Easterly Government Properties, Inc. — Q1 2018 Form 10-Q
Business context and reporting period
Quarter ended March 31, 2018. Easterly is an internally managed REIT focused on U.S. Government-leased commercial properties. It owned 46 operating properties (44 leased primarily to government agencies and two to private tenants), totaling approximately 3.7 million square feet, plus three properties under development. Operating properties were 100% leased; the U.S. Government represented 99.2% of rental income.
Financial performance and position
- Revenue: $36.0 million, up 20.4% from $29.9 million in Q1 2017. Rental income rose to $32.3 million from $26.0 million.
- Profit: Operating income was $7.4 million versus $4.0 million; net income was $1.8 million versus $1.5 million. Net income attributable to Easterly was $1.5 million versus $1.2 million. Basic and diluted EPS were $0.03 in both periods.
- Operating margin: Operating income was 20.6% of revenue, compared with 13.2% in Q1 2017. Interest expense increased to $5.6 million from $2.4 million, reflecting debt added after Q1 2017.
- REIT performance measures: FFO was $16.4 million versus $14.4 million; adjusted FFO was $13.7 million versus $13.6 million. These are non-GAAP supplemental measures, not cash flow or liquidity measures.
- Cash flow: Operating activities provided $12.1 million, compared with $10.7 million. Investing used $11.6 million, including $10.4 million for development properties. Financing used $2.7 million. Cash and restricted cash totaled $14.0 million at quarter-end, including $9.6 million of unrestricted cash.
- Debt and liquidity: Debt principal totaled $577.9 million (carrying value $574.2 million). Weighted-average maturity was 7.6 years and weighted-average interest rate 3.7%; 80.2% was fixed-rate, including the swapped term loan. Available revolver capacity was $301.2 million. The $98.8 million revolver matures in February 2019, with two six-month extension options subject to conditions and fees. The company reported compliance with debt covenants.
- Other balance-sheet items: Total assets were $1.425 billion and total liabilities $630.0 million at March 31, 2018. The interest-rate swaps were assets valued at $5.9 million.
- Dividends and equity: Dividends declared were $0.26 per share, versus $0.24 a year earlier. The company issued 671,666 shares through its ATM program for $13.5 million net proceeds during the quarter.
Material changes versus Q1 2017
- Revenue growth was primarily attributed to three operating properties acquired since March 2017 and a full quarter of operations from a property acquired during Q1 2017, partly offset by a property disposal and lower tenant project reimbursements.
- Expenses rose $2.6 million, with acquisition-related property costs, taxes and depreciation contributing to the increase. Interest expense rose $3.2 million, mainly due to senior notes, the VA–Loma Linda mortgage and the term loan.
- Investing outflows were substantially lower than the prior-year quarter ($11.6 million versus $44.2 million), when the company acquired OSHA–Sandy. Financing shifted from $34.2 million provided in Q1 2017 to $2.7 million used in Q1 2018.
- The company revised Q1 2017 comparative depreciation and amortization downward by $191,000 due to an identified useful-life error involving assets at three properties. It deemed the error immaterial to previously issued statements; revised Q1 2017 net income increased by the same amount.
Outlook, risks and notable items
- Management stated it expects available cash, operating cash flow, revolver capacity and other financing sources to cover anticipated needs for the next 12 months, including debt service, tenant improvements and distributions. No earnings or FFO guidance was provided.
- Management anticipates distributing all taxable income and declared a $0.26 quarterly dividend, payable June 28, 2018. Required distributions may require cash reserves, asset sales, additional debt or, potentially, shares.
- Future minimum contractual property rent payments were $850.8 million. Six tenants, representing approximately 12.8% of rentable area and 11.5% of annualized lease income, had exercisable early-termination rights; 11.1% of annualized lease income was scheduled to expire in 2018 under current contract terms.
- Key exposures include dependence on the U.S. Government, real-estate development and leasing risks, refinancing and interest-rate risk, and geographic concentration: California represented approximately 33.3% of annualized lease income. Three properties under development were expected to add approximately 0.3 million square feet upon completion; estimated development obligations totaled $39.1 million.
- The company reported no material off-balance-sheet arrangements, material litigation, significant subsequent events, or material changes to previously disclosed risk factors. Disclosure controls were deemed effective, with no material quarter-to-quarter change in internal control over financial reporting.
- Adoption of the new revenue standard did not materially affect the financial statements. The company was evaluating the new lease standard, effective for it in 2019; it noted potential changes to the timing of recognition for non-lease components.
Investor verification priorities
- Review tenant renewals, expirations and termination rights, especially the 2018 lease expirations and six soft-term tenants.
- Monitor the February 2019 revolver maturity, extension conditions, covenant headroom and refinancing plans.
- Track development costs, project completion and leasing, including the estimated $39.1 million of development obligations.
- Assess the sustainability of distributions against operating cash flow, required REIT distributions and investment needs.
- Confirm the implications of government revenue concentration and California property exposure, and compare adjusted FFO with GAAP earnings and cash flow.