Easterly Government Properties, Inc. — Q2 2017 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2017; financial statements are unaudited. Unless stated otherwise, dollar amounts below are in millions. Easterly is a REIT focused on acquiring, developing and managing commercial properties leased mainly to U.S. Government agencies.
Business and portfolio
At quarter-end, the company owned 45 operating properties totaling approximately 3.5 million square feet, all reported 100% leased, plus two properties under development. The U.S. Government represented approximately 97.4% of rental income. Portfolio growth included the acquisitions of OSHA–Sandy and VA–Loma Linda, and development of an FDA laboratory in Lenexa, Kansas. The Loma Linda property is leased to the VA for 20 years; the Lenexa lease term is 20 years beginning upon completion.
Financial results
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Total revenue | $30.6 | $24.9 | $60.5 | $48.9 |
| Operating income | $4.7 | $3.0 | $8.5 | $6.1 |
| Consolidated net income | $1.0 | $1.0 | $2.4 | $2.1 |
| Net income attributable to Easterly | $0.8 | $0.7 | $1.9 | $1.4 |
| EPS, basic and diluted | $0.02 | $0.02 | $0.05 | $0.05 |
| FFO, as Adjusted (non-GAAP) | $13.5 | $11.7 | $27.1 | $23.2 |
Operating margin was approximately 15.4% in Q2 2017 versus 12.2% in Q2 2016, and 14.0% versus 12.4% for the six-month periods. Net margin on consolidated net income was approximately 3.3% versus 4.2% in Q2 and 3.9% versus 4.4% for the six-month periods. FFO and adjusted FFO are supplemental non-GAAP measures, not measures of cash flow or liquidity.
Q2 revenue increased $5.7 million, principally from properties acquired since June 2016. Expenses rose $4.0 million, including higher property costs and depreciation tied to acquisitions. Interest expense increased $1.7 million to $3.7 million, largely reflecting newly issued notes and the term loan. Six-month revenue rose $11.6 million, while interest expense increased $2.2 million. Growth in operating income was partly offset by financing costs and higher expenses.
Cash flow, debt and liquidity
- Six-month operating cash flow was $24.5 million, versus $21.0 million. Investing used $256.2 million, primarily for real estate acquisitions; financing provided $232.9 million. Cash and cash equivalents ended June at $6.1 million.
- Debt principal outstanding was approximately $549.4 million (reported net carrying value: $545.6 million). The company reported weighted-average debt maturity of 8.7 years and weighted-average interest rate of 3.6%; 84.8% of debt was fixed-rate, including the term loan hedged with swaps.
- Debt included $68.0 million drawn on the revolving facility, $100.0 million on a term loan, $175.0 million in unsecured notes, and $206.4 million in mortgage principal. The revolving facility had $332.0 million available capacity, with an accordion feature for additional capacity subject to terms.
- Management said available cash, operating cash flow and financing sources were expected to meet anticipated liquidity needs for the next 12 months. The company was in compliance with debt covenants at June 30. It had no material off-balance-sheet arrangements.
Capital, distributions and outlook
The company issued $175 million of senior unsecured notes in May at fixed rates of 4.05%–4.30%, with maturities from 2027 to 2032, and entered into a $127.5 million mortgage loan secured by VA–Loma Linda. It also had a $100 million term loan effectively fixed at 3.12% through interest-rate swaps. The company completed a forward equity offering of 4.945 million shares; it expected approximately $94 million of gross proceeds upon settlement, anticipated by September 27, 2017. An ATM program had approximately $98.1 million of gross sales capacity remaining at June 30.
The board declared a $0.25-per-share quarterly dividend, payable September 28, 2017. The filing provides no quantified earnings or FFO guidance. Management stated that liquidity was expected to be adequate for anticipated needs, while noting that unexpected cash requirements or reduced access to financing could affect liquidity. The company intends to distribute taxable income as required to maintain REIT status.
Risks, contingencies and other items
- Revenue dependence is concentrated: U.S. Government tenants generated approximately 97.4% of rental income. Government spending priorities, leasing preferences or tenant decisions could affect results.
- Four tenants, covering approximately 12.9% of rentable area and 11.8% of annualized lease income, had exercisable early-termination (“soft-term”) rights. Lease expirations include 10.7% of annualized lease income in 2018 and 14.4% in 2021.
- California represented approximately 35.9% of annualized lease income; the company cited exposure to regional economic, real estate and natural-disaster risks.
- Interest-rate sensitivity: a 25-basis-point change in rates on variable-rate debt would change annual interest expense by approximately $0.2 million. The company reported a $0.6 million six-month unrealized loss on swaps in other comprehensive income.
- Management identified acquisition, development, refinancing, debt covenant, tenant retention, real estate, insurance, environmental, weather, cybersecurity and capital-market risks. No material litigation or material changes to previously disclosed risk factors were reported. Disclosure controls were assessed as effective.
Important facts for investors to verify
- Whether the forward equity agreements settled as expected and the resulting proceeds and share dilution.
- Acquisition and development execution, including completion and leasing commencement for FDA–Lenexa.
- Renewal, termination and rollover outcomes for soft-term leases and leases expiring in 2017–2021.
- Debt covenants, refinancing requirements, interest-rate exposure and continued access to revolver capacity.
- Dividend coverage using recurring operating cash flow and REIT taxable income, rather than relying solely on GAAP earnings or non-GAAP FFO.