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EX-31.1 - EX-31.1 - Easterly Government Properties, Inc.dea-ex311_8.htm

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2017

OR

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      To                     

Commission file number 001-36834

 

EASTERLY GOVERNMENT PROPERTIES, INC.

(Exact Name of Registrant as Specified in Its Charter)

 

 

Maryland

 

47-2047728

(State of Incorporation)

 

(IRS Employer Identification No.)

 

 

 

2101 L Street NW, Suite 650, Washington, D.C.

 

20037

(Address of Principal Executive Offices)

 

(Zip Code)

(202) 595-9500

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes      No  

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes      No  

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large Accelerated Filer

 

 

Accelerated Filer

 

 

 

 

 

 

Non-Accelerated Filer

 

  (Do not check if smaller reporting company)

 

Smaller Reporting Company

 

 

 

 

 

 

Emerging growth company

 

 

 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.    

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes      No  

As of November 1, 2017, the registrant had 43,873,796 shares of common stock, par value $0.01 per share, outstanding.

 

 

 

 


INDEX TO FINANCIAL STATEMENTS

 

 

Page

Part I: Financial Information

 

 

 

   Item 1: Financial Statements:

 

Consolidated Financial Statements

 

 

 

Consolidated Balance Sheets as of September 30, 2017 and December 31, 2016 (unaudited)

1

 

 

Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2017 and 2016 (unaudited)

2

 

 

 

 

 

Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended September 30, 2017 and 2016 (unaudited)

3

 

 

Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2017 and 2016 (unaudited)

4

 

 

Notes to the Consolidated Financial Statements

6

 

 

   Item 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations

18

 

 

   Item 3: Quantitative and Qualitative Disclosures About Market Risk

29

 

 

   Item 4: Controls and Procedures

29

 

 

Part II: Other Information

 

 

 

   Item 1: Legal Proceedings

30

 

 

   Item 1A: Risk Factors

30

 

 

   Item 2: Unregistered Sales of Equity Securities and Use of Proceeds

30

 

 

   Item 3: Defaults Upon Senior Securities

30

 

 

   Item 4: Mine Safety Disclosures

30

 

 

   Item 5: Other Information

30

 

 

   Item 6: Exhibits

31

 

 

Signatures

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 


Easterly Government Properties, Inc.

Consolidated Balance Sheets (unaudited)

(Amounts in thousands, except share amounts)

 

 

 

September 30, 2017

 

 

December 31, 2016

 

Assets

 

 

 

 

 

 

 

 

Real estate properties, net

 

$

1,195,618

 

 

$

901,066

 

Cash and cash equivalents

 

 

6,551

 

 

 

4,845

 

Restricted cash

 

 

3,866

 

 

 

1,646

 

Deposits on acquisitions

 

 

1,100

 

 

 

1,750

 

Rents receivable

 

 

9,664

 

 

 

8,544

 

Accounts receivable

 

 

7,532

 

 

 

5,823

 

Deferred financing, net

 

 

1,158

 

 

 

2,787

 

Intangible assets, net

 

 

131,408

 

 

 

113,795

 

Interest rate swaps

 

 

3,088

 

 

 

3,785

 

Prepaid expenses and other assets

 

 

8,050

 

 

 

1,422

 

Total assets

 

$

1,368,035

 

 

$

1,045,463

 

Liabilities

 

 

 

 

 

 

 

 

Revolving credit facility

 

 

59,250

 

 

 

212,167

 

Term loan facility, net

 

 

99,167

 

 

 

 

Notes payable, net

 

 

173,676

 

 

 

 

Mortgage notes payable, net

 

 

203,999

 

 

 

80,806

 

Intangible liabilities, net

 

 

40,866

 

 

 

41,840

 

Accounts payable and accrued liabilities

 

 

21,946

 

 

 

13,784

 

Total liabilities

 

 

598,904

 

 

 

348,597

 

 

 

 

 

 

 

 

 

 

Commitments and contingencies (Note 10)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Equity

 

 

 

 

 

 

 

 

Common stock, par value $0.01, 200,000,000 shares authorized,

   43,873,796 and 36,874,810 shares issued and outstanding at September 30, 2017

   and December 31, 2016, respectively

 

 

439

 

 

 

369

 

Additional paid-in capital

 

 

718,880

 

 

 

596,971

 

Retained earnings

 

 

4,414

 

 

 

1,721

 

Cumulative dividends

 

 

(72,195

)

 

 

(42,794

)

Accumulated other comprehensive income

 

 

2,627

 

 

 

3,038

 

Total stockholders' equity

 

 

654,165

 

 

 

559,305

 

Non-controlling interest in Operating Partnership

 

 

114,966

 

 

 

137,561

 

Total equity

 

 

769,131

 

 

 

696,866

 

Total liabilities and equity

 

$

1,368,035

 

 

$

1,045,463

 

 

The accompanying notes are an integral part of these consolidated financial statements.

1

 


Easterly Government Properties, Inc.

Consolidated Statements of Operations (unaudited)

(Amounts in thousands, except share and per share amounts)

 

 

 

For the three months ended September 30,

 

 

For the nine months ended September 30,

 

 

 

2017

 

 

2016

 

 

2017

 

 

2016

 

Revenues

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Rental income

 

$

30,079

 

 

$

24,493

 

 

$

83,600

 

 

$

68,520

 

Tenant reimbursements

 

 

3,554

 

 

 

2,385

 

 

 

10,156

 

 

 

7,016

 

Other income

 

 

225

 

 

 

97

 

 

 

592

 

 

 

331

 

Total revenues

 

 

33,858

 

 

 

26,975

 

 

 

94,348

 

 

 

75,867

 

Operating expenses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Property operating

 

 

6,718

 

 

 

5,308

 

 

 

18,904

 

 

 

14,726

 

Real estate taxes

 

 

3,452

 

 

 

2,533

 

 

 

9,166

 

 

 

7,233

 

Depreciation and amortization

 

 

14,141

 

 

 

12,237

 

 

 

40,663

 

 

 

34,174

 

Acquisition costs

 

 

206

 

 

 

660

 

 

 

1,194

 

 

 

1,339

 

Corporate general and administrative

 

 

2,920

 

 

 

3,066

 

 

 

9,506

 

 

 

9,154

 

Total expenses

 

 

27,437

 

 

 

23,804

 

 

 

79,433

 

 

 

66,626

 

Operating income

 

 

6,421

 

 

 

3,171

 

 

 

14,915

 

 

 

9,241

 

Other expenses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense, net

 

 

(5,495

)

 

 

(2,043

)

 

 

(11,626

)

 

 

(5,967

)

Net income

 

 

926

 

 

 

1,128

 

 

 

3,289

 

 

 

3,274

 

Non-controlling interest in Operating Partnership

 

 

(144

)

 

 

(233

)

 

 

(596

)

 

 

(1,005

)

Net income available to Easterly Government

   Properties, Inc.

 

$

782

 

 

$

895

 

 

$

2,693

 

 

$

2,269

 

Net income available to Easterly Government

   Properties, Inc. per share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

0.02

 

 

$

0.02

 

 

$

0.07

 

 

$

0.08

 

Diluted

 

$

0.02

 

 

$

0.02

 

 

$

0.07

 

 

$

0.07

 

Weighted-average common shares outstanding

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

39,962,471

 

 

 

34,967,482

 

 

 

38,098,805

 

 

 

28,886,697

 

Diluted

 

 

41,903,977

 

 

 

36,904,564

 

 

 

40,012,282

 

 

 

30,722,389

 

Dividends declared per common share

 

$

0.25

 

 

$

0.23

 

 

$

0.74

 

 

$

0.68

 

 

The accompanying notes are an integral part of these consolidated financial statements.

2

 


Easterly Government Properties, Inc.

Consolidated Statements of Comprehensive Income (unaudited)

(Amounts in thousands, except share amounts)

 

 

 

For the three months ended September 30,

 

 

For the nine months ended September 30,

 

 

 

2017

 

 

2016

 

 

2017

 

 

2016

 

Net income

 

$

926

 

 

$

1,128

 

 

$

3,289

 

 

$

3,274

 

Other comprehensive loss:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized loss on interest rate swaps

 

 

(111

)

 

 

 

 

 

(697

)

 

 

 

Other comprehensive loss:

 

 

(111

)

 

 

 

 

 

(697

)

 

 

 

Comprehensive income

 

 

815

 

 

 

1,128

 

 

 

2,592

 

 

 

3,274

 

Non-controlling interest in Operating Partnership

 

 

(144

)

 

 

(233

)

 

 

(596

)

 

 

(1,005

)

Other comprehensive loss attributable to

   non-controlling interest

 

 

77

 

 

 

 

 

 

286

 

 

 

 

Comprehensive income attributable to Easterly

   Government Properties, Inc.

 

$

748

 

 

$

895

 

 

$

2,282

 

 

$

2,269

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

 

3

 


Easterly Government Properties, Inc.

Consolidated Statements of Cash Flows (unaudited)

(Amounts in thousands)

 

 

 

For the nine months ended September 30,

 

 

 

2017

 

 

2016

 

Cash flows from operating activities

 

 

 

 

 

 

 

 

Net income

 

$

3,289

 

 

$

3,274

 

Adjustments to reconcile net income to net cash provided by operating activities

 

 

 

 

 

 

 

 

Depreciation and amortization

 

 

40,663

 

 

 

34,174

 

Straight line rent

 

 

(1,376

)

 

 

(17

)

Amortization of above- / below-market leases

 

 

(6,283

)

 

 

(5,225

)

Amortization of unearned revenue

 

 

(82

)

 

 

(77

)

Amortization of loan premium / discount

 

 

(64

)

 

 

(64

)

Amortization of deferred financing costs

 

 

848

 

 

 

649

 

Non-cash compensation

 

 

2,215

 

 

 

2,164

 

Net change in:

 

 

 

 

 

 

 

 

Rents receivable

 

 

265

 

 

 

(940

)

Accounts receivable

 

 

(1,709

)

 

 

(1,216

)

Prepaid expenses and other assets

 

 

(1,632

)

 

 

(336

)

Accounts payable and accrued liabilities

 

 

6,690

 

 

 

3,840

 

Net cash provided by operating activities

 

 

42,824

 

 

 

36,226

 

Cash flows from investing activities

 

 

 

 

 

 

 

 

Real estate acquisitions and deposits

 

 

(342,566

)

 

 

(140,403

)

Additions to operating properties

 

 

(2,221

)

 

 

(664

)

Additions to development properties

 

 

(5,560

)

 

 

(145

)

Restricted cash

 

 

(2,220

)

 

 

304

 

Net cash (used in) investing activities

 

 

(352,567

)

 

 

(140,908

)

Cash flows from financing activities

 

 

 

 

 

 

 

 

Payment of deferred financing costs

 

 

(3,398

)

 

 

(848

)

Issuance of common shares

 

 

107,190

 

 

 

84,943

 

Credit facility draws

 

 

108,000

 

 

 

73,250

 

Credit facility repayments

 

 

(260,917

)

 

 

(21,000

)

Term loan draws

 

 

100,000

 

 

 

 

Issuance of notes payable

 

 

175,000

 

 

 

 

Issuance of mortgage notes payable

 

 

127,500

 

 

 

 

Repayments of mortgage notes payable

 

 

(2,221

)

 

 

(2,131

)

Dividends and distributions paid

 

 

(35,483

)

 

 

(29,245

)

Payment of offering costs

 

 

(4,222

)

 

 

(4,105

)

Net cash provided by financing activities

 

 

311,449

 

 

 

100,864

 

Net increase (decrease) in cash and cash equivalents

 

 

1,706

 

 

 

(3,818

)

Cash and cash equivalents, beginning of period

 

 

4,845

 

 

 

8,176

 

Cash and cash equivalents, end of period

 

$

6,551

 

 

$

4,358

 

 

 The accompanying notes are an integral part of these consolidated financial statements.

 

4

 


Easterly Government Properties, Inc.

Consolidated Statements of Cash Flows (unaudited)

(Amounts in thousands)

 

Supplemental disclosure of cash flow information is as follows:

 

 

 

For the nine months ended September 30,

 

 

 

2017

 

 

2016

 

Cash paid for interest

 

$

8,456

 

 

$

5,531

 

Supplemental disclosure of non-cash information

 

 

 

 

 

 

 

 

Additions to operating properties accrued, not paid

 

$

819

 

 

$

174

 

Additions to development properties accrued, not paid

 

 

719

 

 

 

18

 

Financing costs accrued, not paid

 

 

 

 

 

78

 

Offering costs accrued, not paid

 

 

27

 

 

 

 

Unrealized loss on interest rate swaps

 

 

(697

)

 

 

 

Exchange of Common Units for Shares of Common Stock

 

 

 

 

 

 

 

 

Non-controlling interest in Operating Partnership

 

$

(20,401

)

 

$

(96,578

)

Common stock

 

 

14

 

 

 

64

 

Additional paid-in capital

 

 

20,387

 

 

 

96,514

 

Total

 

$

 

 

$

 

 

The accompanying notes are an integral part of these consolidated financial statements.

5

 


Easterly Government Properties, Inc.

Notes to the Consolidated Financial Statements (unaudited)

1. Organization and Basis of Presentation

The information contained in the following notes to the consolidated financial statements is condensed from that which would appear in the annual consolidated financial statements; accordingly, the consolidated financial statements included herein should be reviewed in conjunction with the consolidated financial statements for the fiscal year ended December 31, 2016, and related notes thereto, included in the Annual Report on Form 10-K of Easterly Government Properties, Inc. (which may be referred to in these financial statements as the “Company,” “we,” “us,” or “our”) for the year ended December 31, 2016 filed with the U.S. Securities and Exchange Commission (the “SEC”) on March 2, 2017.

The Company is a Maryland corporation that has elected to be taxed as a real estate investment trust (“REIT”) under the Internal Revenue Code, as amended (the “Code”) commencing with its taxable year ended December 31, 2015. The operations of the Company are carried on primarily through Easterly Government Properties LP (the “Operating Partnership”) and the wholly owned subsidiaries of the Operating Partnership.

We are an internally managed REIT, focused primarily on the acquisition, development, and management of Class A commercial properties that are leased to U.S. Government agencies that serve essential functions. We generate substantially all of our revenue by leasing our properties to such agencies, either directly or through the U.S. General Services Administration (“GSA”). Our objective is to generate attractive risk-adjusted returns for our stockholders over the long term through dividends and capital appreciation.

As of September 30, 2017, we wholly owned 46 operating properties in the United States, including 43 operating properties that were leased primarily to U.S. Government tenant agencies and three operating properties that were entirely leased to private tenants, encompassing approximately 3.7 million square feet in the aggregate. In addition, we wholly owned two properties under development encompassing approximately 0.1 million square feet. We focus on acquiring, developing, and managing U.S. Government leased properties that are essential to supporting the mission of the tenant agency and strive to be a partner of choice for the U.S. Government, working with the tenant agency to meet its needs and objectives.

The Operating Partnership holds substantially all of our assets and conducts substantially all our business. The Company is the sole general partner of the Operating Partnership. The Company owned approximately 85.1% of the aggregate limited partnership interests in the Operating Partnership (“common units”) at September 30, 2017. We believe that we have operated and have been organized in conformity with the requirements for qualification and taxation as a REIT for U.S federal income tax purposes commencing with our taxable year ended December 31, 2015.

Principle of Consolidation

The accompanying consolidated financial statements are presented on the accrual basis of accounting in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and include the accounts of the Company, including Easterly Government Properties TRS, LLC, Easterly Government Services, LLC and the Operating Partnership. All significant intercompany balances and transactions have been eliminated in consolidation.

Basis of Presentation

The condensed consolidated financial statements included herein are unaudited; however, they include all adjustments (consisting only of normal recurring adjustments) which, in the opinion of management, are necessary to state fairly the consolidated financial position of the Company at September 30, 2017, and the consolidated results of operations for the three and nine months ended September 30, 2017 and 2016 and the consolidated cash flows for the nine months ended September 30, 2017 and 2016. The year-end condensed consolidated balance sheet data was derived from audited financial statements, but does not include all disclosures required by GAAP. The results of operations for the interim periods presented are not necessarily indicative of the results to be expected for the full year.

The preparation of the consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the balance sheet and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

 

 

6

 


2. Summary of Significant Accounting Policies

The significant accounting policies used in the preparation of the Company’s condensed consolidated financial statements are disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016.

Recently Adopted Accounting Pronouncements

On January 1, 2017, the Company adopted ASU 2017-01, Business Combinations (Topic 805), which clarifies the framework for determining whether an integrated set of assets and activities meets the definition of a business. The revised framework establishes a screen for determining whether an integrated set of assets and activities is a business and narrows the definition of a business, which is expected to result in fewer transactions being accounted for as business combinations. Acquisitions of integrated sets of assets and activities that do not meet the definition of a business are accounted for as asset acquisitions. As a result, the Company believes most of our future acquisitions of operating properties will qualify as asset acquisitions and third-party transaction costs associated with these acquisitions will be capitalized while internal acquisition costs will continue to be expensed.

On January 1, 2017, the Company adopted ASU No. 2016-09, Compensation – Stock Compensation, which identifies areas for simplification involving several aspects of accounting for share-based payment transactions. The new guidance allows for entities to make an entity-wide accounting policy election to either estimate the number of awards that are expected to vest or account for forfeitures when they occur. In addition, the guidance allows employers to withhold shares to satisfy minimum statutory tax withholding requirements up to the employees’ maximum individual tax rate without causing the award to be classified as a liability. The guidance also stipulates that cash paid by an employer to a taxing authority when directly withholding shares for tax-withholding purposes should be classified as a financing activity on the statement of cash flows. The implementation of this update did not have a material impact on our consolidated financial statements.

Recent Accounting Pronouncements Not Yet Adopted

In May 2014, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2014-09, Revenue from Contracts with Customers, which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers and will replace most existing revenue recognition guidance when it becomes effective. This amendment applies to all contracts with customers except those that are within the scope of other topics in the FASB ASC (“Accounting Standards Codification”). In July 2015, the FASB issued ASU 2015-14 which deferred the effective date of ASU 2014-09 by one year to annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period.

The Company expects to adopt ASU 2014-09 using the modified retrospective approach. The Company has evaluated the impact of this new guidance and does not expect the adoption of this guidance to be material to its financial results. Additional information about the Company’s revenue streams and other considerations are summarized below.

Rental income from real property  is derived from rental agreements, whereby 43 of the Company’s operating properties are leased primarily to the U.S. Government and three of the Company’s operating properties are entirely leased to private tenants. Rental income from real property is specifically excluded from ASU 2014-09.

Tenant reimbursements – is comprised of tenant reimbursements for real estate taxes, and certain other expenses, as well as tenant construction project reimbursements that consist primarily of subcontracted costs that are reimbursed to us by the tenant. Reimbursements from real estate taxes and certain other expenses are not included within the scope of ASU 2014-09. After adoption of ASU 2014-09, we believe that we will account for tenant construction project reimbursement arrangements using the percentage of completion method, which is the method we have used historically.

Other income – is comprised primarily of the management fee income associated with tenant construction project reimbursements. After adoption of ASU 2014-09 we believe that we will account for the management fee associated with tenant construction project reimbursements using the percentage of completion method, which is the method we have used historically.

Once the new guidance setting forth principles for the recognition, measurement, presentation and disclosure of leases (discussed below) goes into effect, we believe that the new revenue standard may apply to executory costs and other components of revenue due under leases that are deemed to be non-lease components, even when the revenue for such activities is not separately stipulated in the lease. In that case, then revenue from these items previously recognized on a straight-line basis under current lease guidance would be recognized under the new revenue guidance as the related services are delivered. As a result, while the total revenue recognized over time would not differ under the new guidance, the recognition pattern could be different. The Company is currently in the process of evaluating the significance of the difference in the recognition pattern that would result from this change.  

7

 


The Company is continuing to evaluate the disclosure requirements in the guidance and has not determined the impact on the footnote disclosures to its consolidated financial statements.

In February 2016, the FASB issued ASU No. 2016-02, Leases, which sets out the principles for the recognition, measurement, presentation and disclosure of leases for both parties to a contract (i.e., lessees and lessors). The new standard requires lessees to apply a dual approach, classifying leases as either finance or operating leases based on the principle of whether or not the lease is effectively a financed purchase of the leased asset by the lessee. This classification will determine whether the lease expense is recognized based on an effective interest method or on a straight-line basis over the term of the lease. A lessee is also required to record a right-of-use asset and a lease liability for all leases with a term of greater than 12 months regardless of their classification. Leases with a term of 12 months or less will be accounted for in the same manner as operating leases today.

As of September 30, 2017, the Company had a sublease for office space in Washington D.C. expiring in June 2021 and a lease for office space in San Diego, CA expiring in April 2022.  The remaining contractual payments under the Company’s lease and sublease for office space aggregate $2.0 million.

The new standard requires lessors to account for leases using an approach that is substantially equivalent to existing guidance for sales-type leases, direct financing leases and operating leases.  As discussed in further detail above, in connection with the new revenue guidance, we believe that the new revenue standard may apply to executory costs and other components of revenue deemed to be non-lease components, even when the revenue for such activities is not separately stipulated in the lease. In that case, we would need to separate the lease components of revenue due under leases from the non-lease components. Under the new guidance, we would continue to recognize the lease components of lease revenue on a straight-line basis over our respective lease terms as we do under prior guidance. However, we would recognize the non-lease components under the new revenue guidance as the related services are delivered. As a result, while the total revenue recognized over time would not differ under the new guidance, the recognition pattern could be different. The Company is currently in the process of evaluating the significance of the difference in the recognition pattern that would result from this change.  

Additionally, ASU 2016-02 will require that lessees and lessors capitalize, as initial direct costs, only those costs that are incurred due to the execution of a lease.  Under ASU 2016-02, allocated payroll costs and other costs that are incurred regardless of whether the lease is obtained will no longer be capitalized as initial direct costs and instead will be expensed as incurred.  The new standard requires lessors to account for leases using an approach that is substantially equivalent to existing guidance for sales-type leases, direct financing leases and operating leases.

ASU No. 2016-02 is effective for reporting periods beginning January 1, 2019, with modified retrospective application for each reporting period presented at the time of adoption. Early adoption is also permitted for this guidance. The Company is in the process of evaluating the impact of this new guidance.

In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230), which provides classification guidance for certain cash receipts and cash payments including payment of debt extinguishment costs, settlement of zero-coupon debt instruments, insurance claim payments and distributions from equity method investees. The standard is effective on January 1, 2018, with early adoption permitted. The Company is in the process of evaluating the impact of this new guidance.

In November 2016, the FASB issued ASU No. 2016-18, Statement of Cash Flows (Topic 230), which requires that the statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows.  The standard is effective on January 1, 2018, with early adoption permitted. The Company is in the process of evaluating the impact of this new guidance.

In February 2017, the FASB issued ASU No. 2017-05, Other Income-Gains and Losses from the Derecognition of Nonfinancial Assets (Subtopic 610-20): Clarifying the Scope of Asset Derecognition Guidance and Accounting for Partial Sales of Nonfinancial Assets. This ASU clarifies the scope and accounting of a financial asset that meets the definition of an “in-substance nonfinancial asset” and defines the term “in-substance nonfinancial asset.”  This ASU also adds guidance for partial sales of nonfinancial assets.  ASU 2017-05 will be effective at the same time ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606), is effective.  The Company is in the process of evaluating the impact of this new guidance.

In August 2017, the FASB issued ASU 2017-12, Derivatives and Hedging: Targeted Improvements to Accounting for Hedging Activities. The purpose of this updated guidance is to better align a company’s financial reporting for hedging activities with the economic objectives of those activities. The transition guidance provides companies with the option of either adopting the new standard early using a modified retrospective transition method in any interim period after issuance of the update, or alternatively adopting the new standard for fiscal years beginning after December 15, 2018. This adoption method may require the Company to

8

 


recognize the cumulative effect of initially applying the ASU as an adjustment to accumulated other comprehensive income with a corresponding adjustment to the opening balance of retained earnings as of the beginning of the fiscal year that an entity adopts the update. While the Company continues to assess all potential impacts of the standard, we do not expect the adoption of this guidance to have a material impact on our consolidated financial statements.

 

 

3. Real Estate and Intangibles

During the nine months ended September 30, 2017, we acquired three operating properties, OSHA – Sandy, VA – Loma Linda and FBI – Salt Lake in asset acquisitions for an aggregate purchase price of $337.6 million, of which VA – Loma Linda comprised $212.6 million. We allocated the purchase price of the acquisition based on the estimated fair values of the acquired assets and assumed liabilities as follows (dollars in thousands):

 

 

 

Total

 

Real estate

 

 

 

 

Land

 

$

16,886

 

Building

 

 

281,195

 

Acquired tenant improvements

 

 

7,690

 

Total real estate

 

 

305,771

 

Intangible assets

 

 

 

 

In-place leases

 

 

25,748

 

Acquired leasing commissions

 

 

12,403

 

Total intangible assets

 

 

38,151

 

Intangible liabilities

 

 

 

 

Below-market leases

 

 

(6,357

)

Total intangible liabilities

 

 

(6,357

)

Purchase price

 

$

337,565

 

 

We did not assume any debt upon acquisition of these properties.  The intangible assets and liabilities of operating properties acquired during the nine months ended September 30, 2017 have a weighted average amortization period of 15.91 years as of September 30, 2017. During the nine months ended September 30, 2017, we included $7.5 million of revenues and $1.7 million of net income in our consolidated statement of operations related to operating properties acquired.

During the nine months ended September 30, 2017, we incurred $1.2 million of acquisition-related expenses including $1.0 million of internal costs associated with property acquisitions.

Pro Forma Financial Information

We did not have any business combinations during the nine months ended September 30, 2017. As such, the unaudited pro forma financial information set forth below presents results for the nine months ended September 30, 2016 as if the ICE – Albuquerque, NPS – Omaha, DEA – Birmingham, FBI – Birmingham and EPA – Kansas City acquisitions had occurred on January 1, 2015. The pro forma information is not necessarily indicative of the results that actually would have occurred nor does it intend to indicate future operating results (dollars in thousands):

 

 

 

For the nine months ended

 

Proforma (unaudited)

 

September 30, 2016

 

Total rental revenue

 

$

81,197

 

Net income (loss) (1)

 

 

5,219

 

 

 

(1)

The net income for the nine months ended September 30, 2016 excludes $1.3 million of property acquisition costs.

 

9

 


In addition to the above operating property acquisitions, we acquired one property which is currently under development, FDA – Lenexa, during the nine months ended September 30, 2017.

Consolidated Real Estate and Intangibles

Real estate and intangibles consisted of the following as of September 30, 2017 (dollars in thousands):

 

 

 

Total

 

Real estate properties, net

 

 

 

 

Land

 

$

129,709

 

Building

 

 

1,068,758

 

Acquired tenant improvements

 

 

47,626

 

Construction in progress

 

 

10,855

 

Accumulated amortization

 

 

(61,330

)

Total Real estate properties, net

 

$

1,195,618

 

Intangible assets, net

 

 

 

 

In-place leases

 

$

148,409

 

Acquired leasing commissions

 

 

35,587

 

Above market leases

 

 

10,631

 

Accumulated amortization

 

 

(63,219

)

Total Intangible assets, net

 

$

131,408

 

Intangible liabilities, net

 

 

 

 

Below market leases

 

$

(62,855

)

Accumulated amortization

 

 

21,989

 

Total Intangible liabilities, net

 

$

(40,866

)

 

 

10

 


4. Debt

At September 30, 2017, our borrowings consisted of the following (dollars in thousands):

 

Loan

 

Principal Outstanding

 

 

Interest Rate (1)

 

 

Maturity Date

 

Revolving credit facility:

 

 

 

 

 

 

 

 

 

 

 

Senior unsecured revolving credit facility (2)

 

$

59,250

 

 

L + 150bps

 

 

February 2019 (3)

 

Total revolving credit facility

 

 

59,250

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Term loan facility:

 

 

 

 

 

 

 

 

 

 

 

Senior unsecured term loan facility

 

 

100,000

 

 

3.17% (4)

 

 

September 2023

 

Total term loan facility

 

 

100,000

 

 

 

 

 

 

 

 

Less: Total unamortized deferred financing fees

 

 

(833

)

 

 

 

 

 

 

 

Total term loan facility, net

 

 

99,167

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Notes payable:

 

 

 

 

 

 

 

 

 

 

 

Senior unsecured notes payable, series A

 

 

95,000

 

 

 

4.05%

 

 

May 2027

 

Senior unsecured notes payable, series B

 

 

50,000

 

 

 

4.15%

 

 

May 2029

 

Senior unsecured notes payable, series C

 

 

30,000

 

 

 

4.30%

 

 

May 2032

 

Total notes payable

 

 

175,000

 

 

 

 

 

 

 

 

Less: Total unamortized deferred financing fees

 

 

(1,324

)

 

 

 

 

 

 

 

Total notes payable, net

 

 

173,676

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Mortgage notes payable:

 

 

 

 

 

 

 

 

 

 

 

CBP - Savannah

 

 

14,388

 

 

3.40% (5)

 

 

July 2033

 

ICE - Charleston

 

 

20,088

 

 

4.21% (5)

 

 

January 2027

 

MEPCOM - Jacksonville

 

 

11,016

 

 

4.41% (5)

 

 

October 2025

 

USFS II - Albuquerque

 

 

16,969

 

 

4.46% (5)

 

 

July 2026

 

DEA - Pleasanton

 

 

15,700

 

 

L + 150bps (5)

 

 

October 2023

 

VA - Loma Linda

 

 

127,500

 

 

 

3.59%

 

 

July 2027

 

Total mortgage notes payable

 

 

205,661

 

 

 

 

 

 

 

 

Less: Total unamortized deferred financing fees

 

 

(2,059

)

 

 

 

 

 

 

 

Less: Total unamortized premium/discount

 

 

397

 

 

 

 

 

 

 

 

Total mortgage notes payable, net

 

 

203,999

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total debt

 

 

536,092

 

 

 

 

 

 

 

 

 

(1)

At September 30, 2017, the one-month LIBOR (“L”) was 1.23%. The current interest rate is not adjusted to include the amortization of deferred financing fees or debt issuance costs incurred in obtaining debt or any unamortized fair market value premiums. The spread over the applicable rate for the Company's senior unsecured revolving credit facility and senior unsecured term loan facility is based on the Company's consolidated leverage ratio, as defined in the respective loan agreements.

 

(2)

Available capacity of $340.7 million at September 30, 2017 with an accordion feature that provides additional capacity of up to $250.0 million, for a total facility size of not more than $650.0 million.

 

(3)

Our senior unsecured revolving credit facility has two six-month as-of-right extension options subject to certain conditions and the payment of an extension fee.

 

(4)

Entered into two interest rate swaps with an effective date of March 29, 2017 with an aggregate notional value of $100.0 million to effectively fix the interest rate at 3.17% annually, based on the Company’s consolidated leverage ratio, as defined in the senior unsecured term loan facility agreement.

 

(5)

Effective interest rates are as follows: CBP - Savannah 4.12%, ICE - Charleston 3.93%, MEPCOM - Jacksonville 3.89%, USFS II - Albuquerque 3.92%, DEA - Pleasanton 1.8%.

 

11

 


The table below sets forth the costs included in interest expense related to the Company’s debt arrangements on the accompanying Consolidated Statement of Operations for the three and nine months ended September 30, 2017 and 2016 (dollars in thousands):

 

 

For the three months ended September 30,

 

 

For the nine months ended September 30,

 

Costs Included in Interest Expense

 

2017

 

 

2016

 

 

2017

 

 

2016

 

Amortization of deferred financing fees

 

$

332

 

 

$

217

 

 

$

848

 

 

$

649

 

On May 25, 2017, the Operating Partnership issued $175 million of fixed rate, senior unsecured notes (the “Notes) in a private placement pursuant to a purchase agreement among the Operating Partnership, the Company and the purchasers of the Notes (the “Purchase Agreement”). The Notes are unconditionally guaranteed by the Company and various subsidiaries of the Operating Partnership (the “Subsidiary Guarantors”).

Subject to the terms of the Purchase Agreement and the Notes, upon certain events of default, including, but not limited to, (i) a default in the payment of any principal, “make-whole” amount or interest under the Notes, and (ii) a default in the payment of certain other indebtedness of the Operating Partnership or of the Company or of the Subsidiary Guarantors, the principal and accrued and unpaid interest and the make-whole amount on the outstanding Notes will become due and payable at the option of the holders. The Purchase Agreement and the Notes also contain various covenants, including, among others, financial covenants with respect to debt service coverage, consolidated net worth, fixed charges and consolidated leverage and covenants relating to liens. If the Operating Partnership or the Company breaches any of these covenants, the principal and accrued and unpaid interest and the make-whole amount on the outstanding Notes will become due and payable at the option of the holders.

The Operating Partnership may prepay at any time all, or from time to time any part of, the Notes, in the amount not less than 5% of the aggregate principal amount of the Notes then outstanding at (i) 100% of the principal amount so prepaid, together with accrued interest, and (ii) a make-whole amount that is calculated by discounting the value of the remaining scheduled interest payments that would otherwise be payable through the scheduled maturity date of the applicable Notes on the principal amount being prepaid. The Operating Partnership has the right to make tender offers and is required to make other prepayment offers under the terms set forth in the Purchase Agreement.

On June 28, 2017, the Company, through a wholly-owned subsidiary of the Operating Partnership, entered into a $127.5 million mortgage loan secured by VA – Loma Linda.

Financial Covenant Considerations

The Company was in compliance with all financial and other covenants as of September 30, 2017 related to its senior unsecured revolving credit facility, senior unsecured term loan facility, senior unsecured notes payable and secured mortgage notes payable.

Fair Value of Debt

As of September 30, 2017, the carrying value of our senior unsecured revolving credit facility approximated fair value. In determining the fair value we considered the short term maturity, variable interest rate and credit spreads. We deem the fair value of our senior unsecured revolving credit facility as a Level 3 measurement.

As of September 30, 2017, the carrying value of our senior unsecured term loan facility approximated fair value. In determining the fair value we considered the variable interest rate and credit spreads. We deem the fair value of our senior unsecured term loan facility as a Level 3 measurement.

At September 30, 2017, the fair value of our notes payable was determined by discounting future contractual principal and interest payments using prevailing market rates. We deem the fair value measurement of our notes payable instruments as a Level 3 measurement. At September 30, 2017, the fair value of our notes payable was $178.3 million.

At September 30, 2017, the fair value of our mortgage debt was determined by discounting future contractual principal and interest payments using prevailing market rates. We deem the fair value measurement of our mortgage debt instruments as a Level 3 measurement. At September 30, 2017, the fair value of our mortgage debt was $204.8 million. 

 

 

12

 


5. Derivatives and Hedging Activities

As of September 30, 2017, the Company had two outstanding forward-starting interest rate swaps with an aggregate notional value of $100.0 million that were designated as cash flow hedges. The forward swaps have an effective date of March 29, 2017 and extend until the maturity of our senior unsecured term loan facility on September 29, 2023. The forward swaps effectively fix the interest rate under our senior unsecured term loan facility at 3.17% annually based on the Company’s current consolidated leverage ratio and a variable interest rate of one-month LIBOR.

Cash Flow Hedges of Interest Rate Risk

As of September 30, 2017, our forward swaps were classified as an asset on our consolidated balance sheet at $3.1 million. The effective portion of changes in the fair value of derivatives designated and qualified as cash flow hedges is recorded in accumulated other comprehensive income and will be reclassified to interest expense in the period that the hedged forecasted transactions affect earnings on the Company’s variable rate debt.  The ineffective portion of the change in fair value of the derivatives is recognized directly in earnings into interest expense.  For the nine months ended September 30, 2017 the amount of unrealized loss recognized in accumulated other comprehensive income on interest rate swaps was $0.7 million and the amount of loss reclassified from accumulated other comprehensive income into interest expense was $0.2 million.  Additionally, during the nine months ended September 30, 2017, there was no ineffectiveness.

The Company estimates that less than $0.1 million will be reclassified from accumulated other comprehensive income as a decrease to interest expense over the next 12 months.

Credit-Risk-Related Contingent Features

The Company has agreements with each of its derivative counterparties that contain a provision where the Company could be declared in default on its derivative obligations if repayment of the underlying indebtedness is accelerated by the lender due to the Company’s default on such indebtedness.  As of September 30, 2017, the Company did not have any derivatives in a net liability position.

 

 

6. Fair Value Measurements

Accounting standards define fair value as the exit price, or the amount that would be received upon sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.  The standards also establish a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available.  Observable inputs are inputs market participants would use in valuing the asset or liability developed based on market data obtained from sources independent of us.  Unobservable inputs are inputs that reflect our assumptions about the factors market participants would use in valuing the asset or liability developed based upon the best information available in the circumstances.  The hierarchy of these inputs is broken down into three levels: Level 1, defined as observable inputs such as quoted prices in active markets; Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions. Categorization within the valuation hierarchy is based upon the lowest level of input that is most significant to the fair value measurement.

Recurring fair value measurements

The fair values of our interest rate swaps are determined using widely accepted valuation techniques, including discounted cash flow analysis on the expected cash flows of each derivative. This analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs, including interest rate curves and implied volatilities in such interest rates.   While the Company determined that the majority of the inputs used to value its derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with its derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by the Company and its counterparties. The Company has determined that the significance of the impact of the credit valuation adjustments made to its derivative contracts, which determination was based on the fair value of each individual contract, was not significant to the overall valuation. As a result, all of the Company’s derivatives held as of September 30, 2017 were classified as Level 2 of the fair value hierarchy.  

The carrying values of cash and cash equivalents, restricted cash, accounts receivable, other assets and accounts payable and accrued expenses are reasonable estimates of fair values because of the short maturities of these instruments. For our disclosure of debt fair values in Note 4, we estimated the fair value of our unsecured senior revolving credit facility based on the short term maturity, variable interest rates and credit spreads (categorized within Level 3 of the fair value hierarchy), estimated the fair value of our senior unsecured term loan facility based on the variable interest rate and credit spreads (categorized within Level 3 of the fair

13

 


value hierarchy) and estimated the fair value of our other debt based on the discounted estimated future cash payments to be made on such debt (categorized within Level 3 of the fair value hierarchy); the discount rates used approximate current market rates for loans, or groups of loans, with similar maturities and credit quality, and the estimated future payments included scheduled principal and interest payments.  Fair value estimates are made as of a specific point in time, are subjective in nature and involve uncertainties and matters of significant judgment.  Settlement at such fair value amounts may not be possible and may not be prudent management decision.

The table below presents the Company’s assets and liabilities measured at fair value on a recurring basis as of September 30, 2017, aggregated by the level in the fair value hierarchy within which those measurements fall.

 

 

 

As of September 30, 2017

 

Balance Sheet Line Item

 

Level 1

 

 

Level 2

 

 

Level 3

 

Interest rate swaps - Asset

 

$

 

 

$

3,088

 

 

$

 

 

 

7. Equity

The following table summarizes the changes in our stockholders’ equity for the nine months ended September 30, 2017 and 2016 (dollars in thousands):

 

 

 

Shares

 

 

Common

Stock

Par

Value

 

 

Additional

Paid-in

Capital

 

 

Retained Earnings

(Deficit)

 

 

Cumulative Dividends

 

 

Accumulated Other Comprehensive Income

 

 

Non-

controlling

Interest in

Operating

Partnership

 

 

Total

Equity

 

Nine months ended September 30, 2017

 

Balance at December 31, 2016

 

 

36,874,810

 

 

$

369

 

 

$

596,971

 

 

$

1,721

 

 

$

(42,794

)

 

$

3,038

 

 

$

137,561

 

 

$

696,866

 

Stock based compensation

 

 

 

 

 

 

 

 

 

240

 

 

 

 

 

 

 

 

 

 

 

 

1,975

 

 

 

2,215

 

Dividends and distributions paid

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(29,401

)

 

 

 

 

 

(6,082

)

 

 

(35,483

)

Grant of unvested restricted stock

 

 

17,912

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Redemption of common units for shares of common stock

 

 

1,361,594

 

 

 

14

 

 

 

20,387

 

 

 

 

 

 

 

 

 

 

 

 

(20,401

)

 

 

 

Issuance of common stock

 

 

5,619,480

 

 

 

56

 

 

 

102,885

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

102,941

 

Unrealized loss on interest rate swaps