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PDM > SEC Filings for PDM > Form 10-Q on 30-Jul-2014All Recent SEC Filings

Show all filings for PIEDMONT OFFICE REALTY TRUST, INC.

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


30-Jul-2014

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, 2013.

Liquidity and Capital Resources
We intend to use cash flows generated from the operation of our properties, proceeds from our $500 Million Unsecured Line of Credit, and proceeds from selective property dispositions as our primary sources of immediate liquidity. As of the time of this filing, we had approximately $187.6 million of capacity remaining under our $500 Million Unsecured Line of Credit available for future borrowing. Depending on the timing and volume of our property acquisition and disposition activities and debt maturities, we may also issue additional equity or debt securities from time to time. We may also seek additional borrowings from third-party lenders as further sources of capital. The availability and attractiveness of terms for these additional sources of capital is highly dependent on market conditions.

Our most consistent use of capital has historically been, and will continue to be, to fund capital expenditures related to our existing portfolio of properties. During the six months ended June 30, 2014 and June 30, 2013 we incurred the following types of capital expenditures (in thousands):

                                                                     Six Months Ended
                                                             June 30, 2014        June 30, 2013


Capital expenditures for new development                  $           4,242     $           204
Capital expenditures for redevelopment/renovations                    2,922                   -
Other capital expenditures, including tenant improvements            61,772              84,130
Total capital expenditures(1)                             $          68,936     $        84,334

(1) Of the total amounts capitalized, approximately $1.6 million and $0 relates to soft costs such as capitalized interest, payroll, and other general and administrative expenses for the six months ended June 30, 2014 and 2013, respectively.

"Capital expenditures for new development" relate to the construction of a 300,000 square foot, 11-story office tower in Houston, Texas. We broke ground on the development in April 2014 and anticipate expending approximately $60-$65 million for the project over the course of the next twelve months, and approximately $25 million in leasing commissions and tenant improvements during subsequent lease-up of the property. "Capital expenditures for redevelopment/renovation" relate to repositioning our 3100 Clarendon Boulevard building in Arlington, Virginia from governmental use to private sector use. We anticipate spending approximately $25-$30 million related to the project and expect to complete the project by early 2015. Following completion of the redevelopment of the asset, we anticipate spending approximately $20 million in re-leasing costs, consisting of both leasing commissions and tenant improvements.

"Other capital expenditures" include two types of specifically identified projects: (i) building improvement projects that we as the owner may choose to perform at our discretion at any of our various properties; and (ii) tenant improvement allowances that we have committed to as part of executed leases with our tenants, with the majority of such expenditures typically relating to the latter type. During the six months ended June 30, 2014 and 2013, we committed to spend approximately $2.45 and $2.53 per square foot per year of lease term, respectively, for tenant improvement allowances related to new and renewal leases executed during such period. As of June 30, 2014, unrecorded contractual obligations for non-incremental tenant improvements related to our existing lease portfolio totaled $63.4 million, down from $99.4 million as of June 30, 2013. The timing of the funding of these commitments is largely dependent upon tenant requests for reimbursement; however, we would anticipate that a significant portion of these improvement allowances may be requested over the next 3 years based on when the underlying leases commence. In some instances, these obligations may expire with the respective lease, without further recourse to us. Commitments for incremental tenant improvements associated with new leases, primarily at value-add properties, totaled approximately $16.9 million as of June 30, 2014, down from $28.2 million as of June 30, 2013. Additionally, during the six months ended June 30, 2014 and 2013, we paid $11.4 million and $13.2 million , respectively, in leasing commissions and committed to pay $1.31 and $1.06 per square foot per year of lease term, respectively, for new and renewal leases.


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In addition to the amounts that we have committed to as part of already executed leases, we anticipate continuing to incur similar market-based tenant improvement allowances and leasing commissions in conjunction with procuring future leases. Given that our primary operating model is to lease large blocks of space to credit-worthy tenants, some of these items can result in significant capital outlays. Both the timing and magnitude of such expenditures have yet to be determined and are highly dependent on competitive market conditions of the respective office market at the time of lease negotiations. In particular, there are a total of four blocks of space in excess of 200,000 square feet in our Chicago and Washington, D.C portfolios that are currently vacant and we may grant significant concession packages to secure new tenants for those spaces, among others.

Subject to the identification and availability of attractive investment opportunities and our ability to consummate such acquisitions on satisfactory terms, acquiring new assets compatible with our investment strategy could also be a significant use of capital. In addition, our board of directors has authorized a repurchase plan 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 net assets to be and we may use capital resources to make purchases under this plan. As of June 30, 2014, there was $37.2 million of authorized capacity remaining on the program which may be spent prior to the program's expiration in October 2015.

Finally, although we currently only have $105.0 million of secured debt on our US Bancorp building maturing over the next twelve months, on a longer term basis, we expect to use capital to repay debt when obligations become due. During the six months ended June 30, 2014, we used the proceeds of a $400 million unsecured senior note issuance, as well as a $300 million unsecured term loan to repay $575 million in secured debt which was scheduled to mature during the six months ended June 30, 2014. The remaining $125 million of proceeds was used to pay down outstanding balances on our $500 Million Unsecured Line of Credit. In conjunction with the issuance of the $400 million unsecured senior notes, and considering the historically low interest rate environment, we settled five forward starting interest rate swaps, at the time of the issuance of the notes, resulting in a cash settlement in our favor of approximately $15.0 million.

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, development projects, and selective acquisitions of new properties;
(iv) the timing of significant expenditures for tenant improvements, building redevelopment projects, 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 per share on a fully diluted basis decreased from $0.11 for the three months ended June 30, 2013 to $0.07 for the three months ended June 30, 2014. The current quarter's results include increases in income associated with new leases commencing, several lease renewals at increased rental rates, and properties acquired during or after the second quarter of 2013; however, this additional income was more than offset by
(i) $4.9 million of higher property operating costs attributable to newly acquired properties; (ii) $3.9 million of higher depreciation expense associated with tenant and building improvements placed into service during 2013 and 2014; and (iii) $2.4 million of higher amortization expense associated with properties acquired after the second quarter of 2013. Additionally, the prior quarter's recoveries associated with previously recognized casualty losses and litigation settlement expense were approximately $2.0 million higher due to the timing of reimbursements as compared to the current period.


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Comparison of the three months ended June 30, 2014 versus the three months ended June 30, 2013

Income from Continuing Operations

The following table sets forth selected data from our consolidated statements of
income for the three months ended June 30, 2014 and 2013, respectively, as well
as each balance as a percentage of total revenues for the same periods presented
(dollars in millions):

                                                                                                  $
                                     June 30,                     June 30,                    Increase
                                       2014            %            2013           %         (Decrease)
Revenue:
Rental income                      $     113.3                  $    108.0                  $       5.3
Tenant reimbursements                     24.7                        24.1                          0.6
Property management fee revenue            0.5                         0.5                            -
Total revenues                           138.5         100  %        132.6         100  %           5.9
Expense:
Property operating costs                  57.1          41  %         52.2          39  %           4.9
Depreciation                              34.1          25  %         30.2          23  %           3.9
Amortization                              13.6          10  %         11.2           8  %           2.4
General and administrative                 7.1           5  %          6.3           5  %           0.8
Real estate operating income              26.6          19  %         32.7          25  %          (6.1 )
Other income (expense):
Interest expense                         (18.0 )       (13 )%        (18.2 )       (14 )%           0.2
Other income/(expense)                    (0.4 )         -  %         (0.1 )         -  %          (0.3 )
Net recoveries from casualty
events and litigation settlements          1.5           1  %          3.5           3  %          (2.0 )
Equity in income/(loss) of
unconsolidated joint ventures             (0.4 )         -  %          0.2           -  %          (0.6 )
Income from continuing operations  $       9.3           7  %   $     18.1          14  %   $      (8.8 )
Income from discontinued
operations                         $       1.8                  $     17.3                  $     (15.5 )

Revenue

Rental income increased from approximately $108.0 million for the three months ended June 30, 2013 to approximately $113.3 million for the three months ended June 30, 2014 primarily due to approximately $4.2 million of additional revenue attributable to properties acquired during 2013, the renewal of a lease at a higher rental rate with the sole tenant at our 1901 Market Street building in Philadelphia, Pennsylvania, as well as higher rental rates for the main tenant at our 1201 Eye Street building in Washington, D.C. These increases were partially offset by the expiration of a 220,000 square foot lease at our 3100 Clarendon Boulevard building in December 2013.

Tenant reimbursements increased from approximately $24.1 million for the three months ended June 30, 2013 to approximately $24.7 million for the three months ended June 30, 2014. The increase is mainly attributable to the expiration of certain operating expense abatements for a major tenant at our 500 West Monroe Street building in Chicago, Illinois coupled with higher recoverable operating expenses at the same location.

Expense

Property operating costs increased approximately $4.9 million for the three months ended June 30, 2014 compared to the same period in the prior year due to approximately $1.8 million of additional operating expenses attributable to properties acquired during 2013. Property tax expense increased approximately $2.0 million amongst our existing portfolio of assets as compared to the same period in the prior year, half of which is associated with an increase at our Aon Center building in Chicago, Illinois. We also incurred higher utility expenses of approximately $0.5 million, which in large part is due to the harsh weather in markets in which we own and operate properties.

Depreciation expense increased approximately $3.9 million for the three months ended June 30, 2014 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


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subsequent to April 1, 2013 which contributed approximately $2.5 million of the increase. The remainder of the increase is mainly due to additional depreciation recognized on new properties acquired during 2013.

Amortization expense increased approximately $2.4 million for the three months ended June 30, 2014 compared to the same period in the prior year. The increase is solely due to additional amortization associated with intangible lease assets on new properties acquired during 2013.

General and administrative expenses increased approximately $0.8 million for the three months ended June 30, 2014 compared to the same period in the prior year. The increase is mainly attributable to higher stock compensation costs, as well as higher state and local taxes due to a non-recurring refund recognized in the prior year.

Other Income (Expense)

Interest expense decreased approximately $0.2 million for the three months ended June 30, 2014 compared to the same period in the prior year due to lower average interest rates as a result of refinancing activity during the first quarter of 2014.

The variance in other income/(expense) is primarily due to acquisition costs of approximately $0.3 million incurred in the current year associated with the acquisition of the 5 Wall Street building in Burlington, Massachusetts.

We recognized a decrease in net recoveries of casualty loss and litigation settlement expense for the three months ended June 30, 2014 compared to the same period in the prior year of approximately $2.0 million. Amounts recognized in both periods are largely associated with the receipt of insurance proceeds related to litigation settlement expense previously incurred, as well as insurance proceeds associated with damage to certain of our assets in the New York/New Jersey markets as a result of Hurricane Sandy. The timing of such reimbursements is dependent upon outside parties.

Equity in income/(loss) of unconsolidated joint ventures decreased approximately $0.6 million during the three months ended June 30, 2014, as compared to the prior year. In August 2013, we purchased all of the remaining interests in three office properties previously held through two unconsolidated joint ventures. The acquisition resulted in a decrease in equity in income/(loss) of unconsolidated joint ventures as compared to the prior period, as the results of operations of these properties are now consolidated on the same basis as our other wholly-owned properties. In addition, one of the two remaining unconsolidated assets, Two Park Center in Hoffman Estates, Illinois, was sold in May 2014 and our pro-rata share of the loss on sale of approximately $0.2 million is included in the current period.

Income from Discontinued Operations

The operations of assets that we have sold or classified as held for sale during periods prior to April 1, 2014 are presented in the accompanying statement of operations as discontinued operations for all period presented (see Note 9 to our accompanying consolidated financial statements for a complete listing of assets sold and classified as discontinued operations). Income from discontinued operations decreased approximately $15.5 million for the three months ended June 30, 2014 compared to the same period in the prior year primarily due to the recognition of a gain on the sale of our 1200 Enclave Parkway building in Houston, Texas in the prior period of approximately $16.2 million as compared to a gain on the sale of the 1441 West Long Lake Road building and the 4685 Investment Drive building in Troy, Michigan for a total gain of $1.3 million in the current period. 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 that may be classified as discontinued operations.


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Comparison of the six months ended June 30, 2014 versus the six months ended June 30, 2013

Income from Continuing Operations

The following table sets forth selected data from our consolidated statements of
income for the six months ended June 30, 2014 and 2013, respectively, as well as
each balance as a percentage of total revenues for the same periods presented
(dollars in millions):

                                                                                                  $
                                     June 30,                     June 30,                    Increase
                                       2014            %            2013           %         (Decrease)
Revenue:
Rental income                      $     224.2                  $    214.0                  $      10.2
Tenant reimbursements                     49.7                        49.6                          0.1
Property management fee revenue            1.0                         1.1                         (0.1 )
Total revenues                           274.9         100  %        264.7         100  %          10.2
Expense:
Property operating costs                 115.4          42  %        104.4          39  %          11.0
Depreciation                              67.8          25  %         59.0          22  %           8.8
Amortization                              28.2          10  %         20.2           8  %           8.0
General and administrative                11.7           4  %         10.8           4  %           0.9
Real estate operating income              51.8          19  %         70.3          27  %         (18.5 )
Other income (expense):
Interest expense                         (36.9 )       (14 )%        (34.6 )       (13 )%          (2.3 )
Other income/(expense)                    (0.4 )         -  %         (1.4 )        (1 )%           1.0
Net recoveries from casualty
events and litigation settlements          4.5           2  %          3.4           1  %           1.1
Equity in income/(loss) of
unconsolidated joint ventures             (0.6 )         -  %          0.6           -  %          (1.2 )
Income from continuing operations  $      18.4           7  %   $     38.3          14  %   $     (19.9 )
Income from discontinued
operations                         $       2.2                  $     11.7                  $      (9.5 )

Revenue

Rental income increased from approximately $214.0 million for the six months ended June 30, 2013 to approximately $224.2 million for the six months ended June 30, 2014 primarily due to approximately $12.0 million of additional revenue attributable to properties acquired during 2013, the renewal of a lease at a higher rental rate with the sole tenant at our 1901 Market Street building, as well as higher rental rates for the main tenant at our 1201 Eye Street building. These increases were partially offset by the expiration of a 330,000 square foot lease at our One Independence Square building in Washington, D.C. during March 2013 and a 220,000 square foot lease at our 3100 Clarendon Boulevard building in December 2013.

Tenant reimbursements increased from approximately $49.6 million for the six months ended June 30, 2013 to approximately $49.7 million for the six months ended June 30, 2014. Although we recognized approximately $1.3 million of additional tenant reimbursements associated with properties acquired during 2013 during the current period, these increases were offset by a reduction in such reimbursements as a result of abatements on new leases commencing at our Aon Center building.

Expense

Property operating costs increased approximately $11.0 million for the six months ended June 30, 2014 compared to the same period in the prior year primarily due to approximately $5.3 million of additional operating expenses attributable to properties acquired during 2013. We also incurred higher utility and snow removal costs of $1.5 million and $0.6 million, respectively, which in large part is due to the harsh weather in markets in which we own and operate properties. Additionally, property tax expense increased by approximately $1.6 million at certain of our properties.

Depreciation expense increased approximately $8.8 million for the six months ended June 30, 2014 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, 2013 which contributed approximately $5.1 million of the increase. Properties acquired during 2013 provided an additional increase of $2.0 million of depreciation expense.


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Amortization expense increased approximately $8.0 million for the six months ended June 30, 2014 compared to the same period in the prior year. Of the total variance, approximately $5.7 million of expense is due to additional amortization on new properties acquired during 2013. The acceleration of amortization expense related to the early termination of a lease at our 400 Bridgewater Crossing building in Bridgewater, New Jersey and a structured partial lease termination at our 1430 Enclave Parkway building in Houston, Texas contributed approximately $2.7 million to the increase.

General and administrative expenses increased approximately $0.9 million for the six months ended June 30, 2014 compared to the same period in the prior year. The increase is mainly attributable to higher stock compensation costs and higher state and local taxes due to a non-recurring refund recognized in the prior year.

Other Income (Expense)

Interest expense increased approximately $2.3 million for the six months ended June 30, 2014 compared to the same period in the prior year. The increase is attributable to higher outstanding debt balances during the current year primarily as a result of property acquisitions during 2013 and shares repurchased pursuant to our stock repurchase plan, offset by lower average interest rates due to refinancing activity during the first quarter of 2014.

The variance in other income/(expense) is primarily due to acquisition costs of approximately $0.9 million incurred in the prior year associated with acquisition transactions as compared to the current year.

We recognized an increase in net recoveries of casualty loss and litigation settlement expense for the six months ended June 30, 2014 compared to the same period in the prior year of approximately $1.1 million. These recoveries are non-recurring in nature and are largely associated with the receipt of insurance proceeds related to litigation settlement expense previously incurred, as well as insurance proceeds associated with damage to certain of our assets in the New York/New Jersey markets as a result of Hurricane Sandy. The timing of such reimbursements is dependent upon outside parties.

Equity in income/(loss) of unconsolidated joint ventures decreased approximately $1.2 million during the six months ended June 30, 2014, as compared to the prior year. In August 2013, we purchased all of the remaining interests in three office properties previously held through two unconsolidated joint ventures. The acquisition resulted in a decrease in equity in income/(loss) of unconsolidated joint ventures as compared to the prior period, as the results of operations of these properties are now consolidated on the same basis as our other wholly-owned properties. In addition, one of the two remaining unconsolidated assets, Two Park Center, was sold in May 2014 and our pro-rata share of the loss on sale of approximately $0.2 million is included in the current period.

Income from Discontinued Operations

The operations of assets that we have sold or classified as held for sale during periods prior to April 1, 2014 are presented in the accompanying statement of operations as discontinued operations for all period presented (see Note 9 to our accompanying consolidated financial statements for a complete listing of assets sold and classified as discontinued operations). Income from discontinued operations decreased approximately $9.5 million for the six months ended June 30, 2014 compared to the same period in the prior year primarily due to the recognition of a gain on the sale of the 1200 Enclave Parkway building of approximately $16.2 million in the prior year offset by an impairment charge, also in the prior period, of $6.4 million at the 1111 Durham Avenue building in South Plainfield, New Jersey. 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 that may be classified as discontinued operations.

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

Net income calculated in accordance with U.S. generally accepted accounting principles ("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 . . .

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