COPT Defense Properties (Corporate Office Properties Trust) — Q2 2010 Form 10-Q
Business context and reporting period. The company is a REIT focused on office properties serving U.S. government, defense IT and data tenants. This unaudited report covers the quarter and six months ended June 30, 2010; dollar amounts below are in millions unless noted. At quarter-end, COPT had 247 wholly owned operating properties totaling 19.5 million square feet and 22 properties under construction, development or redevelopment.
Financial performance and position
| Metric | Q2 2010 | Q2 2009 | Six months 2010 | Six months 2009 |
|---|---|---|---|---|
| Total revenue | $135.3 | $208.3 | $284.9 | $389.3 |
| Operating income | $34.0 | $35.3 | $65.4 | $71.5 |
| Income from continuing operations | $8.3 | $17.7 | $18.2 | $35.4 |
| Net income attributable to COPT common shareholders | $4.4 | $12.6 | $10.4 | $24.7 |
| Basic EPS | $0.07 | $0.22 | $0.17 | $0.45 |
| Diluted FFO per share | $0.53 | $0.67 | $1.06 | $1.34 |
| NOI from continuing real estate operations | $69.3 | $67.9 | $133.3 | $135.1 |
- Revenue and earnings: Q2 revenue fell 35%, primarily because construction and other service revenue declined to $26.1 million from $103.3 million. Rental revenue increased to $91.2 million from $87.6 million. Six-month common-shareholder net income fell 58.1%.
- Operating trends and margins: Six-month same-office NOI declined $6.4 million, or 4.9%; same-office average occupancy was 89.6% versus 92.3%. Portfolio occupancy was 88.3% at June 30, down from 90.8% at year-end. New construction and acquisitions added NOI, partly offsetting same-office weakness and vacancies at properties slated for redevelopment.
- Cash flow: For the first six months, operating cash flow was $78.6 million, down from $128.4 million; investing cash outflow was $155.7 million; financing cash inflow was $78.7 million. Cash and cash equivalents ended at $9.9 million. Cash dividends paid were $54.1 million.
- Debt and liquidity: Debt, net, was $2.182 billion, up from $2.054 billion at December 31, 2009. Cash was $9.9 million and restricted cash and marketable securities were $20.7 million. The $700 million revolving credit facility had $449.5 million available; the $225 million construction facility had $122.1 million available. The company reported covenant compliance.
- Investment: Properties, net, totaled $3.131 billion. Additions to properties were $145.7 million during the six months. COPT acquired a 152,000-square-foot McLean, Virginia property for $40 million and issued $240 million of 4.25% exchangeable senior notes due 2030.
Material changes, outlook and risks
- Interest expense increased to $25.8 million in Q2 from $18.6 million, and to $48.5 million for six months from $38.0 million. Management attributed the increase to higher average debt and higher weighted-average borrowing rates.
- Service-operation NOI fell to $0.7 million in Q2 from $2.2 million, and to $1.6 million for six months from $3.7 million, mainly due to lower activity on one large construction contract.
- Management said liquidity and capital resources were adequate for near- and longer-term needs, and expected available credit capacity to cover 2010 maturities and planned construction. It also noted that selective property sales could provide capital. No numerical earnings or FFO guidance is stated in the supplied filing text.
- Development pipeline at quarter-end included 10 construction projects with $88.9 million of estimated remaining costs, 12 development projects with $336.6 million remaining, and two redevelopments with $11.7 million remaining. Completion and leasing outcomes remain uncertain; the Redstone Gateway joint venture is expected to develop over approximately 20 years, and its partner has no future funding obligation.
- Key stated risks include weak leasing and property markets, tenant credit and occupancy, refinancing and interest-rate exposure, development cost or leasing shortfalls, joint-venture partner funding, REIT qualification, government actions and environmental requirements. Management expected the challenging leasing environment to persist through 2010 and possibly beyond.
- Contingencies include guarantees on an unconsolidated venture’s debt with a maximum potential payment of approximately $67 million, subject to indemnity recovery, and environmental indemnities for New Jersey properties with stated caps, including $12.5 million for certain consequential damages. Management did not expect routine litigation or identified environmental matters to materially harm financial position, operations or liquidity. No material risk-factor changes were reported.
- Interest-rate swaps had a $4.3 million liability fair value; management estimated a 1% increase in short-term rates would have increased first-half interest expense by $1.1 million. Disclosure controls were considered effective, with no material quarterly change in internal control over financial reporting.
Important facts for investors to verify
- Whether occupancy stabilizes or improves, particularly in Colorado Springs and Suburban Maryland, and whether vacancies at redevelopment properties are re-leased.
- How same-office NOI, rental rates, lease expirations and tenant credit quality develop amid the stated difficult leasing conditions.
- Funding, completion, leasing and expected returns for the substantial development pipeline, including Redstone Gateway and its potential funding requirements.
- Debt maturities, refinancing access, covenant headroom and the effect of interest rates; verify the terms and potential dilution or cash-repurchase implications of exchangeable notes.
- Whether operating cash flow can support capital spending, dividends and debt service, given the year-over-year decline in first-half operating cash flow.
- Potential exposure under joint-venture guarantees and environmental indemnities, and any changes in related contingencies.