Piedmont Office Realty Trust, Inc. — Q2 2017 Form 10-Q
Reporting period: Three and six months ended June 30, 2017. Amounts are in U.S. dollars; financial statement amounts are in millions unless noted. The filing identifies the registrant as Piedmont Office Realty Trust, Inc.
Business context and portfolio
Piedmont is a REIT focused on owning, developing, and managing U.S. office properties. At quarter-end it owned 67 in-service office properties, representing approximately 20 million square feet, and held one additional building through an unconsolidated joint venture. The consolidated portfolio was 91.0% leased, compared with 91.4% a year earlier. Approximately 88% of annualized lease revenue came from select submarkets in eight Eastern U.S. markets.
Key financial results
| Metric | Q2 2017 | Q2 2016 | First half 2017 | First half 2016 |
|---|---|---|---|---|
| Total revenue | $148.7 | $135.3 | $297.1 | $273.3 |
| Real estate operating income | $35.5 | $14.8 | $68.8 | $41.2 |
| Income from continuing operations | $17.2 | $(1.6) | $32.4 | $8.8 |
| Net income applicable to Piedmont | $23.7 | $72.3 | $38.8 | $82.7 |
| Diluted net income per share | $0.16 | $0.50 | $0.27 | $0.57 |
| Cash provided by operating activities | Not stated for quarter | Not stated for quarter | $111.7 | $102.7 |
Q2 total revenue rose about 10% year over year, mainly from new lease commencements and portfolio transactions. Reported operating margin was approximately 24%, versus 11% in Q2 2016; first-half margins were 23% and 15%, respectively. First-half same-store NOI increased 12.9% on a cash basis and 8.7% on an accrual basis. These are company-defined non-GAAP measures.
Net income declined year over year because gains on property sales were much lower: $6.5 million in Q2 2017 versus $73.8 million in Q2 2016. The prior-year quarter also included $11.0 million of real estate impairment charges, which did not recur in 2017. First-half FFO was $0.91 per diluted share, compared with $0.81; AFFO was $105.0 million versus $93.2 million.
Cash, debt, and liquidity
- Cash and cash equivalents were $9.6 million at June 30, 2017, compared with $7.0 million at December 31, 2016. First-half operating cash flow was $111.7 million; investing activities used $45.1 million and financing activities used $63.9 million.
- Total debt, net of discounts, premiums, and issuance costs, was approximately $2.053 billion, up from $2.020 billion at year-end. The weighted-average effective debt rate was 3.48%; estimated fair value was $2.081 billion. Total liabilities were $2.240 billion and equity was $2.080 billion.
- Debt included $210 million drawn on the $500 million unsecured line of credit and $140 million of secured Washington, D.C. loans at quarter-end. After quarter-end, Piedmont used sale proceeds to repay both balances in full; it reported full availability under the $500 million line as of the filing. Management said no other debt matured before May 2018.
- Interest-rate swaps with $600 million notional hedged two term loans. Management estimated that a 1 percentage-point rise in rates on variable-rate borrowings outstanding at June 30 would increase annual interest expense by approximately $3.8 million. Piedmont reported compliance with debt covenants.
Material changes, outlook, and risks
- On July 5, 2017, Piedmont sold Two Independence Square in Washington, D.C. for approximately $360 million, with net proceeds of about $352 million. The building had been classified as held for sale at June 30. The company used proceeds to repay the line of credit and the $140 million secured loans. It also sold its final property in an unconsolidated joint venture on July 27; Piedmont’s share of the purchase price was approximately $12.7 million.
- The Board declared a Q3 2017 dividend of $0.21 per common share, payable September 15 to holders of record August 25. Management said increased net dispositions could generate one-time capital gains and that special dividends may be considered; no earnings or FFO guidance was provided.
- Leasing and occupancy remain key operating drivers. Lease expirations represented 3.7% of annualized lease revenue for the remainder of 2017 and 7.4% for 2018. Approximately 238,000 square feet of executed leases had not commenced, and 1.3 million square feet of commenced leases remained subject to some rent or expense abatement. Management noted that downtime, concessions, rent roll-downs, and future leasing costs can pressure results.
- Committed tenant-improvement funding included $31.4 million of non-incremental commitments over the next five years, much of which management expects could be requested within three years, plus $13.2 million for incremental improvements tied to executed leases. First-half capital expenditures were $58.3 million.
- Management cited exposure to office-market and economic conditions, competition for tenants, large-tenant defaults, property impairment, construction costs, interest rates, and REIT qualification. It reported no material pending legal proceedings and no known material changes to previously disclosed risk factors.
- Management stated that a material weakness involving goodwill accounting for property dispositions and held-for-sale assets had been remediated as of June 30, 2017. Disclosure controls were assessed as effective; investors may wish to review the remediation and subsequent testing.
- Management did not expect a material financial-statement impact from adoption of the revenue-recognition amendments, expected in Q1 2018, but anticipated some revenue classification changes. The lease standard, effective for Piedmont in Q1 2019, remained under evaluation.
Most important facts for investors to verify
- Whether post-quarter property-sale proceeds and debt repayments were completed as described, and the resulting debt balance, interest cost, and revolver availability.
- Occupancy and leasing trends, including lease commencements, abatements, upcoming expirations, renewal rents, and tenant-improvement and leasing-commission requirements.
- How recurring operating performance compares with GAAP earnings, particularly given the impact of property-sale gains, non-GAAP FFO/AFFO measures, and one-time leasing or reimbursement items.
- Cash available after capital expenditures and dividends, and the timing and amount of future tenant-improvement commitments and debt maturities.
- Progress in validating remediation of the goodwill-accounting material weakness and the effect of upcoming accounting-standard adoptions.