Business context and reporting period
Piedmont Office Realty Trust, Inc. is a REIT focused on commercial office properties, primarily in the eastern United States. This Form 10-Q covers the quarter and six months ended June 30, 2018; results are unaudited. At quarter-end, the portfolio comprised 53 in-service office properties and one redevelopment asset, approximately 16.2 million square feet, and was 90.6% leased. About 91% of Annualized Lease Revenue came from select submarkets in eight major office markets.
Financial performance and position
Amounts below are in millions, except per-share data and where noted.
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Total revenue | $129.2 | $148.7 | $259.1 | $297.1 |
| Real estate operating income | $25.9 | $35.5 | $53.5 | $68.8 |
| Real estate operating margin | 20% | 24% | 21% | 23% |
| Net income applicable to Piedmont | $10.9 | $23.7 | $68.8 | $38.8 |
| Diluted EPS | $0.09 | $0.16 | $0.52 | $0.27 |
| NAREIT FFO per diluted share | $0.41 | $0.46 | $0.83 | $0.91 |
| Adjusted FFO | $39.4 | $50.9 | $85.2 | $105.0 |
Operating cash flow was $83.2 million for the first half, versus $111.7 million in 2017. Investing activities provided $351.5 million, mainly from property sale proceeds; financing used $433.1 million, including debt repayments, repurchases, and dividends. Cash and cash equivalents were $8.9 million at June 30 ($10.4 million including restricted cash and escrows).
Total debt was $1.721 billion, compared with $1.727 billion at year-end 2017; estimated fair value was $1.726 billion. The weighted-average stated/effectively fixed debt rate was 3.71%. Stockholders’ equity was $1.743 billion and total assets were $3.624 billion. The company reported $238 million drawn on its $500 million revolver and $263 million of unused capacity as of the filing date. Management said it was in compliance with debt covenants.
Material changes versus comparable periods
- Q2 revenue declined $19.5 million year over year, substantially due to property dispositions; rental income was down $17.0 million. The company attributed the decline in quarterly earnings mainly to dispositions and the prior-year $6.5 million property-sale gain. Lower interest expense and the reduction in shares outstanding partly offset the impact.
- First-half revenue declined $38.0 million, primarily from dispositions. Net income increased year over year largely because the first half of 2018 included a $45.2 million gain on sale, versus $6.4 million in 2017. First-half FFO per share nevertheless declined to $0.83 from $0.91.
- Piedmont completed the sale of a 14-property portfolio in January 2018, recognizing a $45.2 million gain, and acquired 501 West Church Street in Orlando for a contractual purchase price of $28.0 million. It also repaid its $300 million 2013 and $170 million 2015 unsecured term loans, entered a new $250 million seven-year term loan, and had $238 million outstanding on its revolver.
- The company repurchased approximately 14.3 million shares for $264.8 million during the first half. Shares outstanding fell from 142.4 million at year-end to 128.4 million at June 30.
Same-store NOI for the first half increased 3.3% on a cash basis but decreased 0.9% on an accrual basis. Management attributed the cash-basis improvement primarily to rental abatements expiring, and the accrual-basis decline mainly to downtime associated with a large lease at 6011 Connection Drive.
Outlook, risks, contingencies, and unusual items
- The filing provides no specific earnings or revenue guidance. Management identified operating cash flows, selective property dispositions, and the revolver as near-term liquidity sources; acquisitions and further share repurchases may also use capital. A third-quarter dividend of $0.21 per share was declared on August 1, 2018, payable September 21 to holders of record August 31.
- Portfolio leasing risks include lease downtime, concessions and abatements, and the possibility that renewals or new leases occur at lower rents. Scheduled expirations represented 1.8% of Annualized Lease Revenue for the rest of 2018 and 12.0% for 2019. Approximately 285,000 square feet of executed leases for vacant space had not commenced, and 747,000 square feet of commenced leases were subject to some rental and/or operating-expense abatement.
- Existing lease commitments included about $40.0 million of potential non-incremental tenant improvements over five years, largely expected to be funded within three years, and $11.8 million of incremental tenant improvements associated with executed leases. Timing depends in part on tenant reimbursement requests.
- Interest-rate exposure remains: $238 million on the revolver and $100 million of the new term loan were variable-rate at quarter-end. Management estimated that a 1 percentage-point increase in rates on existing variable borrowings would add about $3.4 million to annual interest expense. Swaps covered $450 million of notional debt.
- Management cited office-market demand, competition, tenant credit and lease renewals, economic conditions, development costs, interest rates, and REIT qualification among relevant risks. It reported no material pending legal proceedings, no off-balance-sheet arrangements, and no material changes to previously disclosed risk factors. Adoption of lease accounting in 2019 was expected to create a right-of-use asset and liability under lessee accounting; the impact was still being evaluated.
Important facts for investors to verify
- How much of the year-over-year revenue and operating-income decline reflects dispositions versus performance of retained properties; review same-store NOI on both cash and accrual bases.
- The recurring earnings contribution of the $45.2 million disposition gain, and the reconciliation of GAAP income to FFO, Core FFO, and AFFO.
- Leasing progress, occupancy, lease commencement timing, abatements, and upcoming expirations—especially the 2019 exposure and the large Dallas lease noted by management.
- Debt maturities, revolver extension options, covenant headroom, interest-rate exposure, and the ongoing capacity to fund tenant improvements, dividends, and any further repurchases.
- The sustainability of cash flows and distributions after the substantial first-half share repurchases and property sales.