Piedmont Office Realty Trust, Inc. — 2017 Form 10-K
Reporting period: Year ended December 31, 2017; filed February 21, 2018. Piedmont is an office REIT focused on primarily Class A properties in the eastern half of the United States. The filing reports 67 in-service properties and approximately 19 million square feet at year-end; after the January 2018 portfolio sale, it had 53 properties, approximately 16.5 million square feet, and 91.8% leased.
Key financial results
| Metric | 2017 | 2016 |
|---|---|---|
| Total revenue | $574.2 million | $555.7 million |
| Income from continuing operations | $17.7 million | $6.3 million |
| Net income applicable to Piedmont | $133.6 million | $99.7 million |
| Diluted earnings per share | $0.92 | $0.69 |
| NAREIT FFO | $254.4 million; $1.75 per diluted share | $242.5 million; $1.67 per diluted share |
| Core FFO | $254.4 million; $1.75 per diluted share | $243.4 million; $1.67 per diluted share |
| Adjusted FFO | $200.3 million | $189.4 million |
| Cash from operating activities | $242.8 million | $231.8 million |
| Total assets | $4.00 billion | $4.37 billion |
| Total debt | $1.73 billion | $2.02 billion |
Revenue rose 3.3%, driven mainly by $15.9 million higher rental income from leases commencing in 2016 and 2017. Real estate operating income was $81.3 million, or about 14% of revenue, versus $70.8 million, or about 13%, in 2016. Interest expense increased $3.2 million to $68.1 million. The filing does not provide a single comparable GAAP operating margin measure beyond the income and expense figures shown.
Net income included $115.9 million of property-sale gains, principally the $109.4 million gain on Two Independence Square, and a $46.5 million real estate impairment charge. Excluding property-sale gains and real estate depreciation, amortization, and impairment through the company’s NAREIT FFO calculation, FFO increased about 4.9%. AFFO, a non-GAAP measure, increased about 5.8%.
Cash, debt and capital allocation
- Year-end cash and cash equivalents were $7.4 million; cash, cash equivalents and restricted cash totaled $8.8 million. Operating cash flow was $242.8 million, while capital expenditures were $79.8 million.
- Year-end debt-to-gross-assets ratio was 34.3%, within management’s stated target range of 30%–40%. Weighted-average debt interest rate was 3.48%. A 1 percentage-point rate increase on variable-rate debt outstanding at year-end was estimated to add approximately $1.9 million in annual interest expense.
- On January 4, 2018, the company completed the sale of 14 non-strategic properties for approximately $425.9 million gross proceeds, with up to $4.5 million additional contingent proceeds. It used sale proceeds, cash and revolver borrowings to repay $470 million of term loans; management said this reduced debt-to-gross-assets to approximately 30%. At filing, $178 million of the $500 million credit line was unused, and no scheduled debt maturities remained over the following 15 months.
- 2017 common dividends declared were $1.34 per share, including a $0.50 special dividend paid January 9, 2018, funded in part by taxable gain on the Two Independence Square sale. The board declared a $0.21-per-share first-quarter 2018 dividend.
- The company repurchased 2.9 million shares in the fourth quarter at an average $19.68 per share. From January 1 through February 21, 2018, it repurchased a further 7.8 million shares at a weighted-average $18.97. The board renewed authorization for up to $200 million of additional repurchases through February 2020.
Portfolio, changes and management commentary
- Year-end leased occupancy was 89.7%, down from 94.2% in 2016, mainly because three development properties totaling about 700,000 square feet entered service, two large leases expired, and a fully leased Washington, D.C. property was sold. Occupancy was 91.8% after the January dispositions.
- Year-end annualized lease revenue (ALR, a non-GAAP measure) was $561.3 million for the in-service portfolio before dispositions; the post-sale portfolio’s ALR was $507.1 million. Average remaining lease term was approximately seven years. No tenant represented 5% or more of ALR after the dispositions; 64.1% of ALR came from investment-grade or nationally recognized corporations or government agencies.
- Same-store NOI increased 9.3% on a cash basis and 5.8% on an accrual basis. Management attributed growth primarily to lease commencements and the expiration of rent abatements, with some benefit from tenant dispute recoveries and restructuring fees.
- Management described the 14-property sale as substantially completing its strategy to concentrate the portfolio in eight core markets. Sale proceeds were applied to debt repayment, share repurchases and the $35 million acquisition of Norman Pointe I in Minneapolis. A $28 million Orlando property acquisition was under contract as of February 19, 2018.
- There is no quantified earnings, FFO, occupancy or dividend guidance in the filing. Management expects to fund liquidity principally from property operating cash flow, selective dispositions and the credit facility; future distributions and capital allocation depend on cash generation, debt and property needs, investment opportunities, and REIT requirements.
Risks, contingencies and unusual items
- Key risks include office-market and economic weakness, concentration in office properties and eight principal markets, competition for tenants, lease expirations and tenant defaults, leasing concessions and improvement costs, and the potential for property impairments.
- Other material risks include interest-rate and refinancing exposure, debt covenant restrictions, real estate illiquidity, development and redevelopment execution, environmental and regulatory liabilities, natural disasters and insurance limits, cybersecurity, joint-venture partner risks, and maintaining REIT qualification. The filing discusses potential effects of the Tax Cuts and Jobs Act but says management did not expect a significant financial-statement impact based on its assessment at that time.
- The $46.5 million impairment related to the 14-property disposition group. Fourth-quarter 2017 net loss applicable to Piedmont was $31.4 million, or $0.21 per share, reflecting the impairment; annual net income was substantially supported by property-sale gains.
- Tenant improvement commitments at year-end included approximately $38.6 million of non-incremental commitments over five years and $14.1 million of incremental commitments associated with executed leases, excluding the sale portfolio. Routine litigation was not expected to have a material adverse effect; no material pending legal proceedings were reported.
- Ernst & Young issued unqualified audit opinions on the financial statements and internal controls. The company reported effective disclosure controls and internal control over financial reporting. Deloitte was engaged to audit fiscal 2018.
Important facts for investors to verify
- Confirm the final net proceeds from the 14-property sale, any contingent leasing proceeds, and the resulting debt, leverage and credit-line balances after the January 2018 repayments.
- Assess the occupancy and leasing outlook, particularly the 2018 lease expirations representing 7.5% of post-disposition ALR, vacant space, and leases not yet commenced or still receiving abatements.
- Reconcile GAAP earnings with FFO, Core FFO and AFFO, and evaluate the impact of sale gains, impairments, capital expenditures and tenant leasing costs on recurring cash generation.
- Review the use of proceeds among debt repayment, share repurchases, dividends and acquisitions, including the renewed $200 million repurchase authorization and the sustainability of distributions.
- Monitor office-market concentration, debt maturities and variable-rate exposure, covenant headroom, tenant credit quality, and the effects of new tax and accounting standards.