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PDM > SEC Filings for PDM > Form 10-Q on 1-Aug-2013All Recent SEC Filings

Show all filings for PIEDMONT OFFICE REALTY TRUST, INC.

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


1-Aug-2013

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, 2012, as well as the Current Report on Form 8-K containing Exhibit 99.1 filed on June 4, 2013, for the purpose of recasting certain sections of Piedmont's Annual Report on Form 10-K for the year ended December 31, 2012 for dispositions subsequent to December 31, 2012.

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 source of immediate liquidity. During the three months ended June 30, 2013, we issued $350 million in aggregate principal amount of Senior Notes and used the proceeds from the issuance to pay down our $500 Million Unsecured Line of Credit. As a result, as of the time of this filing, we had approximately $394.6 million in capacity under the line of credit 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). Depending on the timing and volume of additional property acquisition and disposition activities and debt maturities, we may also issue additional equity or debt securities under the shelf registration statement that we filed during the quarter ended June 30, 2013. In addition, we may also seek additional borrowings from third-party lenders as additional sources of capital. The availability and attractiveness of terms for these additional sources of capital is highly dependent on market conditions.

We estimate that our most consistent 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 our discretion at any of our various properties and (ii) tenant improvement allowances and leasing commissions that we have committed to as part of executed leases with our tenants. Due to the high lease rollover that we have experienced over the last several years, the majority of our expected capital expenditures relate to leasing commissions and tenant improvement allowances as we complete tenant build outs in preparation for the commencement of executed leases. During the year ended December 31, 2012 and the six months ended June 30, 2013, we incurred obligations totaling approximately $5.39 and $3.59 per square foot per year of lease term, respectively, for such capital expenditures. As of June 30, 2013, unrecorded contractual obligations for non-incremental tenant improvements related to our existing lease portfolio totaled $99.4 million. The timing of the funding of these commitments is largely dependent upon tenant requests for reimbursement; however, we anticipate that the majority of this amount may be requested over the next 12 - 24 months as certain significant leases commence over the next twelve months. In some instances, 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 $28.2 million.

We also anticipate incurring market-based concession packages, typically consisting of the tenant allowances described above and/or rent abatement periods, and paying broker commissions in conjunction with the commencement of recently executed, or soon to be executed, leases. In addition, we anticipate continuing to grant such concession packages as we negotiate future leases. Given our average lease size of between 30,000 and 35,000 square feet, some of the concession packages that we grant can result in significant capital outlays. In particular, there are currently five blocks of space in excess of 200,000 square feet in our Washington, D.C. and Chicago portfolio that are subject to re-leasing efforts, and we may grant similar concession packages to secure new, or renew existing, tenants for those spaces. Both the timing and magnitude of any such concessions have yet to be determined and are highly dependent on competitive market conditions at the time of lease negotiations.

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. During the six months ended June 30, 2013, we acquired two properties, Arlington Gateway in the Washington, D.C. market, and 5 & 15 Wayside Road in the Boston, Massachusetts market. Both purchases were initially funded using our $500 Million Unsecured Line of Credit, and the related draws were subsequently refinanced during the quarter ended June 30, 2012 using the proceeds from our Senior Notes issuance. Further, our board of directors has authorized a $300 million repurchase program for our common stock for use when we believe that our stock is trading at a meaningful discount to what we believe the fair value of our assets to be. Including $14.5 million of purchases during the quarter ended June 30, 2013, we have expended approximately $109.8 million (including transactions fees) for stock purchases since the program's inception in November 2011 and we may continue to use capital to make additional purchases as market conditions warrant. Approximately $190.2 million of


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authorized capacity remains on the program which could be spent prior to the program's expiration in November 2013. Additionally, our board may authorize the extension of the program.

On a longer term basis, we expect to use capital to repay debt when obligations become due. We currently have no debt maturing in 2013; however, we have $575 million of secured debt maturing in 2014. Subject to our assessment of market conditions, we currently anticipate refinancing these amounts with unsecured debt. In anticipation of incurring additional debt and considering the historically low interest rate environment, we have entered into several forward starting interest rate swaps with a total notional value of $280 million to partially protect us against rising interest rates and to lock a portion of the interest rate on any future unsecured debt. Again, subject to our assessment of market conditions, we may enter into additional similar swaps in the future.

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 June 30, 2012 to $0.11 per share for the three months ended June 30, 2013 primarily due to the loss of rental income from the expiration of a 330,000 square foot lease in Washington, D.C. and increased interest expense associated with higher outstanding debt balances during the current quarter as a result of property acquisitions as compared to the quarter ended June 30, 2012 and higher depreciation expense related to increased capital expenditures over the last twelve months, partially offset by net income from properties acquired during the current year and insurance recoveries related to litigation settlement expense and casualty losses incurred in prior periods.

Comparison of the three months ended June 30, 2013 versus the three months ended June 30, 2012

The following table sets forth selected data from our consolidated statements of income for the three months ended June 30, 2013 and 2012, respectively, as well as each balance as a percentage of total revenues for the same periods presented (dollars in millions):


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                                                                                                $
                                      June 30,                   June 30,                    Increase
                                        2013           %           2012           %         (Decrease)
Revenue:
Rental income                        $   110.0                  $   104.2                  $      5.8
Tenant reimbursements                     24.3                       26.8                        (2.5 )
Property management fee revenue            0.5                        0.6                        (0.1 )
Total revenues                           134.8         100  %       131.6         100  %          3.2
Expense:
Property operating costs                  53.0          39  %        52.5          40  %          0.5
Depreciation                              30.8          23  %        27.2          21  %          3.6
Amortization                              11.3           8  %        11.3           8  %            -
General and administrative                 6.3           5  %         4.9           4  %          1.4
Real estate operating income              33.4          25  %        35.7          27  %         (2.3 )
Other income (expense):
Interest expense                         (18.2 )       (14 )%       (15.9 )       (12 )%         (2.3 )
Interest and other income (expense)       (0.1 )         -  %         0.3           -  %         (0.4 )
Litigation settlement recovery             1.3           1  %           -           -  %          1.3
Net recoveries of casualty loss            2.3           2  %           -           -  %          2.3
Equity in income of unconsolidated
joint ventures                             0.1           -  %         0.2           -  %         (0.1 )
Income from continuing operations    $    18.8          14  %   $    20.3          15  %   $     (1.5 )
Income from discontinued operations  $    16.5                  $    10.4                  $      6.1

Continuing Operations

Revenue

Rental income increased from approximately $104.2 million for the three months ended June 30, 2012 to approximately $110.0 million for the three months ended June 30, 2013 primarily due to approximately $5.7 million of additional revenue attributable to properties acquired during the current year as well as the commencement of several significant leases over the last twelve months, partially offset by the expiration of a 330,000 square foot lease at our One Independence Square building in Washington, D. C. during March of 2013.

Tenant reimbursements decreased from approximately $26.8 million for the three months ended June 30, 2012 to approximately $24.3 million for the three months ended June 30, 2013. The variance is primarily attributable to an approximate $2.1 million reduction in tenant reimbursements as a result of operating expense and tax abatements granted on a large lease renewal at the 500 W. Monroe building.

Expense

Property operating costs increased approximately $0.5 million for the three months ended June 30, 2013 compared to the same period in the prior year primarily due to properties acquired during the current year which contributed $2.0 million to the increase. However, this increase was partially offset by reduction in operating costs of approximately $1.1 million related to the lease expiration of a single tenant at our One Independence Square building, as well as a property tax refund of approximately $0.6 million at our Two Independence Square building.

Depreciation expense increased approximately $3.6 million for the three months ended June 30, 2013 compared to the same period in the prior year. The variance is largely attributable to depreciation on additional tenant and building improvements placed in service subsequent to the prior period which contributed approximately $2.5 million of the increase. The remainder of the increase is due to new properties acquired during the current year.

General and administrative expenses increased approximately $1.4 million for the three months ended June 30, 2013 compared to the same period in the prior year. The increase in expenses is primarily attributable to lower insurance recoveries related to now-settled-litigation defense costs in the current period than in the prior period, as well as the non-recurrence of bad debt recoveries and lower state business tax refunds as compared to the prior period.


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Other Income (Expense)

Interest expense increased approximately $2.3 million for the three months ended June 30, 2013 compared to the same period in the prior year. The increase is attributable to higher outstanding, long-term debt balances during the current quarter as a result of property acquisitions as compared to the quarter ended June 30, 2012.

Interest and other income decreased approximately $0.4 million for the three months ended June 30, 2013 compared to the same period in the prior year. The decrease reflects higher interest income included in the prior 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, and the Willamette building, and 18.19 acres of adjoining, undeveloped land in Beaverton, Oregon (collectively the "Portland Portfolio"), which was fully repaid at maturity in October 2012.

During the current period, we recognized approximately $1.3 million in insurance recoveries associated with the $7.5 million litigation settlement we paid in early 2013 related to two class action lawsuits. We expect to receive additional insurance recoveries related to the settlements in future periods.

The approximate $2.3 million net casualty gain we recognized during the current period is due to insurance recoveries related to the damage incurred at certain of our assets in the New York/New Jersey markets as a result of Hurricane Sandy which occurred during the fourth quarter of 2012. We anticipate receiving further recoveries related to Hurricane Sandy under our insurance programs in future periods.

Discontinued Operations

In accordance with GAAP, the operations of the Portland Portfolio, the 26200 Enterprise Way building in Lake Forest, California, the 110 and 112 Hidden Lake Circle buildings in Duncan, South Carolina, the 1111 Durham Avenue building in South Plainfield, New Jersey, and the 1200 Enclave Parkway building in Houston, Texas are classified as discontinued operations for all periods presented. Income from discontinued operations increased approximately $6.1 million for the three months ended June 30, 2013 compared to the same period in the prior year. The increase is primarily due to the gain realized on the sale of the 1200 Enclave Parkway building in the current period of approximately $16.3 million as compared to the gain realized on the sale of the 26200 Enterprise Way building in the prior period of approximately $10.0 million. We do not expect that income from discontinued operations will be comparable to future periods, as such income is subject to the occurrence and timing of future property dispositions.

Comparison of the six months ended June 30, 2013 versus the six months ended June 30, 2012

The following table sets forth selected data from our consolidated statements of income for the six months ended June 30, 2013 and 2012, respectively, as well as each balance as a percentage of total revenues for the same periods presented (dollars in millions):


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                                                                                                 $
                                      June 30,                   June 30,                    Increase
                                        2013           %           2012           %         (Decrease)
Revenue:
Rental income                        $   218.0                  $   208.2                  $       9.8
Tenant reimbursements                     49.9                       53.3                         (3.4 )
Property management fee revenue            1.2                        1.2                            -
Total revenues                           269.1         100  %       262.7         100  %           6.4
Expense:
Property operating costs                 105.9          39  %       104.2          40  %           1.7
Depreciation                              60.2          22  %        54.1          20  %           6.1
Amortization                              20.4           8  %        23.9           9  %          (3.5 )
General and administrative                10.8           4  %        10.1           4  %           0.7
Real estate operating income              71.8          27  %        70.4          27  %           1.4
Other income (expense):
Interest expense                         (34.6 )       (13 )%       (32.5 )       (12 )%          (2.1 )
Interest and other income/(expense)       (1.4 )         -  %         0.4           -  %          (1.8 )
Litigation settlement recovery             1.3           -  %           -           -  %           1.3
Net recoveries of casualty loss            2.1           1  %           -           -  %           2.1
Equity in income of unconsolidated
joint ventures                             0.6           -  %         0.4           -  %           0.2
Income from continuing operations    $    39.8          15  %   $    38.7          15  %   $       1.1
Income from discontinued operations  $    10.3                  $    29.3                  $     (19.0 )

Continuing Operations

Revenue

Rental income increased from approximately $208.2 million for the six months ended June 30, 2012 to approximately $218.0 million for the six months ended June 30, 2013 primarily due to approximately $6.9 million of additional revenue attributable to properties acquired during the current year as well as the commencement of several significant leases over the last twelve months, offset by the expiration of a 330,000 square foot lease at our One Independence Square building in Washington, D. C. during March of 2013.

Tenant reimbursements decreased from approximately $53.3 million for the six months ended June 30, 2012 to approximately $49.9 million for the six months ended June 30, 2013. The variance is mainly attributable to an approximate $3.1 million reduction in tenant reimbursements as a result of operating expense and tax abatements granted on a large lease renewal at the 500 W. Monroe building.

Expense

Property operating costs increased approximately $1.7 million for the six months ended June 30, 2013 compared to the same period in the prior year. Properties acquired during the current period contributed approximately $2.3 million of additional operating costs, which was partially offset by lower property tax expense and repair and maintenance costs at our 500 W. Monroe building.

Depreciation expense increased approximately $6.1 million for the six months ended June 30, 2013 compared to the same period in the prior year. The variance is largely attributable to depreciation on additional tenant and building improvements placed in service subsequent to January 1, 2012 which contributed approximately $4.7 million of the increase. The remainder of the increase is due to new properties acquired during the current period.

Amortization expense decreased approximately $3.5 million for the six months ended June 30, 2013 compared to the same period in the prior year. The variance is primarily attributable to reduced amortization expense as a result of lease intangible assets becoming fully amortized at certain of our existing properties subsequent to January 1, 2012. However, this decrease was partially offset by approximately $3.7 million of additional amortization expense related to intangible assets assumed upon the acquisition of the Arlington Gateway building and the 5 & 15 Wayside Road building during the current period and the amortization of deferred costs associated with new and renewal leases commencing since the prior period end.


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General and administrative expenses increased approximately $0.7 million for the six months ended June 30, 2013 compared to the same period in the prior year primarily due to higher state and local taxes and personnel costs.

Other Income (Expense)

Interest expense increased approximately $2.1 million for the six months ended June 30, 2013 compared to the same period in the prior year. The increase is attributable to higher outstanding debt balances during the current period as a result of property acquisitions as compared to the six month period ended June 30, 2012.

Interest and other income/(expense) decreased approximately $1.8 million for the six months ended June 30, 2013 compared to the same period in the prior year. The decrease reflects approximately $1.2 million of costs associated with the acquisitions of the Arlington Gateway building and the 5 & 15 Wayside Road building during the current period, as well as higher interest income in the prior period related to a $19.0 million note receivable originated as part of the sale of the Portland Portfolio, which was fully repaid at maturity in October 2012.

During the current period, we recognized approximately $1.3 million in insurance recoveries associated with the $7.5 million litigation settlement we paid in early 2013 related to two class action lawsuits. We expect to receive additional insurance recoveries related to the settlements in future periods.

The approximate $2.1 million net casualty gain we recognized during the current period is due to insurance recoveries related to the damage incurred at certain of our assets in the New York/New Jersey markets as a result of Hurricane Sandy which occurred during the fourth quarter of 2012. We anticipate further recoveries related to Hurricane Sandy under our insurance programs in future periods.

Discontinued Operations

In accordance with GAAP, the operations of 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, the 1111 Durham Avenue building in South Plainfield, New Jersey, and the1200 Enclave Parkway building in Houston, Texas are classified as discontinued operations for all periods presented. Income from discontinued operations decreased approximately $19.0 million for the six months ended June 30, 2013 compared to the same period in the prior year. The decrease is primarily due to the gain realized on the sale of the Portland Portfolio and the 26200 Enterprise Way building in the prior period of approximately $17.8 million and $10.0 million, respectively. Although we recorded a $16.3 million gain on the sale of the 1200 Enclave Parkway building in the current period, we also recorded an impairment charge of approximately $6.4 million during the six months ended June 30, 2013 to reflect the difference in carrying value of the 1111 Durham Avenue building at the time the asset met the held for sale criteria and its estimated fair value. 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 sales of property and impairment charges (including our proportionate share of any impairment charges and/or gains or losses from sales of property related to investments in unconsolidated joint ventures), plus depreciation and amortization on real estate assets (including our proportionate share of depreciation and amortization related to investments in unconsolidated joint ventures). Other REITs may not define FFO in accordance with the National Association of Real Estate Investment Trusts ("NAREIT") definition, or may interpret the current NAREIT definition differently than we do; therefore, our computation of FFO may not be comparable to such other REITs.

We calculate Core FFO as FFO (calculated as set forth above) exclusive of the net effects of acquisition costs and significant, non-recurring items.


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We calculate AFFO as Core FFO (calculated as set forth above) exclusive of the net effects of: (i) amortization associated with deferred financing costs; (ii) depreciation of non real estate assets; (iii) straight-line lease revenue/expense; (iv) amortization of above and below-market lease intangibles;
(v) stock-based and other non-cash compensation expense; (vi) amortization of discount on Senior Notes and interest rate swap settlements; (vii) acquisition costs, and (viii) non-incremental capital expenditures (as defined below). Our proportionate share of such adjustments related to investments in unconsolidated joint ventures are also included when calculating AFFO.

Reconciliations of net income to FFO, Core FFO, and AFFO are presented below (in thousands except per share amounts):

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