Easterly Government Properties, Inc. — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018; comparative periods are 2017. Amounts below are in millions unless noted. The unaudited statements are prepared under GAAP.
Business context
Easterly is an internally managed REIT focused on owning, developing and managing commercial properties leased primarily to U.S. Government agencies. At quarter-end it owned 56 operating properties totaling approximately 4.8 million square feet, plus three properties under development. Operating properties were 100% leased; the U.S. Government generated approximately 98.7% of rental income.
Financial results and key metrics
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Total revenue | $39.4 | $33.9 | $112.4 | $94.3 |
| Operating income | $7.4 | $6.6 | $22.0 | $15.5 |
| Consolidated net income | $2.5 | $1.1 | $6.0 | $3.9 |
| Net income attributable to Easterly | $2.2 | $0.9 | $5.1 | $3.2 |
| Basic and diluted EPS | $0.03 | $0.02 | $0.08 | $0.08 |
| Operating margin | 18.8% | 19.5% | 19.6% | 16.4% |
| Net margin | 6.3% | 3.3% | 5.4% | 4.1% |
For the nine months, operating cash flow was $49.1 million versus $42.8 million; investing cash use was $370.6 million versus $350.3 million; and financing cash provided was $316.6 million versus $311.4 million. Cash and restricted cash totaled $11.3 million at September 30, 2018, including $6.9 million of unrestricted cash.
Quarter-end total assets were $1,778.5 million and total liabilities were $737.2 million. Debt principal outstanding was approximately $670.0 million (reported debt carrying value, net of fees and other adjustments, was $665.6 million). Management reported a weighted-average debt maturity of seven years and weighted-average interest rate of 3.7%; 70.3% of principal debt was fixed rate and 29.7% variable rate. The $450 million revolving facility had $417.0 million available. The company was in compliance with debt covenants.
Nine-month FFO, as Adjusted, a company-presented non-GAAP measure, was $44.6 million versus $40.5 million. The company cautions that FFO measures are supplemental and are not measures of cash flow or liquidity.
Material changes versus prior period
- Q3 revenue rose $5.6 million, mainly from acquisitions; nine-month revenue increased $18.0 million. Management attributed most of the growth to acquired properties and fuller-period contributions from prior acquisitions.
- Nine-month operating income increased $6.5 million, while interest expense increased $4.4 million to $16.0 million. The increase reflected additional interest on debt issued or assumed in 2017 and 2018, partly offset by lower revolving borrowings and more capitalized development interest.
- During the nine months, Easterly acquired ten operating properties for an aggregate purchase price of approximately $321 million, including eight properties from a 14-property portfolio. The portfolio’s stated total purchase price was approximately $430 million.
- Common shares outstanding increased to 60.8 million from 44.8 million at year-end 2017. The company issued 15.4 million shares in the period; the June offering included forward-sale agreements whose physical settlement was expected by December 21, 2018.
- Dividends declared were $0.26 per share for each of the first three 2018 quarters, compared with $0.25 for Q3 2017.
Outlook, risks and unusual items
- Management said anticipated cash flows and financing sources should provide adequate capital for the next 12 months, including debt service, distributions, tenant improvements and other obligations. No earnings or FFO guidance was provided.
- The company expected to close on the three remaining properties in the portfolio acquisition before December 31, 2018, subject to customary conditions. After quarter-end, it completed three more portfolio acquisitions and reported that 11 of 14 had closed.
- After quarter-end, the FEMA–Tracy development was substantially completed and a 20-year GSA lease commenced. An October amendment reduced the 2016 term-loan margin and extended its maturity to March 29, 2024.
- Key stated risks include dependence on U.S. Government tenants and spending decisions, lease termination or nonrenewal, real-estate development and acquisition execution, interest rates and refinancing, and weather or natural disasters. California represented approximately 29.7% of annualized lease income; 15 properties were located there.
- Six tenants, representing approximately 6.3% of rentable area and 4.5% of annualized lease income, had exercisable early-termination rights before stated lease expirations. Management said it did not consider early termination likely, but this is not assured.
- The company revised 2017 comparative results for an identified useful-life estimate error, which it deemed immaterial to previously issued statements. The revision reduced nine-month 2017 depreciation expense by $0.6 million and increased reported net income by the same amount.
- Management reported effective disclosure controls, no material litigation, and no material changes to previously disclosed risk factors. Adoption of the new revenue standard did not materially affect the financial statements; the company was still evaluating the expected impact of the new lease standard, effective January 1, 2019.
Important facts for investors to verify
- Whether the remaining portfolio properties closed as expected, and the final purchase price, financing and contribution to rent and earnings.
- Physical settlement of the forward-sale agreements, net proceeds received and resulting share dilution.
- Lease rollover and early-termination exposure, particularly upcoming expirations and the concentration in California and U.S. Government tenants.
- Debt costs and exposure to variable rates: management estimated that a 25-basis-point change in variable rates would change annual interest expense by approximately $0.5 million.
- Cash available after acquisitions, development spending and dividends, and the company’s continued covenant compliance.
- Comparability of reported growth with acquisition effects and the revised 2017 depreciation and earnings figures.