Summary of Significant Accounting Policies

9 Months Ended

Sep. 30, 2019

Summary of Significant Accounting Policies [Abstract]

Summary of Significant Accounting Policies

2. Summary of Significant Accounting Policies

Basis of Presentation – The accompanying financial statements have been prepared by management in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) for interim financial information and in compliance with the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”). These unaudited consolidated financial statements and related notes should be read in conjunction with the audited consolidated financial statements and related notes and management’s discussion and analysis included in our Annual Report on Form 10-K for the year ended December 31, 2018, filed with the SEC on February 25, 2019. The consolidated balance sheet data included herein as of December 31, 2018 was derived from audited financial statements, but does not include all disclosures required by U.S. GAAP. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included.

The accompanying financial statements are presented for both QTS Realty Trust, Inc. and QualityTech, LP. References to “QTS” mean QTS Realty Trust, Inc. and its controlled subsidiaries and references to the “Operating Partnership” mean QualityTech, LP and its controlled subsidiaries.

The Operating Partnership meets the definition and criteria of a variable interest entity (“VIE”) in accordance with ASC 810 Consolidation, and the Company is the primary beneficiary of the VIE. As discussed below, the Company’s only material asset is its ownership interest in the Operating Partnership, and consequently, all of its assets and liabilities represent those assets and liabilities of the Operating Partnership. The Company’s debt is an obligation of the Operating Partnership where the creditors may have recourse, under certain circumstances, against the credit of the Company.

QTS is the sole general partner of the Operating Partnership. Management operates QTS and the Operating Partnership as one business. The management of QTS consists of the same employees as the management of the Operating Partnership. QTS does not conduct business itself, other than acting as the sole general partner of the Operating Partnership and issuing public equity from time to time. QTS has not issued or guaranteed any indebtedness. Except for net proceeds from public equity issuances by QTS, which are contributed to the Operating Partnership in exchange for units of limited partnership interest of the Operating Partnership, the Operating Partnership generates all remaining capital required by the business through its operations, the direct or indirect incurrence of indebtedness, and the issuance of partnership units. Therefore, as general partner with control of the Operating Partnership, QTS consolidates the Operating Partnership for financial reporting purposes.

The Company presents one set of notes for the financial statements of QTS and the Operating Partnership.

As discussed above, QTS owns no operating assets and has no operations independent of the Operating Partnership and its subsidiaries. Also, the Operating Partnership owns no operating assets and has no operations independent of its subsidiaries. Obligations under the 4.75% Senior Notes due 2025 and the unsecured credit facility, both discussed in Note 8, are fully, unconditionally, and jointly and severally guaranteed by the Operating Partnership’s existing subsidiaries (other than certain foreign subsidiaries and receivables entities) and future subsidiaries that guarantee any indebtedness of QTS Realty Trust, Inc., the Operating Partnership, QTS Finance Corporation (the co-issuer of the 4.75% Senior Notes due 2025) or any subsidiary guarantor. The indenture governing the 4.75% Senior Notes due 2025 restricts the ability of the Operating Partnership to make distributions to QTS, subject to certain exceptions, including distributions required in order for QTS to maintain its status as a real estate investment trust under the Internal Revenue Code of 1986, as amended (the “Code”).

The interim consolidated financial statements of QTS Realty Trust, Inc. include the accounts of QTS Realty Trust, Inc. and its majority owned subsidiaries. This includes the operating results of the Operating Partnership for all periods presented.

Use of Estimates – The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Significant items subject to such estimates and assumptions include the useful lives of fixed assets, allowances for doubtful accounts and deferred tax assets and the valuation of derivatives, real estate assets, acquired intangible assets and certain accruals.

Principles of Consolidation – The consolidated financial statements of QTS Realty Trust, Inc. include the accounts of QTS Realty Trust, Inc. and its controlled subsidiaries. The consolidated financial statements of QualityTech, LP include the accounts of QualityTech, LP and its subsidiaries. All significant intercompany accounts and transactions have been eliminated in the financial statements.

We evaluate our investments in unconsolidated entities to determine whether they should be recorded on a consolidated basis. The percentage of ownership interest in the entity, an evaluation of control and whether a VIE exists are all considered in our consolidation assessment. Investments in real estate entities which we have the ability to exercise significant influence, but do not have financial or operating control, are accounted for using the equity method of accounting. Accordingly, our share of the earnings or losses of these entities is included in consolidated net income (loss).

Variable Interest Entities (VIEs) – We determine whether an entity is a VIE and, if so, whether it should be consolidated by utilizing judgments and estimates that are inherently subjective. The determination of whether an entity in which we hold a direct or indirect variable interest is a VIE is based on several factors, including whether the entity’s total equity investment at risk upon inception is sufficient to finance the entity’s activities without additional subordinated financial support. We make judgments regarding the sufficiency of the equity at risk based first on a qualitative analysis, and then a quantitative analysis, if necessary.

We analyze any investments in VIEs to determine if we are the primary beneficiary. In evaluating whether we are the primary beneficiary, we evaluate our direct and indirect economic interests in the entity. A reporting entity is determined to be the primary beneficiary if it holds a controlling financial interest in the VIE. Determining which reporting entity, if any, has a controlling financial interest in a VIE is primarily a qualitative approach focused on identifying which reporting entity has both (1) the power to direct the activities of a VIE that most significantly impact such entity’s economic performance and (2) the obligation to absorb losses or the right to receive benefits from such entity that could potentially be significant to such entity. Performance of that analysis requires the exercise of judgment.

We consider a variety of factors in identifying the entity that holds the power to direct matters that most significantly impact the VIE’s economic performance including, but not limited to, the ability to direct financing, leasing, construction and other operating decisions and activities. In addition, we consider the rights of other investors to participate in those decisions, to replace the manager and to sell or liquidate the entity. We determine whether we are the primary beneficiary of a VIE at the time we become involved with a variable interest entity and reconsider that conclusion

continually. As of September 30, 2019, we had one unconsolidated entity that was considered a VIE for which we are not the primary beneficiary. Our maximum exposure to losses associated with this VIE is limited to our aggregate investment, which was approximately $30.7 million as of September 30, 2019.

Reclassifications – Revenue categories in the statement of operations for the three and nine months ended September 30, 2018 have been reclassified to conform to 2019 presentation which is presented in accordance with ASC 842 and the reclassifications consists of two categories instead of four categories presented historically. The statement of operations for the three months ended September 30, 2018 incorporates a reclassification of $1.2 million of straight line rent from the “Other” line item into the “Rental” line item, a reclassification of $11.8 million of “Recoveries from Customers” from its own line item into the “Rental” line item, as well as the combination of $7.5 million of what was previously classified as “Cloud and managed services” revenue and less than $0.1 million of remaining “Other” revenue into a single “Other” line item. The statement of operations for the nine months ended September 30, 2018 incorporates a reclassification of $5.3 million of straight line rent from the “Other” line item into the “Rental” line item, a reclassification of $33.8 million of “Recoveries from Customers” from its own line item into the “Rental” line item, as well as the combination of $31.7 million of what was previously classified as “Cloud and managed services” revenue and $0.7 million of remaining “Other” revenue into a single “Other” line item.

Real Estate Assets – Real estate assets are reported at cost. All capital improvements for the income-producing properties that extend their useful lives are capitalized to individual property improvements and depreciated over their estimated useful lives. Depreciation for real estate assets is generally provided on a straight-line basis over 40 years from the date the property was placed in service. Property improvements are depreciated on a straight-line basis over the life of the respective improvement ranging from 20 to 40 years from the date the components were placed in service. Leasehold improvements are depreciated over the lesser of 20 years or through the end of the respective life of the lease. Repairs and maintenance costs are expensed as incurred. For the three months ended September 30, 2019, depreciation expense related to real estate assets and non-real estate assets was $29.8 million and $2.9 million, respectively, for a total of $32.7 million. For the three months ended September 30, 2018, depreciation expense related to real estate assets and non-real estate assets was $25.8 million and $3.3 million, respectively, for a total of $29.1 million. For the nine months ended September 30, 2019, depreciation expense related to real estate assets and non-real estate assets was $86.8 million and $8.7 million, respectively, for a total of $95.5 million. For the nine months ended September 30, 2018, depreciation expense related to real estate assets and non-real estate assets was $74.4 million and $9.7 million, respectively, for a total of $84.1 million. We capitalize certain development costs, including internal costs incurred in connection with development. The capitalization of costs during the construction period (including interest and related loan fees, property taxes and other direct and indirect costs) begins when development efforts commence and ends when the asset is ready for its intended use. Capitalization of such costs, excluding interest, aggregated to $4.8 million and $4.5 million for the three months ended September 30, 2019 and 2018, respectively, and $13.1 million and $11.7 million for the nine months ended September 30, 2019 and 2018, respectively. Interest is capitalized during the period of development by applying our weighted average effective borrowing rate to the actual development and other capitalized costs paid during the construction period. Interest is capitalized until the property is ready for its intended use. Interest costs capitalized totaled $8.7 million and $6.7 million for the three months ended September 30, 2019 and 2018, respectively, and $24.9 million and $18.1 million for the nine months ended September 30, 2019 and 2018, respectively.

Acquisitions and Sales – Acquisitions of real estate and other entities are either accounted for as asset acquisitions or business combinations depending on facts and circumstances. When substantially all of the fair value of gross assets acquired is concentrated in a single identifiable asset or a group of similar identifiable assets, the transaction is accounted for as an asset acquisition. In an asset acquisition, the purchase price paid for assets acquired is allocated between identified tangible and intangible assets acquired based on relative fair value. Transaction costs associated with asset acquisitions are capitalized. When substantially all of the fair value of assets acquired is not concentrated in a group of similar identifiable assets, the set of assets will generally be considered a business. When accounting for business combinations purchase accounting is applied to the assets and liabilities related to all real estate investments acquired in accordance with the accounting requirements of ASC 805, Business Combinations, which requires the recording of net assets of acquired businesses at fair value. The fair value of the consideration transferred is assigned to the acquired tangible assets, consisting primarily of land, construction in progress, building and improvements, and identified intangible assets and liabilities, consisting of the value of above-market and below-market leases, value of in-place leases, value of customer relationships, trade names, software intangibles and finance leases. The excess of the fair value

of liabilities assumed, common stock issued and cash paid over the fair value of identifiable assets acquired is allocated to goodwill, which is not amortized. Transaction costs associated with business combinations are expensed as incurred.

In developing estimates of fair value of acquired assets and assumed liabilities, management analyzes a variety of factors including market data, estimated future cash flows of the acquired operations, industry growth rates, current replacement cost for fixed assets and market rate assumptions for contractual obligations. Such a valuation requires management to make significant estimates and assumptions, particularly with respect to the intangible assets.

Acquired in-place leases are amortized as amortization expense on a straight-line basis over the remaining life of the underlying leases. This amortization expense is accounted for as real estate amortization expense.

Acquired customer relationships are amortized as amortization expense on a straight-line basis over the expected life of the customer relationship. This amortization expense is accounted for as real estate amortization expense.

Other acquired intangible assets, which includes platform, above or below market leases, and trade name intangibles, are amortized on a straight-line basis over their respective expected lives. Above or below market leases are amortized as a reduction to or increase in rental revenue when we are the lessor as well as a reduction to or increase in rent expense over the remaining lease terms when we are the lessee. The expense associated with trade name intangibles is accounted for as real estate amortization expense, whereas the expense associated with the amortization of platform intangibles is accounted for as non-real estate amortization expense.

We account for the sale of assets to non-customers under Financial Accounting Standards Board (“FASB”) Accounting Standards Update (“ASU”) No. 2017-05, Other Income—Gains and Losses from the Derecognition of Nonfinancial Assets (Subtopic 610-20), which provides for recognition or derecognition based on transfer of ownership. During the three months ended March 31, 2019, we sold our Manassas facility to an unconsolidated affiliate in exchange for cash consideration and noncash consideration in the form of an equity interest in the unconsolidated entity. After measuring the consideration received at fair value, we recognized a $13.4 million gain on sale of real estate, net of approximately $5.8 million of transaction costs, associated with our contribution of certain assets in our Manassas facility to the unconsolidated entity. Substantially all of the fair value of the assets contributed to the entity was concentrated in a group of similar identifiable assets and the sale of the assets were not to a customer, therefore the transaction was accounted for as an asset sale. The gain on sale of real estate is included within the “Gain on sale of real estate, net” line item of the consolidated statements of operations.

Impairment of Long-Lived Assets, Intangible Assets and Goodwill – We review our long-lived assets and intangible assets for impairment when events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. Recoverability of assets to be held and used is measured by comparison of the carrying amount to the future net cash flows, undiscounted and without interest, expected to be generated by the asset group. If the net carrying value of the asset exceeds the value of the undiscounted cash flows, the fair value of the asset is assessed and may be considered impaired. An impairment loss is recognized based on the excess of the carrying amount of the impaired asset over its fair value. No impairment losses were recorded for the three and nine months ended September 30, 2019. We recognized $3.3 million and $7.6 million of impairment losses related to certain non-real estate product related assets during the three and nine months ended September 30, 2018, respectively, which was included in the “Restructuring” line item of the consolidated statement of operations.

The fair value of goodwill is the consideration transferred in a business combination which is not allocable to identifiable intangible and tangible assets. Goodwill is subject to at least an annual assessment for impairment. In connection with the goodwill impairment evaluation that we performed as of October 1, 2018, we determined qualitatively that it is not more likely than not that the fair value of our one reporting unit was less than the carrying amount, thus we did not perform a quantitative analysis. As we continue to operate and assess our goodwill at the consolidated level for our single reporting unit and our market capitalization significantly exceeds our net asset value, further analysis was not deemed necessary as of September 30, 2019.

Assets Held for Sale – We completed the sale of the Manassas facility to an unconsolidated entity on February 22, 2019. As of December 31, 2018, prior to our sale of the assets to the entity, the completion of the sale was probable and we

accordingly reclassified certain assets, as well as liabilities associated with those assets, as held for sale. As of December 31, 2018, the asset value of $71.8 million associated with the held for sale assets was included within the “Assets held for sale” line item of the consolidated statements of financial position and primarily consisted of construction in progress. As of December 31, 2018, the liability value of $24.3 million associated with the held for sale liabilities was included within the “Liabilities held for sale” line item of the consolidated statements of financial position and primarily consisted of accounts payable and accrued liabilities associated with construction in progress assets. See Note 7 for further discussion of the unconsolidated entity.

Cash and Cash Equivalents – We consider all demand deposits and money market accounts purchased with a maturity date of three months or less at the date of purchase to be cash equivalents. Our account balances at one or more institutions periodically exceed the Federal Deposit Insurance Corporation (“FDIC”) insurance coverage and, as a result, there is concentration of credit risk related to amounts on deposit in excess of FDIC coverage. We mitigate this risk by depositing a majority of our funds with several major financial institutions. We also have not experienced any losses and do not believe that the risk is significant.

Deferred Costs – Deferred costs, net, on our balance sheets include both financing costs and leasing costs.

Deferred financing costs represent fees and other costs incurred in connection with obtaining debt and are amortized over the term of the loan and are included in interest expense. Debt issuance costs related to revolving debt arrangements are deferred and presented as assets on the balance sheet; however, all other debt issuance costs are recorded as a direct offset to the associated liability. Amortization of debt issuance costs, including those costs presented as offsets to the associated liability in the consolidated balance sheet, was $1.0 million for both the three months ended September 30, 2019 and 2018, respectively, and $2.9 million for both the nine months ended September 30, 2019 and 2018, respectively. Deferred financing costs presented as assets on the balance sheet related to revolving debt arrangements, net of accumulated amortization, are as follows:

	September 30,		December 31,
(dollars in thousands)	2019		2018
	(unaudited)
Deferred financing costs	$	11,519	$	11,530
Accumulated amortization		(5,289)		(3,859)
Deferred financing costs, net	$	6,230	$	7,671

Deferred financing costs presented as offsets to the associated liabilities on the balance sheet related to fixed debt arrangements, net of accumulated amortization, are as follows:

	September 30,		December 31,
(dollars in thousands)	2019		2018
	(unaudited)
Deferred financing costs	$	14,609	$	14,501
Accumulated amortization		(4,449)		(2,944)
Deferred financing costs, net	$	10,160	$	11,557

Initial direct costs, or deferred leasing costs, include commissions paid to third parties, including brokers, leasing and referral agents, and internal sales commissions paid to employees for successful execution of lease agreements and are accounted for pursuant to ASC 842, Leases. These costs are incurred when we execute lease agreements and represent only incremental costs that would not have been incurred if the lease agreement had not been executed. To a lesser extent, we incur the same incremental costs to obtain managed service contracts with customers that are accounted for pursuant to ASC 606, Revenue from Contracts with Customers. Because the framework of accounting for these costs and the underlying nature of the costs are the same for our revenue and lease contracts, the costs are presented on a combined basis within our financial statements and within the below table. Both revenue and leasing commissions are capitalized and generally amortized over the term of the related leases or the expected term of the contract using the straight-line method. If a customer lease terminates prior to the expiration of its initial term, any unamortized initial direct costs

related to the lease are written off to amortization expense. Amortization of deferred leasing costs totaled $6.7 million and $5.5 million for the three months ended September 30, 2019 and 2018, respectively, and $17.7 million and $15.7 million for the nine months ended September 30, 2019 and 2018, respectively. Deferred leasing costs, net of accumulated amortization, are as follows:

	September 30,		December 31,
(dollars in thousands)	2019		2018
	(unaudited)
Deferred leasing costs	$	70,594	$	63,018
Accumulated amortization		(28,512)		(25,593)
Deferred leasing costs, net	$	42,082	$	37,425

Revenue Recognition – We derive our revenues from leases with customers for data center space which include lease components and nonlease revenue components, such as power, tenant recoveries, cloud and managed services. We adopted Accounting Standards Codification (“ASC”) Topic 842, Leases, the new accounting standard for leases, effective January 1, 2019 using the modified retrospective approach. In addition, we adopted ASC Topic 606, Revenue from Contracts with Customers, the new accounting standard for revenue from contracts with customers, effective January 1, 2018 using the modified retrospective approach. We have elected the available practical expedient to combine our nonlease revenue components that have the same pattern of transfer as the related operating lease component into a single combined lease component under ASC 842. See the “Recently Adopted Accounting Standards” section below for further details.

A description of each of our disaggregated revenue streams is as follows:

Rental Revenue

Our leases with customers are classified as operating leases and rental revenue is recognized on a straight-line basis over the customer lease term. Occasionally, customer leases include options to extend or terminate the lease agreements. We do not include any of these extension or termination options in a customer’s lease term for lease classification purposes or recognizing rental revenue unless it is reasonably certain the customer will exercise these extension or termination options.

Rental revenue also includes revenue from power delivery on fixed power arrangements, whereby customers are billed and pay a fixed monthly fee per committed available amount of connected power. These fixed power arrangements require us to provide a series of distinct services and stand ready to deliver the power over the contracted term which is co-terminus with the lease. Customer fixed power arrangements have the same pattern of transfer over the lease term as the lease component and are therefore combined with the lease component to form a single lease component that is recognized over the term of the lease on a straight line basis.

In addition, rental revenue includes straight line rent. Straight line rent represents the difference in rents recognized during the period versus amounts contractually due pursuant to the underlying leases and is recorded as deferred rent receivable/payable in the consolidated balance sheets. For lease agreements that provide for scheduled rent increases, rental income is recognized on a straight-line basis over the non-cancellable term of the leases, which commences when control of the space has been provided to the customer. The amount of the straight-line rent receivable on the balance sheets included in rents and other receivables, net was $34.6 million and $29.7 million as of September 30, 2019 and December 31, 2018, respectively.

Rental revenue also includes amortization of set-up fees which are amortized over the term of the respective lease as discussed below.

Variable Lease Revenue from Recoveries

Certain customer leases contain provisions under which customers reimburse us for power and cooling-related charges as well as a portion of the property’s real estate taxes, insurance and other operating expenses. Recoveries of power and cooling-related expenses relate specifically to our variable power arrangements, whereby customers pay variable monthly fees for the specific amount of power utilized at the current utility rates. Our performance obligation is to stand

ready to deliver power over the life of the customer contract up to a contracted power capacity. Customers have the flexibility to increase or decrease the amount of power consumed, and therefore sub-metered power revenue is constrained at contract inception. The reimbursements are included in revenue as recoveries from customers and are recognized each month as the uncertainty related to the consideration is resolved (i.e. we provide power to our customers) and customers utilize the power. Reimbursement of real estate taxes, insurance, common area maintenance, or other operating expenses are accounted for as variable payments under lease guidance pursuant to the practical expedient and are recognized as revenue in the period that the expenses are recognized. Variable lease revenue from recoveries discussed above, including power, common area maintenance or other operating costs, have the same pattern of transfer over the lease term as the lease component and are therefore combined with the lease component to form a single lease component. Variable lease revenue from recoveries is included within the “rental” line item of the statement of operations.

Other Revenue

Other revenue primarily consists of revenue from our cloud and managed service offerings. We, through our Taxable REIT Subsidiaries (“TRS”), may provide both our cloud product and use of our managed services to our customers on an individual or combined basis. In both our cloud and managed services offerings the TRS’s performance obligation is to provide services (e.g. cloud hosting, data backup, data storage or data center personnel labor hours) to facilitate a fully integrated information technology (“IT”) outsourcing environment over a contracted term. Although underlying services may vary, over the contracted term monthly service offerings are substantially the same and we account for the services as a series of distinct services in accordance with ASC 606. Service fee revenue is recognized as the revenue is earned, which generally coincides with the services being provided. As we have the right to consideration from customers in an amount that corresponds directly with the value to the customer of the TRS’s performance of providing continuous services, we recognize monthly revenue for the amount invoiced.

With respect to the transaction price allocated to remaining performance obligations within our cloud and managed service contracts, we have elected to use the optional exemption provided by ASC 606 whereby we are not required to estimate the total transaction price allocated to remaining performance obligations as we apply the “right-to-invoice” practical expedient. As described above, the nature of our performance obligation in these contracts is to provide monthly services that are substantially the same and accounted for as a series of distinct services. These contracts generally have a remaining term ranging from month-to-month to three years.

Management fees and other revenues are generally received from our unconsolidated affiliate properties as well as third parties. Management fee revenue is earned based on a contractual percentage of unconsolidated affiliate property revenue. Development fee revenue is earned on a contractual percentage of hard costs to develop a property. We recognize revenue for these services provided when earned based on the performance criteria in ASC 606, with such revenue recorded in “Other” revenue on the consolidated statement of operations.

Allowance for Uncollectible Accounts Receivable – We record a provision for uncollectible accounts if a receivable balance relating to contractual rent, rental revenue recorded on a straight-line basis, tenant recoveries or other billed amounts is considered by management to be not probable of collection, and this provision is recorded as a reduction to leasing revenues. We also record a general provision of estimated uncollectible tenant receivables that is based on management’s historical experience and a review of the current status of our receivables deemed probable of collection. This provision is recorded as bad debt expense and recorded within Property Operating Costs within the consolidated statement of operations. The aggregate allowance for doubtful accounts on the consolidated balance sheet was $1.9 million and $3.8 million as of September 30, 2019 and December 31, 2018, respectively.

Deferred Income – Deferred income generally results from non-refundable charges paid by the customer at lease inception to prepare their space for occupancy. We record this initial payment, commonly referred to as set-up fees, as a deferred income liability which amortizes into rental revenue over the term of the related lease on a straight-line basis. Deferred income was $41.4 million and $33.2 million as of September 30, 2019 and December 31, 2018, respectively. Additionally, $4.0 million and $3.3 million of deferred income was amortized into revenue for the three months ended September 30, 2019 and 2018, respectively, and $11.1 million and $9.4 million for the nine months ended September 30, 2019 and 2018, respectively.

Foreign Currency - The financial position of foreign subsidiaries is translated at the exchange rates in effect at the end of the period, while revenues and expenses are translated at average exchange rates during the period. Gains or losses from translation of foreign operations where the local currency is the functional currency are included as components of other comprehensive income (loss). Gains or losses from foreign currency transactions are included in determining net income (loss).

Equity-based Compensation – Equity-based compensation costs are measured based upon their estimated fair value on the date of grant or modification and amortized ratably over their respective service periods. We have elected to account for forfeitures as they occur. Equity-based compensation expense was $4.5 million and $3.9 million for the three months ended September 30, 2019 and 2018, respectively, and $12.1 million and $11.4 million for the nine months ended September 30, 2019 and 2018, respectively. Equity-based compensation expense for the nine months ended September 30, 2018 excludes $3.1 million of equity-based compensation expense associated with the acceleration of equity awards related to certain employees impacted by the Company’s strategic growth plan, all of which was incurred during the six months ended June 30, 2018. The aforementioned equity-based compensation expense is included in the “Restructuring” expense line item on the consolidated statements of operations.

Segment Information – We manage our business as one operating segment and thus one reportable segment consisting of a portfolio of investments in multiple data centers.

Customer Concentrations – As of September 30, 2019, one of our customers represented 9.8% of our total monthly rental revenue. No other customers exceeded 6% of total monthly rental revenue.

As of September 30, 2019, three of our customers exceeded 5% of trade accounts receivable. In aggregate, these three customers accounted for approximately 26% of trade accounts receivable. One of these customers individually exceeded 10% of trade accounts receivable, at approximately 13%.

Income Taxes – We have elected for two of our existing subsidiaries to be taxed as taxable REIT subsidiaries pursuant to the REIT rules of the U.S. Internal Revenue Code. Pursuant to the transaction described in Note 3 - Acquisitions, we also have subsidiaries subject to tax in non-US jurisdictions.

For the taxable REIT subsidiaries, income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized.

A current and deferred tax expense has been recognized in the nine months ended September 30, 2019, in connection with recorded operating activity. As of September 30, 2019, one of our taxable REIT subsidiaries is in a net deferred tax liability position primarily due to a valuation allowance against certain deferred tax assets. In considering whether it is more likely than not that some portion or all of the deferred tax assets will be realized, it has been determined that it is possible that some or all of our deferred tax assets could ultimately expire unused. We establish valuation allowances against deferred tax assets when the ability to fully utilize these benefits is determined to be uncertain.

We provide a valuation allowance against deferred tax assets if, based on management’s assessment of operating results and other available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized. The evidence contemplated by management at September 30, 2019 consists of current and prior operating results, available tax planning strategies, and the scheduled reversal of existing taxable temporary differences. Evidence from the scheduled reversal of taxable temporary differences relies on management judgements based on the accumulation of available evidence. Those judgements may be subject to change in the future as evidence available to management changes. Management’s assessment of our valuation allowance may further change based on our generation of or ability to project future operating income, and changes in tax policy or tax planning strategies.

We provide for income taxes during interim periods based on the estimated effective tax rate for the year. The effective tax rate is subject to change in the future due to various factors such as the operating performance of the taxable REIT subsidiaries, tax law changes, and future business acquisitions or divestitures. The taxable subsidiaries’ effective tax rates were (8.5%) and 8.9% for the nine months ended September 30, 2019 and 2018, respectively.

Fair Value Measurements – ASC Topic 820, Fair Value Measurement, emphasizes that fair value is a market-based measurement, not an entity-specific measurement. Therefore, a fair value measurement should be determined based on the assumptions that market participants would use in pricing the asset or liability. As a basis for considering market participant assumptions in fair value measurements, a fair value hierarchy is established that distinguishes between market participant assumptions based on market data obtained from sources independent of the reporting entity (observable inputs that are classified within Levels 1 and 2 of the hierarchy) and the reporting entity’s own assumptions about market participant assumptions (unobservable inputs classified within Level 3 of the hierarchy).

Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that we have the ability to access. Level 2 inputs are inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs may include quoted prices for similar assets and liabilities in active markets, as well as inputs that are observable for the asset or liability (other than quoted prices), such as interest rates, foreign exchange rates, and yield curves that are observable at commonly quoted intervals. Level 3 inputs are unobservable inputs for the asset or liability, which are typically based on an entity’s own assumptions, as there is little, if any, related market activity. In instances where the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability.

As of September 30, 2019, we valued our derivative instruments primarily utilizing Level 2 inputs. See Note 16 – ‘Fair Value of Financial Instruments’ for additional details.

Recently Adopted Accounting Standards

Revenue from Contracts with Customers

In May 2014, the Financial Accounting Standards Board (“FASB”) issued guidance codified in ASC Topic 606, Revenue from Contracts with Customers, which supersedes the former revenue recognition requirements in ASC Topic 605, Revenue Recognition. Under this new guidance, entities should recognize revenues to depict the transfer of promised goods or services to customers in an amount that reflects the consideration the entity expects to receive in exchange for those goods or services. The standard establishes a five-step model framework which recognizes revenue as an entity transfers control of goods or services to the customer and requires enhanced disclosures. We adopted ASC Topic 606 effective January 1, 2018, and elected the modified retrospective transition approach. The adoption did not result in a cumulative catch-up adjustment to opening equity and does not change the recognition pattern of our operating revenues.

Leases

In February 2016, and further amended in 2018, the FASB issued ASC Topic 842, Leases, which supersedes the former lease guidance in ASC 840, Leases. The new standard increases transparency and comparability most significantly by requiring the recognition by lessees of right-of-use (“ROU”) assets and lease liabilities on the balance sheet for those leases classified as operating leases. Under the standard, disclosures are required to meet the objective of enabling users of financial statements to assess the amount, timing, and uncertainty of cash flows arising from leases.

We adopted ASC 842 effective January 1, 2019 using the modified retrospective approach, which applied the provisions of the new guidance at the effective date without adjusting comparative periods presented. We elected a package of practical expedients permitted under the transition guidance within the new standard which allowed us to not reassess (i) whether expired or existing contracts contain a lease under the new standard, (ii) the lease classification for existing leases or (iii) whether previously-capitalized initial direct costs would qualify for capitalization under the new standard.

We did not elect the hindsight practical expedient which permits entities to use hindsight in determining the lease term and assessing impairment.

The adoption of ASC 842 impacted our consolidated balance sheet with the recognition of existing operating leases as lessee resulting in $62.9 million of ROU assets and $70.7 million of lease liabilities recorded as of January 1, 2019. We also recognized a $1.8 million cumulative effect adjustment to retained earnings. The adjustment to retained earnings was due to an impairment of certain ROU assets associated with vacant office space for which we are a lessee and assumed in a prior acquisition. See the table below for the impact of adoption of the lease standard on our consolidated balance sheet as of January 1, 2019 (in thousands):

	As Previously		New Lease Standard
	Reported		Adjustment		As Adjusted
Operating lease right-of-use assets	$	—	$	62,922	$	62,922
Operating lease liabilities		—		70,657		70,657
Deferred rent payable		5,922		(5,922)		—

As lessor, accounting for our leases will remain largely unchanged from ASC 840. The new lease standard more narrowly defines initial direct costs as only costs that are incremental to origination of a lease (i.e. costs that would not have been incurred had the lease not been obtained). We did not historically capitalize non-incremental costs, therefore this change will have no impact on the accounting for initial direct costs in the consolidated financial statements on a prospective basis.

Additionally, from a lessor perspective, we elected a practical expedient which allows lessors to combine nonlease components with the related lease components if both the timing and pattern of transfer are the same for the nonlease component(s) and related lease component, and the lease component would be classified as an operating lease. The single combined component is accounted for under ASC 842 if the lease component is the predominant component and is accounted for under ASC 606 if the nonlease components are the predominant components. Lessors are permitted to apply the practical expedient to all existing leases on a retrospective or prospective basis. We elected the practical expedient to combine our lease and nonlease components that meet the defined criteria and will account for the combined lease component under ASC 842 on a prospective basis.

New Accounting Pronouncements

In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement. The amendments in ASU 2018-13 eliminate the requirements to disclose the amount and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy, valuation processes for Level 3 fair value measurements, and policy for timing of transfers between levels. ASU 2018-13 also provides clarification in the measurement uncertainty disclosure by explaining that the disclosure is to communicate information about the uncertainty in measurement as of the reporting date. In addition, ASU 2018-13 added the following requirements: changes in unrealized gains and losses for the period included in other comprehensive income for recurring Level 3 fair value measurements held at the end of the reporting period; and range and weighted average of significant unobservable inputs used in Level 3 fair value measurements. Finally, ASU 2018-13 updated language to further encourage entities to apply materiality when considering de minimus determination for disclosure requirements. The guidance will be applied retrospectively for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years, with the exception of amendments to changes in unrealized gains and losses, the range and weighted average of significant unobservable inputs used for Level 3 fair value measurements, and the narrative description of measurement uncertainty which will be applied prospectively. Early adoption is permitted. We do not expect the provisions of the standard will have a material impact on our consolidated financial statements.

In August 2018, the FASB issued ASU 2018-15, Intangibles – Goodwill and Other – Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement that is a Service Contract. The amendments in ASU 2018-15 require an entity in a service contract hosting arrangement apply Subtopic 350-40 to identify costs to capitalize or expense related to the service contract. ASU 2018-15 also requires the entity to capitalize the implementation costs of the service contract hosting arrangement and amortize such costs over the

life of the contract and present the capitalized costs in the same line item as fees associated with the hosting service on the statement of income and statement of cash flows. The guidance will be applied retrospectively for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years, with the exception of all implementation costs incurred after the date of adoption which will be applied prospectively. We do not expect this standard will have a material impact on our net income. However, this standard will likely result in certain expenses currently recognized as non real estate depreciation being recognized as general and administrative or operating expense in future periods.

In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, and subsequent amendments to the guidance: ASU 2018-19 in November 2018, ASU 2019-04 in April 2019, and ASU 2019-05 in May 2019. The standard, as amended, requires entities to use a new impairment model based on current expected credit losses (“CECL”) rather than incurred losses. The CECL model is designed to capture expected credit losses through the establishment of an allowance account, which will be presented as an offset to the amortized cost basis of the related financial asset. The guidance is effective for interim and annual periods beginning after December 15, 2019. Early adoption is permitted. As the majority of our revenue is generated from operating leases which are governed under ASC Topic 842, we do not currently expect the provisions of the standard will have a material impact on our consolidated financial statements.

We determined all other recently issued accounting pronouncements will not have a material impact on our consolidated financial statements or do not materially apply to our operations.