COPT Defense Properties (Corporate Office Properties Trust) — Q2 2011 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2011; financial statements are unaudited. The REIT focuses on office and data-center properties serving U.S. government, defense IT and related tenants. At quarter-end, it reported 249 wholly owned operating office properties totaling 20.2 million square feet, plus development projects and a partially operational wholesale data center.
Key financial results
Amounts below are in millions of dollars, except per-share data and where noted.
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Total revenue | $146.6 | $132.8 | $287.8 | $279.8 |
| Operating income (loss) | ($1.6) | $33.0 | $2.8 | $63.8 |
| Net income (loss) | ($26.0) | $9.2 | ($44.6) | $19.8 |
| Net income (loss) attributable to common shareholders | ($28.3) | $4.4 | ($50.1) | $10.4 |
| Basic and diluted EPS | ($0.42) | $0.07 | ($0.75) | $0.17 |
| Operating cash flow | Not presented quarterly | Not presented quarterly | $92.5 | $78.6 |
- Property operations: Q2 continuing real estate NOI was $73.8 million, up from $67.5 million. Six-month continuing real estate NOI was $144.3 million, versus $130.2 million. Same-office NOI declined $1.3 million in Q2 and $3.0 million for the six months; growth from acquired and newly operational properties more than offset this decline.
- FFO: Diluted FFO per share was $0.02 for Q2 and $0.15 for the six months, versus $0.53 and $1.06, respectively, in 2010. Management’s adjusted-for-comparability diluted FFO per share was $0.57 for Q2 and $1.09 for the six months, versus $0.54 and $1.06. These are non-GAAP measures, not substitutes for earnings or cash flow.
- Margins and occupancy: Q2 real estate NOI was approximately 62% of reported real estate operations revenue ($73.8 million on $118.5 million). Wholly owned office portfolio occupancy was 87.3% at June 30, down from 88.2% at December 31, 2010; average contractual annual rent was $25.91 per square foot, including estimated expense reimbursements.
- Balance sheet and liquidity: Total assets were $3.87 billion and total liabilities $2.51 billion. Debt, net, was $2.30 billion, down from $2.32 billion at year-end. Cash and cash equivalents were $11.7 million; restricted cash and marketable securities were $22.9 million. The $800 million revolving credit facility had $452.1 million available, and the $225 million revolving construction facility had $50 million available. COPT reported compliance with its debt covenants.
- Cash deployment and capital: Six-month investing cash outflow was $137.3 million, primarily reflecting $99.2 million of construction, development and redevelopment spending, plus other property investment. Financing cash inflow was $46.4 million. A May public offering of 4.6 million shares at $33 per share generated $145.7 million net of underwriting discounts, before offering expenses; proceeds were used to repay revolving debt and for general corporate purposes. The Q2 common dividend was $0.4125 per share.
Material changes and unusual items
- Results were heavily affected by non-cash property impairments. The filing reports $66.0 million of impairment expense in continuing operations for the first six months and $72.3 million total impairment losses including discontinued operations. This includes a $27.7 million Fort Ritchie impairment recorded in March and Q2 impairments associated primarily with properties identified for disposal.
- In April, the board approved a Strategic Reallocation Plan to dispose of non-strategic properties over three years. Management estimated net proceeds, after repayment of secured debt, of approximately $200 million and expects to reinvest proceeds in properties serving government, defense IT and related data sectors. Three properties were sold in May for $3.8 million, with a $0.15 million gain; 17 operating properties and a recently redeveloped property were classified as held for sale at quarter-end.
- Revenue growth reflected real estate operations, including acquisitions and construction completions, while six-month construction and other service revenue fell to $49.1 million from $63.4 million. Service margins remained small.
- Interest expense rose to $53.2 million for the first half from $48.1 million, despite a lower reported weighted-average debt rate, as average debt increased to fund acquisition and construction activity. The company issued $145.7 million of equity proceeds and reduced reported total debt modestly.
- KEYW share sales generated a $2.1 million gain in the first half. COPT’s CEO left KEYW’s board effective July 1; thereafter COPT began accounting for its KEYW common shares as a trading security at fair value, with unrealized changes through earnings.
Outlook, risks and contingencies
- Leasing outlook: Management expected the challenging leasing environment to persist at least through 2011, but believed office leasing fundamentals were at or near bottom by March. Leasing was delayed by the late federal budget approval and continuing-resolution restrictions; management expected to complete some delayed leasing in the second half of 2011. Further federal budget or debt-ceiling delays could defer leasing into 2012.
- Development and funding: COPT expected to replace its revolving credit facility in 2011 and anticipated refinancing 2011–2012 debt maturities and funding construction through credit facilities and secured debt, unsecured debt and/or equity markets. The existing $800 million revolver was due in September 2011, with a conditional one-year extension option. Contractual obligations included $504.5 million of balloon maturities in the remainder of 2011 and $449.3 million in 2012; the filing says the company expects to refinance these maturities. Development plans included 10 office construction projects, eight development projects, two redevelopments and completion of the data center.
- Government and real estate risks: Risks include reduced government spending or shutdown effects on rents and renewals, weaker leasing or tenant credit, financing availability and interest rates, development delays or cost overruns, partner funding shortfalls, and potential further impairments. COPT stated it did not believe defense IT would be significantly affected by potential defense-spending reductions, but that view is management’s assessment, not assurance.
- Fort Ritchie: Army disclosures about past tactical defoliant/herbicide testing and use increased uncertainty over litigation, development rights and future demand. COPT recorded a $27.7 million impairment; related litigation and development uncertainty remain relevant.
- Interest-rate exposure: Variable-rate debt was $843.7 million. Management estimated that a 1% increase in short-term rates would have increased first-half interest expense by $1.6 million, after swaps. Interest-rate derivative liabilities were $10.0 million; approximately $8.1 million was expected to be reclassified from accumulated other comprehensive loss as additional interest expense over the next 12 months.
- Contingencies: Guarantees relating to an unconsolidated joint venture could require payments of up to approximately $65 million, subject to indemnification provisions. A tax-incremental-financing obligation had a recorded liability of $4.2 million. Separate environmental indemnities include stated caps of $5.0 million, $12.5 million and $1.5 million, with the latter also limited to $300,000 annually. Management said routine litigation was not expected to materially affect financial position, operations or liquidity.
- No specific earnings or FFO guidance was provided. Management said liquidity and capital resources were adequate for near- and longer-term requirements. The filing reported effective disclosure controls and no material change in internal control over financial reporting; it also reported no material change in the risk factors from the 2010 Form 10-K.
Important facts for investors to verify
- Progress, timing and net cash proceeds from the Strategic Reallocation Plan, including the assumptions behind the approximately $200 million estimate.
- Whether planned federal leasing activity resumes, and the effects of federal budget, debt-ceiling and government-spending developments on occupancy and renewals.
- Refinancing or replacement of the revolver and the company’s ability to meet near-term maturities and fund committed development spending on expected terms.
- Further impairment or legal developments at Fort Ritchie and the outcome of environmental and joint-venture contingencies.
- Underlying same-office NOI, occupancy and rent trends, alongside reported GAAP losses and the assumptions used in adjusted FFO.
- Interest-rate exposure, derivative values and potential cash settlement obligations, as well as the earnings impact of KEYW fair-value accounting.