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The loss of key personnel, particularly Chad L. Williams, our Chairman and Chief Executive Officer, and William H. Schafer, our Chief Financial Officer, could have a material adverse effect on us.

Our continued success depends, to a significant extent, on the continued services of key personnel, particularly Chad L. Williams, our Chairman and Chief Executive Officer, and William H. Schafer, our Chief Financial Officer, who have extensive market knowledge and long-standing business relationships. In particular, our reputation among and our relationships with our key customers are the direct result of a significant investment of time and effort by these individuals to build our credibility in a highly specialized industry. The loss of services of one or more key members of our executive management team, particularly our Chairman and Chief Executive Officer or our Chief Financial Officer, could diminish our business and investment opportunities and our relationships with lenders, business partners and existing and prospective customers and could have a material adverse effect on us.

Any inability to recruit or retain qualified personnel, or maintain access to key third-party service providers, could have a material adverse effect on us.

We must continue to identify, hire, train, and retain IT professionals, technical engineers, operations employees, and sales and senior management personnel who maintain relationships with our customers and who can provide the technical, strategic and marketing skills required to grow our company, develop and expand our data centers, maximize our rental and services income and achieve the highest sustainable rent levels at each of our facilities. There is a shortage of qualified personnel in these fields, and we compete with other companies for the limited pool of these personnel. Competitive pressures may require that we enhance our pay and benefits package to compete effectively for such personnel. An increase in these costs or our inability to recruit and retain necessary technical, managerial, sales and marketing personnel or to maintain access to key third-party providers could have a material adverse effect on us.

Our decentralized management structure may lead to incidents or developments that could damage our reputation and could have a material adverse effect on us.

We have a decentralized management structure that enables the local managers at each of our data centers to quickly and effectively respond to trends in their respective markets. While we believe that we exercise an appropriate level of central control and supervision over all of our operations, the local managers retain a certain amount of operational and decision-making flexibility, including the management of the particular data center, sourcing, pricing and other sales decisions. We cannot guarantee that our local managers will not take actions or experience problems that could damage our reputation or have a material adverse effect on us.

We may be unable to identify and complete acquisitions on favorable terms or at all, which may inhibit our growth and have a material adverse effect on us.

We continually evaluate the market of available properties and may acquire additional properties when opportunities exist. Our ability to acquire properties on favorable terms is subject to the following significant risks:

 

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we may be unable to acquire a desired property because of competition from other real estate investors with significant resources and/or access to capital, including both publicly traded REITs and institutional investment funds;

 

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even if we are able to acquire a desired property, competition from other potential acquirors may significantly increase the purchase price or result in other less favorable terms;

 

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  Ÿ  

even if we enter into agreements for the acquisition of a desired property, these agreements are subject to customary conditions to closing, including completion of due diligence investigations to our satisfaction, and we may incur significant expenses for properties we never actually acquire;

 

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we may be unable to finance acquisitions on favorable terms or at all; and

 

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we may acquire properties subject to liabilities and without any recourse, or with only limited recourse, with respect to unknown liabilities such as liabilities for clean-up of environmental contamination, claims by customers, vendors or other persons dealing with the former owners of the properties and claims for indemnification by general partners, directors, officers and others indemnified by the former owners of the properties.

Any inability to complete property acquisitions on favorable terms or at all could have a material adverse effect on us.

We may be unable to successfully integrate and operate acquired properties, which could have a material adverse effect on us.

Even if we are able to make acquisitions on favorable terms, our ability to successfully integrate and operate them is subject to the following significant risks:

 

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we may spend more than budgeted amounts to make necessary improvements or renovations to acquired properties, as well as require substantial management time and attention;

 

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we may be unable to integrate new acquisitions quickly and efficiently, particularly acquisitions of operating businesses or portfolios of properties, into our existing operations;

 

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acquired properties may be subject to reassessment, which may result in higher than expected property tax payments;

 

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our customer retention and lease renewal risks may be increased; and

 

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market conditions may result in higher than expected vacancy rates and lower than expected rental rates.

Any inability to integrate and operate acquired properties to meet our financial, operational and strategic expectations could have a material adverse effect on us.

We recently acquired our Sacramento facility and expect a transition period during which our retention and lease renewal risks may be increased. Management also may be required to spend a greater portion of its time at the Sacramento facility (rather than the other facilities) in order to manage its successful integration into our platform. We will continue to operate the Sacramento facility in the same manner (and with the same degree of care and skill) as our other properties, but if customers are unsatisfied, they may fail to renew their leases or breach their existing leases. In the event that customers fail to renew their leases, the revenue at the Sacramento facility may decrease, which could have a material adverse effect on us.

We may be subject to unknown or contingent liabilities related to properties or businesses that we acquire, which may result in damages and investment losses.

Assets and entities that we have acquired or may acquire in the future may be subject to unknown or contingent liabilities for which we may have limited or no recourse against the sellers. Unknown or contingent liabilities might include liabilities for clean-up or remediation of environmental conditions, claims of customers, vendors or other persons dealing with the acquired entities, tax liabilities and other liabilities whether incurred in the ordinary course of business or otherwise. In the

 

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future we may enter into transactions with limited representations and warranties or with representations and warranties that do not survive the closing of the transactions, in which event we would have no or limited recourse against the sellers of such properties. While we usually require the sellers to indemnify us with respect to breaches of representations and warranties that survive, such indemnification is often limited and subject to various materiality thresholds, a significant deductible or an aggregate cap on losses. As a result, there is no guarantee that we will recover any amounts with respect to losses due to breaches by the sellers of their representations and warranties. In addition, the total amount of costs and expenses that we may incur with respect to liabilities associated with acquired properties and entities may exceed our expectations. Finally, indemnification agreements between us and the sellers typically provide that the sellers will retain certain specified liabilities relating to the assets and entities acquired by us. While the sellers are generally contractually obligated to pay all losses and other expenses relating to such retained liabilities, there can be no guarantee that such arrangements will not require us to incur losses or other expenses as well. Any of these matters could have a material adverse effect on us.

Risks Related to Financing

An inability to access external sources of capital on favorable terms or at all could limit our ability to execute our business and growth strategies.

In order to qualify and maintain our qualification as a REIT, we are required under the Code to distribute at least 90% of our “REIT taxable income” (determined before the deduction for dividends paid and excluding net capital gains) annually. In addition, we will be subject to income tax at regular corporate rates to the extent that we distribute less than 100% of our “REIT taxable income,” including any net capital gains. Because of these distribution requirements, we may not be able to fund future capital needs, including capital for development projects and acquisition opportunities, from operating cash flow. Consequently, we intend to rely on third-party sources of capital to fund a substantial amount of our future capital needs. We may not be able to obtain such financing on favorable terms or at all. Any additional debt we incur will increase our leverage, expose us to the risk of default and impose operating restrictions on us. In addition, any equity financing could be materially dilutive to the equity interests held by our stockholders. Our access to third-party sources of capital depends, in part, on general market conditions, the market’s perception of our growth potential, our leverage, our current and expected results of operations, liquidity, financial condition and cash distributions to stockholders and the market price of our common stock. If we cannot obtain capital when needed, we may not be able to execute our business and growth strategies (including redeveloping or acquiring properties when strategic opportunities exist), satisfy our debt service obligations, make the cash distributions to our stockholders necessary to qualify and maintain our qualification as a REIT (which would expose us to significant penalties and corporate level taxation), or fund our other business needs, which could have a material adverse effect on us.

Upon completion of this offering, our pro forma indebtedness outstanding as of June 30, 2013 will be approximately $315 million, which will expose us to interest rate fluctuations and the risk of default thereunder.

Upon completion of this offering, our pro forma indebtedness outstanding as of June 30, 2013 will be approximately $315 million. Approximately $145 million of this indebtedness bears interest at a variable rate, including the impact of hedging arrangements. Increases in interest rates, or the loss of the benefits of our existing or future hedging agreements, would increase our interest expense, which would adversely affect our cash flow and our ability to service our debt. Our organizational documents contain no limitations regarding the maximum level of indebtedness, as a percentage of our market capitalization or otherwise, that we may incur. We may incur significant additional indebtedness,

 

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including mortgage indebtedness, in the future. Our substantial outstanding pro forma indebtedness, and the limitations imposed on us by our debt agreements, could have other significant adverse consequences, including the following:

 

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our cash flow may be insufficient to meet our required principal and interest payments;

 

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we may use a substantial portion of our cash flows to make principal and interest payments and we may be unable to obtain additional financing as needed or on favorable terms, which could, among other things, have a material adverse effect on our ability to complete our redevelopment pipeline, capitalize upon emerging acquisition opportunities, make cash distributions to our stockholders, or meet our other business needs;

 

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we may be unable to refinance our indebtedness at maturity or the refinancing terms may be less favorable than the terms of our original indebtedness;

 

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we may be forced to dispose of one or more of our properties, possibly on unfavorable terms or in violation of certain covenants to which we may be subject;

 

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we may be required to maintain certain debt and coverage and other financial ratios at specified levels, thereby reducing our financial flexibility;

 

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our vulnerability to general adverse economic and industry conditions may be increased;

 

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greater exposure to increases in interest rates for our variable rate debt and to higher interest expense on future fixed rate debt;

 

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we may be at a competitive disadvantage relative to our competitors that have less indebtedness; and

 

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we may default on our indebtedness by failure to make required payments or violation of covenants, which would entitle holders of such indebtedness and possibly other indebtedness to accelerate the maturity of their indebtedness and, if such indebtedness is secured, to foreclose on our properties that secure their loans and receive an assignment of our rents and leases.

The occurrence of any one of these events could have a material adverse effect on us. In addition, any foreclosure on our properties could create taxable income without accompanying cash proceeds, which could adversely affect our ability to meet the REIT distribution requirements imposed by the Code.

Our existing indebtedness contains, and any future indebtedness may contain, covenants that restrict our ability to engage in certain activities, which could have a material adverse effect on us.

Our existing indebtedness contains, and our future indebtedness may contain, certain covenants which, among other things, restrict our ability to sell, without the consent of the applicable lender, one or more properties. In addition, such covenants also may restrict our ability to engage in mergers or consolidations that result in a change in control of us, without the consent of the applicable lender. These covenants may restrict our ability to engage in certain transactions that may be in our best interest. In addition, failure to meet the covenants may result in an event of default under the applicable indebtedness, which could result in the acceleration of the applicable indebtedness and potentially other indebtedness and foreclosure upon any property securing such indebtedness, which could have a material adverse effect on us.

Our unsecured credit facility and Richmond credit facility contain provisions that may limit our ability to make distributions to our stockholders. These facilities generally provide that if a default occurs and is continuing, we will be precluded from making distributions on our common stock (other than those

 

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required to allow us to qualify and maintain our status as a REIT, so long as such default does not arise from a payment default or event of insolvency) and lenders under the facility and, potentially, other indebtedness, could accelerate the maturity of the related indebtedness. In addition, these facilities also contain covenants providing for a maximum distribution of the greater of (i) 95% of our Funds from Operations (as defined in such agreement) and (ii) the amount required for us to qualify as a REIT.

Mortgage and other secured indebtedness expose us to the possibility of foreclosure, which could result in the loss of our investment in a property or group of properties or other assets subject to indebtedness.

Incurring mortgage and other secured indebtedness increases our risk of property losses because defaults on indebtedness secured by properties or other assets may result in foreclosure actions initiated by lenders and ultimately our loss of the property or other assets securing any loans for which we are in default. Any foreclosure on a mortgaged property or group of properties could have a material adverse effect on the overall value of our portfolio of data centers. For tax purposes, a foreclosure of any of our properties would be treated as a sale of the property for a purchase price equal to the outstanding balance of the indebtedness secured by the mortgage. If the outstanding balance of the indebtedness secured by the mortgage exceeds our tax basis in the property, we would recognize taxable income on foreclosure, but would not receive any cash proceeds.

Our hedging transactions involve costs and expose us to potential losses.

Hedging agreements enable us to convert floating rate liabilities to fixed rate liabilities or fixed rate liabilities to floating rate liabilities. Upon completion of this offering, we expect to be a party to two interest rate swap agreements, which effectively fix the applicable LIBOR interest rate on $150 million of our outstanding indebtedness at 0.5825% through September 2014. Hedging transactions expose us to certain risks, including that losses on a hedge position may reduce the cash available for distribution to stockholders and such losses may exceed the amount invested in such instruments and that counterparties to such agreements could default on their obligations, which could increase our exposure to fluctuating interest rates. In addition, hedging agreements may involve costs, such as transaction fees or breakage costs, if we terminate them. The REIT rules impose certain restrictions on our ability to utilize hedges, swaps and other types of derivatives to hedge our liabilities. We expect that our board of directors will adopt a general policy with respect to our use of interest rate swaps, the purchase or sale of interest rate collars, caps or floors, options, mortgage derivatives and other hedging instruments in order to hedge all or a portion of our interest rate risk, given the cost of such hedges and the need to qualify and maintain our qualification as a REIT. We expect our policy to state that we will not use derivatives for speculative or trading purposes and will only enter into contracts with major financial institutions based on their credit rating and other factors. We may use hedging instruments in our risk management strategy to limit the effects of changes in interest rates on our operations. However, neither our current nor any future hedges may be effective in eliminating all of the risks inherent in any particular position due to the fact that, among other things, the duration of the hedge may not match the duration of the related liability, the credit quality of the hedging counterparty owing money on the hedge may be downgraded to such an extent that it impairs our ability to sell or assign our side of the hedging transaction and the hedging counterparty owing money in the hedging transaction may default on its obligation to pay. The use of derivatives could have a material adverse effect on us.

 

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Risks Related to the Real Estate Industry

The operating performance and value of our properties are subject to risks associated with the real estate industry, and we cannot assure you that we will execute our business and growth strategies successfully.

As a real estate company, we are subject to all of the risks associated with owning and operating real estate, including:

 

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adverse changes in international, national or local economic and demographic conditions;

 

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vacancies or our inability to rent space on favorable terms, including possible market pressures to offer customers rent abatements, customer improvements, early termination rights or below-market renewal options;

 

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adverse changes in the financial condition or liquidity of buyers, sellers and customers (including their ability to pay rent to us) of properties, including data centers;

 

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the attractiveness of our properties to customers;

 

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competition from other real estate investors with significant resources and assets to capital, including other real estate operating companies, publicly traded REITs and institutional investment funds;

 

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reductions in the level of demand for data center space;

 

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increases in the supply of data center space;

 

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fluctuations in interest rates, which could have a material adverse effect on our ability, or the ability of buyers and customers of properties, including data centers, to obtain financing on favorable terms or at all;

 

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increases in expenses that are not paid for by or cannot be passed on to our customers, such as the cost of complying with laws, regulations and governmental policies;

 

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the relative illiquidity of real estate investments, especially the specialized real estate properties that we hold and seek to acquire and develop;

 

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changes in, and changes in enforcement of, laws, regulations and governmental policies, including, without limitation, health, safety, environmental, zoning and tax laws, and governmental fiscal policies;

 

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property restrictions and/or operational requirements pursuant to restrictive covenants, reciprocal easement agreements, operating agreements or historical landmark designations; and

 

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civil unrest, acts of war, terrorist attacks and natural disasters, including earthquakes, tornados, hurricanes and floods, which may result in uninsured and underinsured losses.

In addition, periods of economic slowdown or recession, rising interest rates or declining demand for real estate, or the public perception that any of these events may occur, could result in a general decline in occupancy and rental sales, and therefore revenues, or an increased incidence of defaults under existing leases. Accordingly, we cannot assure you that we will be able to execute our business and growth strategies. Any inability to operate our properties to meet our financial, operational and strategic expectations could have a material adverse affect on us.

The illiquidity of real estate investments could significantly impede our ability to respond to adverse changes in economic, financial, investment and other conditions.

Because real estate investments are relatively illiquid, our ability to promptly sell one or more properties in our portfolio in response to changing economic, financial, investment or other conditions

 

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is limited. The real estate market is affected by many factors that are beyond our control, including those described above. In particular, data centers represent a particularly illiquid part of the overall real estate market. This illiquidity is driven by a number of factors, including the relatively small number of potential purchasers of such data centers—including other data center operators and large corporate users—and the relatively high cost per square foot to develop data centers, which substantially limits a potential buyer’s ability to purchase a data center property with the intention of redeveloping it for an alternative use, such as an office building, or may substantially reduce the price buyers are willing to pay. Our inability to dispose of properties at opportune times or on favorable terms could have a material adverse effect on us.

In addition, the federal tax code imposes restrictions on a REIT’s ability to dispose of properties that are not applicable to other types of real estate companies. In particular, the tax laws applicable to REITs require that we hold our properties for investment, rather than primarily for sale in the ordinary course of business, which may cause us to forego or defer sales of properties that otherwise would be in our best interest. Therefore, we may not be able to vary our portfolio in response to economic, financial, investment or other conditions promptly or on favorable terms, which could have a material adverse effect on us.

Declining real estate valuations could result in impairment charges, the determination of which involves a significant amount of judgment on our part. Any impairment charge could have a material adverse effect on us.

We review our properties for impairment on a quarterly and annual basis and whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. Indicators of impairment include, but are not limited to, a sustained significant decrease in the market price of or the cash flows expected to be derived from a property. A significant amount of judgment is involved in determining the presence of an indicator of impairment. If the total of the expected undiscounted future cash flows is less than the carrying amount of a property on our balance sheet, a loss is recognized for the difference between the fair value and carrying value of the property. The evaluation of anticipated cash flows requires a significant amount of judgment regarding assumptions that could differ materially from actual results in future periods, including assumptions regarding future occupancy, rental rates and capital requirements. Any impairment charge could have a material adverse effect on us.

Each of our properties is subject to real and personal property taxes, which could significantly increase our property taxes as a result of tax rate changes and reassessments and have a material adverse effect on us.

Each of our properties is subject to real and personal property taxes. These taxes may increase as tax rates change and as the properties are assessed or reassessed by taxing authorities. It is likely that the properties will be reassessed by taxing authorities as a result of (i) the acquisition of the properties by us and (ii) the informational returns that we must file in connection with the formation transactions. Any increase in property taxes on the properties could have a material adverse effect on us.

If California changes its property tax scheme, our California properties could be subject to significantly higher tax levies.

Owners of California property are subject to particularly high property taxes. Voters in the State of California previously passed Proposition 13, which generally limits annual real estate tax increases to 2% of assessed value per annum. From time to time, various groups have proposed repealing Proposition 13, or providing for modifications such as a “split roll tax,” whereby commercial property, for example, would be taxed at a higher rate than residential property. Given the uncertainty, it is not possible to quantify the risk to us of a tax increase or the resulting impact on us of any increase, but any tax increase could be significant at our California properties.

 

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Uninsured and underinsured losses could have a material adverse effect on us.

We carry comprehensive liability, fire, extended coverage, earthquake, business interruption and rental loss insurance with respect to our properties, and we plan to obtain similar coverage for properties we acquire in the future. However, certain types of losses, generally of a catastrophic nature, such as earthquakes and floods, may be either uninsurable or not economically insurable. Should a property sustain damage, we may incur losses due to insurance deductibles, to co-payments on insured losses or to uninsured losses. In the event of a substantial property loss, the insurance coverage may not be sufficient to pay the full current market value or current replacement cost of the property. Inflation, changes in building codes and ordinances, environmental considerations, and other factors also might make it infeasible to use insurance proceeds to replace a property after it has been damaged or destroyed. Under such circumstances, the insurance proceeds we receive might not be adequate to restore our economic position with respect to such property. Lenders may require such insurance and our failure to obtain such insurance may constitute default under loan agreements, which could have a material adverse effect on us. Finally, a disruption in the financial markets may make it more difficult to evaluate the stability, net assets and capitalization of insurance companies and any insurer’s ability to meet its claim payment obligations. A failure of an insurance company to make payments to us upon an event of loss covered by an insurance policy could have a material adverse effect on us. In the event of an uninsured or partially insured loss, we could lose some or all of our capital investment, cash flow and revenues related to one or more properties, which could also have a material adverse effect on us.

As the current or former owner or operator of real property, we could become subject to liability for environmental contamination, regardless of whether we caused such contamination, which could have a material adverse effect on us.

Under various federal, state and local statutes, regulations and ordinances relating to the protection of the environment, a current or former owner or operator of real property may be liable for the cost to remove or remediate contamination resulting from the presence or discharge of hazardous substances, wastes or petroleum products on, under, from or in such property. These costs could be substantial, liability under these laws may attach without regard to whether the owner or operator knew of, or was responsible for, the presence of the contaminants, and the liability may be joint and several. Some of our properties contain large underground or aboveground fuel storage tanks used to fuel generators for emergency power, which is critical to our operations. If any of the tanks that we own or operate releases fuel to the environment, we would likely have to pay to clean up the contamination. In addition, prior owners and operators have used our current properties for industrial and commercial purposes, which could have resulted in environmental contamination, including our Dallas and Richmond data center properties, which were previously used as semiconductor plants. Moreover, the presence of contamination or the failure to remediate contamination at our properties may (1) expose us to third-party liability, (2) subject our properties to liens in favor of the government for damages and costs the government incurs in connection with the contamination, (3) impose restrictions on the manner in which a property may be used or businesses may be operated, or (4) materially adversely affect our ability to sell, lease or develop the real estate or to borrow using the real estate as collateral. In addition, there may be material environmental liabilities at our properties of which we are not aware. We also may be liable for the costs of remediating contamination at off-site facilities at which we have arranged, or will arrange, for disposal or treatment of our hazardous substances without regard to whether we complied or will comply with environmental laws in doing so. Any of these matters could have a material adverse effect on us.

 

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We could become subject to liability for failure to comply with environmental, health and safety requirements or zoning laws, which could cause us to incur additional expenses.

Our properties are subject to federal, state and local environmental, health and safety laws and zoning requirements, including those regarding the handling of regulated substances and wastes, emissions to the environment and fire codes. For instance, our properties are subject to regulations regarding the storage of petroleum for auxiliary or emergency power and air emissions arising from the use of generators. In particular, generators at our data center facilities are subject to strict emissions limitations, which could preclude us from using critical back-up systems and lead to significant business disruptions at such facilities and loss of our reputation. If we exceed these emissions limits, we may be exposed to fines and/or other penalties. In addition, we lease some of our properties to our customers who also are subject to such environmental, health and safety laws and zoning requirements. If we, or our customers, fail to comply with these various laws and requirements, we might incur costs and liabilities, including governmental fines and penalties. Moreover, we do not know whether existing laws and requirements will change or, if they do, whether future laws and requirements will require us to make significant unanticipated expenditures that could have a material adverse effect on us. Environmental noncompliance liability also could affect a customer’s ability to make rental payments to us.

We could become subject to liability for asbestos-containing building materials in the buildings on our property, which could cause us to incur additional expenses.

Some of our properties may contain, or may have contained, asbestos-containing building materials. Environmental, health and safety laws require that owners or operators of or employers in buildings with asbestos-containing materials, or ACM, properly manage and maintain these materials, adequately inform or train those who may come into contact with ACM and undertake special precautions, including removal or other abatement, in the event that ACM is disturbed during building maintenance, renovation or demolition. These laws may impose fines and penalties on employers, building owners or operators for failure to comply with these laws. In addition, third parties may seek recovery from employers, owners or operators for personal injury associated with exposure to asbestos. If we become subject to any of these penalties or other liabilities as a result of ACM at one or more of our properties, it could have a material adverse effect on us.

Our properties may contain or develop harmful mold or suffer from other adverse conditions, which could lead to liability for adverse health effects and costs of remediation.

When excessive moisture accumulates in buildings or on building materials, mold growth may occur, particularly if the moisture problem remains undiscovered or is not addressed over a period of time. Some molds may produce airborne toxins or irritants. Indoor air quality issues also can stem from inadequate ventilation, chemical contamination from indoor or outdoor sources and other biological contaminants such as pollen, viruses and bacteria. Indoor exposure to airborne toxins or irritants above certain levels can cause a variety of adverse health effects and symptoms, including allergic or other reactions. As a result, the presence of significant mold or other airborne contaminants at any of our properties could require us to undertake a costly remediation program to contain or remove the mold or other airborne contaminants from the affected property or increase indoor ventilation. In addition, the presence of significant mold or other airborne contaminants could expose us to liability from our customers, employees of our customers and others if property damage or personal injury occurs. Thus, conditions related to mold or other airborne contaminants could have a material adverse effect on us.

Laws, regulations or other issues related to climate change could have a material adverse effect on us.

If we, or other companies with which we do business, particularly utilities that provide our facilities with electricity, become subject to laws or regulations related to climate change, it could have a

 

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material adverse effect on us. Congress is currently considering new laws, regulations and interpretations relating to climate change, including potential cap-and-trade systems, carbon taxes and other requirements relating to reduction of carbon footprints and/or greenhouse gas emissions. The federal government and some of the states and localities in which we operate have enacted certain climate change laws and regulations and/or have begun regulating carbon footprints and greenhouse gas emissions. Although these laws and regulations have not had any known material adverse effect on us to date, they could limit our ability to develop new facilities or result in substantial compliance costs, retrofit costs and construction costs, including monitoring and reporting costs and capital expenditures for environmental control facilities and other new equipment. Furthermore, our reputation could be damaged if we violate climate change laws or regulations. We cannot predict the impact of future laws and regulations, or future interpretations of current laws and regulations, related to climate change. Lastly, the potential physical impacts of climate change on our operations are highly uncertain, and would be particular to the geographic circumstances in areas in which we operate. These may include changes in rainfall and storm patterns and intensities, water shortages, changing sea levels and changing temperatures. Any of these matters could have a material adverse effect on us.

We are exposed to ongoing litigation and other legal and regulatory actions, which may divert management’s time and attention, require us to pay damages and expenses or restrict the operation of our business.

We are subject to the risk of legal claims and proceedings and regulatory enforcement actions in the ordinary course of our business and otherwise, and we could incur significant liabilities and substantial legal fees as a result of these actions. Our management may devote significant time and attention to the resolution (through litigation, settlement or otherwise) of these actions, which would detract from our management’s ability to focus on our business. Any such resolution could involve payment of damages or expenses by us, which may be significant. In addition, any such resolution could involve our agreement to terms that restrict the operation of our business. The results of legal proceedings cannot be predicted with certainty. We cannot guarantee losses incurred in connection with any current or future legal or regulatory proceedings or actions will not exceed any provisions we may have set aside in respect of such proceedings or actions or will not exceed any available insurance coverage. The occurrence of any of these events could have a material adverse effect on us.

We may incur significant costs complying with various federal, state and local regulations, which could have a material adverse effect on us.

The properties in our portfolio are subject to various federal, state and local regulations, including the Americans with Disabilities Act, or ADA, as well as state and local fire and life safety requirements. Under the ADA, all places of public accommodation must meet federal requirements related to access and use by disabled persons. A number of additional federal, state and local regulations may also require modifications to our properties, or restrict our ability to renovate our properties. If we fail to comply with these various requirements, we might incur governmental fines or private damage awards. We cannot predict the ultimate amount of the cost of compliance with the ADA or other legislation. In addition, we do not know whether existing requirements will change, or if they do, whether future requirements will require us to make significant unanticipated expenditures that could have a material adverse effect on us.

 

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Risks Related to Our Organizational Structure

We have no operating history as a public company, and our inexperience may impede our ability to successfully manage our business.

We have no operating history as a public company. As a result, we cannot assure you that our past experience will be sufficient to successfully operate our company as a public company. Although certain of our executive officers and directors have experience in the real estate industry, and Mr. Schafer, our Chief Financial Officer, was previously the Chief Financial Officer of a publicly traded REIT, we cannot assure you that our past experience will be sufficient to operate a business in accordance with the Code requirements for REIT qualification or in accordance with the requirements of the SEC and the NYSE for public companies. Upon completion of this offering, even though we will be an “emerging growth company” as defined in the JOBS Act, and therefore may take advantage of various exemptions to public reporting requirements, we will be required to develop and implement substantial control systems and procedures in order to qualify and maintain our qualification as a REIT, satisfy our periodic and current reporting requirements under applicable SEC regulations and comply with NYSE listing standards. As a result, we will incur significant legal, accounting and other expenses that we did not incur as a private company, and our management and other personnel will need to devote a substantial amount of time to comply with these rules and regulations and establish the corporate infrastructure and controls demanded of a publicly traded REIT. These expenses and time commitments could be substantially more than we currently expect. In addition, we may initially incur higher general and administrative expenses than our competitors that are managed by persons with experience operating a public company. If our finance and accounting organization is unable for any reason to respond adequately to the increased demands that will result from being a public company, the quality and timeliness of our financial reporting may suffer and we could experience significant deficiencies or material weaknesses in our disclosure controls and procedures and our internal control over financial reporting.

We have identified two significant deficiencies, as defined in the U.S. Public Company Accounting Oversight Board Standard AU Section 325, related to our internal control over financial reporting. One significant deficiency relates to IT controls over how program changes are migrated from testing to the actual environment and logical access. The other significant deficiency relates to our cost capitalization of development and specifically how we track our data regarding such development. Following the identification of these significant deficiencies, we have taken measures which we believe will remediate the significant deficiencies. However, the implementation of these measures may not fully address the significant deficiencies, and we cannot yet conclude that they have been fully remedied, nor can we assure you that there will be no significant deficiencies, or even material weaknesses, discovered in the future.

An inability to establish effective disclosure controls and procedures and internal control over financial reporting could cause us to fail to meet our reporting obligations under Exchange Act on a timely basis or result in material misstatements or omissions in our Exchange Act reports (including our financial statements), either of which, as well as the perception thereof, could cause investors to lose confidence in our company and could have a material adverse effect on us and cause the market price of our common stock to decline significantly. As a result of the foregoing, we cannot assure you that we will be able to execute our business and growth strategies as a publicly traded REIT.

Upon completion of this offering and our formation transactions, Chad L. Williams and General Atlantic will own approximately     % and     % of our outstanding common stock on a fully diluted basis, respectively, and will have the ability to exercise significant influence on our company and any matter presented to our stockholders.

Upon completion of this offering, Chad L. Williams, our Chairman and Chief Executive Officer, and General Atlantic will own approximately     % and     %, respectively, of our outstanding common

 

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stock on a fully diluted basis. No other stockholder is permitted to own more than     % of the aggregate of the outstanding shares of our common stock, except for certain designated investment entities that may own up to 9.8% of the aggregate of the outstanding shares of our common stock, subject to certain conditions, and except as approved by our board of directors pursuant to the terms of our charter. Consequently, Mr. Williams and General Atlantic may be able to significantly influence the outcome of matters submitted for stockholder action, including the election of our board of directors and approval of significant corporate transactions, such as business combinations, consolidations and mergers, as well as the determination of our day-to-day business decisions and management policies. In addition, General Atlantic and its affiliates may have an interest in directly or indirectly pursuing acquisitions, divestitures, financings or other transactions that, in their judgment, could enhance their other equity investments, even though such transactions might involve risks to us. As a result, Mr. Williams and General Atlantic could exercise their influence on us in a manner that conflicts with the interests of other stockholders. Moreover, if Mr. Williams and/or General Atlantic were to sell, or otherwise transfer, all or a large percentage of their holdings, the market price of our common stock could decline and we could find it difficult to raise the capital necessary for us to execute our business and growth strategies.

In addition to the foregoing, Mr. Williams will have a significant vote in matters submitted to a vote of stockholders as a result of his ownership of Class B common stock (which gives Mr. Williams voting power equal to his fully diluted economic interest in us), including the election of directors. Mr. Williams may have interests that differ from holders of our Class A common stock, including by reason of his remaining interest in our operating partnership, and may accordingly vote in ways that may not be consistent with the interests of holders of Class A common stock.

Our tax protection agreement, during its term, could limit our ability to sell or otherwise dispose of certain properties and may require our operating partnership to maintain certain debt levels that otherwise would not be required to operate our business.

In connection with this offering and the formation transactions, we will enter into a tax protection agreement with Chad L. Williams, our Chairman and Chief Executive Officer, and his affiliates and family members who own OP units that provides that if (1) we sell, exchange, transfer, convey or otherwise dispose of our Atlanta Metro, Suwanee or Santa Clara data centers in a taxable transaction prior to January 1, 2026, referred to as the protected period, (2) cause or permit any transaction that results in the disposition by Mr. Williams or his affiliates and family members who own OP units of all or any portion of their interests in the operating partnership in a taxable transaction during the protected period or (3) fail prior to the expiration of the protected period to maintain approximately $150 million of indebtedness that would be allocable to Mr. Williams and his affiliates for tax purposes or, alternatively, fail to offer Mr. Williams and his affiliates and family members who own OP units the opportunity to guarantee specific types of the operating partnership’s indebtedness in order to enable them to continue to defer certain tax liabilities, we will indemnify Mr. Williams and his affiliates and family members who own OP units against certain resulting tax liabilities. Therefore, although it may be in our stockholders’ best interest that we sell, exchange, transfer, convey or otherwise dispose of one of these properties, it may be economically prohibitive for us to do so during the protected period because of these indemnity obligations. Moreover, these obligations may require us to maintain more or different indebtedness than we would otherwise require for our business. As a result, the tax protection agreement will, during its term, restrict our ability to take actions or make decisions that otherwise would be in our best interests. As of June 30, 2013, our Atlanta Metro, Suwanee and Santa Clara data centers represented approximately 76% of our annualized rent.

 

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Our charter and Maryland law contain provisions that may delay, defer or prevent a change in control of our company, even if such a change in control may be in your interest, and as a result may depress our common stock price.

The Stock Ownership Limit Imposed by the Code for REITs and Imposed by our Charter May Restrict our Business Combination Opportunities that Might Involve a Premium Price for Shares of Our Common Stock or Otherwise be in the Best Interest of Our Stockholders.    In order for us to maintain our qualification as a REIT under the Code, not more than 50% in value of our outstanding stock may be owned, directly or indirectly, by five or fewer individuals (defined in the Code to include certain entities) at any time during the last half of each taxable year following our first year. Our charter, with certain exceptions, authorizes our board of directors to take the actions that are necessary and desirable to preserve our qualification as a REIT. Unless exempted by our board of directors, no person may actually or constructively own more than     % of the aggregate of the outstanding shares of our common stock by value or by number of shares, whichever is more restrictive, or    % of the aggregate of the outstanding shares of our preferred stock by value or by number of shares, whichever is more restrictive. However, certain entities that are defined as designated investment entities in our charter, which generally includes pension funds, mutual funds and certain investment management companies, are permitted to own up to 9.8% of the aggregate of the outstanding shares of our common stock or preferred stock, so long as each beneficial owner of the shares owned by such designated investment entity would satisfy the    % ownership limit if those beneficial owners owned directly their proportionate share of the common stock owned by the designated investment entity.

In addition, our charter provides an excepted holder limit that allows Chad L. Williams, his family members and entities owned by or for the benefit of them, and any person who is or would be a beneficial owner or constructive owner of shares of our common stock as a result of the beneficial ownership or constructive ownership of shares of our common stock by Chad L. Williams, his family members and certain entities controlled by them, as a group, to own more than    % of the aggregate of the outstanding shares of our common stock, so long as, under the applicable tax attribution rules, no one such excepted holder treated as an individual would hold more than    % of the aggregate of the outstanding shares of our common stock, no two such excepted holders treated as individuals would own more than    % of the aggregate of the outstanding shares of our common stock, no three such excepted holders treated as individuals would own more than    % of the aggregate of the outstanding shares of our common stock, no four such excepted holders treated as individuals would own more than    % of the aggregate of the outstanding shares of our common stock and no five such excepted holders treated as individuals would own more than    % of the aggregate of the outstanding shares of our common stock. Currently, Chad L. Williams would be attributed all of the shares of common stock owned by each such other excepted holder and, accordingly, the Williams excepted holders as a group would not be allowed to own in excess of    % of the aggregate of the outstanding shares of our common stock. If at a later time, there were not one excepted holder that would be attributed all of the shares owned by such excepted holders as a group, the excepted holder limit as applied to the Williams group would not permit each such excepted holder to own    % of the aggregate of the outstanding shares of our common stock. Rather, the excepted holder limit as applied to the Williams group would prevent two or more such excepted holders who are treated as individuals under the applicable tax attribution rules from owning a higher percentage of our common stock than the maximum amount of shares that could be owned by any one such excepted holder (    %), plus the maximum amount of shares of common stock that could be owned by any one or more other individual common stockholders who are not excepted holders (    %).

Our charter also provides an excepted holder limit that allows General Atlantic, and any person who is or would be a beneficial owner or constructive owner of shares of our common stock as a result of the beneficial ownership or constructive ownership of shares of our common stock by General

 

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Atlantic, as a group, to own more than    % of the aggregate of the outstanding shares of our common stock, so long as, under the applicable tax attribution rules, no one such excepted holder treated as an individual would hold more than    % of the aggregate of the outstanding shares of our common stock, no two such excepted holders treated as individuals would own more than    % of the aggregate of the outstanding shares of our common stock, no three such excepted holders treated as individuals would own more than    % of the aggregate of the outstanding shares of our common stock, no four such excepted holders treated as individuals would own more than    % of the aggregate of the outstanding shares of our common stock, and no five such excepted holders treated as individuals would own more than    % of the aggregate of the outstanding shares of our common stock. Currently, there are more than five excepted holders who would be attributed all of the shares of common stock owned by General Atlantic. Therefore, the excepted holder limit as applied to the General Atlantic group would prevent five such excepted holders who are treated as individuals under the applicable tax attribution rules from owning a higher percentage of our common stock than the maximum amount of shares that could be owned by any one such excepted holder (    %), plus the maximum amount of shares that could be owned by any four other individual stockholders who are not excepted holders (    %).

Our board of directors may, in its sole discretion, grant other exemptions to the stock ownership limits, subject to such conditions and the receipt by our board of directors of certain representations and undertakings. We also intend to grant General Atlantic an exception from our ownership limit prior to or simultaneously with completion of this offering. In addition to these ownership limits, our charter also prohibits any person from (a) beneficially or constructively owning, as determined by applying certain attribution rules of the Code, our stock that would result in us being “closely held” under Section 856(h) of the Code or that would otherwise cause us to fail to qualify as a REIT, (b) transferring stock if such transfer would result in our stock being owned by fewer than 100 persons, (c) beneficially or constructively owning shares of our capital stock that would result in us owning (directly or indirectly) an interest in a tenant if the income derived by us from that tenant for our taxable year during which such determination is being made would reasonably be expected to equal or exceed the lesser of one percent of our gross income or an amount that would cause us to fail to satisfy any of the REIT gross income requirements and (d) beneficially or constructively owning shares of our capital stock that would cause us otherwise to fail to qualify as a REIT. The ownership limits imposed under the Code are based upon direct or indirect ownership by “individuals,” but only during the last half of a tax year. The ownership limits contained in our charter key off of the ownership at any time by any “person,” which term includes entities. These ownership limitations in our charter are common in REIT charters and are intended to provide added assurance of compliance with the tax law requirements, and to minimize administrative burdens. However, the ownership limits on our common stock also might delay, defer or prevent a transaction or a change in control of our company that might involve a premium price for shares of our common stock or otherwise be in the best interest of our stockholders.

Our Authorized but Unissued Shares of Common and Preferred Stock May Prevent a Change in Control of Our Company that Might Involve a Premium Price for Shares of Our Common Stock or Otherwise be in the Best Interest of Our Stockholders.    Our charter authorizes us to issue additional shares of common and preferred stock. In addition, our board of directors may, without stockholder approval, amend our charter to increase the aggregate number of shares of our common stock or the number of shares of stock of any class or series that we have authority to issue and classify or reclassify any unissued shares of common or preferred stock and set the preferences, rights and other terms of the classified or reclassified shares; provided that our board of directors may not amend our charter to increase the aggregate number of shares of Class B common stock that we have the authority to issue or reclassify any shares of our capital stock as Class B common stock without stockholder approval. As a result, our board of directors may establish a series of shares of common or preferred stock that could delay, defer or prevent a transaction or a change in control of our company that might involve a premium price for shares of our common stock or otherwise be in the best interest of our stockholders. In addition, any preferred stock that we issue would rank senior to our

 

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common stock with respect to the payment of distributions and other amounts (including upon liquidation), in which case we could not pay any distributions on our common stock until full distributions have been paid with respect to such preferred stock.

Certain Provisions of Maryland Law Could Inhibit a Change in Control of Our Company.    Certain provisions of the Maryland General Corporation Law, or the MGCL, may have the effect of deterring a third party from making a proposal to acquire us or of impeding a change in control under circumstances that otherwise could provide the holders of our common stock with the opportunity to realize a premium over the then-prevailing market price of our common stock. Our board of directors may elect to become subject to the “business combination” provisions of the MGCL that, subject to limitations, prohibit certain business combinations (including a merger, consolidation, share exchange, or, in circumstances specified in the statute, an asset transfer or issuance or reclassification of equity securities) between us and an “interested stockholder” (defined generally as any person who beneficially owns 10% or more of our thenoutstanding voting capital stock or an affiliate or associate of ours who, at any time within the two-year period prior to the date in question, was the beneficial owner of 10% or more of our then-outstanding voting capital stock) or an affiliate thereof for five years after the most recent date on which the stockholder becomes an interested stockholder. After the five-year prohibition, any business combination between us and an interested stockholder generally must be recommended by our board of directors and approved by the affirmative vote of at least (1) 80% of the votes entitled to be cast by holders of outstanding shares of our voting capital stock; and (2) two-thirds of the votes entitled to be cast by holders of voting capital stock of the corporation other than shares held by the interested stockholder with whom or with whose affiliate the business combination is to be effected or held by an affiliate or associate of the interested stockholder. These super-majority vote requirements do not apply if our common stockholders receive a minimum price, as defined under Maryland law, for their shares in the form of cash or other consideration in the same form as previously paid by the interested stockholder for its shares. These provisions of the MGCL do not apply, however, to business combinations that are approved or exempted by a board of directors prior to the time that the interested stockholder becomes an interested stockholder. Pursuant to the statute, our board of directors has by resolution opted out of the business combination provisions of the MGCL and, consequently, the five-year prohibition and the supermajority vote requirements will not apply to business combinations between us and an interested stockholder, unless our board in the future alters or repeals this resolution. We cannot assure that you that our board of directors will not determine to become subject to such business combination provisions in the future. However, an alteration or repeal of this resolution will not have any effect on any business combinations that have been consummated or upon any agreements existing at the time of such modification or repeal.

The “control share” provisions of the MGCL provide that “control shares” of a Maryland corporation (defined as shares which, when aggregated with other shares controlled by the stockholder (except solely by virtue of a revocable proxy), entitle the stockholder to exercise one of three increasing ranges of voting power in electing directors) acquired in a “control share acquisition” (defined as the direct or indirect acquisition of ownership or control of issued and outstanding “control shares”) have no voting rights except to the extent approved by our stockholders by the affirmative vote of at least two-thirds of all the votes entitled to be cast on the matter, excluding votes entitled to be cast by the acquirer of control shares, our officers and our personnel who are also our directors. Our bylaws contain a provision exempting from the control share acquisition statute any and all acquisitions by any person of shares of our stock. There can be no assurance that this provision will not be amended or eliminated at any time in the future.

Certain provisions of the MGCL permit our board of directors, without stockholder approval and regardless of what is currently provided in our charter or bylaws, to adopt certain provisions, some of which (for example, a classified board) we do not yet have, that may have the effect of limiting or precluding a third party from making an acquisition proposal for us or of delaying, deferring or

 

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preventing a change in control of our company under circumstances that otherwise could provide the holders of shares of our common stock with the opportunity to realize a premium over the then current market price. For example, our charter contains a provision whereby we elect, at such time as we become eligible to do so, to be subject to the provisions of Title 3, Subtitle 8 of the MGCL relating to the filling of vacancies on our board of directors. See “Material Provisions of Maryland Law and of Our Charter and Bylaws.”

Certain Provisions in the Partnership Agreement of Our Operating Partnership May Delay, Defer or Prevent Unsolicited Acquisitions of us or Changes in Our Control.    Provisions in the partnership agreement of our operating partnership may delay, defer or prevent unsolicited acquisitions of us or changes in our control. These provisions include, among others:

 

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redemption rights of qualifying parties;

 

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a requirement that we may not be removed as the general partner of the operating partnership without our consent;

 

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transfer restrictions on our OP units;

 

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our ability, as general partner, in some cases, to amend the partnership agreement without the consent of the limited partners; and

 

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the right of the limited partners to consent to transfers of the general partnership interest and mergers under specified circumstances.

These provisions could discourage third parties from making proposals involving an unsolicited acquisition of us or change of our control, although some stockholders might consider such proposals, if made, desirable.

Our charter and bylaws, the partnership agreement of our operating partnership and Maryland law also contain other provisions that may delay, defer or prevent a transaction or a change in control of our company that might involve a premium price for our common stock or that our stockholders otherwise believe to be in their best interests. See “Description of the Partnership Agreement of QualityTech, LP—Transfers” and “Material Provisions of Maryland Law and of Our Charter and Bylaws—Removal of Directors,” “—Control Share Acquisitions,” “—Advance Notice of Director Nominations and New Business.”

Our Chairman and Chief Executive Officer has Outside Business Interests that Could Require Time and Attention and May Interfere with his Ability to Devote Time to our Business.

Chad L. Williams, our Chairman and Chief Executive Officer, has outside business interests that are not being contributed to our company which could require his time and attention. These interests include the ownership of our Overland Park, Kansas facility, at which our corporate headquarters is also located (which is leased to us), and certain office and other properties and certain other non-real estate business ventures. Mr. Williams’ employment agreement requires that he devote substantially all of his time to our company, provided that he will be permitted to engage in other specified activities, including the management of personal investments and affairs, including active involvement in real estate or other investments not involving data centers in any material respect. Mr. Williams may also have fiduciary obligations associated with these business interests that interfere with his ability to devote time to our business and that could have a material adverse effect on us.

We are a holding company with no direct operations and will rely on distributions received from our operating partnership to make distributions to our stockholders.

We are a holding company and conduct all of our operations through our operating partnership. We do not have, apart from our general and limited partnership interest in the operating partnership,

 

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any independent operations. As a result, we will rely on distributions from our operating partnership to make any distributions to our stockholders we might declare on our common stock and to meet any of our obligations, including tax liability on taxable income allocated to us from our operating partnership (which might not make distributions to our company equal to the tax on such allocated taxable income). The ability of subsidiaries of the operating partnership to make distributions to the operating partnership, and the ability of our operating partnership to make distributions to us in turn, will depend on their operating results and on the terms of any financing arrangements they have entered into. Such financing arrangements may contain lockbox arrangements, reserve requirements, covenants and other provisions that prohibit or otherwise restrict the distribution of funds, including upon default thereunder. In addition, because we are a holding company, your claims as common stockholders of our company will be structurally subordinated to all existing and future liabilities and other obligations (whether or not for borrowed money) and any preferred equity of our operating partnership and its subsidiaries. Therefore, in the event of our bankruptcy, liquidation or reorganization, our assets and those of our operating partnership and its subsidiaries will be able to satisfy the claims of our common stockholders only after all of our and our operating partnership’s and its subsidiaries’ liabilities and other obligations and any preferred equity have been paid in full.

After giving effect to this offering, we will own approximately    % of limited partnership interests in our operating partnership (    % of the interests, if the underwriters’ option to purchase additional shares is exercised in full). Our operating partnership may, in connection with our acquisition of additional properties or otherwise, issue additional OP units to third parties. Such issuances would reduce our ownership in our operating partnership. Because you will not directly own OP units, you will not have any voting rights with respect to any such issuances or other partnership level activities of the operating partnership.

Our formation transactions were not negotiated in arm’s length transactions, and the value received by GA REIT and Mr. Williams as a result of the formation transactions and this offering may exceed the fair market value of the assets they originally contributed to our operating partnership.

The value received by GA REIT and Chad L. Williams as a result of the formation transactions and this offering, and the percentage of our company that they will own following the completion of this offering, was not negotiated on an arm’s length basis. Further, the value of their interests in us will increase or decrease if the market price of our common stock increases or decreases. Therefore, the value of the interests that GA REIT and Mr. Williams will own in our company may exceed the fair market value of the assets they originally contributed to our operating partnership.

Conflicts of interest exist or could arise in the future with holders of OP units, which may impede business decisions that could benefit our stockholders.

Conflicts of interest exist or could arise in the future as a result of the relationships between us and our affiliates, on the one hand, and our operating partnership or any partner thereof, on the other. Our directors and officers have duties to our company and our stockholders under applicable Maryland law in connection with their management of our company. At the same time, we, as general partner, have fiduciary duties to our operating partnership and to its limited partners under Maryland law in connection with the management of our operating partnership. Our duties as general partner to our operating partnership and its partners may come into conflict with the duties of our directors and officers to our company and our stockholders. These conflicts may be resolved in a manner that is not in the best interest of our stockholders.

Additionally, the partnership agreement expressly limits our liability by providing that we and our officers, directors, agents and employees will not be liable or accountable to our operating partnership

 

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for losses sustained, liabilities incurred or benefits not derived if we or such officer, director, agent or employee acted in good faith. In addition, our operating partnership is required to indemnify us, and our officers, directors, agents, employees and designees to the extent permitted by applicable law from and against any and all claims arising from operations of our operating partnership, unless it is established that (1) the act or omission was committed in bad faith, was fraudulent or was the result of active and deliberate dishonesty, (2) the indemnified party received an improper personal benefit in money, property or services or (3) in the case of a criminal proceeding, the indemnified person had reasonable cause to believe that the act or omission was unlawful. The provisions of Maryland law that allow the fiduciary duties of a general partner to be modified by a partnership agreement have not been resolved in a court of law, and we have not obtained an opinion of counsel covering the provisions set forth in the partnership agreement that purport to waive or restrict our fiduciary duties that would be in effect were it not for the partnership agreement.

Our rights and the rights of our stockholders to take action against our directors and officers are limited, which could limit our stockholders’ recourse in the event of actions not in our stockholders’ best interests.

Under Maryland law generally, a director is required to perform his or her duties in good faith, in a manner he or she reasonably believes to be in the best interests of our company and with the care that an ordinarily prudent person in a like position would use under similar circumstances. Under Maryland law, directors are presumed to have acted with this standard of care. In addition, our charter limits the liability of our directors and officers to us and our stockholders for money damages, except for liability resulting from:

 

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actual receipt of an improper benefit or profit in money, property or services; or

 

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active and deliberate dishonesty by the director or officer that was established by a final judgment as being material to the cause of action adjudicated.

Our charter obligates us to indemnify our directors and officers for actions taken by them in those capacities to the maximum extent permitted by Maryland law. Our bylaws require us to indemnify each director or officer, to the maximum extent permitted by Maryland law, in the defense of any proceeding to which he or she is made, or threatened to be made, a party by reason of his or her service to us. In addition, we may be obligated to advance the defense costs incurred by our directors and officers. As a result, we and our stockholders may have more limited rights against our directors and officers than might otherwise exist absent the current provisions in our charter and bylaws or that might exist with other companies.

Our board of directors may change our policies and practices and enter into new lines of business without a vote of our stockholders, which limits your control of our policies and practices and could have a material adverse effect on us.

Our major policies, including our policies and practices with respect to investments, financing, growth and capitalization, are determined by our board of directors. We may change these and other policies from time to time or enter into new lines of business, at any time, without the consent of our stockholders. Accordingly, our stockholders will have limited control over changes in our policies. These changes could result in our making investments and engaging in business activities that are different from, and possibly riskier than, the investments and business activities described in this prospectus. A change in our policies and procedures or our entry into new lines of business may increase our exposure to other risks or real estate market fluctuations and could have a material adverse effect on us.

 

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Risks Related to this Offering

Following the repayment of certain indebtedness with the net proceeds of this offering, management will have broad discretion in the application of any remaining net proceeds, and we may not use the proceeds effectively.

The net proceeds of this offering will be used to repay the promissory note secured by our Dallas facility and certain amounts outstanding under our unsecured revolving credit facility, and any remaining net proceeds may be used for other purposes, including to fund ongoing development costs and future acquisitions. We have not identified specific acquisitions for which we may use the remaining balance of the net proceeds of this offering. While we expect to apply any remaining net proceeds in a manner consistent with our business plan and acquisition strategies, we may not be able to identify, acquire, and successfully manage or otherwise exploit new investment opportunities, and we cannot assure you that the net proceeds so applied will result in any improvement in our business. Therefore, you will be unable to evaluate the allocation of this portion of the net proceeds from this offering or the economic merits of any redevelopment projects, acquisitions or other uses of such proceeds before making an investment decision to purchase our common stock.

Our cash available for distribution to stockholders may not be sufficient to pay distributions at expected or REIT-required levels, or at all, and we may need to borrow or rely on other third-party capital in order to make such distributions, as to which no assurance can be given, which could cause the market price of our common stock to decline significantly.

We intend to pay regular quarterly distributions to our stockholders and have targeted an initial distribution rate based upon our estimate of our annualized cash flow that will be available for distribution. No assurance can be given that our estimated cash available for distribution to our stockholders will be accurate or that our actual cash available for distribution to our stockholders will be sufficient to pay distributions to them at any expected or REIT-required level or at any particular yield, or at all. Accordingly, we may need to borrow or rely on other third-party capital to make distributions to our stockholders, and such third-party capital may not be available to us on favorable terms or at all. As a result, we may not be able to pay distributions to our stockholders in the future. Our failure to pay any such distributions or to pay distributions that fail to meet our stockholders’ expectations from time to time or the distribution requirements for a REIT could cause the market price of our common stock to decline significantly. All distributions will be made at the discretion of our board of directors and will depend on our historical and projected results of operations, liquidity and financial condition, our REIT qualification, our debt service requirements, operating expenses and capital expenditures, prohibitions and other restrictions under financing arrangements and applicable law and other factors as our board of directors may deem relevant from time to time. In addition, we may pay distributions some or all of which may constitute a return of capital. To the extent that we decide to make distributions in excess of our current and accumulated earnings and profits, such distributions would generally be considered a return of capital for federal income tax purposes to the extent of the holder’s adjusted tax basis in its shares. A return of capital is not taxable, but it has the effect of reducing the holder’s adjusted tax basis in its investment. To the extent that distributions exceed the adjusted tax basis of a holder’s shares, they will be treated as gain from the sale or exchange of such shares. See “U.S. Federal Income Tax Considerations—Taxation of Holders of Stock.” If we borrow to fund distributions, our future interest costs would increase, thereby reducing our earnings and cash available for distribution from what they otherwise would have been.

Future issuances or sales of our common stock, or the perception of the possibility of such issuances or sales, may depress the market price of our common stock.

We cannot predict the effect, if any, of our future issuances or sales of our common stock or OP units, or future resales of our common stock or OP units by existing holders, or the perception of such

 

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issuances, sales or resales, on the market price of our common stock. Any such future issuances, sales or resales, or the perception that such issuances, sales or resales might occur, could depress the market price of our common stock and also may make it more difficult and costly for us to sell equity or equity-related securities in the future at a time and upon terms that we deem desirable.

Upon completion of this offering, we will have             shares of our Class A common stock outstanding. In addition, upon the completion of this offering, we will have             shares of our Class B common stock and OP units outstanding (each of which may, and in certain cases must, exchange into shares of Class A common stock on a one-for-one basis). Subject to applicable law, our board of directors has the authority, without further stockholder approval, to issue additional shares of common stock and preferred stock on the terms and for the consideration it deems appropriate.

We and our officers and directors and the Selling Stockholder have agreed with the underwriters, subject to certain exceptions, not to dispose of or hedge any shares of our common stock or securities convertible into or exchangeable or exercisable for shares of our Class A common stock (including Class B common stock and OP units) during the period from the date of this prospectus continuing through the date 180 days after the date of this prospectus, except with the prior written consent of the representatives. If the restrictions under the lock-up arrangements expire or are waived, the related shares of common stock will be available for sale or resale, as the case may be, and such sales or resales, or the perception of such sales or resales, could depress the market price for our common stock. Accordingly, you should not rely upon such lock-up agreements to limit the number of shares of our common stock sold into the market.

In addition to the restricted stock granted to our directors, executive officers and other employees under our equity incentive plan in connection with this offering, in the future we may issue shares of our common stock and securities convertible into, or exchangeable or exercisable for, our common stock under our equity incentive plan. We intend to file with the SEC a registration statement on Form S-8 covering the common stock issuable under our equity incentive plan. Shares of our common stock covered by such registration statement will be eligible for transfer or resale without restriction under the Securities Act, unless held by affiliates. We also may issue from time to time additional shares of our common stock or OP units in connection with acquisitions and may grant registration rights in connection with such issuances pursuant to which we would agree to register the resale of such securities under the Securities Act. In addition, we have granted registration rights to General Atlantic, Chad L. Williams, our Chairman and Chief Executive Officer, and others with respect to shares of common stock owned by them or to be received by them in connection with our formation transactions or upon redemption of OP units held by them. The market price of our common stock may decline significantly upon the registration of additional shares of our common stock pursuant to registration rights granted in our formation transactions, see “Certain Relationships and Related Party Transactions—Registration Rights” or future issuances of equity in connection with acquisitions or our equity incentive plan.

Future issuances of debt securities, which would rank senior to our common stock upon our liquidation, and future issuances of equity securities (including OP units), which would dilute the holdings of our existing common stockholders and may be senior to our common stock for the purposes of making distributions, periodically or upon liquidation, may negatively affect the market price of our common stock.

In the future, we may issue debt or equity securities or incur other borrowings. Upon our liquidation, holders of our debt securities and other loans and preferred stock will receive a distribution of our available assets before common stockholders. If we incur debt in the future, our future interest costs could increase and adversely affect our results of operations and liquidity.

 

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We are not required to offer any additional equity securities to existing common stockholders on a preemptive basis. Therefore, additional common stock issuances, directly or through convertible or exchangeable securities (including OP units), warrants or options, will dilute the holdings of our existing common stockholders and such issuances, or the perception of such issuances, may reduce the market price of our common stock. Our preferred stock, if issued, would likely have a preference on distribution payments, periodically or upon liquidation, which could eliminate or otherwise limit our ability to make distributions to common stockholders. Because our decision to issue debt or equity securities or incur other borrowings in the future will depend on market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing, nature or success of our future capital-raising efforts. Thus, common stockholders bear the risk that our future issuances of debt or equity securities or our incurrence of other borrowings will negatively affect the market price of our common stock.

We are an “emerging growth company,” and we cannot be certain if the reduced reporting requirements applicable to emerging growth companies will make our common stock less attractive to investors.

We are an “emerging growth company” as defined in the JOBS Act. We will remain an “emerging growth company” until the earliest to occur of (i) the last day of the fiscal year during which our total annual revenue equals or exceeds $1 billion (subject to adjustment for inflation), (ii) the last day of the fiscal year following the fifth anniversary of this offering, (iii) the date on which we have, during the previous three-year period, issued more than $1 billion in non-convertible debt or (iv) the date on which we are deemed to be a “large accelerated filer” under the Exchange Act. We may take advantage of exemptions from various reporting requirements that are applicable to other public companies that are not emerging growth companies, including, but not limited to, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and stockholder approval of any golden parachute payments not previously approved. We cannot predict if investors will find our common stock less attractive because we may rely on these exemptions and benefits under the JOBS Act. If some investors find our common stock less attractive as a result, there may be a less active trading market for our common stock and the market price of our common stock may be more volatile and decline significantly.

If you purchase common stock in this offering, you will experience immediate and substantial dilution.

We expect the initial public offering price of our common stock to be higher than the pro forma net tangible book value per share of our outstanding common stock. Accordingly, if you purchase common stock in this offering, you will experience immediate dilution of approximately $         in the pro forma net tangible book value per share of common stock. This means that investors who purchase common stock in this offering will pay a price per share that exceeds the per share pro forma book value of our tangible assets after subtracting our liabilities.

There is currently no public market for our common stock and an active trading market for our common stock may never develop or, if one develops, be sustained following this offering.

Prior to this offering, there has not been a public market for our common stock. An active trading market for our common stock may never develop or, if one develops, be sustained, which may adversely affect your ability to sell your common stock at the timing and price desired and could depress the market price of your common stock. In addition, the initial public offering price will be determined through negotiations between us and the representatives of the underwriters and, accordingly, the market price of our common stock after this offering may trade below the initial public offering price in this offering.

 

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The trading volume and market price of our common stock may be volatile and could decline significantly following this offering.

Even if an active trading market develops and is sustained for our common stock, the market price of our common stock may be volatile. The stock markets, including the NYSE, on which we expect to list our common stock, have experienced significant price and volume fluctuations. As a result, the market price of our common stock is likely to be similarly volatile, and could decline significantly after this offering, unrelated to our operating performance or prospects. The market price of our common stock could be subject to wide fluctuations in response to a number of factors, including those listed in this “Risk Factors” section of this prospectus and others such as:

 

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our operating performance and prospects and those of other similar companies;

 

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actual or anticipated variations in our financial condition, liquidity, results of operations, FFO, NOI, EBITDA or MRR in the amount of distributions, if any, paid to our stockholders;

 

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changes in our estimates or those of securities analysts relating to our earnings or other operating metrics;

 

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publication of research reports about us, our significant customers, our competition, data center companies generally, the real estate industry or the technology industry;

 

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additions or departures of key personnel;

 

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the passage of legislation or other regulatory developments that adversely affect us or our industry;

 

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changes in market valuations of similar companies;

 

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adverse market reaction to leverage we may incur or equity we may issue in the future;

 

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actions by institutional stockholders;

 

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actual or perceived accounting issues, including changes in accounting principles;

 

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compliance with NYSE requirements;

 

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our qualification and maintenance as a REIT;

 

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terrorist acts;

 

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speculation in the press or investment community;

 

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the realization of any of the other risk factors presented in this prospectus;

 

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adverse developments in the creditworthiness, business or prospects of one or more of our significant customers; and

 

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general market and economic conditions.

In the past, securities class action litigation has often been instituted against companies following periods of volatility in the market price of their common stock. This type of litigation, if brought against us, could result in substantial costs and divert our management’s attention and resources, which could have a material adverse effect on us.

Increases in market interest rates may cause prospective purchasers to seek higher distribution yields and therefore reduce demand for our common stock and result in a decline in the market price of our common stock.

The price of our common stock may be influenced by our distribution yield (i.e., the amount of our annual or annualized distributions, if any, as a percentage of the market price of our common stock)

 

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relative to market interest rates. An increase in market interest rates, which are currently low relative to historical levels, may lead prospective purchasers and holders of our common stock to expect a higher distribution yield, which we may not be able, or may choose not, to satisfy. As a result, prospective purchasers may decide to purchase other securities rather than our common stock, which would reduce the demand for our common stock, and existing holders of our common stock may decide to sell their shares, either of which could result in a decline in the market price of our common stock.

Affiliates of our underwriters may receive benefits in connection with this offering that create potential conflicts of interest.

Affiliates of each of the underwriters of this offering are lenders under our unsecured credit facility. To the extent that our operating partnership uses a portion of the net proceeds received by us from this offering to repay borrowings outstanding under our unsecured credit facility, such affiliates of our underwriters will receive their proportionate shares of any amount of our unsecured credit facility that is repaid with the net proceeds received by us from this offering. These transactions create potential conflicts of interest because the underwriters have an interest in the successful completion of this offering beyond the underwriting discounts and commissions they will receive. These interests may influence the decision regarding the terms and circumstances under which the offering is completed.

Risks Related to Our Status as a REIT

If we do not qualify as a REIT, or fail to remain qualified as a REIT, we will be subject to federal income tax as a regular corporation and could face significant tax liability, which would reduce the amount of cash available for distribution to our stockholders and could have a material adverse effect on us.

We intend to operate in a manner that will allow us to qualify as a REIT for federal income tax purposes under the Code commencing with our taxable year ending December 31, 2013. We have received an opinion of our special REIT tax counsel, Hogan Lovells, with respect to our qualification as a REIT in connection with this offering of common stock. Investors should be aware, however, that opinions of counsel are not binding on the Internal Revenue Service, or IRS, or any court. The opinion of Hogan Lovells represents only the view of Hogan Lovells based on its review and analysis of existing law and on certain representations as to factual matters and covenants made by us, including representations relating to the values of our assets and the sources of our income. The opinion is expressed as of the date issued. Hogan Lovells will have no obligation to advise us or the holders of our common stock of any subsequent change in the matters stated, represented or assumed or of any subsequent change in applicable law. Furthermore, both the validity of the opinion of Hogan Lovells and our qualification as a REIT will depend on our satisfaction of certain asset, income, organizational, distribution, stockholder ownership and other requirements on a continuing basis, the results of which will not be monitored by Hogan Lovells. Our ability to satisfy the asset tests depends upon our analysis of the characterization and fair market values of our assets, some of which are not susceptible to a precise determination, and for which we will not obtain independent appraisals.

Although we have requested a private letter ruling from the IRS, in respect of certain limited matters, as further described below under “U.S. Federal Income Tax Considerations,” we have not requested and do not plan to request a ruling from the IRS, that we qualify as a REIT, and the statements in this prospectus are not binding on the IRS, or any court. If we lose our REIT status, we will face serious tax consequences that would substantially reduce our cash available for distribution to our stockholders and our business operations in general for each of the years involved because:

 

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we would not be allowed a deduction for distributions to stockholders in computing our taxable income and would be subject to federal income tax at regular corporate rates and, therefore, would have to pay significant income taxes;

 

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  Ÿ  

we also could be subject to the federal alternative minimum tax and possibly increased state and local taxes; and

 

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unless we are entitled to relief under applicable statutory provisions, we could not elect to be taxed as a REIT for four taxable years following the year during which we were disqualified.

In addition, if we fail to qualify as a REIT, we will not be required to make distributions to stockholders, and all distributions to stockholders will be subject to tax as dividend income to the extent of our current and accumulated earnings and profits. As a result of all these factors, our failure to qualify as a REIT also could impair our ability to execute our business and growth strategies and could have a material adverse effect on us and depress the market price of our common stock.

Qualifying as a REIT involves highly technical and complex provisions of the Code and therefore, in certain circumstances, may be subject to uncertainty.

In order to qualify as a REIT, we must satisfy a number of requirements, including requirements regarding the composition of our assets, the sources of our income and the diversity of our share ownership. Also, we must make distributions to stockholders aggregating annually at least 90% of our “REIT taxable income” (determined without regard to the dividends paid deduction and excluding net capital gain). Compliance with these requirements and all other requirements for qualification as a REIT involves the application of highly technical and complex Code provisions for which there are only limited judicial and administrative interpretations. The complexity of these provisions and of the applicable Treasury regulations that have been promulgated under the Code is greater in the case of a REIT that, like us, holds its assets through a partnership and conducts significant business operations through a taxable REIT subsidiary. Even a technical or inadvertent mistake could jeopardize our REIT status. In addition, the determination of various factual matters and circumstances relevant to REIT qualification is not entirely within our control and may affect our ability to qualify as a REIT. Accordingly, we cannot be certain that our organization and operation will enable us to qualify as a REIT for federal income tax purposes.

Even if we qualify as a REIT, we will be subject to some taxes that will reduce our cash flow.

Even if we qualify for taxation as a REIT, we may be subject to certain federal, state and local taxes on our income and assets, including taxes on any undistributed income, tax on income from some activities conducted as a result of a foreclosure, and state or local income, property and transfer taxes. Any of these taxes would decrease cash available for the payment of our debt obligations and distributions to stockholders. Quality Technology Services Holding, LLC, our taxable REIT subsidiary, and certain of its subsidiaries will be subject to federal corporate income tax on their net taxable income, if any, which is initially expected to consist of the revenues mainly derived from providing technical services on a contract basis to our customers.

Moreover, if we have net income from “prohibited transactions,” that income will be subject to a 100% tax. In general, prohibited transactions are sales or other dispositions by us and not by our taxable REIT subsidiary of property held primarily for sale to customers in the ordinary course of business. The determination as to whether a particular sale is a prohibited transaction depends on the facts and circumstances related to that sale. The need to avoid prohibited transactions could cause us to forgo or defer sales of properties that our operating partnership and the entities that held our acquired properties otherwise would have sold or that might otherwise be in our best interest to sell.

 

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If the structural components of our properties were not treated as real property for purposes of the REIT qualification requirements, we could fail to qualify as a REIT, which could have a material adverse effect on us.

A significant portion of the value of our properties is attributable to structural components related to the provision of electricity, heating ventilation and air conditioning, humidification regulation, security and fire protection, and telecommunication services. If rent attributable to personal property leased in connection with a lease of real property is significant, the portion of total rent that is attributable to the personal property will not be qualifying income for purposes of the REIT income tests. Therefore, if our structural components are determined not to constitute real property for purposes of the REIT qualification requirements, we could fail to qualify as a REIT, which could have a material adverse effect on us and depress the market price of our common stock.

To maintain our REIT status, we may be forced to seek third-party capital during unfavorable market conditions.

To qualify as a REIT, we generally must distribute to our stockholders at least 90% of our “REIT taxable income” (determined without regard to the dividends paid deduction and excluding net capital gain) each year, and we will be subject to regular corporate income taxes to the extent that we distribute less than 100% of our “REIT taxable income” each year. In addition, we will be subject to a 4% nondeductible excise tax on the amount, if any, by which distributions paid by us in any calendar year are less than the sum of 85% of our ordinary income, 95% of our capital gain net income and 100% of our undistributed income from prior years. In order to maintain our REIT status and avoid the payment of income and excise taxes, we may need to seek third-party capital to meet the REIT distribution requirements even if the then-prevailing market conditions are not favorable. These capital needs could result from differences in timing between the actual receipt of cash and inclusion of income for federal income tax purposes, the effect of non-deductible capital expenditures, the creation of reserves or required debt or amortization payments.

Dividends payable by REITs do not qualify for the reduced tax rates available for some dividends, which could depress the market price of our common stock if it is perceived as a less attractive investment.

The American Taxpayer Relief Act of 2012, or ATRA, was enacted on January 3, 2013. Under ATRA, for taxable years beginning after 2012, for non-corporate taxpayers, the maximum rate applicable to “qualified dividend income” paid by regular “C” corporations to U.S. stockholders generally is 20%. Dividends payable by REITs, however, generally are not eligible for the current reduced rate, except to the extent that certain holding requirements have been met and a REIT’s dividends are attributable to dividends received by a REIT from taxable corporations (such as a REIT’s taxable REIT subsidiaries), to income that was subject to tax at the REIT/corporate level, or to dividends properly designated by the REIT as “capital gains dividends.” Although ATRA does not adversely affect the taxation of REITs or dividends payable by REITs, it could cause non-corporate taxpayers to perceive investments in REITs to be relatively less attractive than investments in the stocks of regular “C” corporations that pay dividends, which could depress the market price of the stock of REITs, including our common stock.

Complying with REIT requirements may cause us to liquidate or forgo otherwise attractive investment opportunities.

To qualify as a REIT, we must ensure that, at the end of each calendar quarter, at least 75% of the value of our assets consists of cash, cash items, government securities and “real estate assets” (as defined in the Code), including certain mortgage loans and securities. The remainder of our investments (other than government securities, qualified real estate assets and securities issued by a

 

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TRS) generally cannot include more than 10% of the outstanding voting securities of any one issuer or more than 10% of the total value of the outstanding securities of any one issuer. In addition, in general, no more than 5% of the value of our total assets (other than government securities, qualified real estate assets and securities issued by a TRS) can consist of the securities of any one issuer, and no more than 25% of the value of our total assets can be represented by securities of one or more TRSs. See “U.S. Federal Income Tax Considerations.” If we fail to comply with these requirements at the end of any calendar quarter, we must correct the failure within 30 days after the end of the calendar quarter or qualify for certain statutory relief provisions to avoid losing our REIT qualification and suffering adverse tax consequences. As a result, we may be required to liquidate or forgo otherwise attractive investment opportunities. These actions could have the effect of reducing our income and amounts available for distribution to our stockholders.

In addition to the asset tests set forth above, to qualify as a REIT we must continually satisfy tests concerning, among other things, the sources of our income, the amounts we distribute to our stockholders and the ownership of our stock. We may be unable to pursue investment opportunities that would be otherwise advantageous to us in order to satisfy the source-of-income or asset-diversification requirements for qualifying as a REIT. Thus, compliance with the REIT requirements may hinder our ability to make certain attractive investments.

Complying with REIT requirements may limit our ability to hedge effectively and may cause us to incur tax liabilities.

The REIT provisions of the Code substantially limit our ability to hedge our assets and liabilities. Any income from a hedging transaction that we enter into to manage the risk of interest rate changes with respect to borrowings made or to be made to acquire or carry real estate assets does not constitute “gross income” for purposes of the 75% or 95% gross income tests that apply to REITs, provided that certain identification requirements are met. To the extent that we enter into other types of hedging transactions or fail to properly identify such transaction as a hedge, the income is likely to be treated as non-qualifying income for purposes of both of the gross income tests. See “U.S. Federal Income Tax Considerations.” As a result of these rules, we may be required to limit our use of advantageous hedging techniques or implement those hedges through a TRS. This could increase the cost of our hedging activities because our TRS may be subject to tax on gains or expose us to greater risks associated with changes in interest rates than we would otherwise want to bear. In addition, losses in our TRS will generally not provide any tax benefit, except that such losses could theoretically be carried back or forward against past or future taxable income in the TRS.

If our OP fails to qualify as a partnership for federal income tax purposes, we would fail to qualify as a REIT and suffer other adverse consequences.

We believe that our operating partnership is organized and will be operated in a manner so as to be treated as a partnership, and not an association or publicly traded partnership taxable as a corporation for federal income tax purposes. As a partnership, it will not be subject to federal income tax on its income. Instead, each of its partners, including us, will be allocated that partner’s share of the operating partnership’s income. No assurance can be provided, however, that the IRS will not challenge its status as a partnership for federal income tax purposes, or that a court would not sustain such a challenge. If the IRS were successful in treating our operating partnership as an association or publicly traded partnership taxable as a corporation for federal income tax purposes, we would fail to meet the gross income tests and certain of the asset tests applicable to REITs and, accordingly, would cease to qualify as a REIT. Also, the failure of our operating partnership to qualify as a partnership would cause it to become subject to federal corporate income tax, which would reduce significantly the amount of its cash available for debt service and for distribution to its partners, including us.

 

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We will have a carryover tax basis on certain of our assets as a result of the formation transactions, and the amount that we have to distribute to stockholders therefore may be higher.

As a result of the tax-free merger of GA REIT with and into us, certain of our operating properties, including Atlanta Metro, Suwanee, Richmond, Santa Clara, Miami and Wichita, will have carryover tax bases that are lower than the fair market values of these properties at the time of this offering. As a result of this lower aggregate tax basis, we will recognize higher taxable gain upon the sale of these assets, and we will be entitled to lower depreciation deductions on these assets than if we had purchased these properties in taxable transactions at the time of this offering. Lower depreciation deductions and increased gains on sales generally will increase the amount of our required distribution under the REIT rules, and will decrease the portion of any distribution that otherwise would have been treated as a “return of capital” distribution.

As a result of our formation transactions, our TRS may be limited in using certain tax benefits and, consequently, may have greater taxable income.

If a corporation undergoes an “ownership change” within the meaning of Section 382 of the Code and the Treasury Regulations thereunder, such corporation’s ability to use net operating losses, or NOLs, generated prior to the time of that ownership change may be limited. To the extent the affected corporation’s ability to use NOLs is limited, such corporation’s taxable income may increase. As of June 30, 2013, we had approximately $17.6 million of NOLs (all of which are attributable to our TRS) that will begin to expire in 2029 if not utilized. In general, an ownership change occurs if one or more large stockholders, known as “5% stockholders,” including groups of stockholders that may be aggregated and treated as a single 5% stockholder, increase their aggregate percentage interest in a corporation by more than 50% over their lowest ownership percentage during the preceding three-year period. We believe that the formation transactions will cause an ownership change within the meaning of Section 382 of the Code with respect to our TRS. Accordingly, to the extent our TRS has taxable income in future years, its ability to use NOLs incurred prior to our formation transactions in such future years will be limited, and it will have greater taxable income as a result of such limitation.

Legislative or other actions affecting REITs could materially and adversely affect us and our investors.

The rules dealing with federal income taxation are constantly under review by persons involved in the legislative process and by the IRS and the U.S. Department of the Treasury. Changes to the tax laws, with or without retroactive application, could materially and adversely affect us and our investors. We cannot predict how changes in the tax laws might affect us or our investors. New legislation, Treasury regulations, administrative interpretations or court decisions could significantly and negatively affect our ability to qualify as a REIT or the federal income tax consequences of such qualification.

 

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

Some of the statements contained in this prospectus constitute forward-looking statements within the meaning of the federal securities laws. Forward-looking statements relate to expectations, beliefs, projections, future plans and strategies, anticipated events or trends and similar expressions concerning matters that are not historical facts. In particular, statements pertaining to our capital resources, portfolio performance and results of operations contain forward-looking statements. Likewise, our pro forma financial statements and all of our statements regarding anticipated growth in our funds from operations and anticipated market conditions are forward-looking statements. In some cases, you can identify forward-looking statements by the use of forward-looking terminology such as “may,” “will,” “should,” “expects,” “intends,” “plans,” “anticipates,” “believes,” “pro forma,” “estimates,” “predicts,” or “potential” or the negative of these words and phrases or similar words or phrases which are predictions of or indicate future events or trends and which do not relate solely to historical matters. You can also identify forward-looking statements by discussions of strategy, plans or intentions.

The forward-looking statements contained in this prospectus reflect our current views about future events and are subject to numerous known and unknown risks, uncertainties, assumptions and changes in circumstances that may cause our actual results to differ significantly from those expressed in any forward-looking statement. We do not guarantee that the transactions and events described will happen as described (or that they will happen at all). The following factors, among others, could cause actual results and future events to differ materially from those set forth or contemplated in the forward-looking statements:

 

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adverse economic or real estate developments in our markets or the technology industry;

 

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national and local economic conditions;

 

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difficulties in identifying properties to acquire and completing acquisitions;

 

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our failure to successfully develop, redevelop and operate acquired properties and operations;

 

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significant increases in construction and development costs;

 

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the increasingly competitive environment in which we operate;

 

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defaults on or non-renewal of leases by customers;

 

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increased interest rates and operating costs, including increased energy costs;

 

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financing risks, including our failure to obtain necessary outside financing;

 

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decreased rental rates or increased vacancy rates;

 

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dependence on third parties to provide Internet, telecommunications and network connectivity to our data centers;

 

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our failure to qualify and maintain our qualification as a REIT;

 

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environmental uncertainties and risks related to natural disasters;

 

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financial market fluctuations; and

 

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changes in real estate and zoning laws and increases in real property tax rates.

While forward-looking statements reflect our good faith beliefs, they are not guarantees of future performance. We disclaim any obligation to publicly update or revise any forward-looking statement to reflect changes in underlying assumptions or factors, of new information, data or methods, future events or other changes. For a further discussion of these and other factors that could cause our future results to differ materially from any forward-looking statements, see the section above entitled “Risk Factors.”

 

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USE OF PROCEEDS

We estimate that the net proceeds we will receive from this offering, after deducting the underwriting discounts and commissions and estimated expenses of the offering payable by us, will be approximately $         million (or approximately $         million if the underwriters exercise their option to purchase additional shares in full), based on an assumed initial public offering price of $         per share, which is the mid-point of the range set forth on the front cover of this prospectus.

We intend to contribute the net proceeds received by us from this offering to our operating partnership in exchange for OP units. The operating partnership intends to use the net proceeds as follows:

 

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approximately $         million to repay amounts outstanding under our unsecured revolving credit facility; and

 

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the remaining balance to fund ongoing redevelopment costs, to fund future acquisitions and for general corporate purposes.

Pending application of the cash proceeds, we will invest the net proceeds in interest-bearing accounts and short-term, interest-bearing securities, which are consistent with our intention to qualify for taxation as a REIT.

As of June 30, 2013, we had approximately $244 million outstanding under our unsecured revolving credit facility. The unsecured revolving credit facility matures on May 1, 2017 (which maturity may be extended for an additional one year at our option subject to certain conditions). Amounts outstanding under our unsecured revolving credit facility bear interest at a variable rate equal to, at our election, LIBOR or a base rate, plus a spread that will range, depending upon our leverage ratio, from 2.10% to 2.85% for LIBOR rate loans or 1.10% to 1.85% for base rate loans, and bore interest at a rate of 2.55% as of June 30, 2013.

The proceeds of the unsecured revolving credit facility have been used to repay amounts outstanding under our secured credit facility, a loan secured by our Miami facility, a bridge loan secured by our Santa Clara facility, seller financing obtained to acquire our Lenexa and Dallas facilities, a loan for the purchase of land near our Suwanee facility and a loan from Chad L. Williams and entities controlled by Mr. Williams, and for redevelopment purposes.

Affiliates of each of the underwriters of this offering are lenders under our unsecured credit facility. As described above, our operating partnership intends to use a portion of the net proceeds to repay borrowings outstanding under our unsecured revolving credit facility. As such, these affiliates will receive their proportionate shares of any amount of our unsecured revolving credit facility that is repaid with the net proceeds of this offering. See “Underwriting.” The repayment of amounts outstanding under our unsecured revolving credit facility will not affect the commitments of these affiliates of the underwriters to fund future amounts thereunder in accordance with the terms of the facility.

We will not receive any proceeds from the sale of our Class A common stock by the Selling Stockholder.

 

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DISTRIBUTION POLICY

To satisfy the requirements to qualify as a REIT, and to avoid paying tax on our income, we intend to make regular quarterly distributions of all, or substantially all, of our REIT taxable income (excluding net capital gains) to our stockholders. We intend to make a pro rata initial distribution with respect to the period commencing on the completion of this offering and ending                 , 2013, based on a distribution of $         per share for a full quarter. On an annualized basis, this would be $         per share, or an annual distribution rate of approximately     % based on an assumed initial public offering price at the mid-point of the price range indicated on the cover of this prospectus. We estimate that this initial annual distribution rate will represent approximately     % of estimated cash available for distribution to our common stockholders for the 12-month period ending June 30, 2014. We do not plan to reduce our intended initial annual distribution rate if the underwriters exercise their option to purchase additional shares of Class A common stock. Furthermore, we plan to maintain this rate for the 12-month period following completion of this offering unless circumstances change materially.

Our intended initial annual distribution rate has been established based on our estimate of cash available for distribution for the 12-month period ending June 30, 2014, which we have calculated based on adjustments to our pro forma income from continuing operations for the 12 months ended June 30, 2013 (after giving effect to this offering). This estimate was based on the pro forma operating results and does not take into account our business and growth strategies, nor does it take into account any unanticipated expenditures we may have to make or any financings to fund such expenditures. In estimating our cash available for distribution for the 12 months ending June 30, 2014, we have made certain assumptions as reflected in the table and footnotes below.

Our estimate of cash available for distribution does not include the effect of any changes in our working capital resulting from changes in our working capital accounts. Our estimate also does not reflect the amount of cash estimated to be used for investing activities for acquisition, redevelopment and other capital expenditures and other activities, other than recurring capital expenditures. It also does not reflect the amount of cash estimated to be used for financing activities, other than scheduled loan principal payments on mortgage and other indebtedness that will be outstanding upon completion of this offering. Any such investing and/or financing activities may materially and adversely affect our estimate of cash available for distribution. Because we have made the assumptions set forth above in estimating cash available for distribution, we do not intend this estimate to be a projection or forecast of our actual results of operations, EBITDA, NOI, FFO, liquidity or financial condition and have estimated cash available for distribution for the sole purpose of determining our estimated initial annual distribution amount. Our estimate of cash available for distribution should not be considered as an alternative to cash flow from operating activities (computed in accordance with GAAP) or as an indicator of our liquidity or our ability to pay distributions. In addition, the methodology upon which we made the adjustments described below is not necessarily intended to be a basis for determining future dividends or other distributions.

No assurance can be given that our estimated cash available for distribution to our stockholders will be accurate or that our actual cash available for distribution to our stockholders will be sufficient to pay distributions to them at any expected or REIT-required level or at any particular yield, or at all. Accordingly, we may need to borrow or rely on other third-party capital to make distributions to our stockholders, and such third-party capital may not be available to us on favorable terms or at all. As a result, we may not be able to pay distributions to our common stockholders in the future. In addition, our preferred stock, if issued, would likely have a preference on distribution payments. All distributions will be made at the discretion of our board of directors and will depend on our historical and projected results of operations, liquidity and financial condition, our REIT qualification, our debt service requirements, operating expenses and capital expenditures, prohibitions and other restrictions under financing arrangements and applicable law and other factors as our board of directors may deem relevant from

 

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time to time. If we borrow to fund distributions, our future interest costs would increase, thereby reducing our earnings and cash available for distribution from what they otherwise would have been. Distributions in excess of our current and accumulated earnings and profits will not be taxable to a taxable U.S. stockholder under current U.S. federal income tax law to the extent those distributions do not exceed the stockholder’s adjusted tax basis in his or her common stock, but rather will reduce the adjusted basis of the common stock. In that case, the gain (or loss) recognized on the sale of those common stock or upon our liquidation will be increased (or decreased) accordingly. To the extent those distributions exceed a taxable U.S. stockholder’s adjusted tax basis in his or her common stock, they generally will be treated as a gain realized from the taxable disposition of those shares. The percentage of our distributions to our stockholders that exceeds our current and accumulated earnings and profits may vary substantially from year to year. For a more complete discussion of the tax treatment of distributions to holders of our common stock, see “U.S. Federal Income Tax Considerations.”

Our unsecured credit facility and Richmond credit facility contain provisions that may limit our ability to make distributions to our stockholders. These facilities generally provide that if a default occurs and is continuing, we will be precluded from making distributions on our common stock (other than those required to allow us to qualify and maintain our status as a REIT, so long as such default does not arise from a payment default or event of insolvency) and lenders under the facility and, potentially, other indebtedness, could accelerate the maturity of the related indebtedness. In addition, these facilities also contain covenants providing for a maximum distribution of the greater of (i) 95% of our Funds from Operations (as defined in such agreement) and (ii) the amount required for us to qualify as a REIT.

U.S. federal income tax law requires that a REIT distribute annually at least 90% of its REIT taxable income, excluding net capital gains, and that it pay tax at regular corporate rates to the extent that it annually distributes less than 100% of its REIT taxable income, including capital gains. For more information, please see “U.S. Federal Income Tax Considerations.” We anticipate that our estimated cash available for distribution will exceed the annual distribution requirements applicable to REITs and the amount necessary to avoid the payment of tax on undistributed income. However, under some circumstances, we may be required to make distributions in excess of cash available for distribution in order to meet these distribution requirements and we may need to borrow funds to make certain distributions.

The following table describes our pro forma income from continuing operations for the year ended December 31, 2012, and the adjustments we have made thereto in order to estimate our initial cash available for distribution for the 12 months ending June 30, 2014 (amounts in millions except share data, per share data, square footage data and percentages):

 

Pro forma income (loss) from continuing operations for the 12 months ended December 31, 2012

   $
 
            
 
  
  

Less: Pro forma income (loss) from continuing operations for the six months ended June 30, 2012

  

Add: Pro forma income (loss) from continuing operations for the six months ended June 30, 2013

  
  

 

 

 

Pro forma income (loss) from continuing operations for the 12 months ended June 30, 2013

   $     

Add: Pro forma depreciation and amortization(1)

  

Add: Net increases in contractual rental income during the 12 months ended June 30, 2013(2)

  

Add: Net increases in contractual rental income during the 12 months ending June 30, 2014(3)

  

Less: Net decreases in contractual rental income due to lease expirations, assuming rental churn based on historical data(4)

  

Less: Net effects of straight line rents(5)

  

Add: Non-cash compensation expense(6)

  

Add: Amortization of deferred financing costs(7)

  
  

 

 

 

 

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Estimated cash flow from operating activities for the 12 months ending June 30, 2014

   $            

Estimated cash flows used in investing activities:

  

Less: Contractual obligations for leasing commissions(8)

  

Less: Estimated annual provision for recurring capital expenditures(9)

  
  

 

 

 

Total estimated cash flows used in investing activities

  

Estimated cash flows used in financing activities—scheduled principal amortization payments of capital and other long-term lease obligations(10)

  
  

 

 

 

Estimated cash available for distribution for the 12 months ending June 30, 2014

   $     

Our share of estimated cash available for distribution(11)

  

Non-controlling interests’ share of estimated cash available for distribution

  

Total estimated initial annual distributions to stockholders

   $     

Estimated initial annual distribution per share(12)

   $     

Payout ratio based on our share of estimated cash available for distribution(13)

         

 

(1)  

Pro forma depreciation and amortization for the 12 months ended December 31, 2012

   $            
 

Less: pro forma depreciation and amortization for the six months ended June 30, 2012

   $     
 

Add: pro forma depreciation and amortization for the six months ended June 30, 2013

   $     
    

 

 

 
 

Pro forma depreciation and amortization for the 12 months ended June 30, 2013

   $     
(2)   Represents net increases in contractual rental revenue from new leases, renewals and contractual rent increases, net of abatements, that were not in effect for the entire 12-month period ended June 30, 2013, based on leases entered into or that expired and were not renewed through June 30, 2013, less estimated variable expenses associated with such leases using our average NOI margin (excluding recoveries from customers) of         % for the 12 months ended June 30, 2013:       
 

Total net increases in contractual rental revenue during the 12 months ended June 30, 2013 due to leases that were not in effect for the entire 12 month period ended June 30, 2013

   $            
 

Average NOI margin (excluding recoveries from customers) for the 12 months ended June 30, 2013

         
 

Total estimated increase in contractual rental income during the 12 months ending June 30, 2014 due to leases that were not in effect for the entire 12-month period ended June 30, 2013

   $     
(3)   Represents net increases in contractual rental revenue from new leases, renewals and contractual rent increases, net of abatements, entered into as of                     , 2013, that will go into effect during the 12-month period ending June 30, 2014, less estimated variable expenses associated with such leases using our average NOI margin (excluding recoveries from customers) of         % for the 12 months ending June 30, 2014:       
 

Total net increases in contractual rental revenue that will go into effect during the 12-month period ending June 30, 2014 from new leases entered into as of                     , 2013

   $     
 

Average NOI margin (excluding recoveries from customers) for the 12 months ended June 30, 2013

         
 

Total estimated increase in contractual rental income during the 12 months ending June 30, 2014 due to increases in contractual rental revenue that will go into effect during the 12-month period ending June 30, 2014.

   $     
 

Contractual rental revenue to be recognized during the 12-month period ending June 30, 2014 is determined as follows:

   

 

Annualized contractual rental revenue from new leases, renewals and contractual rent increases, net of abatements, entered into as of June 30, 2013

   $     
 

Less: Annualized contractual rental revenue from leases, renewals and contractual rent increases, net of abatements, entered into as of                     , 2013 that will not commence billing until after June 30, 2014

   $     
 

Less: Contractual rental revenue from leases, renewals and contractual rent increases, net of abatements, entered into as of                     , 2013 not recognized in the 12-month period ending June 30, 2014 due to timing of commencement of billing

   $            
    

 

 

 
 

Contractual rental revenue to be recognized during the 12-month period ending June 30, 2014 from new leases, renewals and contractual rent increases, net of abatements

   $     

 

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(4)   Represents estimated decreases in contractual rental revenue during the 12 months ending June 30, 2014 due to lease terminations and expirations, assuming an annual rental churn rate of         % (which is equal to our rental churn rate for the 6-month period ended June 30, 2013 multiplied by two), less estimated variable expenses associated with such leases using our average NOI margin (excluding recoveries from tenants) of         % for the 12-month period ended June 30, 2013. We define rental churn as when a customer completely departs our platform in a given period. This presentation assumes no additional leasing activity through June 30, 2014 and no customer downgrades prior to June 30, 2014.
(5)   Represents the conversion of estimated rental revenues and expenses for the 12 months ended June 30, 2013 from a straight-line basis to cash basis recognition.
(6)   Represents pro forma non-cash compensation expense related to the vesting of incentive awards granted under our 2013 Equity Incentive Plan.
(7)   Represents pro forma non-cash amortization of financing costs for the 12 months ended June 30, 2013.
(8)   Reflects contractual leasing commissions for the 12 months ending June 30, 2014 based on new and renewal leases entered into through             , 2013. Does not include obligations for customer improvements estimated at $         million for the 12 months ending June 30, 2014, which are expected to be funded from borrowings.
(9)   For the 12 months ending June 30, 2014, our estimate of the costs of recurring capital expenditures (excluding customer improvements and leasing commissions) is approximately $         million, based on the average annual capital expenditures cost of $         per net rentable square foot incurred during 2010, 2011 and 2012 and for the six months ended June 30, 2013, multiplied by the average total operating NRSF in our portfolio during the period. The following table sets forth certain information regarding historical recurring capital expenditures at the properties in our portfolio through June 30, 2013 (in millions):

 

     Year Ended December 31,      Six Months
Ended
June 30,
     Weighted Average
January 1, 2010 -
June 30, 2013
 
        2010            2011            2012         2013     

Recurring capital expenditures (excluding customer improvements and leasing commissions)

   $                $                $                $                $            

Average total operating NRSF during period (square feet)

              
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total estimated recurring capital expenditures (per square foot)

   $         $         $         $         $     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(10)   Represents scheduled amortization payments of capital lease obligations and other long-term lease obligations due during the 12 months ending June 30, 2014.
(11)   Represents our share of estimated cash available for distribution and estimated initial annual cash distributions to our stockholders is based on an estimated approximate     % aggregate partnership interest in our operating partnership.
(12)   Based on a total of                  shares of Class A common stock to be outstanding after this offering, consisting of shares to be sold in this offering (assuming no exercise of the underwriters’ option to purchase additional shares), shares of common stock issued to our continuing investors in connection with our formation transactions, restricted shares of common stock to be issued to certain of our directors, executive officers and employees upon completion of this offering and                  shares of Class B common stock issued in connection with our formation transactions.
(13)   Calculated as an estimated initial annual distribution per share divided by our share of estimated cash available for distribution per share for the 12 months ending June 30, 2014.

 

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CAPITALIZATION

The following table sets forth the historical capitalization of our predecessor as of June 30, 2013 and our capitalization as of June 30, 2013 on a pro forma basis, giving effect to (i) the formation transactions, (ii) this offering and (iii) the use of the net proceeds from this offering as described in “Use of Proceeds.” You should read this table in conjunction with “Use of Proceeds,” “Selected Financial Data,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our predecessor’s consolidated financial statements and the notes to our predecessor’s financial statements appearing elsewhere in this prospectus.

 

     June 30, 2013  
     Historical
(unaudited)
     Pro Forma  
     ($ in thousands except per share amounts)  

Debt:

     

Mortgages notes payable

   $ 89,903       $ 89,903   

Unsecured revolving credit facility

     244,000           

Unsecured term loan

     225,000         225,000   

Capital lease obligations

     2,163         2,163   

Stockholders’ Equity:

     

Preferred shares, $0.01 par value per share,                 shares authorized, no shares issued and outstanding, as adjusted

               

Class A common stock, $0.01 par value per share,                  shares authorized and                 shares issued and outstanding, as adjusted(1)

          

Class B common stock, $0.01 par value per share,                  shares authorized and                 shares issued and outstanding, as adjusted(2)

          

Additional paid in capital

          

Partners’ capital

     129,380           
  

 

 

    

 

 

 

Total QTS Realty Trust, Inc. stockholders equity

          

Noncontrolling interest

          

Total equity

   $ 129,380       $     
  

 

 

    

 

 

 

Total capitalization

   $ 690,446       $     
  

 

 

    

 

 

 

 

(1) Pro forma outstanding Class A common stock includes (i)                 shares of Class A common stock to be sold by us in this offering, (ii)                 shares of Class A common stock issued to our continuing investors in connection with our formation transactions and (iii)                 shares of Class A common stock, including                  restricted shares (based on the mid-point of the price range set forth on the cover of this prospectus), to be issued upon completion of this offering to certain directors, executive officers and employees. Amount excludes (i)                 additional shares of Class A common stock issuable upon exercise of the underwriters’ option to purchase additional shares, (ii) options to acquire                  shares of Class A common stock to be issued upon completion of this offering to certain directors, executive officers and employees and (iii)                 additional shares of Class A common stock reserved for future issuance under our equity incentive plan, upon redemption of OP units, in exchange for Class B common stock and upon conversion of outstanding LTIP units.
(2) Pro forma outstanding Class B common stock includes                  shares of Class B common stock issued in connection with our formation transactions.

 

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DILUTION

Dilution After This Offering

Purchasers of our Class A common stock offered by this prospectus will experience an immediate and substantial dilution of the net tangible book value of our Class A common stock from the assumed initial public offering price at the mid-point of the price range set forth on the cover of this prospectus. Net tangible book value per share represents the amount of total tangible assets less total liabilities, divided by the number of outstanding shares of common stock, assuming the conversion of LTIP units into OP Units, the exchange of OP units into shares of our Class A common stock on a one-for-one basis and the conversion of shares of our Class B common stock into shares of our Class A common stock on a one-for-one basis. At June 30, 2013, our predecessor had a net tangible book value of approximately $121.7 million, or $         per share of common stock held by continuing investors. After giving effect to the sale of our common stock by us in this offering, the application of aggregate net proceeds received by us from the offering and completion of the formation transactions, the pro forma net tangible book value as of June 30, 2013 attributable to common stockholders would have been $         million, or $         per share of common stock. This amount represents an immediate increase in net tangible book value of $         per share to our continuing investors and an immediate dilution in pro forma net tangible book value of $         per share from the public offering price of $         per share of common stock to our new investors. The following table illustrates this per share dilution.

 

Assumed initial public offering price per share at the mid-point of the price range set forth on the cover of this prospectus

      $                    

Net tangible book value per share of our predecessor as of June 30, 2013, before the formation transactions and this offering(1)

   $                       

Net increase in net tangible book value per share attributable to the formation transactions, but before this offering

   $        

Pro forma net tangible book value per share after the formation transactions, but before this offering

   $        

Increase in pro forma net tangible book value per share attributable to this offering(2)

   $        

Pro forma net tangible book value per share after the formation transactions and this offering(3)

      $     

Dilution in pro forma net tangible book value per share to new investors(4)

      $     

 

(1) Net tangible book value per share of our predecessor as of June 30, 2013 before the formation transactions and this offering was determined by dividing the net tangible book value of our predecessor as of June 30, 2013 by the number of shares of common stock and OP units held by continuing investors immediately prior to this offering.
(2) The increase in pro forma net tangible book value per share attributable to this offering was determined by subtracting the pro forma net tangible book value per share after the formation transactions, but before this offering, from the pro forma net tangible book value per share after the formation transactions and this offering.
(3) The pro forma net tangible book value per share after the formation transactions and this offering was determined by dividing net tangible book value of approximately $         million by                  shares of common stock and OP units to be outstanding after this offering, which amount excludes the shares and the related proceeds that may be issued by us upon exercise of the underwriters’ option to purchase additional shares and additional common stock reserved for future issuance under our equity incentive plan.
(4) The dilution in pro forma net tangible book value per share to new investors was determined by subtracting pro forma net tangible book value per share after the formation transactions and this offering from the assumed initial public offering price paid by a new investor for our common stock. For the purpose of calculating our predecessor’s pro forma book values, we have assumed that, as of June 30, 2013, the common stock and OP units to be issued as part of the formation transactions were outstanding as of such date.

 

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Assuming the underwriters exercise their option to purchase additional shares of Class A common stock in full, our net tangible book value at June 30, 2013 would have been $         million, or $         per share of Class A common stock. This represents an immediate dilution in pro forma net tangible book value of $         per share of Class A common stock to our new investors.

Differences Between New Investors and Continuing Investors

The table below summarizes, as of June 30, 2013, on a pro forma basis after giving effect to the formation transactions, the related financing transactions and this offering, the differences between the number of shares of Class A common stock and OP Units to be received by the continuing investors in connection with the formation transactions and the new investors purchasing shares in this offering, the total consideration paid and the average price per share of Class A common stock or OP unit paid by the continuing investors in connection with the formation transactions and paid in cash by the new investors purchasing shares in this offering (based on the net tangible book value attributable to the existing investors in the formation transactions). In calculating the shares to be issued in this offering, we used an assumed initial public offering price of $         per share, which is the mid-point of the price range set forth on the front cover page of this prospectus.

 

     Class A Common Stock/OP
Units Issued/Granted
    Pro Forma
Net Tangible Book Value
of Contribution/Cash(1)
     Average Price
Per Share
 
     Number    Percentage     Amount      Percentage     

Continuing investors(2)

                       $                  %       $            

New investors

                    %       $     
  

 

  

 

 

   

 

 

    

 

 

    
             
  

 

  

 

 

   

 

 

    

 

 

    

Total

               $           100.0%      
  

 

  

 

 

   

 

 

    

 

 

    

 

(1) Represents pro forma net tangible book value as of June 30, 2013 of the initial operating properties after giving effect to the formation transactions, the related financing transactions and this offering (but prior to deducting the estimated costs of this offering).
(2) Includes                  OP units to be issued in connection with the formation transactions and an aggregate of                  shares of Class A common stock (based on the mid-point of the price range set forth on the cover of this prospectus) to be granted to certain of our directors, executive officers and employees concurrently with the completion of this offering.

 

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SELECTED FINANCIAL DATA

The following table sets forth selected financial data on an historical basis for QualityTech, LP, which is our predecessor. We have not presented historical data for QTS Realty Trust, Inc. because we have not had any corporate activity since our formation other than the issuance of shares of common stock in connection with our initial capitalization and activity in connection with this offering. Accordingly, we do not believe that a discussion of the historical results of QTS Realty Trust, Inc. would be meaningful. Prior to or concurrently with the completion of this offering, we will consummate a series of transactions pursuant to which we will become the sole general partner and majority owner of our predecessor, which then will be our operating partnership, and thereby indirectly acquire the properties and data center business described in this prospectus. We refer to these transactions as our “formation transactions.” Substantially all of our assets will be held by, and our operations will be conducted through, our operating partnership. We will contribute the net proceeds received by us from this offering to our operating partnership in exchange for OP units. For more information regarding our predecessor and the formation transactions, please see “Structure and Formation of Our Company.”

The historical financial data as of December 31, 2012 and 2011 and for each of the years ended December 31, 2012, 2011 and 2010 has been derived from our predecessor’s audited financial statements included elsewhere in this prospectus. The historical balance sheet as of December 31, 2010 has been derived from our predecessor’s audited financial statements not otherwise included in this prospectus. The historical financial data as of June 30, 2013 and for each of the six months ended June 30, 2013 and 2012 has been derived from our predecessor’s unaudited financial statements included elsewhere in this prospectus and includes all adjustments that management considers necessary to present fairly the information set forth therein. The historical financial data for our predecessor is not necessarily indicative of our results of operations, cash flows or financial condition following the completion of this offering and our formation transactions.

The unaudited pro forma condensed consolidated financial data for the year ended December 31, 2012 and as of and for the six months ended June 30, 2013 are presented as if this offering, the formation transactions, the acquisition of the Sacramento data center in December 2012 and the effect of certain financing transactions as described in the pro forma condensed consolidated financial statements included elsewhere in this prospectus had all occurred on June 30, 2013 for the pro forma condensed consolidated balance sheet and on January 1, 2012 for the pro forma condensed consolidated statement of operations. Our pro forma condensed consolidated financial data is not necessarily indicative of what our actual financial condition and results of operations would have been as of the date and for the periods indicated, nor does it purport to represent our future financial condition or results of operations.

The following table sets forth selected financial and operating data on a pro forma and a consolidated historical basis for our predecessor. You should read the following selected financial data in conjunction with our pro forma financial statements, our predecessor’s historical consolidated financial statements, the combined statements of revenues and certain operating expenses of our Sacramento data center and, in each case, the related notes thereto, along with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” which are included elsewhere in this prospectus.

 

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    Six Months Ended June 30,
(unaudited)
    Year Ended December 31,  
    Pro
Forma
2013
    2013     2012     Pro Forma
2012
(unaudited)
    2012     2011     2010  
    ($ in thousands)  

Statement of Operations Data

             

Revenues:

             

Rental

  $ 68,589      $ 68,589      $ 59,516      $ 131,135      $ 120,758      $ 104,051      $ 92,800   

Recoveries from customers

    6,322        6,322        4,489        10,613        9,294        12,154        12,506   

Cloud and managed services

    8,435        8,435        6,883        14,497        14,497        12,173        9,054   

Other

    1,092        1,092        444        1,385        1,210        2,018        5,795   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

    84,438        84,438        71,332        157,630        145,759        130,396        120,155   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses

             

Property operating costs

    29,292        29,292        25,556        56,993        51,506        57,900        60,408   

Real estate taxes and insurance

    2,203        2,203        1,525        4,304        3,632        2,621        2,378   

Depreciation and amortization

    22,061        22,061        16,394        39,438        34,932        26,165        19,086   

General and administrative

    19,290        19,290        17,187        36,610        35,986        28,470        22,844   

Transaction costs

                         897        897                 

Gain on legal settlement

                                       (3,357       

Restructuring charge

                  3,291        3,291        3,291                 
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

    72,846        72,846        63,953        141,533        130,244        111,799        104,716   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

    11,592        11,592        7,379        16,097        15,515        18,597        15,439   

Other income and expense:

             

Interest income

    13        13        46        69        61        71        233   

Interest expense

    (4,459     (11,634     (12,393     (10,105     (25,140     (19,713     (23,502

Other (expense) income, net

           (3,277     (1,434     (1,153     (1,151     136        22,214   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before gain on sale of real estate

    7,146        (3,306     (6,402     4,908        (10,715     (909     14,384   

Gain on sale of real estate

                         948        948                 
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

  $ 7,146      $ (3,306   $ (6,402   $ 5,856      $ (9,767   $ (909   $ 14,384   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Other Data (unaudited)

             

FFO(1)

  $ 26,763      $ 16,311      $ 8,753      $ 39,931      $ 20,253      $ 23,047      $ 31,771   

Operating FFO(1)

    26,763        19,588        13,171        45,246        25,568        13,900        2,456   

Recognized MRR (in the period)(2)

    73,785        73,785        63,188        141,151        128,533        108,942        98,832   

MRR (at period end)(2)

    12,743        12,743        11,021        11,857        11,857        9,898        9,138   

NOI(3)

    52,943        52,943        44,251        96,614        90,904        70,011        57,369   

EBITDA(4)

    33,653        30,376        22,339        55,330        50,244        44,898        56,739   

Adjusted EBITDA(4)

    34,448        34,448        27,253        60,416