Piedmont Office Realty Trust, Inc. — Q2 2014 Form 10-Q
Reporting period: Three and six months ended June 30, 2014. Unaudited. Unless noted, amounts are in millions of dollars. Piedmont is a REIT focused on U.S. office properties.
Business context and portfolio
At quarter-end, Piedmont owned 73 consolidated office properties comprising 21.1 million square feet, plus one redevelopment asset and an office building through an unconsolidated joint venture. The portfolio was 87.0% leased, versus 86.4% a year earlier; one property undergoing redevelopment was excluded from the occupancy calculation. Approximately 90% of annualized lease revenue came from nine key markets.
Financial performance
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Total revenue | $138.6 | $132.6 | $274.9 | $264.7 |
| Real estate operating income | $26.6 | $32.7 | $51.8 | $70.3 |
| Operating income margin | 19% | 25% | 19% | 27% |
| Income from continuing operations | $9.3 | $18.1 | $18.4 | $38.3 |
| Net income attributable to Piedmont | $12.3 | $35.4 | $21.7 | $50.0 |
| Diluted net income per share | $0.08 | $0.21 | $0.14 | $0.30 |
| Funds from Operations (FFO) per diluted share | $0.37 | $0.37 | $0.75 | $0.72 |
| Core FFO per diluted share | $0.37 | $0.35 | $0.72 | $0.71 |
| Adjusted FFO per diluted share | $0.15 | $0.20 | $0.36 | $0.42 |
Q2 revenue rose about 4.5% year over year, led by properties acquired in 2013 and higher rents on certain leases. Higher property costs, depreciation and amortization more than offset the revenue gain, reducing operating income. Six-month revenue rose about 3.8%, while operating income declined about 26%. GAAP net income comparisons were also affected by property-sale gains, particularly the $16.3 million gain recorded in Q2 2013.
Operating cash flow was $108.9 for the first half, up from $86.8 a year earlier. Capital expenditures were $68.9, compared with $84.3. Cash and cash equivalents were $8.6 at June 30, versus $7.0 at year-end 2013. First-half cash used in financing was $50.0, including $61.8 of dividends paid and $54.7 of common-stock repurchases.
Debt, liquidity and capital
Total debt was $2.107 billion at June 30, 2014, compared with $2.002 billion at December 31, 2013. Secured debt declined to $449.7 from $987.5, while unsecured debt increased to $1.657 billion from $1.015 billion. The weighted-average contractual rate was 3.49%. Piedmont issued $400 million of 4.45% senior notes due 2024 and drew its $300 million unsecured term loan, using proceeds principally to repay maturing secured debt and reduce revolver borrowings. It also assumed a $33.7 million mortgage in connection with its 5 Wall Street acquisition.
The $500 million unsecured line of credit had $312.0 million outstanding and approximately $187.6 million of remaining capacity. Management identified operating cash flow, revolver availability and selective property sales as primary near-term liquidity sources. A $105 million secured loan matures within the next 12 months. A 1 percentage-point increase in variable rates on the borrowings outstanding at quarter-end would increase annual interest expense by approximately $4.1 million.
Material changes, outlook and risks
- Same-store performance: Cash-basis same-store NOI decreased 2.5% in Q2 and 8.9% for the first half year over year. Management attributed pressure to lease downtime, rent and operating-expense abatements, and lease expirations. It expected sequential comparisons to improve in the second half as signed leases commence and abatements end. Approximately 0.7 million square feet of executed leases had not yet commenced and 1.4 million square feet of commenced leases remained in some form of abatement.
- Development and redevelopment: Piedmont began construction of a 300,000-square-foot Houston office tower in April and anticipated spending $60–$65 million over the following 12 months, plus about $25 million in later leasing commissions and tenant improvements. It expected to spend $25–$30 million repositioning 3100 Clarendon Boulevard, with about $20 million in subsequent re-leasing costs.
- Tenant and leasing commitments: Potential non-incremental tenant-improvement commitments were $63.4 million; incremental commitments associated with new leases were $16.9 million. Timing depends substantially on tenant reimbursement requests and lease commencements. Management noted four vacant blocks exceeding 200,000 square feet in Chicago and Washington, D.C., which may require significant concessions to lease.
- Dividend: The board declared a Q3 2014 dividend of $0.20 per common share, payable September 19 to holders of record August 29.
- Unusual items and accounting: Piedmont received a $15.0 million gain from settling forward-starting interest-rate swaps, recorded in accumulated other comprehensive income and to be amortized against interest expense over the term of the 2024 notes. Effective April 1, it adopted new discontinued-operations presentation rules; this changed the classification of the 2020 W. 89th Street sale. The filing reports no material change in previously disclosed risk factors and no litigation expected by management to have a material adverse effect.
- Principal risks: Office leasing demand, rental rates and property values; tenant defaults or lease expirations; competition and leasing concessions; access to financing; interest-rate exposure; capital needs for tenant improvements and redevelopment; potential impairment; environmental and regulatory matters; and maintaining REIT qualification. Management reported disclosure controls were effective and no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether leasing of currently vacant space and expiry of rent abatements deliver the expected second-half improvement in same-store NOI and occupancy.
- The actual cost, timing, lease-up and returns of the Houston development and 3100 Clarendon Boulevard redevelopment.
- Tenant-improvement and leasing-commission outlays, including the timing and amount of the $63.4 million and $16.9 million commitments.
- Debt maturities, remaining revolver capacity, refinancing terms and the effect of changes in variable interest rates.
- How recurring operating performance compares with GAAP results and non-GAAP FFO, Core FFO and AFFO, including the effects of property sales, non-recurring recoveries and capital expenditures.
- The sustainability of the $0.20 quarterly dividend relative to operating cash flow, capital requirements and REIT distribution obligations.