Easterly Government Properties, Inc. — Q2 2016 Form 10-Q
Reporting period: Three and six months ended June 30, 2016; financial statements are unaudited. Amounts below are in millions unless stated otherwise. The company is an internally managed REIT focused on commercial properties leased primarily to U.S. Government agencies.
Business context
At quarter-end, the company owned 38 properties totaling approximately 2.8 million square feet; the portfolio was 100% leased to 20 tenants. Federal agencies accounted for approximately 96.4% of rental income. The company owned approximately 78% of its Operating Partnership.
Financial performance and position
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Total revenue | $24.9 | $19.3 | $48.9 | $29.3 |
| Operating income | $3.0 | $2.3 | $6.1 | $0.1 |
| Net income (loss) | $1.0 | $1.0 | $2.1 | $(7.0) |
| Net income (loss) attributable to Easterly | $0.7 | $0.6 | $1.4 | $(2.3) |
| Basic and diluted EPS | $0.02 | $0.02 | $0.05 | $(0.12) |
| Operating cash flow | Not provided by quarter | Not provided by quarter | $21.0 | $7.0 |
Q2 revenue increased 29.4% year over year and operating income rose 32.6%; net income increased modestly. Six-month comparisons are affected by the February 2015 IPO and formation transactions, the addition of properties, and a $5.1 million unrealized investment loss recorded in the 2015 period. Reported operating margin was approximately 12.2% in Q2 2016 versus 11.9% in Q2 2015; the six-month figures were approximately 12.4% and 0.4%, respectively.
- Cash flow: For the six months, investing activities used $129.9 million, principally for $52.0 million of acquisitions and $77.8 million of acquisition deposits. Financing activities provided $104.4 million. Cash and cash equivalents ended at $3.7 million, down from $8.2 million at year-end 2015.
- Debt and liquidity: Debt totaled $280.5 million: $198.2 million drawn on the $400 million revolver and $82.3 million of mortgage debt. The revolver had $201.8 million available. Management said anticipated cash flows and available sources should cover expected needs for the next 12 months; the company reported compliance with debt covenants.
- Rates: 76.4% of debt was variable-rate and 23.6% fixed-rate. Management estimated a 25-basis-point change in variable rates would affect annual interest expense by approximately $0.5 million.
- Other measures: FFO was $12.1 million for Q2 and $24.1 million for the six months; FFO, as Adjusted, was $11.7 million and $23.2 million, respectively. These are supplemental, non-GAAP measures, not measures of cash flow or liquidity.
- Dividends and equity: The company declared a $0.23-per-share dividend for each of Q1 and Q2 2016. A June public offering generated $84.9 million gross proceeds; forward sales for 1.5 million shares could provide approximately $27.0 million gross proceeds if physically settled in full by December 7, 2016.
Material changes and developments
Revenue growth primarily reflected acquisitions and, for the six-month comparison, properties contributed in the 2015 formation transactions. Q2 expenses rose by $4.9 million, including higher property costs, depreciation and amortization, and corporate general and administrative costs. Interest expense increased as revolver borrowings and average borrowing rates rose. During the first half, the company acquired two properties for $52.0 million. After quarter-end, it acquired three additional government-leased properties on July 1, 2016; purchase prices are not stated in the provided filing text.
Total assets rose to $1.018 billion from $912.0 million at December 31, 2015. Revolver borrowings increased from $154.4 million to $198.2 million, while total liabilities rose to $332.5 million from $292.1 million. The company also exchanged 5.7 million Operating Partnership units for common shares and issued shares in the June offering.
Outlook, risks and unusual items
- Management expects liquidity to be adequate for the next 12 months, but noted that unexpected cash needs or reduced access to funding could affect liquidity. The company had $77.8 million in acquisition deposits at quarter-end.
- The company was awarded a lease for a 65,810-square-foot FDA laboratory in Alameda, California, with a 20-year term beginning upon completion of development.
- Eight tenants, representing approximately 20.3% of rentable area and 20.7% of annualized lease income, had exercisable early-termination rights at June 30. Additional rights become exercisable for tenants representing 0.8% of area and 0.9% of income in the second half of 2016, and 4.2% of area and 3.4% of income in 2017. The company stated it did not believe early termination was likely, but this is a material occupancy risk.
- Geographic and tenant concentration are significant: California represented approximately 30.3% of annualized lease income, and federal agencies generated 96.4% of rental income. The filing identifies dependence on government leasing and spending, property and development risks, refinancing and interest-rate risks, and other real estate and capital-market risks.
- The $500 million universal shelf registration statement became effective in May 2016; the filing does not assure that future offerings will be completed. No material off-balance-sheet arrangements or material litigation were reported. Disclosure controls were deemed effective, and no material change in internal control was reported.
Important facts for investors to verify
- Potential early lease terminations, particularly among tenants with current soft-term rights and leases expiring in 2016–2021.
- Execution and funding of acquisitions, including use of the $77.8 million in deposits, and settlement terms for the forward share agreements.
- Exposure to federal leasing and spending, California concentration, and the effect of any tenant or geographic disruption.
- Revolver availability, interest-rate exposure, covenant headroom, and refinancing needs as the facility approaches maturity.
- Comparability of prior-year results given the IPO, formation transactions, changed accounting presentation, and property additions; also distinguish GAAP results from FFO measures.