Piedmont Office Realty Trust, Inc. — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017; balance-sheet comparisons are with December 31, 2016. Dollar amounts are in U.S. dollars. The filing identifies the registrant as Piedmont Office Realty Trust, Inc.
Business context and operating performance
- Piedmont is a REIT focused on owning, developing, and managing commercial office properties. At quarter-end it owned 68 in-service office properties, with approximately 20 million square feet in its consolidated portfolio; the portfolio was 91.5% leased.
- Revenue grew 7.6% year over year to $148.5 million. Rental income was $123.5 million, up $8.8 million, and tenant reimbursements were $24.5 million, up $1.7 million.
- Net income applicable to Piedmont increased to $15.1 million from $10.4 million. Diluted earnings per share rose to $0.10 from $0.07.
- Real estate operating income was $33.3 million versus $26.4 million; its margin on revenue increased to approximately 22.4% from 19.1%. Interest expense rose to $18.1 million from $16.4 million.
- NAREIT FFO was $66.2 million, or $0.45 per diluted share, compared with $59.9 million, or $0.41 per share. Core FFO was also $66.2 million, or $0.45 per share. AFFO increased to $54.1 million from $43.6 million. These are non-GAAP measures.
- Same-store NOI increased 9.6% on an accrual basis and 16.9% on a cash basis. Management attributed the increases principally to lease commencements and the expiration of rent abatements.
Cash flow, balance sheet, debt, and liquidity
- Operating cash flow was $50.3 million, compared with $49.7 million in Q1 2016. Capital expenditures were $28.2 million; investing activities used $32.8 million. Financing activities used $17.6 million, including $61.1 million of dividends paid and $100.0 million of debt proceeds, partly offset by $55.3 million of repayments.
- Cash and cash equivalents were $6.8 million at March 31, versus $7.0 million at year-end. Total assets were $4.35 billion and total equity was $2.09 billion.
- Total debt carrying value was $2.066 billion, up from $2.020 billion at December 31. The weighted-average stated/effectively fixed rate shown in the debt schedule was 3.43%. Debt fair value was estimated at $2.084 billion.
- At March 31, $223 million was drawn on the $500 million unsecured line of credit. The filing separately reports $287 million of remaining capacity as of the filing date, reflecting a later balance; verify the applicable date and draw amount. Management said it believed it was in compliance with debt covenants.
- Management expected the pending Two Independence Square sale proceeds to repay the line of credit and the $140 million Washington, D.C. fixed-rate loan, which opens for prepayment in August 2017. The next stated debt maturity after that loan is May 2018.
Material changes, outlook, and risks
- Revenue growth reflected new leases, properties acquired in 2016, and approximately $1.0 million of one-time lease restructuring fees. A $0.6 million prior-period reimbursement recovery following a favorable court ruling also contributed to reimbursements. Higher amortization and interest expense partly offset the improvement.
- Piedmont entered a binding agreement to sell Two Independence Square in Washington, D.C. for $359.6 million; closing was expected in mid-2017, subject to government approval. The property was classified as held for sale.
- Management reported 382,000 square feet of executed leases for vacant space that had not commenced and 1.2 million square feet of commenced leases still under some form of rent abatement. Lease commencements typically occur 6–18 months after execution, so downtime and abatements may delay cash-flow benefits.
- The board declared a Q2 2017 dividend of $0.21 per common share and renewed the share repurchase authorization for up to $250 million through May 2, 2019. Management said increased net dispositions could produce large one-time capital gains and potentially lead to special dividends; no earnings guidance was provided.
- Controls issue: Management identified a material weakness in internal control over financial reporting related to accounting for goodwill in property sales and assets held for sale. Disclosure controls were concluded to be ineffective at quarter-end. Management described remediation steps and expected remediation by June 30, 2017; lenders had waived any related potential debt-default issues concerning prior-period information and GAAP books and records.
- Key risks include office-market and leasing conditions, tenant defaults or terminations, concentrated exposure to major markets and tenants, property values and impairment, development costs, REIT qualification, and interest-rate exposure. A 1 percentage-point increase in variable rates on quarter-end borrowings was estimated to increase annual interest expense by approximately $3.9 million.
- Existing lease-related commitments included approximately $33.2 million of potential non-incremental tenant improvements over five years and $17.1 million of incremental tenant improvements under executed leases. Management reported no material pending legal proceedings.
Most important facts for investors to verify
- Whether the $359.6 million Two Independence Square sale closed, its net proceeds, and the resulting debt repayments.
- The current line-of-credit balance and available capacity, given the different figures reported for March 31 and the filing date.
- Progress and completion of remediation of the material weakness, and whether disclosure controls have been judged effective in subsequent filings.
- Leasing, occupancy, rent abatements, and the timing and cost of tenant improvements, particularly for vacant and newly completed space.
- Debt maturities, variable-rate exposure, covenant compliance, and the sustainability of dividends and any share repurchases.