Easterly Government Properties, Inc. — Q3 2016 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2016. Amounts below are in millions unless stated otherwise. The company is an internally managed REIT focused on properties leased mainly to U.S. government agencies. At quarter-end it owned 41 operating properties and one property under development; its operating properties were 100% leased.
Financial performance and position
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Total revenue | $27.0 | $19.9 | $75.9 | $49.2 |
| Operating income | $3.2 | $2.2 | $9.2 | $2.3 |
| Net income (loss) | $1.1 | $0.8 | $3.3 | $(6.2) |
| Net income (loss) attributable to Easterly | $0.9 | $0.5 | $2.3 | $(1.8) |
| Basic / diluted EPS | $0.02 / $0.02 | $0.02 / $0.02 | $0.08 / $0.07 | $(0.09) / $(0.09) |
| Operating cash flow | Not provided by quarter | Not provided by quarter | $36.2 | $18.8 |
| FFO / adjusted FFO | $13.4 / $13.1 | $10.2 / $9.8 | $37.4 / $36.3 | $22.3 / $24.0 |
Q3 operating margin was approximately 11.8% and net margin approximately 4.2%. The nine-month 2016 operating margin was approximately 12.2%. FFO and adjusted FFO are non-GAAP supplemental measures, not measures of cash flow or liquidity.
At September 30, total assets were $1,020.6, total liabilities $343.6, and total equity $676.9. Debt carrying value was $288.2: $206.7 drawn on the revolver and $81.6 in mortgage debt. Cash and cash equivalents were $4.4, with $193.3 available on the $400 million revolving facility. A separate $100 million term loan facility had not been drawn. The company reported compliance with debt covenants.
For the first nine months, cash used in investing was $140.9, primarily for property acquisitions; financing provided $100.9. Cash and cash equivalents decreased $3.8 from year-end 2015. Minimum contractual rent payments under leases totaled $491.3.
Changes versus comparable periods
- Q3 revenue increased $7.1 and operating income increased $1.0 year over year, mainly reflecting nine operating properties acquired since September 2015. Higher property costs and depreciation accompanied the added revenue.
- Q3 interest expense rose $0.7 to $2.0, reflecting higher revolver borrowings and a higher average borrowing rate.
- Nine-month revenue increased $26.7 and net income improved by $9.5. The comparison is materially affected by the February 2015 IPO and formation transactions: the 2015 period includes predecessor results and a $5.1 unrealized investment loss under prior accounting; the company now accounts for contributed properties at historical cost. Accordingly, the reported periods are not fully comparable.
- During the first nine months of 2016, five operating properties were acquired for an aggregate $129.4 million, and FDA–Alameda was acquired for development. The company also issued shares and redeemed Operating Partnership units; common shares outstanding rose to 35.2 million from 24.2 million at year-end 2015.
Outlook, risks and unusual items
- Management stated that cash, operating cash flow and available borrowing capacity were expected to cover anticipated liquidity needs for the next 12 months, including debt service, capital needs and distributions. No formal earnings or acquisition guidance was provided.
- Management declared a third-quarter dividend of $0.24 per common share and common unit, payable December 22, 2016. The first- and second-quarter 2016 dividends were each $0.23.
- Government agencies and the GSA accounted for approximately 96.9% of rental income. The filing highlights exposure to changes in government spending, agency leasing preferences and tenant retention. Thirteen properties in California represented approximately 27.5% of annualized lease income.
- Nine tenants, representing approximately 19.3% of rentable area and annualized lease income, had exercisable early-termination rights at quarter-end; additional rights become exercisable later. Management said it did not believe early termination was likely, but this remains a portfolio risk.
- Approximately 77.3% of debt was variable-rate. Management estimated that a 25-basis-point rate change would affect annual interest expense by about $0.6 million. After quarter-end, the company entered forward-starting swaps intended to fix the rate on future term-loan drawings at 3.12% from March 2017 through maturity.
- Acquisition fair values for five 2016 operating-property purchases remained preliminary. The company reported no material litigation, no material off-balance-sheet arrangements, and no material changes to the risk factors in its 2015 Form 10-K. Disclosure controls were assessed as effective.
Important facts for investors to verify
- Whether acquisitions and the development pipeline deliver expected rent and returns, and how preliminary purchase-price allocations are finalized.
- Lease renewal, expiration and early-termination exposure, particularly the disclosed 2017–2021 expirations and soft-term rights.
- Government revenue concentration, California property exposure and any changes in federal agency leasing or spending.
- Revolver usage, the timing and terms of any term-loan draw, variable-rate exposure, swap effectiveness and covenant headroom.
- Cash available for dividends after acquisitions, debt service and capital spending; also verify settlement of the 1.5 million-share forward sale, expected by December 7, 2016.
- Comparability of reported earnings and FFO across periods, given the IPO, predecessor accounting changes, acquisitions and non-GAAP adjustments.