COPT Defense Properties (Corporate Office Properties Trust): Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018. COPT is a REIT and owns approximately 97% of Corporate Office Properties, L.P. (COPLP), which conducts substantially all operations. Unless noted, financial amounts below are in millions.
Business context
COPT owns, manages, leases, develops and selectively acquires office and data-center properties. Its portfolio is concentrated in locations serving U.S. government and defense/IT tenants, alongside regional office properties. At quarter-end, the portfolio included 159 properties totaling 17.7 million square feet, a 19.25-megawatt wholesale data center, nine properties under construction or redevelopment, and approximately 1,000 acres of controlled development land.
Financial and operating performance
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Total revenue | $146.7 | $151.4 | $302.2 | $291.2 |
| Operating income | $38.3 | $36.6 | $74.2 | $72.1 |
| Net income | $21.1 | $18.9 | $39.9 | $41.6 |
| Net income attributable to COPT common shareholders | $19.4 | $7.6 | $36.6 | $25.5 |
| Diluted EPS | $0.19 | $0.08 | $0.36 | $0.26 |
| Real-estate NOI | $80.9 | $80.9 | $159.4 | $160.3 |
| Adjusted diluted FFO per share | $0.51 | $0.49 | $1.01 | $0.96 |
Q2 revenue declined as construction and other service revenue fell $5.6 million, partly offset by growth in real-estate revenue. Operating income rose $1.7 million, reflecting lower total operating expenses, including no impairment charge or early-debt-extinguishment loss in Q2 2018. Six-month net income was lower mainly because 2017 included a $4.3 million real-estate sale gain; six-month common-shareholder income was higher largely because 2017 included preferred dividends and costs associated with redeeming preferred shares. Q2 same-property NOI was essentially flat; six-month same-property NOI decreased $2.0 million, with management citing higher snow, utility and property-tax costs. Construction-service NOI remained small: $0.6 million in Q2 and $1.6 million for the half-year.
Net cash from operating activities was $80.7 million for the first half, down from $117.5 million. Management attributed the decline primarily to paying construction costs in 2018 on a contract funded by the customer in prior years. Investing activities used $96.8 million, compared with $58.8 million used in 2017, when property-sale proceeds were $54.8 million. Financing activities provided $13.8 million, including $52.3 million of net common-share proceeds and $41.9 million of net debt borrowings, partly offset by $58.1 million of dividends and distributions and $15.4 million of capital-lease payments. Cash and restricted cash totaled $12.6 million at period-end; cash and cash equivalents alone were $8.5 million.
Debt, net, was $1.871 billion, up from $1.828 billion at year-end 2017; estimated fair value was $1.899 billion. The company reported approximately $1.351 billion of fixed-rate debt and $533 million of variable-rate debt. Revolver borrowings were $170 million, with $630 million of the $800 million facility available. The facility matures in May 2019, with two six-month extension options subject to conditions. COPT reported compliance with debt covenants. A 1% increase in applicable LIBOR would have raised first-half interest expense by an estimated $0.9 million, after swaps.
Total assets were $3.612 billion and total equity was $1.508 billion at June 30, 2018. The common dividend remained $0.275 per share per quarter, or $0.55 declared for the first half. COPT issued 1.8 million shares under forward equity sale agreements for $52.3 million net proceeds; 5.7 million shares of forward-sale capacity remained.
Material changes, outlook and risks
- Portfolio occupancy was 91.4% at June 30, down from 93.6% at December 31, 2017. Management attributed much of the decline to 404,000 square feet of newly completed space that was unoccupied at period-end; 161,000 square feet in Northern Virginia, leased in June, was expected to be occupied by year-end. Space completed or redeveloped during the half was 75.9% leased at quarter-end.
- Management expected to spend approximately $200 million on construction and development and $35 million on improvements to operating properties during the remainder of 2018. Development and redevelopment commitments were $89.4 million; operating-property capital expenditure commitments were $41.5 million.
- Management stated that liquidity and capital resources were adequate for near- and longer-term requirements without requiring property sales. Funding sources include operating cash flow, revolver borrowings, debt and equity issuance, and potential property dispositions.
- Key disclosed risks include government shutdowns or budget reductions affecting tenant demand and rent, changes in real-estate markets and interest rates, development delays or cost overruns, refinancing and capital-market access, joint-venture risks, and potential dilution from equity issuance. The filing reported no material change to the risk factors in the 2017 Form 10-K and no material off-balance-sheet arrangements.
- A property sold subject to a financial guaranty remains accounted for as held for sale/financing: COPT indemnified the buyer for up to $20 million for a defined capital event through June 30, 2019. Management said it did not expect losses under the guaranty.
- Other commitments and contingencies include $90.2 million of future minimum operating-lease payments, mainly ground leases extending as far as 2100, and environmental indemnities capped at $19 million in aggregate for specified properties. Management did not expect funding under a local tax-increment financing shortfall obligation.
- The company adopted revenue-recognition guidance in 2018 with no financial-statement impact beyond disclosures, and early adopted hedge-accounting guidance. It anticipated adopting the new lease standard in 2019; the assessment was ongoing. Ground-lease payments were $89.4 million in undiscounted future minimum amounts as of June 30, 2018.
Important facts for investors to verify
- Whether newly delivered and leased space becomes occupied as expected, and how occupancy and leasing trends evolve in Defense/IT markets.
- Whether development spending, delivery schedules, leasing and tenant demand support the planned 2018 investment program and future returns.
- The effect of the May 2019 revolver maturity, refinancing conditions, variable interest rates and available borrowing capacity on liquidity and interest expense.
- Whether operating cash flow recovers from the first-half decline and supports dividends, debt service and capital spending.
- The status and potential exposure of the $20 million property-sale guaranty, joint-venture put rights, environmental indemnities and other contractual commitments.
- How lease-accounting adoption and future credit-loss guidance affect reported assets, liabilities, revenue and expenses; the filing does not provide a final quantified impact.