PDM-9.30.12 10-Q
Table of Contents

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
____________________________________________________ 
FORM 10-Q
____________________________________________________  
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT of 1934
For the Quarterly Period Ended September 30, 2012
OR
o
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 001-34626
PIEDMONT OFFICE REALTY TRUST, INC.
(Exact name of registrant as specified in its charter)
 ____________________________________________________ 
Maryland
 
58-2328421
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification Number)

11695 Johns Creek Parkway
Ste. 350
Johns Creek, Georgia 30097
(Address of principal executive offices)
(Zip Code)
(770) 418-8800
(Registrant’s telephone number, including area code)
N/A
(Former name, former address, and former fiscal year, if changed since last report)
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  x    No   o
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  x No  o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large Accelerated filer x
 
Accelerated filer o
 
Non-Accelerated filer o     (Do not check if a smaller reporting company)        
 
Smaller reporting company o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  o No   x
Number of shares outstanding of the Registrant’s
common stock, as of October 30, 2012:
167,847,028 shares
 

Table of Contents

FORM 10-Q
PIEDMONT OFFICE REALTY TRUST, INC.
TABLE OF CONTENTS
 
 
Page No.
PART I.
Financial Statements
 
 
 
 
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
 
 
Item 3.
 
 
 
 
 
Item 4.
 
 
 
PART II.
Other Information
 
 
 
 
 
 
Item 1.
 
 
 
 
 
Item 1A.
 
 
 
 
 
Item 2.
 
 
 
 
 
Item 3.
 
 
 
 
 
Item 4.
 
 
 
 
 
Item 5.
 
 
 
 
 
Item 6.


2
Table of Contents

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
Certain statements contained in this Form 10-Q and other written or oral statements made by or on behalf of Piedmont Office Realty Trust, Inc. (“Piedmont”) may constitute forward-looking statements within the meaning of the federal securities laws. In addition, Piedmont, or its executive officers on Piedmont’s behalf, may from time to time make forward-looking statements in reports and other documents Piedmont files with the Securities and Exchange Commission or in connection with oral statements made to the press, potential investors, or others. Statements regarding future events and developments and Piedmont’s future performance, as well as management’s expectations, beliefs, plans, estimates, or projections relating to the future, are forward-looking statements within the meaning of these laws. Forward-looking statements include statements preceded by, followed by, or that include the words “may,” “will,” “expect,” “intend,” “anticipate,” “estimate,” “believe,” “continue,” or other similar words. Examples of such statements in this report include descriptions of our real estate, financing, and operating objectives; discussions regarding future dividends and stock repurchases; and discussions regarding the potential impact of economic conditions on our portfolio.
These statements are based on beliefs and assumptions of Piedmont’s management, which in turn are based on currently available information. Important assumptions relating to the forward-looking statements include, among others, assumptions regarding the demand for office space in the sectors in which Piedmont operates, competitive conditions, and general economic conditions. These assumptions could prove inaccurate. The forward-looking statements also involve risks and uncertainties, which could cause actual results to differ materially from those contained in any forward-looking statement. Many of these factors are beyond Piedmont’s ability to control or predict. Such factors include, but are not limited to, the following:
•
The success of our real estate strategies and investment objectives, including our ability to identify and consummate suitable acquisitions;
•
The demand for office space, rental rates and property values may continue to lag the general economic recovery causing our business, results of operations, cash flows, financial condition and access to capital to be adversely affected or otherwise impact performance, including the potential recognition of impairment charges;
•
Lease terminations or lease defaults, particularly by one of our large lead tenants;
•
The impact of competition on our efforts to renew existing leases or re-let space on terms similar to existing leases;
•
Changes in the economies and other conditions of the office market in general and of the specific markets in which we operate, particularly in Chicago, Washington, D.C., and the New York metropolitan area;
•
Economic and regulatory changes, including accounting standards, that impact the real estate market generally;
•
Additional risks and costs associated with directly managing properties occupied by government tenants;
•
Adverse market and economic conditions may continue to negatively affect us and could cause us to recognize impairment charges or otherwise impact our performance;
•
Availability of financing and our lending banks’ ability to honor existing line of credit commitments;
•
Costs of complying with governmental laws and regulations;
•
Uncertainties associated with environmental and other regulatory matters;
•
Potential changes in the political environment and reduction in federal and/or state funding of our government tenants;
•
We are and may continue to be subject to litigation, which could have a material adverse effect on our financial condition;
•
Piedmont’s ability to continue to qualify as a REIT under the Internal Revenue Code (the “Code”); and
•
Other factors, including the risk factors discussed under Item 1A. of Piedmont’s Annual Report on Form 10-K for the year ended December 31, 2011.
Management believes these forward-looking statements are reasonable; however, undue reliance should not be placed on any forward-looking statements, which are based on current expectations. Further, forward-looking statements speak only as of the date they are made, and management undertakes no obligation to update publicly any of them in light of new information or future events.

3
Table of Contents

PART I. FINANCIAL STATEMENTS

ITEM 1.
CONSOLIDATED FINANCIAL STATEMENTS
The information presented in the accompanying consolidated balance sheets and related consolidated statements of operations, stockholders’ equity, and cash flows reflects all adjustments that are, in management’s opinion, necessary for a fair and consistent presentation of financial position, results of operations, and cash flows in accordance with U.S. generally accepted accounting principles.
The accompanying financial statements should be read in conjunction with the notes to Piedmont’s financial statements and Management’s Discussion and Analysis of Financial Condition and Results of Operations included in this report on Form 10-Q and with Piedmont’s Annual Report on Form 10-K for the year ended December 31, 2011. Piedmont’s results of operations for the nine months ended September 30, 2012 are not necessarily indicative of the operating results expected for the full year.

4
Table of Contents

PIEDMONT OFFICE REALTY TRUST, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except for share and per share amounts)
 
(Unaudited)
 
 
 
September 30,
2012
 
December 31,
2011
Assets:
 
 
 
Real estate assets, at cost:
 
 
 
Land
$
627,812

 
$
640,196

Buildings and improvements, less accumulated depreciation of $857,993 and $792,342 as of September 30, 2012 and December 31, 2011, respectively
2,902,854

 
2,967,254

Intangible lease assets, less accumulated amortization of $79,640 and $119,419 as of September 30, 2012 and December 31, 2011, respectively
59,076

 
79,248

Construction in progress
22,808

 
17,353

Total real estate assets
3,612,550

 
3,704,051

Investments in unconsolidated joint ventures
37,369

 
38,181

Cash and cash equivalents
20,763

 
139,690

Tenant and notes receivable, net of allowance for doubtful accounts of $346 and $631 as of September 30, 2012 and December 31, 2011, respectively
160,215

 
129,523

Due from unconsolidated joint ventures
533

 
788

Restricted cash and escrows
23,001

 
9,039

Prepaid expenses and other assets
13,552

 
9,911

Goodwill
180,097

 
180,097

Deferred financing costs, less accumulated amortization of $9,887 and $9,214 as of September 30, 2012 and December 31, 2011, respectively
7,022

 
5,977

Deferred lease costs, less accumulated amortization of $115,640 and $120,358 as of September 30, 2012 and December 31, 2011, respectively
230,729

 
230,577

Total assets
$
4,285,831

 
$
4,447,834

Liabilities:
 
 
 
Line of credit and notes payable
$
1,436,025

 
$
1,472,525

Accounts payable, accrued expenses, and accrued capital expenditures
109,125

 
122,986

Deferred income
24,110

 
27,321

Intangible lease liabilities, less accumulated amortization of $39,451 and $63,981 as of September 30, 2012 and December 31, 2011, respectively
42,375

 
49,037

Interest rate swaps
8,916

 
2,537

Total liabilities
1,620,551

 
1,674,406

Commitments and Contingencies
—

 
—

Stockholders’ Equity:
 
 
 
Shares-in-trust, 150,000,000 shares authorized; none outstanding as of September 30, 2012 or December 31, 2011
—

 
—

Preferred stock, no par value, 100,000,000 shares authorized; none outstanding as of September 30, 2012 or December 31, 2011
—

 
—

Common stock, $.01 par value, 750,000,000 shares authorized; 168,044,328 and 172,629,748 shares issued and outstanding as of September 30, 2012 and December 31, 2011, respectively
1,680

 
1,726

Additional paid-in capital
3,665,870

 
3,663,662

Cumulative distributions in excess of earnings
(994,967
)
 
(891,032
)
Other comprehensive loss
(8,916
)
 
(2,537
)
Piedmont stockholders’ equity
2,663,667

 
2,771,819

Noncontrolling interest
1,613

 
1,609

Total stockholders’ equity
2,665,280

 
2,773,428

Total liabilities and stockholders’ equity
$
4,285,831

 
$
4,447,834

See accompanying notes

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Table of Contents

PIEDMONT OFFICE REALTY TRUST, INC.
CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except for share and per share amounts)
 
 
(Unaudited)
 
(Unaudited)
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2012
 
2011
 
2012
 
2011
Revenues:
 
 
 
 
 
 
 
Rental income
$
106,826

 
$
104,121

 
$
317,177

 
$
306,450

Tenant reimbursements
27,470

 
28,234

 
81,120

 
85,703

Property management fee revenue
520

 
110

 
1,719

 
1,303

Other rental income
75

 
13

 
287

 
4,415

 
134,891

 
132,478

 
400,303

 
397,871

Expenses:
 
 
 
 
 
 
 
Property operating costs
51,645

 
50,707

 
157,835

 
152,207

Depreciation
28,489

 
25,891

 
83,252

 
76,193

Amortization
15,302

 
14,808

 
39,474

 
39,098

General and administrative
5,508

 
4,731

 
15,629

 
18,868

 
100,944

 
96,137

 
296,190

 
286,366

Real estate operating income
33,947

 
36,341

 
104,113

 
111,505

Other income (expense):
 
 
 
 
 
 
 
Interest expense
(16,247
)
 
(16,236
)
 
(48,727
)
 
(49,638
)
Interest and other income (expense)
383

 
(91
)
 
765

 
3,130

Equity in income of unconsolidated joint ventures
322

 
485

 
739

 
1,032

Litigation settlement expense
(7,500
)
 
—

 
(7,500
)
 
—

Gain on consolidation of variable interest entity
—

 
—

 
—

 
1,532

 
(23,042
)
 
(15,842
)
 
(54,723
)
 
(43,944
)
Income from continuing operations
10,905

 
20,499

 
49,390

 
67,561

Discontinued operations:
 
 
 
 
 
 
 
Operating income
184

 
3,775

 
1,805

 
11,715

Gain/(loss) on sale of real estate assets
(254
)
 
26,756

 
27,583

 
26,756

Income/(loss) from discontinued operations
(70
)
 
30,531

 
29,388

 
38,471

Net income
10,835

 
51,030

 
78,778

 
106,032

Less: Net income attributable to noncontrolling interest
(4
)
 
(4
)
 
(12
)
 
(12
)
Net income attributable to Piedmont
$
10,831

 
$
51,026

 
$
78,766

 
$
106,020

Per share information – basic:
 
 
 
 
 
 
 
Income from continuing operations
$
0.06

 
$
0.12

 
$
0.29

 
$
0.39

Income from discontinued operations
—

 
0.18

 
0.17

 
0.22

Net income available to common stockholders
$
0.06

 
$
0.30

 
$
0.46

 
$
0.61

Per share information – diluted:
 
 
 
 
 
 
 
Income from continuing operations
$
0.06

 
$
0.12

 
$
0.29

 
$
0.39

Income from discontinued operations
—

 
0.17

 
0.17

 
0.22

Net income available to common stockholders
$
0.06

 
$
0.29

 
$
0.46

 
$
0.61

Weighted-average common shares outstanding – basic
168,805,589

 
172,826,869

 
171,162,281

 
172,755,805

Weighted-average common shares outstanding – diluted
168,929,039

 
173,045,192

 
171,295,098

 
172,995,849

See accompanying notes.

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Table of Contents


PIEDMONT OFFICE REALTY TRUST, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in thousands)
 
(Unaudited)
 
(Unaudited)
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2012
 
2011
 
2012
 
2011
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income attributable to Piedmont
 
 
$
10,831

 
 
 
$
51,026

 
 
 
$
78,766

 
 
 
$
106,020

Other comprehensive income/(loss):
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Effective portion of loss on derivative instruments that are designated and qualify as cash flow hedges (See Note 6)
(2,756
)
 
 
 
—

 
 
 
(8,628
)
 
 
 
(204
)
 
 
Less: reclassification of previously recorded loss included in net income (See Note 6)
762

 
 
 
44

 
 
 
2,249

 


 
895

 


Other comprehensive income/(loss)
 
 
(1,994
)
 
 
 
44

 
 
 
(6,379
)
 
 
 
691

Comprehensive income attributable to Piedmont
 
 
$
8,837

 
 
 
$
51,070

 
 
 
$
72,387

 
 
 
$
106,711
































See accompanying notes

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Table of Contents

PIEDMONT OFFICE REALTY TRUST, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
FOR THE YEAR ENDED DECEMBER 31, 2011
AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2012 (UNAUDITED)
(in thousands, except per share amounts)
 
 
Common  Stock
 
Additional
Paid-In
Capital
 
Cumulative
Distributions
in Excess of
Earnings
 
Other
Comprehensive
Loss
 
Non-
controlling
Interest
 
Total
Stockholders’
Equity
 
Shares
 
Amount
 
Balance, December 31, 2010
172,658

 
$
1,727

 
$
3,661,308

 
$
(895,122
)
 
$
(691
)
 
$
6,232

 
$
2,773,454

Share repurchases as part of an announced program
(199
)
 
(2
)
 
—

 
(3,242
)
 
—

 
—

 
(3,244
)
Offering costs associated with the issuance of common stock
—

 
—

 
(479
)
 
—

 
—

 
—

 
(479
)
Attribution of asset sales proceeds to noncontrolling interest
—

 
—

 
—

 
—

 
—

 
(2,684
)
 
(2,684
)
Dividends to common stockholders ($1.26 per share), distributions to noncontrolling interest, and dividends reinvested
—

 
—

 
(249
)
 
(217,709
)
 
—

 
(2,407
)
 
(220,365
)
Shares issued under the 2007 Omnibus Incentive Plan, net of tax
171

 
1

 
3,082

 
—

 
—

 
—

 
3,083

Net income attributable to noncontrolling interest
—

 
—

 
—

 
—

 
—

 
468

 
468

Net income attributable to Piedmont
—

 
—

 
—

 
225,041

 
—

 
—

 
225,041

Other comprehensive loss
—

 
—

 
—

 
—

 
(1,846
)
 
—

 
(1,846
)
Balance, December 31, 2011
172,630

 
1,726

 
3,663,662

 
(891,032
)
 
(2,537
)
 
1,609

 
2,773,428

Share repurchases as part of an announced program
(4,764
)
 
(48
)
 
—

 
(80,082
)
 
—

 
—

 
(80,130
)
Dividends to common stockholders ($0.60 per share), distributions to noncontrolling interest, and dividends reinvested
—

 
—

 
(143
)
 
(102,619
)
 
—

 
(8
)
 
(102,770
)
Shares issued under the 2007 Omnibus Incentive Plan, net of tax
178

 
2

 
2,351

 
—

 
—

 
—

 
2,353

Net income attributable to noncontrolling interest
—

 
—

 
—

 
—

 
—

 
12

 
12

Net income attributable to Piedmont
—

 
—

 
—

 
78,766

 
—

 
—

 
78,766

Other comprehensive loss
—

 
—

 
—

 
—

 
(6,379
)
 
—

 
(6,379
)
Balance, September 30, 2012
168,044

 
$
1,680

 
$
3,665,870

 
$
(994,967
)
 
$
(8,916
)
 
$
1,613

 
$
2,665,280



See accompanying notes

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Table of Contents

PIEDMONT OFFICE REALTY TRUST, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands) 
 
(Unaudited)
 
Nine Months Ended
 
September 30,
 
2012
 
2011
Cash Flows from Operating Activities:
 
 
 
Net income
$
78,778

 
$
106,032

Operating distributions received from unconsolidated joint ventures
1,805

 
2,289

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Income attributable to noncontrolling interest- discontinued operations
—

 
366

Depreciation
84,100

 
82,660

Amortization of deferred financing costs
2,056

 
4,126

Other amortization
38,895

 
43,316

Accretion of notes receivable discount
—

 
(482
)
Stock compensation expense
1,492

 
2,975

Equity in income of unconsolidated joint ventures
(740
)
 
(1,032
)
Gain on sale of real estate assets, net
(27,583
)
 
(26,756
)
Gain on consolidation of variable interest entity
—

 
(1,532
)
Changes in assets and liabilities:
 
 
 
Increase in tenant receivables, net
(15,358
)
 
(9,690
)
Increase in restricted cash and escrows
(13,813
)
 
(15,792
)
Increase in prepaid expenses and other assets
(3,335
)
 
(4,864
)
(Decrease)/increase in accounts payable and accrued expenses
(483
)
 
1,823

Decrease in deferred income
(3,211
)
 
(7,250
)
Net cash provided by operating activities
142,603

 
176,189

Cash Flows from Investing Activities:
 
 
 
Investments in real estate assets and related intangibles
(74,436
)
 
(175,322
)
Cash assumed upon consolidation of variable interest entity
—

 
5,063

Net sales proceeds from wholly-owned properties
74,845

 
68,041

Net sales proceeds from unconsolidated joint ventures
—

 
3,036

Investments in unconsolidated joint ventures
—

 
(151
)
Deferred lease costs paid
(39,319
)
 
(27,409
)
Net cash used in investing activities
(38,910
)
 
(126,742
)
Cash Flows from Financing Activities:
 
 
 
Deferred financing costs paid
(2,991
)
 
(1,401
)
Proceeds from line of credit and notes payable
365,000

 
469,000

Repayments of line of credit and notes payable
(401,500
)
 
(392,000
)
Costs of issuance of common stock
(229
)
 
—

Share repurchases as part of an announced program
(80,130
)
 
—

Dividends paid and discount on dividend reinvestments
(102,770
)
 
(165,636
)
Net cash used in financing activities
(222,620
)
 
(90,037
)
Net decrease in cash and cash equivalents
(118,927
)
 
(40,590
)
Cash and cash equivalents, beginning of period
139,690

 
56,718

Cash and cash equivalents, end of period
$
20,763

 
$
16,128

Supplemental Disclosures of Significant Noncash Investing and Financing Activities:
 
 
 
Change in accrued offering costs related to issuance of common stock
$
—

 
$
479

Accrued capital expenditures and deferred lease costs
$
11,177

 
$
9,395

Accrued deferred financing costs
$
110

 
$
—

Net assets assumed upon consolidation of variable interest entity, net of notes receivable previously recorded
$
—

 
$
188,283

Liabilities assumed upon consolidation of variable interest entity
$
—

 
$
191,814

See accompanying notes

9
Table of Contents

PIEDMONT OFFICE REALTY TRUST, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2012
(unaudited)

1.Organization
Piedmont Office Realty Trust, Inc. (“Piedmont”) (NYSE: PDM) is a Maryland corporation that operates in a manner so as to qualify as a real estate investment trust (“REIT”) for federal income tax purposes and engages in the acquisition and ownership of commercial real estate properties throughout the United States, including properties that are under construction, are newly constructed, or have operating histories. Piedmont was incorporated in 1997 and commenced operations in June of 1998. Piedmont conducts business primarily through Piedmont Operating Partnership, L.P. (“Piedmont OP”), a Delaware limited partnership, as well as performing the management of its buildings through two wholly-owned subsidiaries, Piedmont Government Services, LLC and Piedmont Office Management, LLC. Piedmont is the sole general partner of Piedmont OP and possesses full legal control and authority over the operations of Piedmont OP. Piedmont OP owns properties directly, through wholly-owned subsidiaries, and through both consolidated and unconsolidated joint ventures. References to Piedmont herein shall include Piedmont and all of its subsidiaries, including Piedmont OP and its subsidiaries and joint ventures.

As of September 30, 2012, Piedmont owned interests in 74 consolidated office properties, plus five buildings owned through unconsolidated joint ventures. Our 74 consolidated office properties are located in 17 metropolitan areas across the United States. These office properties comprise approximately 20.5 million square feet of primarily Class A commercial office space, and were approximately 87.0% leased as of September 30, 2012.

2.Summary of Significant Accounting Policies
Basis of Presentation

The consolidated financial statements of Piedmont have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (the “SEC”), including the instructions to Form 10-Q and Article 10 of Regulation S-X, and do not include all of the information and footnotes required by U.S. generally accepted accounting principles (“GAAP”) for complete financial statements. In the opinion of management, the statements for the unaudited interim periods presented include all adjustments, which are of a normal and recurring nature, necessary for a fair presentation of the results for such periods. Results for these interim periods are not necessarily indicative of a full year’s results and certain prior period amounts have been reclassified to conform to the current period financial statement presentation, specifically relating to the required presentation of income from discontinued operations for the Eastpointe Corporate Center in Issaquah, Washington (sold in July 2011); the 5000 Corporate Court building in Holtsville, New York (sold in August 2011); the 35 West Wacker Drive building in Chicago, IL (sold in December 2011); the Deschutes building, the Rhein building, the Rogue building, the Willamette building, and 18.19 acres of adjoining, undeveloped land in Beaverton, Oregon (collectively the "Portland Portfolio" sold in March 2012); the 26200 Enterprise Way building in Lake Forest, California (sold in May 2012); and the 110 and 112 Hidden Lake Circle buildings in Duncan, South Carolina (sold in September 2012). More information on Piedmont's current year property sales is included in Note 10. Piedmont’s consolidated financial statements include the accounts of Piedmont, Piedmont’s wholly-owned subsidiaries, any variable interest entity of which Piedmont or any of its wholly-owned subsidiaries is considered the primary beneficiary, or any entity in which Piedmont or any of its wholly-owned subsidiaries owns a controlling interest. For further information, refer to the financial statements and footnotes included in Piedmont’s Annual Report on Form 10-K for the year ended December 31, 2011.

Further, Piedmont has formed special purpose entities to acquire and hold real estate. Each special purpose entity is a separate legal entity and consequently the assets of the special purpose entities are not available to all creditors of Piedmont. The assets owned by these special purpose entities are being reported on a consolidated basis with Piedmont’s assets for financial reporting purposes only.

Income Taxes

Piedmont has elected to be taxed as a REIT under the Internal Revenue Code of 1986, as amended (the “Code”), and has operated as such, beginning with its taxable year ended December 31, 1998. To qualify as a REIT, Piedmont must meet certain organizational and operational requirements, including a requirement to distribute at least 90% of its annual REIT taxable income. As a REIT, Piedmont is generally not subject to federal income taxes. Piedmont is subject to certain taxes related to the operations of properties in certain locations, as well as operations conducted by its taxable REIT subsidiary, which have been provided for in the financial statements.


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Goodwill

Goodwill is the excess of cost of an acquired entity over the amounts specifically assigned to assets acquired and liabilities assumed in purchase accounting for business combinations. Piedmont tests the carrying value of its goodwill for impairment on an annual basis, or on an interim basis if an event occurs or circumstances change that would indicate the carrying amount may be impaired. Such interim circumstances may include, but are not limited to, significant adverse changes in legal factors or in the general business climate, adverse action or assessment by a regulator, unanticipated competition, the loss of key personnel, or persistent declines in an entity’s stock price below carrying value of the entity. In accordance with GAAP, Piedmont has the option, should it chose to do so, to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of the reporting unit is less than its carrying amount. If, after assessing the totality of events or circumstances, Piedmont concludes that the estimated fair value is greater than the carrying amount, then performing a further two-step impairment test is unnecessary. However, if Piedmont chooses to forgo the availability of the qualitative analysis, the test prescribed by authoritative accounting guidance is a two-step test. The first step involves comparing the estimated fair value of the entity to its carrying value, including goodwill. Fair value is determined by adjusting the trading price of the stock for various factors including, but not limited to: (i) liquidity or transferability considerations, (ii) control premiums, and/or (iii) fully distributed premiums, if necessary, multiplied by the common shares outstanding. If such calculated fair value exceeds the carrying value, no further procedures or analysis is required. However, if the carrying value exceeds the calculated fair value, goodwill is potentially impaired and step two of the analysis would be required. Step two of the test involves calculating the implied fair value of goodwill by deducting the fair value of all tangible and intangible net assets of the entity from the entity’s fair value calculated in step one of the test. If the implied value of the goodwill (the remainder left after deducting the fair values of the entity from its calculated overall fair value in step one of the test) is less than the carrying value of goodwill, an impairment loss would be recognized.

3.Acquisitions
On June 28, 2012, Piedmont purchased undeveloped land adjacent to the Medici building in Atlanta, Georgia for a purchase price of approximately $2.5 million. The undeveloped land consists of approximately 2.01 acres, is zoned for office and accessory use, and has a site plan approved for approximately 249,000 square feet.

On October 15, 2012, Piedmont purchased undeveloped land adjacent to the Glenridge Highlands II building in Atlanta, Georgia for a purchase price of approximately $1.7 million. The land consists of approximately 3.0 acres, is zoned for office use, and has a site plan approved for approximately 113,000 square feet.


4.
Tenant and Notes Receivable

Tenant and notes receivables as of September 30, 2012 and December 31, 2011, respectively, were comprised of the following (in thousands):

 
September 30,
2012
 
December 31,
2011
Tenant receivables, net of allowance for doubtful accounts of $346 and $631 as of September 30, 2012 and December 31, 2011, respectively
$
24,768

 
$
24,722

Cumulative rental revenue recognized on a straight-line basis in excess of cash received in accordance with lease terms
116,447

 
104,801

Notes receivable received in conjunction with real estate asset sale (See Note 10)
19,000

 
—

Tenant and notes receivable, net
$
160,215

 
$
129,523


5.Line of Credit and Notes Payable
Replacement of $500 Million Unsecured Facility

During the three months ended September 30, 2012, Piedmont OP entered into a new $500 million unsecured line of credit facility (the “$500 Million Unsecured Line of Credit”) with a consortium of lenders to replace its expiring $500 Million Unsecured Facility. The term of the $500 Million Unsecured Line of Credit is four years with a maturity date of August 19, 2016; however, Piedmont may extend the term for up to one additional year (through two available six month extensions) to a final extended maturity date of August 21, 2017 provided Piedmont is not then in default and subject to payment of extension fees. Additionally, under certain terms of the agreement, Piedmont may increase the new facility by up to an additional $500 million (to an aggregate size of $1.0 billion); however, none of the existing lenders have any obligation to participate in such increase. Piedmont paid customary fees

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to the lenders in connection with the closing of the new $500 Million Unsecured Line of Credit.

The $500 Million Unsecured Line of Credit has the option to bear interest at varying levels based on (i) the London Interbank Offered Rate (“LIBOR”) or Base Rate, defined as the greater of the prime rate, the federal funds rate plus 0.5%, or LIBOR for a one-month period plus one percent, (ii) the credit rating for Piedmont, and (iii) for LIBOR loans, an interest period selected by Piedmont of one, two, three, or six months, or to the extent available from all lenders in each case, one year or periods of less than one month. The stated interest rate spread over LIBOR can vary from 1.00% to 1.75% based upon the then current credit rating of Piedmont. As of September 30, 2012, the current stated LIBOR spread on the $500 Million Unsecured Line of Credit was 1.175%.

Under the $500 Million Unsecured Line of Credit, Piedmont is subject to certain financial covenants that require, among other things, the maintenance of an unencumbered interest coverage ratio of at least 1.75, an unencumbered leverage ratio of at least 1.60, a fixed charge coverage ratio of at least 1.50, a leverage ratio of no more than 0.60, and a secured debt ratio of no more than 0.40. As of September 30, 2012, Piedmont had met all of the financial covenant requirements.

Other Financing Activity

During the nine months ended September 30, 2012, Piedmont fully repaid its $140 Million mortgage which had been secured by the 500 W. Monroe building and its $45.0 Million loan which had been secured by the 4250 N. Fairfax building.

Additionally, during the nine months ended September 30, 2012, Piedmont incurred net borrowings of approximately $148.5 million on its $500 Million Unsecured Facility prior to its expiration. Piedmont also made interest payments on all debt facilities, including interest rate swap cash settlements related to certain of its debt facilities, totaling approximately $15.7 million and $16.8 million for the three months ended September 30, 2012 and September 30, 2011, respectively, and approximately $47.1 million and $50.1 million for the nine months ended September 30, 2012 and 2011, respectively.

See Note 8 for a description of Piedmont’s estimated fair value of debt as of September 30, 2012.


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The following table summarizes the terms of Piedmont’s indebtedness outstanding as of September 30, 2012 and December 31, 2011 (in thousands):
Facility
 
Collateral
 
Rate(1)
 
Maturity
 
Amount Outstanding as of
 
September 30,
2012
 
December 31,
2011
Secured (Fixed)
 
 
 
 
 
 
 
 
 
 
$45.0 Million Fixed-Rate Loan
 
4250 N. Fairfax
 
5.20
%
 
6/1/2012
 
$
—

 
$
45,000

$200.0 Million Mortgage Note
 
Aon Center
 
4.87
%
 
5/1/2014
 
200,000

  
200,000

$25.0 Million Mortgage Note
 
Aon Center
 
5.70
%
 
5/1/2014
 
25,000

  
25,000

$350.0 Million Secured Pooled Facility
 
Nine Property Collateralized
Pool (2)
 
4.84
%
 
6/7/2014
 
350,000

  
350,000

$105.0 Million Fixed-Rate Loan
 
US Bancorp Center
 
5.29
%
 
5/11/2015
 
105,000

  
105,000

$125.0 Million Fixed-Rate Loan
 
Four Property Collateralized
Pool (3)
 
5.50
%
 
4/1/2016
 
125,000

  
125,000

$42.5 Million Fixed-Rate Loan
 
Las Colinas Corporate
Center I & II
 
5.70
%
 
10/11/2016
 
42,525

  
42,525

$140.0 Million WDC Mortgage Notes
 
1201 & 1225 Eye Street
 
5.76
%
 
11/1/2017
 
140,000

  
140,000

$140.0 Million 500 W. Monroe Mortgage Loan
 
500 W. Monroe
 
LIBOR +  1.008%

 
8/9/2012
 
—

  
140,000

Subtotal/Weighted Average (4)
 
 
 
5.17
%
 
 
 
987,525

  
1,172,525

Unsecured (Variable)
 
 
 
 
 
 
 
 
 
 
$300 Million Unsecured Term Loan
 
 
 
LIBOR +  1.45%

(5) 
11/22/2016
 
300,000

  
300,000

$500 Million Unsecured Line of Credit
 
 
 
1.40
%
(6) 
8/19/2016
 
148,500

 
—

Subtotal/Weighted Average (4)
 
 
 
2.26
%
 
 
 
448,500

  
300,000

Total/ Weighted Average (4)
 
 
 
4.26
%
 
 
 
$
1,436,025

  
$
1,472,525


(1) 
All of Piedmont’s outstanding debt as of September 30, 2012 and December 31, 2011 is interest-only debt.
(2) 
Nine property collateralized pool includes: 1200 Crown Colony Drive, Braker Pointe III, 2 Gatehall Drive, One and Two Independence Square, 2120 West End Avenue, 400 Bridgewater Crossing, 200 Bridgewater Crossing, and Fairway Center II.
(3) 
Four property collateralized pool includes 1430 Enclave Parkway, Windy Point I and II, and 1055 East Colorado Boulevard.
(4) 
Weighted average is based on contractual balance of outstanding debt and interest rates in the table as of September 30, 2012.
(5) 
The $300 Million Unsecured Term Loan has a stated variable rate; however, Piedmont entered into interest rate swap agreements which effectively fix, exclusive of changes to Piedmont's credit rating, the rate on this facility to 2.69%.
(6) 
Piedmont may select from multiple interest rate options with each draw, including the prime rate and various-length LIBOR locks. All LIBOR selections are subject to an additional spread (1.175% as of September 30, 2012) over the selected rate based on Piedmont’s current credit rating. The outstanding balance as of September 30, 2012 consisted of LIBOR draws at 0.22% (subject to the additional spread mentioned above).

6.Derivative Instruments
Risk Management Objective of Using Derivatives

In addition to operational risks which arise in the normal course of business, Piedmont is exposed to economic risks such as interest rate, liquidity, and credit risk. In certain situations, Piedmont has entered into derivative financial instruments such as interest rate swap agreements and interest rate cap agreements to manage interest rate risk exposure arising from variable rate debt transactions

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that result in the receipt or payment of future known and uncertain cash amounts, the value of which is determined by interest rates. Piedmont’s objective in using interest rate derivatives is to add stability to interest expense and to manage its exposure to interest rate movements.

Cash Flow Hedges of Interest Rate Risk

Interest rate swaps designated as cash flow hedges involve the receipt of variable-rate amounts from a counterparty in exchange for Piedmont making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount.

During the nine months ended September 30, 2012, Piedmont used interest rate swap agreements to hedge the variable cash flows associated with its $300 Million Unsecured Term Loan. Piedmont’s interest rate swap agreements outstanding as of September 30, 2012 were as follows:
 
Interest Rate Derivative
Notional Amount
(in millions)
 
Effective Date
 
Maturity Date
Interest rate swap
$
125

 
11/22/2011
 
11/22/2016
Interest rate swap
75

 
11/22/2011
 
11/22/2016
Interest rate swap
50

 
11/22/2011
 
11/22/2016
Interest rate swap
50

 
11/22/2011
 
11/22/2016
Total
$
300

 
 
 
 

All of Piedmont's interest rate swap agreements outstanding for the periods presented were designated as cash flow hedges of interest rate risk. The effective portion of changes in the fair value of derivatives designated as, and that qualify as, cash flow hedges is recorded in other comprehensive income ("OCI") and is reclassified into earnings as interest expense in the period that the hedged forecasted transaction affects earnings. The effective portion of Piedmont’s interest rate swaps that was recorded in the accompanying consolidated statements of income for the three and nine months ended September 30, 2012 and 2011, respectively, was as follows:

 
Three Months Ended
 
Nine Months Ended
Derivative in
Cash Flow Hedging
Relationships (Interest Rate Swaps) (in thousands)
September 30,
2012
 
September 30,
2011
 
September 30,
2012
 
September 30,
2011
Amount of loss recognized in OCI on derivative
$
2,756

 
$
—

 
$
8,628

 
$
204

Amount of previously recorded loss reclassified from accumulated OCI into interest expense
$
(762
)
 
$
(44
)
 
$
(2,249
)
 
$
(895
)

Piedmont estimates that approximately $3.1 million will be reclassified from accumulated other comprehensive loss to interest expense over the next twelve months; however Piedmont's total exposure to interest rate expense related to the swaps and the associated debt facility is limited to 2.69% (exclusive of changes to Piedmont's credit rating). No gain or loss was recognized related to hedge ineffectiveness or to amounts excluded from effectiveness testing on Piedmont’s cash flow hedges during the three and nine months ended September 30, 2012 or 2011, respectively. Please see the accompanying statements of comprehensive income for a rollforward of Piedmont’s Other Comprehensive Loss account. Additionally, see Note 8 for fair value disclosures of Piedmont's interest rate swap derivatives.

Credit-risk-related Contingent Features

Piedmont has agreements with its derivative counterparties that contain a provision whereby if Piedmont defaults on any of its indebtedness, including default where repayment of the indebtedness has not been accelerated by the lender, then Piedmont could also be declared in default on its derivative obligations. If Piedmont were to breach any of the contractual provisions of the derivative contracts, it would be required to settle its obligations under the agreements at their termination value of the fair values plus accrued interest, or approximately $9.2 million.


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7.Variable Interest Entities
Variable interest holders who have the power to direct the activities of the VIE that most significantly impact the entity’s economic performance and have the obligation to absorb the majority of losses of the entity or the right to receive significant benefits of the entity are considered to be the primary beneficiary and must consolidate the VIE.
A summary of Piedmont’s interests in and consolidation treatment of its VIEs as of September 30, 2012 is as follows (net carrying amount in millions):

Entity
 
Piedmont’s
%
Ownership
of Entity
 
Related
Building
 
Consolidated/
Unconsolidated
 
Net Carrying
Amount as of
September 30,
2012
 
Net Carrying
Amount as of
December 31,
2011
 
Primary Beneficiary
Considerations
1201 Eye Street NW Associates, LLC
 
49.5%
 
1201 Eye Street
 
Consolidated
 
$
(4.4
)
 
$
(3.4
)
 
In accordance with the partnership’s governing documents, Piedmont is entitled to 100% of the cash flow of the entity and has sole discretion in directing the management and leasing activities of the building.
1225 Eye Street NW Associates, LLC
 
49.5%
 
1225 Eye Street
 
Consolidated
 
$
0.8

 
$
0.6

 
In accordance with the partnership’s governing documents, Piedmont is entitled to 100% of the cash flow of the entity and has sole discretion in directing the management and leasing activities of the building.
Wells REIT Multi-State Owner, LLC
 
100%
 
1200 Crown Colony Drive
 
Consolidated
 
$
32.4

 
$
28.0

 
In accordance with a tenant's lease, if Piedmont sells the property on or before March 2013, then the tenant would be entitled to an equity participation fee.
Piedmont 500 W. Monroe Fee, LLC
 
100%
 
500 W. Monroe
 
Consolidated
 
$
194.5

 
$
76.9

 
The Omnibus Agreement with the previous owner includes equity participation rights for the previous owner, if certain financial returns are achieved; however, Piedmont has sole decision making authority and is entitled to the economic benefits of the property until such returns are met.
Suwanee Gateway One, LLC
 
100%
 
Suwanee Gateway One
 
Consolidated
 
$
7.5

 
$
7.7

 
The fee agreement includes equity participation rights for the incentive manager, if certain returns on investment are achieved; however, Piedmont has sole decision making authority and is entitled to the economic benefits of the property until such returns are met.
Medici Atlanta, LLC
 
100%
 
The Medici
 
Consolidated
 
$
13.9

 
$
13.0

 
The fee agreement includes equity participation rights for the incentive manager, if certain returns on investment are achieved; however, Piedmont has sole decision making authority and is entitled to the economic benefits of the property until such returns are met.
400 TownPark, LLC
 
100%
 
400 TownPark
 
Consolidated
 
$
23.6

 
$
23.7

 
The fee agreement includes equity participation rights for the incentive manager, if certain returns on investment are achieved; however, Piedmont has sole decision making authority and is entitled to the economic benefits of the property until such returns are met.

Each of the VIEs described above has the sole purpose of holding office buildings and their resulting operations, and are classified in the accompanying consolidated balance sheets in the same manner as Piedmont’s wholly-owned properties.


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8.Fair Value Measurement of Financial Instruments
Piedmont considers its cash, accounts receivable, notes receivable, restricted cash and escrows, accounts payable and accrued expenses, interest rate swap agreements, and line of credit and notes payable to meet the definition of financial instruments. The following table sets forth the carrying and estimated fair value for each of Piedmont’s financial instruments as of September 30, 2012 and December 31, 2011 (in thousands):

 
As of September 30, 2012
 
As of December 31, 2011
Financial Instrument
Carrying Value
 
Estimated Fair Value
 
Level Within Fair Value Hierarchy
 
Carrying Value
 
Estimated Fair Value
Assets:
 
 
 
 
 
 
 
 
 
Cash and cash equivalents(1)
$
20,763

 
$
20,763

 
Level 1
 
$
139,690

 
$
139,690

Tenant and notes receivable, net(1)
$
160,215

 
$
160,215

 
Level 1
 
$
129,523

 
$
129,523

Restricted cash and escrows(1)
$
23,001

 
$
23,001

 
Level 1
 
$
9,039

 
$
9,039

Liabilities:
 
 
 
 
 
 
 
 
 
Accounts payable and accrued expenses(1)
$
22,719

 
$
22,719

 
Level 1
 
$
14,637

 
$
14,637

Interest rate swap agreements 
$
8,916

 
$
8,916

 
Level 2
 
$
2,537

 
$
2,537

Line of credit and notes payable 
$
1,436,025

 
$
1,488,131

 
Level 2
 
$
1,472,525

 
$
1,529,811


(1) 
For the periods presented, the carrying value approximates estimated fair value due to its short-term maturity.

Piedmont's line of credit and notes payable were carried at book value as of September 30, 2012; however, Piedmont's estimate of their fair value is disclosed in the table above. Piedmont uses widely accepted valuation techniques including discounted cash flow analysis based on the contractual terms of the debt facilities, including the period to maturity of each instrument, and uses observable market-based inputs for similar debt facilities which have transacted recently in the market. Therefore, the fair values determined are considered to be based on significant other observable inputs (Level 2). Scaling adjustments are made to these inputs to make them applicable to the remaining life of Piedmont's outstanding debt. Piedmont has not changed its valuation technique for estimating the fair value of its line of credit and notes payable.

Piedmont’s interest rate swap agreements discussed in Note 6 above are classified as “Interest rate swap” liabilities in the accompanying consolidated balance sheets and were carried at fair value as of September 30, 2012, and December 31, 2011. The valuation of these derivative instruments was determined using widely accepted valuation techniques including discounted cash flow analysis based on the contractual terms of the derivatives, including the period to maturity of each instrument, and uses observable market-based inputs, including interest rate curves and implied volatilities. Therefore, the fair values determined are considered to be based on significant other observable inputs (Level 2). In addition, Piedmont considered both its own and the respective counterparties’ risk of nonperformance in determining the fair value of its derivative financial instruments by estimating the current and potential future exposure under the derivative financial instruments that both Piedmont and the counterparties were at risk for as of the valuation date. The credit risk of Piedmont and its counterparties was factored into the calculation of the estimated fair value of the interest rate swaps; however, as of September 30, 2012 and December 31, 2011, this credit valuation adjustment did not comprise a material portion of the estimated fair value. Therefore, Piedmont believes that any unobservable inputs used to determine the fair values of its derivative financial instruments are not significant to the fair value measurements in their entirety, and does not consider any of its derivative financial instruments to be Level 3 liabilities.

9.Commitments and Contingencies

Commitments Under Existing Agreements

Certain lease agreements include provisions that, at the option of the tenant, may obligate Piedmont to provide funding for capital improvements. Under its existing lease agreements, Piedmont may be required to fund significant tenant improvements, leasing commissions, and building improvements. In addition, certain agreements contain provisions that require Piedmont to issue corporate or property guarantees to provide funding for capital improvements or other financial obligations. Further, Piedmont classifies such tenant and building improvements into two classes: (i) improvements which incrementally enhance the building's asset value by expanding its revenue generating capacity (“incremental capital expenditures”) and (ii) improvements which maintain the building's existing asset value and its revenue generating capacity (“non-incremental capital expenditures”). As of September 30, 2012, Piedmont anticipates funding potential non-incremental capital expenditures for tenant improvements of approximately $122.0 million related to its existing lease portfolio over the respective lease terms, the majority of which Piedmont

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estimates may be required to be funded over the next several years. For most of Piedmont’s leases, the timing of the actual funding of these tenant improvements is largely dependent upon tenant requests for reimbursement. In some cases, these obligations may expire with the leases without further recourse to Piedmont.

Additionally, as of September 30, 2012, commitments for incremental capital expenditures associated with new leases, primarily at value-add properties, totals approximately $63.1 million.

Contingencies Related to Tenant Audits/Disputes

Certain lease agreements include provisions that grant tenants the right to engage independent auditors to audit their annual operating expense reconciliations. Such audits may result in the re-interpretation of language in the lease agreements which could result in the refund of previously recognized tenant reimbursement revenues, resulting in financial loss to Piedmont. Piedmont recorded additional expense related to such tenant audits/disputes of approximately $0.2 million and $0.0 million during the three months ended September 30, 2012 and September 30, 2011, respectively, and approximately $0.2 million for both the nine month periods ended September 30, 2012 and September 30, 2011.

Letters of Credit

As of September 30, 2012, Piedmont was subject to the following letters of credit, which reduce the total outstanding capacity under its $500 Million Unsecured Line of Credit:

Amount
 
Expiration of Letter of Credit (1)
$
382,556

 
July 2013
$
10,000,000

 
July 2013
$
9,033,164

 
July 2013

(1) 
These letter of credit agreements automatically renew for consecutive, one-year periods each anniversary, subject to the satisfaction of the credit obligation and certain other limitations.
Agreements in Principle to Resolve Legal Actions
Piedmont and certain of its current and former officers and directors are currently party to a securities class action lawsuit filed in March 2007 which challenged disclosures made in connection with Piedmont's April 2007 internalization transaction. On September 26, 2012, the Court granted the defendant's motion for summary judgment, and entered judgment in the defendants' favor dismissing all claims.
In addition, Piedmont and certain of its current officers and directors are also party to a second securities class action lawsuit where one of the lead plaintiffs is the same plaintiff in the March 2007 lawsuit. The second suit challenged disclosures made in two separate 2007 Piedmont SEC filings - a response to a May 2007 tender offer for Piedmont's shares, and an October 2007 proxy statement seeking approval of amendments to Piedmont's charter. On August 27, 2012, the Court granted the defendants' motion to dismiss, and entered judgment in the defendants' favor dismissing all claims.

The plaintiffs recently appealed both judgments to the Eleventh Circuit Court of Appeals. On October 11, 2012, Piedmont reached agreement in principle to settle both of the above lawsuits. Under the terms of the proposed settlement of the first suit, the plaintiffs will dismiss the appeal and release all defendants from liability in exchange for total payment of $4.9 million in cash by Piedmont and its insurer. In the second case, the plaintiffs will dismiss the appeal and release all defendants from liability in exchange for total payment of $2.6 million in cash by Piedmont and its insurer. As a result of the agreements to settle, Piedmont recorded a $7.5 million charge (representing the total of both proposed settlements) in its statements of income for the three months ended September 30, 2012. The amounts expected to be recovered from Piedmont's insurers has not yet been determined; therefore, no such amounts have been recorded as of September 30, 2012.

The settlements, which are subject to court approval following the negotiation and execution of definitive agreements, will resolve the appeals and result in the final disposition of both cases.

Please refer to Part II. Item 1 “Legal Proceedings” for a complete description of the chronology of legal actions related to the two lawsuits.


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10.Discontinued Operations

Piedmont has classified the results of operations related to the following properties as discontinued operations (in thousands):

Building(s) Sold
 
Location
 
Date of Sale
 
Gain/(Loss) on Sale
 
Net Sales Proceeds
Eastpointe Corporate Center
 
Issaquah, Washington
 
July 1, 2011
 
$
12,152

 
$
31,704

5000 Corporate Court
 
Holtsville, New York
 
August 31, 2011
 
$
14,367

 
$
36,100

35 West Wacker Drive(1)
 
Chicago, Illinois
 
December 15, 2011
 
$
96,138

 
$
223,981

Portland Portfolio(2)
 
Beaverton, Oregon
 
March 19, 2012
 
$
17,823

 
$
24,832

26200 Enterprise Way
 
Lake Forest, California
 
May 31, 2012
 
$
10,012

 
$
24,411

110 & 112 Hidden Lake Circle Buildings
 
Duncan, South Carolina
 
September 21, 2012
 
$
(252
)
 
$
25,602


(1) 
Piedmont sold its approximate 96.5% ownership in the property. Transaction data above is presented at Piedmont's ownership percentage.
(2) 
The Portland Portfolio consists of four office properties known as the Deschutes building, the Rhein building, the Rogue building, and the Willamette building, as well as 18.19 acres of adjoining, undeveloped land, As part of the transaction, Piedmont accepted an unsecured promissory note from the buyer for the remaining $19.0 million owed on the sale at a rate of 8.73% and a maturity date of October 31, 2012.

Income/(loss) from Discontinued Operations

The details comprising income/(loss) from discontinued operations are presented below (in thousands):

 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2012
 
2011
 
2012
 
2011
Revenues:
 
 
 
 
 
 
 
Rental income
$
434

 
$
9,234

 
$
2,945

 
$
29,941

Tenant reimbursements
73

 
3,790

 
469

 
14,967

Other rental income
—

 
(46
)
 
—

 
303

 
507

 
12,978

 
3,414

 
45,211

Expenses:
 
 
 
 
 
 
 
Property operating costs
100

 
3,758

 
566

 
16,762

Depreciation
163

 
2,000

 
848

 
6,467

Amortization of deferred leasing costs
22

 
1,776

 
148

 
5,406

General and administrative expenses
38

 
(14
)
 
47

 
(157
)
 
323

 
7,520

 
1,609

 
28,478

Other income (expense):
 
 


 
 
 
 
Interest expense
—

 
(1,568
)
 
—

 
(4,653
)
Interest and other income
—

 
16

 
—

 
1

Net income attributable to noncontrolling interest
—

 
(131
)
 
—

 
(366
)
 
—

 
(1,683
)
 
—

 
(5,018
)
Operating income, excluding gain/(loss) on sale
184

 
3,775

 
1,805

 
11,715

Gain/(loss) on sale of real estate assets
(254
)
 
26,756

 
27,583

 
26,756

Income/(loss) from discontinued operations
$
(70
)
 
$
30,531

 
$
29,388

 
$
38,471


11.Stock Based Compensation
Deferred Stock Awards

Piedmont has granted deferred stock awards in the form of restricted stock to its employees. The awards are determined by the Compensation Committee of the board of directors of Piedmont on an annual basis and typically vest over a three-year period beginning on the grant date. In addition, Piedmont has adopted a multi-year performance share program for certain of its employees. Restricted shares are earned based on the relative performance of Piedmont's total stockholder return as compared with a

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predetermined peer group's total stockholder return over a three-year period. Typically, shares are not awarded until the end of the third year in the performance period and vest immediately upon award; however, the inaugural performance share program, which covers the fiscal 2010-2012 performance period, contains three interim performance periods whereby shares may be awarded.

A rollforward of Piedmont's deferred stock award activity for the nine months ended September 30, 2012 is as follows:

 
Unvested Deferred Stock Awards as of January 1, 2012
 
Deferred Stock Awards Granted During Nine Months Ended September 30, 2012
 
Adjustment to Estimated Future Grants of Performance Share Awards During Nine Months Ended September 30, 2012
 
Deferred Stock Awards Vested During Nine Months Ended September 30, 2012
 
Deferred Stock Awards Forfeited During Nine Months Ended September 30, 2012
 
Unvested Deferred Stock Awards as of
September 30, 2012
Shares
511,203

 
209,177

 
(164,740
)
 
(250,269
)
 
(4,546
)
 
300,825

Weighted-Average Grant Date Fair Value (per share)
$
21.67

 
$
17.48

 
$
23.80

 
$
20.95

 
$
18.76

 
$
18.25


A detail of Piedmont’s outstanding employee deferred stock awards as of September 30, 2012 is as follows:

Date of grant
 
Type of Award
 
Net Shares
Granted (1)
 
Grant
Date Fair
Value
 
Vesting Schedule
 
Unvested Shares as of
September 30, 2012
 
May 11, 2010
 
Fiscal Year 2010-2012 Performance Share Program
 
56,875

(2) 
$
28.44

 
Shares vest immediately upon determination of award in 2013.
 
—

(3) 
May 24, 2010
 
Annual Deferred Stock Award
 
161,148

 
$
18.71

 
Of the shares granted, 25% vested on the date of grant, and 25% vested or will vest on May 24, 2011, 2012, and 2013, respectively.
 
53,125

 
May 24, 2010
 
One-Time Special Deferred Stock Award in Recognition of Piedmont's Initial Public Offering
 
40,085

 
$
18.71

 
Of the shares granted, 33.33% vested or will vest on May 24, 2011, 2012, and 2013, respectively.
 
17,457

 
April 5, 2011
 
Annual Deferred Stock Award
 
128,986

 
$
19.40

 
Of the shares granted, 25% vested on the date of grant, and 25% vested or will vest on April 5, 2012, 2013, and 2014, respectively.
 
74,999

 
April 5, 2011
 
Fiscal Year 2011-2013 Performance Share Program
 
—

 
$
18.27

 
Shares vest immediately upon determination of award in 2014.
 
—

(3) 
April 4, 2012
 
Annual Deferred Stock Award
 
191,738

 
$
17.49

 
Of the shares granted, 25% vested on the date of grant, and 25% will vest on April 4, 2013, 2014, and 2015, respectively.
 
155,244

 
April 4, 2012
 
Fiscal Year 2012-2014 Performance Share Program
 
—

 
$
17.42

 
Shares vest immediately upon determination of award in 2015.
 
—

(3) 
Total
 
 
 
 
 
 
 
 
 
300,825

 

(1) 
Amounts reflect the total grant, net of shares surrendered upon vesting to satisfy required minimum tax withholding obligations through September 30, 2012.
(2) 
Represents net shares granted at the end of the first and second interim performance periods ended December 31, 2010 and 2011, respectively.

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(3) 
Estimated based on Piedmont's cumulative total stockholder return for the respective performance period through September 30, 2012. Such estimates are subject to change in future periods based on both Piedmont's and its peers' stock performance and dividends paid.

During the three months ended September 30, 2012 and 2011, respectively, Piedmont recognized approximately $0.9 million and $1.1 million of compensation expense related to stock awards, all of which related to the amortization of nonvested shares. During the nine months ended September 30, 2012 and 2011, Piedmont recognized approximately $3.1 million and $4.8 million of compensation expense related to stock awards, of which $1.8 million and $3.6 million relates to the amortization of nonvested shares, respectively. During the nine months ended September 30, 2012, a total of 178,329 shares were issued to employees, directors, and officers. As of September 30, 2012, approximately $2.5 million of unrecognized compensation cost related to nonvested, share-based compensation remained, which Piedmont will record in its consolidated statements of income over a weighted-average vesting period of approximately one year.

12.Earnings Per Share

There are no adjustments to “Net income attributable to Piedmont” or “Income from continuing operations” for the diluted earnings per share computations.

Net income per share-basic is calculated as net income available to common stockholders divided by the weighted average number of common shares outstanding during the period. Net income per share-diluted is calculated as net income available to common stockholders divided by the diluted weighted average number of common shares outstanding during the period, including nonvested restricted stock. Diluted weighted average number of common shares is calculated to reflect the potential dilution under the treasury stock method that would occur as if the remaining unvested restricted stock awards has vested and resulted in additional common shares outstanding.

The following table reconciles the denominator for the basic and diluted earnings per share computations shown on the consolidated statements of income for the three and nine months ended September 30, 2012 and 2011, respectively:

 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2012
 
2011
 
2012
 
2011
Weighted-average common shares – basic
168,806
 
172,827
 
171,162
 
172,756
Plus incremental weighted-average shares from time-vested conversions:
 
 
 
 
 
 
 
Restricted stock awards
123
 
218
 
133
 
240
Weighted-average common shares – diluted
168,929
 
173,045
 
171,295
 
172,996

13.Other Subsequent Events

Fourth Quarter Dividend Declaration

On October 30, 2012, the board of directors of Piedmont declared dividends for the fourth quarter of 2012 in the amount of $0.20 per common share outstanding to stockholders of record as of the close of business on November 30, 2012. Such dividends are to be paid on December 21, 2012.



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ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with the accompanying consolidated financial statements and notes thereto of Piedmont Office Realty Trust, Inc. (“Piedmont”). See also “Cautionary Note Regarding Forward-Looking Statements” preceding Part I, as well as the notes to our consolidated financial statements and Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year ended December 31, 2011.

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

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

Results of Operations

Overview

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

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

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

 
September 30,
2012
 
%
 
September 30,
2011
 
%
 
$
Increase
(Decrease)
Revenue:
 
 
 
 
 
 
 
 
 
Rental income
$
106.8

 
 
 
$
104.1

 
 
 
$
2.7

Tenant reimbursements
27.5

 
 
 
28.2

 
 
 
(0.7
)
Property management fee revenue
0.5

 
 
 
0.1

 
 
 
0.4

Other rental income
0.1

 
 
 
—

 
 
 
0.1

Total revenues
134.9

 
100
 %
 
132.4

 
100
 %
 
2.5

Expense:
 
 
 
 
 
 
 
 
 
Property operating costs
51.7

 
38
 %
 
50.7

 
38
 %
 
1.0

Depreciation
28.5

 
21
 %
 
25.9

 
20
 %
 
2.6

Amortization
15.3

 
12
 %
 
14.8

 
11
 %
 
0.5

General and administrative expense
5.5

 
4
 %
 
4.7

 
4
 %
 
0.8

Real estate operating income
33.9

 
25
 %
 
36.3

 
27
 %
 
(2.4
)
Other income (expense):
 
 
 
 
 
 
 
 
 
Interest expense
(16.2
)
 
(12
)%
 
(16.2
)
 
(12
)%
 
—

Interest and other income
0.4

 
—
 %
 
(0.1
)
 
—
 %
 
0.5

Equity in income of unconsolidated joint ventures
0.3

 
—
 %
 
0.5

 
—
 %
 
(0.2
)
Litigation settlement expense
(7.5
)
 
(5
)%
 
—

 
—
 %
 
(7.5
)
Income from continuing operations
$
10.9

 
8
 %
 
$
20.5

 
15
 %
 
$
(9.6
)
Income/(loss) from discontinued operations
$
(0.1
)
 
 
 
$
30.5

 
 
 
$
(30.6
)

Continuing Operations

Revenue

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

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

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

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

Expense

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

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

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

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

Other Income (Expense)

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

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

Discontinued Operations

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


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

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

 
September 30,
2012
 
%
 
September 30,
2011
 
%
 
$
Increase
(Decrease)
Revenue:
 
 
 
 
 
 
 
 
 
Rental income
$
317.2

 
 
 
$
306.5

 
 
 
$
10.7

Tenant reimbursements
81.1

 
 
 
85.7

 
 
 
(4.6
)
Property management fee revenue
1.7

 
 
 
1.3

 
 
 
0.4

Other rental income
0.3

 
 
 
4.4

 
 
 
(4.1
)
Total revenues
400.3

 
100
 %
 
397.9

 
100
 %
 
2.4

Expense:
 
 
 
 
 
 
 
 
 
Property operating costs
157.8

 
39
 %
 
152.2

 
38
 %
 
5.6

Depreciation
83.3

 
21
 %
 
76.2

 
19
 %
 
7.1

Amortization
39.5

 
10
 %
 
39.1

 
10
 %
 
0.4

General and administrative expense
15.6

 
4
 %
 
18.9

 
5
 %
 
(3.3
)
Real estate operating income
104.1

 
26
 %
 
111.5

 
28
 %
 
(7.4
)
Other income (expense):
 
 
 
 
 
 
 
 
 
Interest expense
(48.7
)
 
(12
)%
 
(49.6
)
 
(12
)%
 
0.9

Interest and other income
0.8

 
—
 %
 
3.1

 
1
 %
 
(2.3
)
Equity in income of unconsolidated joint ventures
0.7

 
—
 %
 
1.1

 
—
 %
 
(0.4
)
Litigation settlement expense
(7.5
)
 
(2
)%
 
—

 
—
 %
 
(7.5
)
Gain on consolidation of variable interest entity
—

 
—
 %
 
1.5

 
—
 %
 
(1.5
)
Income from continuing operations
$
49.4

 
12
 %
 
$
67.6

 
17
 %
 
$
(18.2
)
Income from discontinued operations
$
29.4

 
 
 
$
38.5

 
 
 
$
(9.1
)

Continuing Operations

Revenue

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

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

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

24
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third-party in December 2011.

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

Expense

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

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

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

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

Other Income (Expense)

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

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

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

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


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Discontinued Operations

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

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

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

We calculate FFO in accordance with the current NAREIT definition as follows: Net income (computed in accordance with GAAP), excluding gains or losses from 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 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) less acquisition costs and other significant, non-recurring items.

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 mezzanine discount income; (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.


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Reconciliations of net income to FFO, Core FFO, and AFFO are presented below (in thousands except per share amounts):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2012
 
Per
Share (1)
 
2011
 
Per
Share(1)
 
2012
 
Per
Share(1)
 
2011
 
Per
Share(1)
Net income attributable to Piedmont
$
10,831

 
$
0.06

 
$
51,026

 
$
0.29

 
$
78,766

 
$
0.46

 
$
106,020

 
$
0.61

Depreciation of real assets (2)
28,763