Easterly Government Properties, Inc. — Q3 2015 Form 10-Q
Business context and reporting period
Quarter ended September 30, 2015; filed November 5, 2015. Easterly is an internally managed REIT focused on U.S. government-leased commercial properties. It completed its IPO and formation transactions on February 11, 2015, and intended to qualify as a REIT beginning with tax year 2015. At quarter-end it owned 32 properties totaling approximately 2.3 million square feet; the portfolio was 100% occupied. The company owned 60.9% of its operating partnership.
Comparisons with 2014 require caution: 2015 results include the company only from the February IPO onward, alongside predecessor results, while 2014 reflects the predecessor under investment-company fair-value accounting. Following the IPO, contributed properties were generally reported using historical-cost accounting. These changes make reported revenue, earnings, cash flows, and fair-value gains or losses not directly comparable.
Financial and operating highlights
| Metric | Three months ended Sep. 30, 2015 | Nine months ended Sep. 30, 2015 |
|---|---|---|
| Total revenue | $19.9 million | $49.2 million |
| Operating income | $2.2 million | $2.3 million |
| Consolidated net income (loss) | $0.8 million | $(6.2) million |
| Net income (loss) attributable to Easterly | $0.5 million | $(1.8) million |
| Basic and diluted EPS | $0.02 | $(0.09) |
| FFO / FFO, as adjusted | $10.2 million / $9.8 million | $22.3 million / $24.0 million |
Q3 operating margin was approximately 10.9% (operating income divided by revenue). Depreciation and amortization was $9.3 million in Q3 and $23.4 million for the nine months. Nine-month acquisition costs were $1.9 million and formation expenses were $1.7 million. Management’s adjusted FFO excludes specified items and is a non-GAAP measure, not a measure of cash flow or liquidity.
- Cash flow: Nine-month operating cash flow was $18.8 million; investing cash outflow was $46.7 million; financing cash inflow was $0.9 million. Cash and cash equivalents were $4.5 million at September 30, down from $31.4 million at year-end 2014. Restricted cash was an additional $1.8 million.
- Liquidity: $349.8 million was available under the $400 million revolving credit facility; $50.2 million was drawn. Management stated that expected cash flows and available resources were adequate for anticipated needs over the next 12 months.
- Debt: Total reported debt was $118.9 million, comprising $50.2 million of revolving borrowings and $68.8 million of mortgage debt. Mortgages were fixed-rate; revolver borrowings were variable-rate. The company reported compliance with facility covenants. A 25-basis-point change in variable rates was estimated to change annual interest expense by approximately $0.3 million.
- Portfolio and leases: Government tenants accounted for approximately 96% of rental income. Weighted-average annualized lease income was $32.17 per square foot. Contractual minimum lease payments totaled approximately $409.9 million. Seven tenants, representing 18.4% of rentable area and 20.8% of annualized lease income, had exercisable early-termination rights.
Material changes and management commentary
The February IPO raised approximately $191.6 million net, and the concurrent private placement generated approximately $105.5 million. Formation transactions added 29 properties; three additional properties were acquired during the period for approximately $50.9 million. Proceeds and revolving borrowings helped repay approximately $293.4 million of prior secured debt. The shift from predecessor fair-value accounting contributed to the sharp contrast between 2014 investment-related gains and 2015 operating results. Nine-month 2014 included a $71.9 million unrealized investment gain; 2015 included a $5.1 million unrealized loss before the IPO. Management also presented unaudited pro forma nine-month results assuming the formation transactions and three acquisitions occurred at the start of 2014: revenue of $60.4 million in each period and net income of $3.8 million in 2015 versus $0.2 million in 2014; these figures are not a forecast and exclude or adjust acquisition and formation costs as described in the filing.
The board declared a Q3 dividend of $0.22 per share, payable December 3, 2015. The company reported no material off-balance-sheet arrangements, no material litigation, and no material changes to previously disclosed risk factors. No specific earnings or acquisition guidance was provided.
Risks, contingencies, and unusual items
- Revenue is highly concentrated in the U.S. Government and GSA; changes in government spending, leasing preferences, or tenant requirements could affect occupancy and rents.
- Early-termination rights create lease-duration risk despite reported full occupancy. California represented approximately 33% of annualized lease income, creating geographic concentration.
- Debt covenants limit leverage, certain investments, and distributions. The facility also caps distributions, subject to its stated REIT-related provisions.
- The company had a tax-protection agreement with a director/executive for contributed Western Devcon properties. After quarter-end, it acquired a DEA laboratory from an entity indirectly owned by that executive; the acquisition included additional tax-protection, debt-guarantee opportunity, and registration-rights arrangements.
- REIT qualification was an intention, not yet an established outcome for the full 2015 tax year. Failure to qualify could result in corporate-level taxation. Environmental, insurance, natural-disaster, refinancing, interest-rate, and real-estate-market risks were also disclosed.
Important facts for investors to verify
- How recurring property-level cash generation and adjusted FFO compare with dividends, debt service, and the company’s planned acquisition pace.
- The terms, timing, and tenant concentration of lease expirations and early-termination rights, including any exercise or renewal activity.
- Current revolver borrowings, variable-rate exposure, covenant headroom, and scheduled mortgage and facility maturities.
- Final acquisition-date valuations and purchase-price allocations for 2015 acquisitions, which the filing described as preliminary.
- REIT qualification and the financial and governance implications of related-party transactions and tax-protection agreements.