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PDM > SEC Filings for PDM > Form 10-Q on 31-Oct-2012All Recent SEC Filings

Show all filings for PIEDMONT OFFICE REALTY TRUST, INC. | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for PIEDMONT OFFICE REALTY TRUST, INC.


31-Oct-2012

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis should be read in conjunction with the accompanying consolidated financial statements and notes thereto of Piedmont Office Realty Trust, Inc. ("Piedmont"). See also "Cautionary Note Regarding Forward-Looking Statements" preceding Part I, as well as the notes to our consolidated financial statements and Management's Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year ended December 31, 2011.

Liquidity and Capital Resources
We intend to use cash flows generated from the operation of our wholly-owned properties, distributions from our joint ventures, proceeds from selective property dispositions, and proceeds from our $500 Million Unsecured Line of Credit as our primary sources of immediate liquidity. During the three months ended September 30, 2012, we entered into a new $500 Million Unsecured Line of Credit to replace the expiring $500 Million Unsecured Facility. All amounts outstanding on the $500 Million Unsecured Facility were transferred to the $500 Million Unsecured Line of Credit at closing. Depending on the timing and volume of our property acquisition and disposition activities, we may also seek other financing opportunities (such as issuance of additional equity or debt securities or additional borrowings from third-party lenders) afforded to us based on our relatively low leverage and quality asset base as additional sources of capital; however, the availability and attractiveness of terms for these sources of capital is highly dependent on market conditions. As of September 30, 2012 approximately $22.5 million of net sales proceeds related to the tax deferred exchange of certain real estate assets under Section 1031 of the Internal Revenue Code ("IRC") was held in escrow pending the acquisition of replacement properties. If suitable replacement properties are not identified within the requisite time frame allowed under the IRC, these proceeds will be returned to the Company as unrestricted cash and become immediately available to fund expenditures. As of the time of this filing, we had $153.5 million outstanding under our $500 Million Unsecured Line of Credit. As a result, we had approximately $327.1 million under this facility available for future borrowing (approximately $19.4 million of capacity is reserved as security for outstanding letters of credit required by various third parties).
We estimate that our most immediate use of capital will be to fund capital expenditures for our existing portfolio of properties. These expenditures include two types of specifically identified building improvement projects:
(i) general repair and maintenance projects that we as the owner may choose to perform at any of our various properties and (ii) tenant improvement allowances and leasing commissions negotiated as part of executed leases with our tenants. Both the timing and magnitude of general repair and maintenance projects are subject to our discretion. We anticipate funding approximately $122.0 million in unrecorded contractual obligations for non-incremental tenant improvements related to our existing lease portfolio over the respective lease term, the majority of which we estimate may be required to be funded over the next several years. For many of our leases, the timing of the actual funding of these tenant improvements is largely dependent upon tenant requests for reimbursement. In some cases, these obligations may expire with the respective lease, without further recourse to us. Additionally, commitments for incremental capital expenditures associated with new leases, primarily at value-add properties, total approximately $63.1 million. We also anticipate funding certain tenant improvements and leasing commissions related to anticipated re-leasing efforts for several of our large tenants as they approach their lease expiration dates in the next twelve to eighteen months. Both the timing and magnitude of these amounts are subject to change as competitive market conditions at the time of lease negotiations dictate. Subject to the identification and availability of attractive investment opportunities and our ability to consummate additional acquisitions on satisfactory terms, acquiring new assets compatible with our investment strategy could also be a significant use of capital. Further, given that the Company's board believes our common stock is trading at a discount to the estimated fair value of our net assets, our board of directors has authorized the use of up to $300 million for the repurchase of our common stock through November 2013. Through September 30, 2012 (including repurchases made in December 2011), we have expended approximately $83.4 million under the stock repurchase program (including transactions fees) and may continue to make additional purchases as market conditions warrant. On a longer term basis, we expect to use funds to make scheduled debt service payments and/or debt repayments when such obligations become due. We currently have no debt maturities until 2014. Our primary focus is to achieve an attractive long-term, risk-adjusted return for our stockholders. Competition to attract and retain high-credit-quality tenants remains intense due to general economic conditions. At the same time, we have been in a period of high lease rollover for the past several years, and in some cases we have had to accept lower market driven rental rates and grant larger tenant improvement packages to renew leases or secure new tenants than a stronger economic climate might have produced. The sale of the 35 West Wacker Drive building in Chicago, Illinois during the fourth quarter of 2011, the commencement of certain significant leases with lower rental rates during 2012, and the downtime we have, and continue to, experience while re-tenanting certain properties put pressure on 2012 cash flow and caused our board of directors to lower our quarterly dividend to $.20 per share ($.80 per share on an annualized basis) beginning with the first quarter of 2012.


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The amount and form of payment (cash or stock issuance) of future dividends to be paid to our stockholders will continue to be largely dependent upon (i) the amount of cash generated from our operating activities; (ii) our expectations of future cash flows; (iii) our determination of near-term cash needs for debt repayments and selective acquisitions of new properties; (iv) the timing of significant expenditures for tenant improvements and general property capital improvements; (v) long-term payout ratios for comparable companies; (vi) our ability to continue to access additional sources of capital, including potential sales of our properties; and (vii) the amount required to be distributed to maintain our status as a REIT. Given the fluctuating nature of cash flows and expenditures, we may periodically borrow funds on a short-term basis to cover timing differences in cash receipts and cash disbursements.

Results of Operations

Overview

Our income from continuing operations decreased from $0.12 per share for the three months ended September 30, 2011 to $0.06 per share for the three months ended September 30, 2012 primarily due to a $7.5 million charge related to proposed settlements of two class action lawsuits. Rental income and property operating costs also increased due to properties acquired during the last twelve months as well as increased occupancy. The increase in rental income was offset by increased depreciation and amortization expense associated with significant tenant improvements and leasing commissions associated with higher leasing activity as well as properties acquired over the last twelve months.

Comparison of the three months ended September 30, 2012 versus the three months ended September 30, 2011

The following table sets forth selected data from our consolidated statements of income for the three months ended September 30, 2012 and 2011, respectively, as well as each balance as a percentage of total revenues for the same periods presented (dollars in millions):

                                                                                                       $
                                  September 30,                   September 30,                    Increase
                                      2012              %             2011              %         (Decrease)
Revenue:
Rental income                    $       106.8                   $       104.1                   $       2.7
Tenant reimbursements                     27.5                            28.2                          (0.7 )
Property management fee revenue            0.5                             0.1                           0.4
Other rental income                        0.1                               -                           0.1
Total revenues                           134.9          100  %           132.4          100  %           2.5
Expense:
Property operating costs                  51.7           38  %            50.7           38  %           1.0
Depreciation                              28.5           21  %            25.9           20  %           2.6
Amortization                              15.3           12  %            14.8           11  %           0.5
General and administrative
expense                                    5.5            4  %             4.7            4  %           0.8
Real estate operating income              33.9           25  %            36.3           27  %          (2.4 )
Other income (expense):
Interest expense                         (16.2 )        (12 )%           (16.2 )        (12 )%             -
Interest and other income                  0.4            -  %            (0.1 )          -  %           0.5
Equity in income of
unconsolidated joint ventures              0.3            -  %             0.5            -  %          (0.2 )
Litigation settlement expense             (7.5 )         (5 )%               -            -  %          (7.5 )
Income from continuing
operations                       $        10.9            8  %   $        20.5           15  %   $      (9.6 )
Income/(loss) from discontinued
operations                       $        (0.1 )                 $        30.5                   $     (30.6 )

Continuing Operations

Revenue

Rental income increased from approximately $104.1 million for the three months ended September 30, 2011 to approximately $106.8 million for the three months ended September 30, 2012. Approximately $1.8 million of the increase is attributable to three properties


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acquired subsequent to June 30, 2011. Additionally, new leases commenced at our Piedmont Pointe I and II buildings in Bethesda, Maryland in late 201l, which contributed to the current year increase.

Tenant reimbursements decreased from approximately $28.2 million for the three months ended September 30, 2011 to approximately $27.5 million for the three months ended September 30, 2012. Lease expirations at our 200 Bridgewater Crossing building in Bridgewater, New Jersey and at our Aon Center building in Chicago, Illinois in December 2011 account for approximately $1.1 million of the decrease. However, these decreases were partially offset by incurring higher property tax expense in the current period which resulted in higher tenant reimbursements primarily at our 800 North Brand Boulevard building in Glendale, California.

Property management fee revenue increased from approximately $0.1 million for the three months ended September 30, 2011 to approximately $0.5 million for the three months ended September 30, 2012. The increase is directly attributable to retaining the property management of the 35 West Wacker Drive building in Chicago, Illinois subsequent to selling the building to an unrelated third-party in December 2011.

Expense

Property operating costs increased approximately $1.0 million for the three months ended September 30, 2012 compared to the same period in the prior year primarily due to an increase in recoverable property taxes of approximately $1.5 million, as well as operating costs contributed by properties acquired subsequent to June 30, 2011, accounting for approximately $0.3 million of the increase. These increases, however, were offset by decreases of approximately $0.5 million in utility costs and $0.3 million in non-recoverable professional service fees.

Depreciation expense increased approximately $2.6 million for the three months ended September 30, 2012 compared to the same period in the prior year. The variance is largely attributable to depreciation on additional tenant improvements placed in service subsequent to June 30, 2011 which contributed approximately $1.9 million of the increase. The remainder of the increase is due to new properties acquired subsequent to June 30, 2011.

Amortization expense increased approximately $0.5 million for the three months ended September 30, 2012 compared to the same period in the prior year. The variance is primarily attributable to the acceleration of amortization expense on certain lease intangible assets related to a lease termination due to a tenant bankruptcy at our 500 W. Monroe building in Chicago, Illinois which contributed an additional $3.5 million of expense. However, this increase is largely offset by reduced amortization expense as a result of lease intangible assets becoming fully amortized at certain of our existing properties subsequent to June 30, 2011.

General and administrative expenses increased approximately $0.8 million for the three months ended September 30, 2012 compared to the same period in the prior year. The increase is primarily attributable to higher bad debt expense and transfer agent expenses during the current period.

Other Income (Expense)

Interest and other income increased approximately $0.5 million for the three months ended September 30, 2012 compared to the same period in the prior year. The increase reflects higher income in the current period related to interest earned on a $19.0 million note receivable originated as part of the sale of the Deschutes building, the Rhein building, the Rogue building, the Willamette building, and 18.19 acres of adjoining, undeveloped land in Beaverton, Oregon (collectively the "Portland Portfolio") in March 2012.

For the three months ended September 30, 2012 we recognized $7.5 million of litigation settlement expense related to potential settlement agreements of the two class action lawsuits. See Note 9 for further detail.

Discontinued Operations

In accordance with GAAP, the operations of the Eastpointe Corporate Center in Issaquah, Washington, the 5000 Corporate Court building in Holtsville, New York, the 35 West Wacker Drive building, the Portland Portfolio, the 26200 Enterprise Way building in Lake Forest, California, and the 110 and 112 Hidden Lake Circle buildings in Duncan, South Carolina are classified as discontinued operations for all periods presented. Income from discontinued operations decreased approximately $30.6 million for the three months ended September 30, 2012 compared to the same period in the prior year primarily due to the net gain realized on the sale of the Eastpointe Corporate Center building and the 5000 Corporate Center building in the prior period for approximately $26.8 million. We incurred a net loss on the sale of the 110 and 112 Hidden Lake Circle buildings in the current period of approximately $0.3 million. We do not expect that income from discontinued operations will be comparable to future periods, as such income is subject to the timing and existence of future property dispositions.


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Comparison of the nine months ended September 30, 2012 versus the nine months ended September 30, 2011

The following table sets forth selected data from our consolidated statements of income for the nine months ended September 30, 2012 and 2011, respectively, as well as each balance as a percentage of total revenues for the same periods presented (dollars in millions):

                                                                                                       $
                                  September 30,                   September 30,                    Increase
                                      2012              %             2011              %         (Decrease)
Revenue:
Rental income                    $       317.2                   $       306.5                   $      10.7
Tenant reimbursements                     81.1                            85.7                          (4.6 )
Property management fee revenue            1.7                             1.3                           0.4
Other rental income                        0.3                             4.4                          (4.1 )
Total revenues                           400.3          100  %           397.9          100  %           2.4
Expense:
Property operating costs                 157.8           39  %           152.2           38  %           5.6
Depreciation                              83.3           21  %            76.2           19  %           7.1
Amortization                              39.5           10  %            39.1           10  %           0.4
General and administrative
expense                                   15.6            4  %            18.9            5  %          (3.3 )
Real estate operating income             104.1           26  %           111.5           28  %          (7.4 )
Other income (expense):
Interest expense                         (48.7 )        (12 )%           (49.6 )        (12 )%           0.9
Interest and other income                  0.8            -  %             3.1            1  %          (2.3 )
Equity in income of
unconsolidated joint ventures              0.7            -  %             1.1            -  %          (0.4 )
Litigation settlement expense             (7.5 )         (2 )%               -            -  %          (7.5 )
Gain on consolidation of
variable interest entity                     -            -  %             1.5            -  %          (1.5 )
Income from continuing
operations                       $        49.4           12  %   $        67.6           17  %   $     (18.2 )
Income from discontinued
operations                       $        29.4                   $        38.5                   $      (9.1 )

Continuing Operations

Revenue

Rental income increased from approximately $306.5 million for the nine months ended September 30, 2011 to approximately $317.2 million for the nine months ended September 30, 2012. Approximately $10.1 million of the variance is attributable to properties acquired subsequent to January 1, 2011, which include the 1200 Enclave Parkway building in Houston, Texas, the 500 W. Monroe building, the Dupree building in Atlanta, Georgia, the Medici building in Atlanta, Georgia, the 225 and 235 Presidential Way buildings in Boston, Massachusetts, and the 400 TownPark building in Lake Mary, Florida. Additionally, new leases commenced at our Piedmont Pointe I and II buildings in late 2011 and at our 1075 West Entrance Drive building in Auburn Hills, Michigan in July 2011, contributed approximately $5.6 million of the year over year increase. These increases were partially offset by a reduction in leased space due to lease expirations at various properties (primarily at our 200 Bridgewater Crossing building, our Windy Point II building in Chicago, Illinois, and our Aon Center building). However, we have since executed a new lease for approximately one-third of the 200 Bridgewater Crossing building which will commence in first quarter 2013, and have executed a new lease for the entire Windy Point II building, also commencing in first quarter 2013.

Tenant reimbursements decreased from approximately $85.7 million for the nine months ended September 30, 2011 to approximately $81.1 million for the nine months ended September 30, 2012. Approximately $5.8 million of the decrease is attributable to the lease expirations noted above at the 200 Bridgewater Crossing building, the Windy Point II building, and the Aon Center building, as well as the 400 Bridgewater Crossing building. Properties acquired subsequent to January 1, 2011 contributed approximately $2.0 million to offset the decline in tenant reimbursements related to these lease expirations.

Property management fee revenue increased from approximately $1.3 million for the nine months ended September 30, 2011 to approximately $1.7 million for the nine months ended September 30, 2012. The increase is primarily attributable to retaining the property management of the 35 West Wacker Drive building in Chicago, Illinois subsequent to selling the building to an unrelated


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third-party in December 2011.

Other rental income is comprised primarily of income recognized for lease terminations and restructurings. Unlike the majority of our rental income, which is recognized ratably over long-term contracts, other rental income is recognized once we have completed our obligation to provide space to the tenant. Lease termination fee income for the nine months ended September 30, 2011 of approximately $4.4 million primarily relate to leases terminated or contracted at the 1201 and 1225 Eye Street buildings in Washington, D.C., the US Bancorp building in Minneapolis, Minnesota, and the 1075 West Entrance building. We do not expect such income to be comparable in future periods, as it will be dependent upon the exercise of lease terminations by tenants and/or the execution of restructuring agreements that may not be in our control or are deemed by management to be in the best interest of the portfolio over the long term.

Expense

Property operating costs increased approximately $5.6 million for the nine months ended September 30, 2012 compared to the same period in the prior year primarily due to properties acquired subsequent to January 1, 2011, accounting for approximately $4.9 million of the increase. The remainder of the variance is due to higher property tax expense and billback expense in 2012 at our Aon Center building.

Depreciation expense increased approximately $7.1 million for the nine months ended September 30, 2012 compared to the same period in the prior year. Of the year over year increase, approximately $4.2 million is attributable to depreciation on additional tenant improvements subsequent to January 1, 2011. The remainder of the increase is due to properties acquired subsequent to January 1, 2011.

Amortization expense increased approximately $0.4 million for the nine months ended September 30, 2012 compared to the same period in the prior year. The variance is primarily attributable to the acceleration of amortization expense on certain lease intangible assets related to a lease termination due to a tenant bankruptcy at our 500 W. Monroe building which contributed an additional $2.4 million of expense. The increase is also attributable to properties acquired subsequent to January 1, 2011. However, these increases are largely offset by reduced amortization expense as a result of lease intangible assets becoming fully amortized at certain of our existing portfolio of properties subsequent to January 1, 2011.

General and administrative expenses decreased approximately $3.3 million for the nine months ended September 30, 2012 compared to the same period in the prior year. The decrease is attributable to recoveries in excess of current period billings from our insurance carriers related to our litigation defense, as well as lower costs associated with our deferred stock compensation plan in the current period, totaling approximately $3.2 million.

Other Income (Expense)

Interest expense decreased approximately $0.9 million for the nine months ended September 30, 2012 compared to the same period in the prior year primarily due to the repayment of the $45.0 Million 500 W. Monroe Mezzanine I Loan in November 2011, the $140.0 Million 500 W. Monroe Mortgage Loan in January 2012, and the $45.0 Million Fixed-Rate Loan secured by the 4250 N. Fairfax building in May 2012. However, in November 2011, we entered into a new $300 Million Unsecured Term Loan which had an effectively fixed interest rate, through interest rate swap agreements, of 2.69% compared to the previous $250 Million Unsecured Term Loan, which carried an effectively fixed rate of 2.36%, and matured in June 2011. The higher interest rate on the new debt, coupled with the higher outstanding balance, resulted in the recognition of increased interest expense in the current period, partially offsetting the effect of the loan pay-offs noted above.

Interest and other income decreased approximately $2.3 million for the nine months ended September 30, 2012 compared to the same period in the prior year. The decrease reflects the recognition in the prior period of approximately $2.6 million of previously deferred property operating income upon consolidation of the 500 W. Monroe building.

For the nine months ended September 30, 2012 we recognized $7.5 million of litigation settlement expense related to potential settlement agreements of the two class action lawsuits. See Note 9 for further detail.

The approximate $1.5 million gain on the consolidation of our VIE recognized during the nine months ended September 30, 2011 is the net result of recording the estimated fair value of the net assets associated with taking ownership of the 500 W. Monroe building through foreclosure.


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Discontinued Operations

In accordance with GAAP, the operations of the Eastpointe Corporate Center, the 5000 Corporate Court building, the 35 West Wacker Drive building, the Portland Portfolio, the 26200 Enterprise Way building, and the 110 and 112 Hidden Lake Circle buildings are classified as discontinued operations for all periods presented. Income from discontinued operations decreased approximately $9.1 million for the nine months ended September 30, 2012 compared to the same period in the prior year and is mostly attributable to the lack of operational activity in the current period at the 35 West Wacker Drive building, Eastpointe Corporate Center, or the 5000 Corporate Court building, as these properties were sold in 2011. We do not expect that income from discontinued operations will be comparable to future periods, as such income is subject to the timing and existence of future property dispositions.

Funds From Operations ("FFO"), Core FFO, and Adjusted Funds from Operations
("AFFO")

Net income calculated in accordance with GAAP is the starting point for calculating FFO, Core FFO, and AFFO. FFO, Core FFO, and AFFO are non-GAAP financial measures and should not be viewed as an alternative measurement of our operating performance to net income. Management believes that accounting for real estate assets in accordance with GAAP implicitly assumes that the value of real estate assets diminishes predictably over time. Since real estate values have historically risen or fallen with market conditions, many industry investors and analysts have considered the presentation of operating results for real estate companies that use historical cost accounting to be insufficient by themselves. As a result, we believe that the use of FFO, Core FFO, and AFFO, together with the required GAAP presentation, provides a more complete understanding of our performance relative to our competitors and a more informed and appropriate basis on which to make decisions involving operating, financing, and investing activities.

We calculate FFO in accordance with the current NAREIT definition as follows:
Net income (computed in accordance with GAAP), excluding gains or losses from . . .

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