COPT Defense Properties (Corporate Office Properties Trust) — Q3 2019 Form 10-Q
Business context and reporting period. This combined filing covers Corporate Office Properties Trust (COPT) and its operating partnership, Corporate Office Properties, L.P. (COPLP), for the quarter and nine months ended September 30, 2019. COPT is a REIT and owned 98.7% of COPLP’s common units. The company owns, manages, leases and develops office and data-center properties, with a portfolio concentrated in U.S. government, defense and IT markets. At quarter-end it reported 169 properties totaling 19.0 million square feet, plus a 19.25-megawatt wholesale data center.
Financial and operating performance
- Revenue: Q3 total revenue was $159.4 million, up 16.0% from $137.4 million; nine-month revenue was $483.4 million, up 10.0% from $439.6 million. Nine-month lease revenue was $391.8 million. Construction and other service revenue rose to $87.9 million for the nine months from $53.2 million, but related expenses were $85.1 million, leaving $2.8 million of service NOI.
- Profit and per-share results: Q3 net income was $23.2 million versus $20.3 million; COPT-attributable net income was $21.3 million, or $0.19 per diluted share, versus $18.7 million and $0.18. Nine-month net income was $155.1 million versus $60.2 million, and diluted EPS was $1.33 versus $0.54. The 2019 nine-month result included an $84.5 million gain on a property-interest sale; this materially affects the year-over-year comparison.
- Property NOI and occupancy: Nine-month real estate NOI was $252.5 million, up 5.1%; same-property NOI increased to $218.5 million from $213.6 million. Same-property average occupancy was 92.0%, up 0.6 percentage points. Overall office and data-center-shell occupancy was 92.7% at September 30, compared with 93.0% at year-end 2018.
- Cash flow and investment: Nine-month operating cash flow was $157.0 million, up from $121.7 million. Investing cash outflow was $108.9 million, versus $152.7 million, reflecting disposition proceeds that partly offset increased development spending. Construction, development and redevelopment cash outlays were $309.0 million, compared with $105.9 million. Cash and cash equivalents were $34.0 million; including restricted cash, period-end cash was $37.5 million.
- Debt and liquidity: Debt, net, was $1.862 billion, up from $1.824 billion at December 31, 2018. The $800 million revolving facility had $580 million available; it matures in March 2023, with two optional six-month extensions. Management reported compliance with debt covenants and investment-grade ratings for COPLP. COPT guarantees certain COPLP debt but has no direct debt of its own.
- Distributions: COPT declared $0.275 per common share in Q3 and $0.825 per share for the nine months, unchanged from the comparable 2018 periods.
Material changes and unusual items
- In June 2019, the company sold a 90% interest in seven Virginia data-center-shell properties for $238.5 million, based on an aggregate property value of $265.0 million, and retained 10% through a new joint venture. The transaction generated an $84.5 million gain.
- COPT issued 1.6 million shares under forward equity agreements for net proceeds of $46.5 million, primarily used to repay revolving-credit borrowings. It reported $300 million of remaining capacity under its at-the-market equity program.
- The company placed 804,000 square feet of newly constructed or redeveloped space into service during the nine months; this space was 100% leased at quarter-end. It had 15 properties under construction or redevelopment, estimated to total approximately 2.6 million square feet upon completion.
- Adoption of new lease accounting guidance in 2019 added right-of-use assets and lease liabilities and changed revenue presentation. Comparative periods were recast for the revenue presentation change, but not otherwise adjusted for adoption.
- A $327,000 impairment was recorded on land in Frederick, Maryland. Interest-rate derivative liabilities increased to $34.8 million from $5.5 million at year-end, contributing to a $34.9 million nine-month other comprehensive loss.
- The terms of $8.8 million of Series I preferred units were amended: the annual cumulative return fell from 7.5% to 3.5% effective September 23, 2019, and redemption terms changed.
Outlook, risks and contingencies
- No specific earnings or FFO guidance is provided in the supplied filing text. Management expected approximately $80 million of construction and development spending and $25 million of operating-property improvements and leasing costs during the remainder of 2019.
- Management expected the contracted sale of controlling interests in two Virginia data-center-shell properties for approximately $67 million to close in Q4 2019. It stated that liquidity was adequate without requiring property sales.
- The wholesale data center was 82.1% leased at September 30, down from 87.6% at year-end 2018. Based on known terminations and non-renewals, management expected occupancy to decline to about 77% by December 2019 and 70% by July 2020.
- Key risks include government budget reductions, shutdowns or delayed space demand; interest-rate and refinancing exposure; development costs, timing and leasing; tenant demand and credit; joint-venture risks; dilution from equity issuance; cyber incidents; and environmental requirements. A 1% increase in LIBOR would have increased nine-month interest expense by an estimated $1.4 million, considering variable-rate debt and swaps.
- Contractual obligations included $217.1 million of development and redevelopment commitments and $60.8 million of tenant and other capital improvements. The filing reported no material off-balance-sheet arrangements, no material litigation, and no material changes to previously disclosed risk factors. It noted possible losses from ordinary-course claims but did not expect them to materially affect results or liquidity.
Important facts for investors to verify
- Separate recurring operating performance from the $84.5 million disposition gain when assessing nine-month earnings growth.
- Track the planned Q4 sale of two data-center-shell properties and the proceeds’ effect on revolving-credit borrowings.
- Monitor wholesale data-center lease expirations, Northern Virginia occupancy, and overall portfolio occupancy.
- Review development spending, completion and lease-up progress, and the company’s remaining contractual commitments.
- Assess debt maturities, variable-rate exposure, derivative liabilities and potential dilution from the equity program.
- Consider the impact of government budget decisions and the company’s substantial exposure to government and defense/IT tenants.