Business context and reporting period
Corporate Office Properties Trust (COPT), a REIT focused on office and data-center properties serving U.S. government and defense information-technology customers, reported unaudited results for the quarter and six months ended June 30, 2012. At quarter-end it owned 228 operating office properties totaling 19.8 million square feet, with nine office properties in construction or redevelopment.
Financial performance and liquidity
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Total revenue | $133.4 million | $137.1 million | $271.0 million | $268.7 million |
| Operating income | $35.8 million | $13.7 million | $72.3 million | $16.3 million |
| Net income (loss) attributable to common shareholders | $6.6 million | $(28.3) million | $9.2 million | $(50.1) million |
| Diluted EPS | $0.09 | $(0.42) | $0.13 | $(0.75) |
| Real estate NOI | $78.8 million | $76.1 million | $155.7 million | $148.4 million |
- Revenue in Q2 declined 2.7%, mainly as lower construction and service revenue more than offset higher real estate revenue. Six-month revenue increased 0.9%. Real estate NOI rose 3.5% in Q2 and 4.9% year to date; the filing reports NOI margins of approximately 63.6% and 62.5%, respectively, based on segment real estate revenue.
- Common-shareholder results improved substantially from 2011, principally because impairment charges were much lower. COPT reported no impairment expense in continuing operations in Q2 2012 versus $20.2 million in Q2 2011; six-month continuing operations included a $2.3 million net impairment recovery versus $47.9 million in charges. Discontinued operations and other property items also included impairments.
- FFO per diluted share, a non-GAAP REIT measure, was $0.54 for Q2 and $1.08 for six months, versus $0.44 and $0.58. Adjusted FFO per diluted share was $0.54 and $1.08, versus $0.57 and $1.06. Management cautions that FFO is not a measure of cash available for distributions or debt service.
- Six-month operating cash flow was $111.9 million, investing cash flow was positive $24.6 million, and financing cash flow was negative $137.3 million; cash declined $0.9 million to $4.7 million. Operating cash flow included a $29.7 million settlement of interest-rate swaps and $19.0 million of proceeds from KEYW stock sales.
- Debt was $2.192 billion at June 30, down from $2.426 billion at year-end 2011. Cash and cash equivalents were $4.7 million and restricted cash and marketable securities were $22.6 million. The $1.0 billion revolving facility had $786 million available; construction facilities had $59.1 million available. Total equity was $1.353 billion.
- COPT issued 6.9 million Series L preferred shares, raising $165.7 million net before offering expenses. The shares have a 7.375% annual dividend rate and a $25 liquidation preference. Common dividends declared were $0.275 per share for Q2, compared with $0.4125 a year earlier.
Material changes and notable events
- Same-office NOI increased $5.0 million for the first six months, while average same-office occupancy edged down to 89.7% from 90.2%. Portfolio office occupancy at quarter-end rose to 87.4% from 86.2% at December 31, 2011; average contractual rent was $27.13 per square foot versus $26.59.
- During the first half COPT sold 11 operating properties totaling 785,000 square feet and other properties for aggregate proceeds of $134.2 million. Net proceeds were used primarily to repay the revolving facility. The company also entered a $250 million unsecured term loan maturing in 2017 and used proceeds to repay revolver borrowings.
- After quarter-end, COPT acquired a fully leased 202,000-square-foot Herndon, Virginia property for $49 million. On July 24 it sold 23 operating properties totaling 1.4 million square feet and a land parcel for $162 million; net proceeds after property debt and transaction costs were about $140 million, primarily used to reduce revolver borrowings.
- COPT was in default at June 30 on a $15 million nonrecourse mortgage secured by a property in its disposition plan. On July 2, the lender accepted a deed in lieu of foreclosure, relieving the debt and accrued interest; COPT reported an approximately $4 million gain on extinguishment.
- The filing reports a $3.3 million out-of-period reduction in 2012 net income ($0.04 per share) related to errors in 2011 and first-quarter 2012 accounting: a deferred-tax error and an over-accrual of incentive compensation. Management said the errors were not material to 2011 or expected 2012 annual results.
Outlook, risks and contingencies
- No specific earnings or FFO guidance is provided. Management said liquidity and capital resources were adequate for near- and longer-term needs, while also expecting significant property sales in the remainder of 2012 and 2013.
- For the remainder of 2012, COPT expected to spend more than $130 million on construction and development and about $40 million on operating-property improvements. It expected to fund these costs and debt maturities mainly through revolver and construction-facility borrowings. It also planned to redeem all Series G preferred shares for $55 million plus accrued dividends on August 6, 2012, using revolver borrowings.
- Key disclosed risks include government shutdowns, budget reductions or delays affecting strategic customers; property demand, rents and values; interest rates and refinancing; the ability to execute planned property sales; development costs and leasing; joint-venture partner performance; impairment risk; REIT qualification; and environmental requirements. COPT said it was within the required debt covenant limits at June 30.
- Variable-rate exposure remained material: management estimated that a 1% increase in short-term rates would have increased first-half interest expense by $2.7 million, after considering swaps. COPT also disclosed guarantees related to a joint venture, environmental indemnities, and a $4.7 million estimated tax-incremental-financing obligation.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter. No material litigation or material change to previously disclosed risk factors was reported.
Important facts for investors to verify
- Whether improved reported earnings persist when impairment recoveries, property disposals and other unusual items are separated from recurring operations.
- Post-quarter use of the $140 million net property-sale proceeds, the $49 million acquisition financing, and the August 2012 Series G redemption.
- Debt maturities and refinancing needs, variable-rate exposure, revolver availability and ongoing covenant compliance.
- Occupancy, leasing and NOI trends in the government- and defense-oriented portfolio, including the status and leasing of development projects and the data center.
- The effects of planned dispositions and the disclosed accounting adjustment on comparable future-period results.